Wednesday, September 25th, 2013
Summary: The uplift in Australia’s housing market is good news for Brickworks, which recently reported a 27% rise in net profit after tax. Brickworks’ cross shareholding in Washington H Soul Pattinson (47.7%) accounts for a high percentage of its $2 billion market capitalisation. This means the overall value of Brickworks’ building materials assets and land investments show the company remains heavily discounted in its current share price, and true value is not being delivered to shareholders.
Key take-out: Brickworks remains an excellent long-term investment for value investors despite its recent share price rally.
In June 2012 I posted an article in Eureka Report that was titled Safe as houses. At that point the price of Brickworks Limited (ASX:BKW) was $10.25 and today, some 15 months later, it stands at about $13.50.
Since that time the share price rise of over 30% (plus dividends of 40.5 cents franked) has outperformed the strongly recovering residential property market. The recommendation and purchase into my portfolio confirms again that investors need to consider the acquisition of quality companies against the sentiment of the market. In June 2012 building materials were not popular, but there was always going to be a cyclical recovery at some point.
The current recovery can be gleaned from the following graphs provided by the Reserve Bank of Australia (RBA) and BKW in a recent presentation pack. It can be observed that the median price of houses across Australia has passed the previous all-time highs set in 2009-10.
This is noteworthy because that period followed the first home buyers grant and support packages provided by the federal government following the global financial crisis. These support mechanisms were designed to help stop Australia from falling into recession. The government overplayed its hand and the stimulation merely drove property prices higher. They corrected in 2011-12, but in the last six months the prices in Sydney and Perth have lifted towards record highs.
Figure 1. Dwelling prices
Source: RBA, RP Data-Rismark
Both New South Wales and Western Australia have seen a surge in building commencements, and these are states where Brickworks has strong market shares.
Figure 2. Australian housing starts by State, FY13 vs. FY12
At the current rate of growth and recovery it is likely that the total value of housing loan approvals will reach a new high in 2013-14, with first-time home buyers representing their normal 10% of this market. The surge to 25% of the new home loan market in 2009-10 shows just how excessive the first home buyers grant scheme was at that point.
Figure 3. Housing loan approvals
Source: ABS, RBA
Loan approvals is one measure of activity, but more important for BKW is the level of building starts. From the chart below (Figure 4) it is likely that commencements in 2013-14 will average 14,000 per month, or close to 165,000 dwellings, which is well above the depths seen in 2009 and 2012. Importantly, that level of starts is still below historic highs and belies the fact that Australia’s population has grown by 1.5% compound over the last 25 years. Clearly Australia is still under-building residences, and this observation alone suggests the outlook for BKW remains very good.
Figure 4. Long-term trends and cycles in Australian housing starts
The Brickworks result
The key metrics of the BKW 2012-13 result were that net profit after tax (before significant items) rose by 27% to $100 million, while the final dividend, disappointingly, was held steady at 27 cents per share fully franked.
Apart from the increasing asset backing and the latent value in the cross shareholding with Soul Pattinson Limited (see below), it would seem that the last six months has seen a solid recovery in BKW’s building operations. Further, the outlook is for this recovery to continue into 2014. The strong tail wind remains the historically low mortgage rates on offer from the banks in response to the historically low cash rate settings of the RBA.
When I scan the result I note the 25% increase in earnings before interest and tax and its composition, presented in Figures 5 and 6 below. In particular, the result showed that BKW has secured pricing power in building products to offset the short-term or cyclical detractions from either lower volumes or higher costs.
Figure 5. BKW FY13 result and EBIT composition
The other feature was the impressive lift in profits generated from the property assets developed in the joint venture trusts. I noted last year that BKW retains significant land holdings at various stages of development.
Not so supportive, though still significant this year, was the investment earnings generated from the cross shareholding in Soul Pattinson (47.7%) and its major investment in New Hope Coal Limited. Certainly coal is at a cyclical low and the earnings and dividends flowing from this related investment are under pressure. It was this pressure that resulted in dividends being held steady by BKW.
Figure 6. Composition of BKW’s FY13 EBIT variation
Concluding comments and valuation
At $13.50 the market capitalisation of BKW has now lifted to above $2 billion, and while this suggests a trailing price-earnings ratio of 20 times it does overlook the significant stated and inferred asset backing of the company. Indeed, it is this feature that captured my attention last year when various proposals were put to the boards of SOL and BKW to unlock the value inherent in the group.
Even at today’s prices, the investment of BKW in SOL effectively accounts for most of the share price or market capitalisation of BKW. SOL is capitalised at $3,320 million, and BKW’s investment is worth $1,418 million.
In other words, the “see through” value of the building materials and the land investments remains heavily discounted in the current share price. The residual $580 million of value generated $82 million of cash profit.
Unfortunately, at present, the true value of the group, generated by the quality of the respective assets and enhanced by the cross shareholdings, is not being delivered to shareholders. Both of the boards of directors of SOL and BKW are restrained from enhancing value for shareholders because of the Corporations Code and its administration by ASIC. Both companies are restrained from increasing their shareholdings in each other by an ill-conceived law that aims to protect minorities, but which actually has the opposite effect.
I remain of the view that patience will be rewarded and that BKW remains an excellent long-term investment for value investors despite its recent share price rally. The company remains leveraged to the building cycle, which is currently supported by historically low interest rate settings. Further, should coal recover then dividends will rise strongly through the BKW-SOL Group.
Figure 7. BKW valuation
As BKW emerges from the cyclical downturn in the building sector, and with the promise of recovery in coal over the next two years, I have adopted the historical average of 13.5% as my projection for sustainable normalised return on equity (NROE).
The valuation of BKW is determined by a range of required returns (RR). The RR is an assessment of specific stock risk as stated as a margin against equity market risk. Today I believe the equity market risk is about 10%, and clearly BKW deserves a premium above this of 2% to 3%.
Therefore my range of values as July 31, 2014 based on forecast earnings is:
- At 12% RR valuation: $14.50
- At 13% RR valuation: $12.74
Based on this, I remain a happy holder of BKW with a proposed accumulation price of $12.50.
Clime Growth Portfolio Statistics
Return since June 30, 2013: 10.60%
Returns since Inception (April 19, 2012): 30.08%
Average Yield: 6.18%
Start Value: $141,128.64
Current Value: $156,092.33
Dividends accrued since June 30, 2013: $1,885.59