Forterra Building Materials
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3 March 2017 FORTERRA BUILDING MATERIALS A tonne of bricks FORT 195p Government aid to boost housebuilding could require at least half a Market Cap: £390.8m billion more bricks by 2021, we estimate. This reinforces what we see as Forterra’s attractions to investors: a fundamental product, underpinned by long-term demand; a consolidated market; and conservative management. Forterra has, in our view, a particularly attractive risk-reward balance and an undemanding valuation relative to its peer group. SHARE PRICE (p) . A UK leader. Forterra is the UK’s second biggest brick maker and is a 230 major producer of concrete and specialist products for housing in 210 particular. It has a niche in high margin ‘Fletton’ bricks. The former 190 Hanson Building Products returned to the stock market in April 2016. 170 Government boost. The Housing White Paper included £8.7bn of 150 . new housebuilding investment. We estimate this could boost brick use 130 by c. 8% from mid-2018 - 2012. Brick makers, rather than national 110 housebuilders, could be the best way to ‘play the volume card’, in our 90 view. 70 50 . Defensive. We believe the sector in general and Forterra in particular Apr-16 Jun-16 Aug-16 Oct-16 Dec-16 Feb-17 are more defensive than in past cycles: the outlook for demand should 12m high/low 203.8p/109.7p be underpinned by government initiatives; brick stocks are at half the Source: LSE Data level of past cycles, supporting pricing power; and the industry is dominated by three producers, with a dwindling threat from imports. Focused on cashflow. We believe management has demonstrated operational and financial conservatism and is highly focused on cashflow. Debt has been falling faster than expected since the IPO, KEY INFORMATION demonstrated at the HY and in trading statements. Enterprise value £484.8m (FY16E basis) . De-stocking. Although low compared to past cycles, industry stock Index/market LSE levels had risen, worrying some investors. However, the situation appears to be rapidly improving as producers have trimmed output. Next news FY16 results, 15 Mar 17 Gearing 212% (FY16E) . Moving to a growth stance? We believe that investors have viewed Forterra as more of ‘value’ than a ‘growth’ stock, with management Net debt/EBITDA 1.3x focused on paying down debt, but we believe there is scope for a step change in brick output and expanding in, for instance, infrastructure. Valuation. Despite rising 76% off its post-Brexit low, FORT trades at a FORTERRA IS A RESEARCH CLIENT OF PROGRESSIVE 2017 P/E of 8.4x and 4.8% yield versus, respectively, 11.1x and 4.0% for Ibstock and 11.7x and 2.6% for Michelmersh, its UK quoted rivals. ANALYSTS YE DEC (£M) 2015 PF 2016E 2017E 2018E Alastair Stewart Sales 290.2 299.8 313.3 329.9 +44 (0)20 7781 5308 EBITDA 67.5 70.8 73.3 79.4 [email protected] Adj. EPS (p) 20.6 22.0 23.2 25.6 DPS (p) 0.0 6.0 9.4 10.5 P/E (x) 9.4 8.8 8.4 7.6 EV/EBITDA1 (x) 8.1 6.8 6.3 5.4 Yield (%) 0.0 3.1 4.8 5.4 Source: Company, Progressive Equity Research est. 1Forecast net debt; PF: pro-forma www.progressive-research.com This marketing communication has not been prepared in accordance with requirements designed to promote the independence of investment research. Please refer to important disclosures at the end of the document. 3 March 2017 CONTENTS A TONNE OF BRICKS ............................................................ 1 OVERVIEW: GOVERNMENT AID UNDERPINS UPBEAT STORY ...... 4 Brief history ....................................................................................... 5 Fundamental product, demand under-pinned, simple structure ........ 5 Niche product offers highest margins ................................................ 6 Financials: steady growth before government fillip ........................... 6 Valuation comparisons ...................................................................... 7 False alarms? Brexit, over-stocking and concrete bricks ................ 11 Forterra side-steps spate of profit warnings .................................... 12 Potentially price-sensitive future newsflow ...................................... 13 FORTERRA’S PRODUCTS AND MARKETS ............................... 14 Product overview: much more than a brick maker .......................... 15 Bricks .............................................................................................. 15 Concrete blocks .............................................................................. 19 Bespoke products ........................................................................... 19 Main brick rivals .............................................................................. 20 A consolidated sector ...................................................................... 21 A disciplined sector ......................................................................... 22 Main producers compared and contrasted ...................................... 23 CONSTRUCTION OUTLOOK .................................................. 26 New housing: steadily growing, with more to come? ...................... 26 Repair, maintenance and improvement: steady earner .................. 28 Other sectors: industrial and infrastructure lead the way ................ 29 MARKET THEME 1: SHORT-TERM, STOCK LEVELS FALLING ..... 31 Production curbed and imports fall .................................................. 32 MARKET THEME 2: GOVERNMENT ‘DE-BOTTLENECKS’ HOUSING .......................................................................... 34 Main proposals ................................................................................ 34 How many more homes (and bricks)? ............................................ 36 Housing Infrastructure Fund ............................................................ 38 Affordable Homes Programme ........................................................ 38 Accelerated Construction programme ............................................. 38 Home Building Fund ....................................................................... 39 Potential cumulative impact and timing: a tonne of bricks ............... 40 London plan yet to be detailed – but likely to be huge .................... 42 Brick makers could benefit ahead of any step change .................... 42 2 3 March 2017 PRODUCT THEMES ............................................................. 43 Concrete vs clay bricks: like chalk and cheese? ............................. 43 Off-site to challenge bricks? ............................................................ 44 PFA: green electricity a (brief) setback for energy-saving blocks .... 44 MANAGEMENT STYLE ......................................................... 46 Profit- rather than growth-focused ................................................... 46 Conservative and cash-focused ...................................................... 46 Going for growth ............................................................................. 46 FINANCIAL PROJECTIONS ................................................... 48 Revenue .......................................................................................... 48 Costs ............................................................................................... 49 Cashflow and balance sheet ........................................................... 51 VALUATION ....................................................................... 53 Valuation comparisons .................................................................... 53 RISKS: POTENTIAL THREATS AND OUR RESPONSES ............... 55 APPENDIX 1: MAKING BRICKS............................................. 57 APPENDIX 2: MANAGEMENT BIOGRAPHIES ........................... 59 Management team .......................................................................... 59 Non-executive directors .................................................................. 59 APPENDIX 3: USEFUL WEB LINKS ........................................ 61 3 3 March 2017 Overview: Government aid underpins upbeat story Theresa May’s government could succeed where her predecessors’ had limited success: in significantly boosting housebuilding volumes. The Housing White Paper has identified around £8.7bn of investment. We estimate conservatively that this could translate into over 110,000 ‘extra’ homes. That’s a lot of bricks. Half a billion, we estimate, from 2018 - 2021, an average 8% on top of the current run rate. This is on top of what had been a healthy outlook and is not included in our current earnings assumptions. The strong long term outlook adds to what we believe is a positive investment story: a fundamental product, in a growth market, in a consolidated sector, with a cash-focused management. It’s tempting to ask: “what isn’t there to like?”. Short-term: full year outlook The potential step-change in new housing production – the principal driver of brick maintained, in spite of initial demand – underpins what we already believed to be the group’s compelling attractions Brexit fears and stock levels to risk-averse value investors: solid demand for a building product that is unlikely ever falling back to normal to go out of fashion in the UK; a consolidated sector; proven management and strong cash generation. The 16 November trading statement reinforced our short-to-medium term views: brick demand has remained high, in spite of Brexit; industry stock levels are quickly returning to normal; and cash flow has been better than expected. Moreover, management demonstrated its conservative initial