Christopher Niesche: Boral looks overseas for growth potential

Boral chief executive Mike Kane.

Australian building materials company Boral isn't relying on a "Trump bump" to make its huge US acquisition a success, but if it happens it will be a bonus.

Boral is spending A$3.5 billion ($3.7b) to acquire Utah-based construction materials group Headwaters, in a deal which could transform its US operations and the company as a whole.

The acquisition comes as the US is in the midst of highway upgrades and the housing market starts to recover. Boral says if US President-elect Donald Trump carries out his promise to launch a massive infrastructure spending programme, that will be the icing on the cake.

It is pleasing to see an Australian company look overseas for growth, rather than contracting and refocusing on Australia's relatively small domestic market, as ANZ bank and insurer IAG have done in the past few years.

Boral, Australia's biggest supplier of building products and construction materials, was already in the US, but earning only meagre returns from its US operations, so the company had to decide to get big or get out.

It is no surprise that chief executive Mike Kane chose to get big.

The 65-year-old from the New York City borough of Bronx does not shy away from a challenge, such as with the building union in Melbourne. Where other building companies have acquiesced to what are, in my opinion, the unreasonable demands of Australia's powerful construction union, Kane has stood up to it.

Boral's US operations to date have mostly focused on the housing market, particularly the manufacture and distribution of bricks and roofing tiles. These are capital-intensive products with high fixed costs, that is, costs are much the same even when Boral's output is low.

The Headwaters acquisition moves the US business away from the capital-intensive, high-fixed cost end of the building materials industry.

It also gives Boral exposure to construction materials used beyond the housing market, in particular fly ash, a by-product of coal power generation used instead of cement in heavy construction.

Finally, the acquisition gives Boral access to Headwaters' US distribution network.

The deal will more than double Boral's revenue from the US market to US$1.8b.

It will also provide Boral with a better balance of revenue between domestic and international markets. Income from Australian operations will now comprise just more than half of its total revenue (down from 67 per cent), whereas sales from Boral USA will now make up 38 per cent of total revenue (up from 19 per cent).

This is similar to the strategy of geographic diversification pursued by Fletcher Building in the past decade or so, to the point where the NZ company now earns only half of its revenue from its home market.

The US housing market is also starting to recover.

It's a good strategy for building materials companies. It means their earnings are less at risk from a construction decline in just one country and they can benefit from an upswing in activity in several countries. On this score, the Headwaters acquisition looks like good timing, as Boral will benefit from a programme of highway upgrades and infrastructure spending underway in the US.

The US housing market is also starting to recover. Housing starts jumped 25 per cent in October, the biggest monthly increase in percentage terms since July 1982. Total starts are expected to rise by about 13 per cent in 2017 to 1.3 million, and hit 1.4m in 2018.

Kane pointed out the recovery is still in its early stages and starts will be well below the long-term average for 1.5m a year for at few years.

Despite the potential for growth, the deal is not without risk.

Headwaters is the largest fly ash maker in the US, with Boral at number two, albeit a lot smaller.

There is a chance competition regulators could block the deal, leaving Boral with a US$75 million break fee and a big hole in its US strategy.

Boral is counting on extracting annual synergies of US$100m from merging the two businesses, with Kane saying there is potential for even more.

Synergies, or the savings companies make from merging administrative, sales, production and other functions, are notoriously difficult to quantify and even harder to achieve. They often provide the rationale for a takeover and the reason for its subsequent failure.

However, under Mike Kane's leadership, Boral's chances of making a go of it are better than most.

Kane has extensive experience in the US construction sector, including in fly ash and ran Boral's US operations before coming to Australia. He has delivered impressive results at Boral since he took the top job in October 2012. He attacked the company's bloated balance sheet and paid down debt.