Government's planned spend-up on construction could give Fletcher Building a boost. Photo / Michael Craig
COMMENT:
Many sets of eyes and ears will have been focused on Wellington this week. As I write, the Budget is due to be announced on Thursday, so will already be old news as this column goes to press.
Nonetheless, given recent statements about encouraging shovel-ready projects, it's likely that infrastructure development will be a key plank of this "economic recovery" Budget.
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• Government's $50b Covid-19 recovery Budget biggest spending package in history
• Craig Stobo: Shovel-ready, but not work-ready
Before Covid-19 (ie, a long time ago, in a galaxy far, far away), there is also a hazy memory of the Government's $12 billion infrastructure spending plans.
On the face of it, this should be good news for NZX-listed Fletcher Building.
Nonetheless, Fletcher's share price has continued to fall while the wider market has staged something of a recovery. Over the past four weeks, Fletcher's share price has continued to drop by around 20 per cent, while the NZX50 index has remained relatively flat. To be fair, this is probably partly because of index rebalancing of major funds.
Like many companies, in late March Fletcher withdrew any earnings guidance for the current financial year and suspended its interim dividend. This followed an upbeat announcement in February about its half-year performance to December 2019, where it reconfirmed its full-year expectations of earnings before interest and tax (Ebit) of $515 to $565m, on the back of a half-year Ebit of $219m.
Somewhat unfortunately, that implies that earnings are more weighted to the second half of the financial year ... now known as the "Covid Period".
There were plenty of bright spots. In a world where cash is king right now, Fletcher showed cash on hand of $570m, with an ability to access a further $900m in additional debt if required. Progress on its "business turnaround" was proceeding to plan. More on that later.
Fletcher Building is a complex beast, with five major divisions. These are focused on: Construction; Distribution, including the well-known Placemakers brand; Concrete (Firth, Winstone, Golden Bay Cement); a Building Products division that manufactures a wide range of construction materials; and a Residential Development division.
In theory, Fletcher Building spans the full industry value chain — from manufacturing building materials, selling them, managing construction projects that use them, and even doing its own developments.
In practice, given the wide range of different building materials, Fletcher would always struggle to maintain a fully-integrated model; its past bete noire has been the sheer complexity associated with managing the vastly different businesses associated with the construction value chain.
And therein lies the rub. It's great to run an integrated business, allowing optimisation of margins, resources, supply chains and internal capabilities across a value chain. But that only works if there are economies of scale or an integration benefit — creating an "advantage" for Fletcher to own them rather than simply buying the products it needs on an open supplier market.
Fletcher's acquisition history is somewhat patchy in this regard.
Fletcher continues to tinker with its portfolio of businesses, no doubt ensuring optimal use of its capital. During 2018, Fletcher made a takeover bid for Steel & Tube, another NZX-listed company, offering $1.90 per share. In response, Steel & Tube found a "white knight" in ASX-listed Bluescope Steel, which took a 16 per cent blocking stake. Given that Steel & Tube's share price is now 64c, Fletcher must be thinking they dodged a bullet.
In fact, the NZX-listed building sector generally has been a fairly good place for investors to lose their cash over the past few years. The sector has been the victim of a perfect storm of issues, including new foreign-backed competitors, rising costs, poor project risk management and much more.
Of course, history isn't necessarily an indicator of future performance. Is Fletcher simply an opportunity in a very good disguise?
Fletcher Construction has exited "vertical" property construction after its well-publicised issues with project cost over-runs during 2018/19. The company made clear that it would maintain its position in "horizontal" infrastructure — mainly the public sector-led investment in roading.
That should help it bid for upcoming work as the Government invests in infrastructure to stimulate the economy. Time will tell if Fletcher has learnt the lessons of its recent past, by pricing in appropriate project risk and reducing the variability of its costs.
While there is no shortage of competitors, project issues with the consortium building Wellington's Transmission Gully motorway may work in Fletcher's favour. With a likely downturn in large-scale private-sector construction activity, Fletcher's now-reduced exposure to vertical construction will also limit its downside.
Both Mico and Placemakers will likely be hit by a significant fall in demand for new residential properties and property renovations, as individuals and developers alike look to conserve cash in a depressed economy.
It's a tough market for Placemakers, competing directly with Bunnings, Mitre 10, Carters (more focused on trade suppliers) and smaller-format local stores such as ITM. It's a market that has seen a wave of store growth in the past decade; Bunnings' announcement this week of seven store closures may be a harbinger of the change to come.
This division comprises around 20 businesses operating manufacturing sites across Australia and New Zealand. It has lately suffered from poor margins in its steel-related businesses, with recent efforts focused on a "turnaround" of its Australian businesses.
This included a planned sale of Rocla (a pipe manufacturer), which has now been delayed as a result of Covid-19.
Australian revenue is around twice New Zealand's, but with only about half of the Ebit, representing a strong upside opportunity if the business turnaround plan succeeds.
The plan was expected to be completed by June 2020. It's now likely Covid-19 will extend that time, creating a longer-than-expected drag on the division's earnings.
Reduced property development will also have a significant impact on longer-term demand for the division's products.
Manufacturing concrete and cement (Firth, Winstone, Golden Bay Cement) brings a measure of stability to Fletcher's income statement. While Concrete revenue is likely to suffer from softening development after Covid-19, this may be offset by increasing government-led infrastructure development.
Across all Fletcher divisions, New Zealand infrastructure-based revenue makes up 22 per cent of the company's turnover. This percentage is likely to increase strongly over the next one or two years.
Fletcher Living is focused solely on residential property development, with about 15 developments in Auckland and Christchurch.
Fletcher's February report showed a decline in Ebit versus the previous half-year, but also stated that earnings were weighted to the next six months (ie, to June 2020).
Those earnings are now at risk as residential property activity slows down post Covid-19.
Fletcher Building was already focused on a "business turnaround" across much of its business, following its annus horribilis of 2018/19. Much effort is going into resolving issues within its Australian (Building Products) and Construction divisions, together comprising about half of Fletcher's overall revenue.
Covid-19 will have lengthened the time for that turnaround process to bear fruit in those divisions and dampened demand across its other major divisions.
Even with government-induced demand helping to offset some of that revenue loss, there is further nervousness about the extent of damage to company revenue and profitability forecasts. Thanks to recent level 2 clarity, the company is probably trying to work this out.
Fletcher does seem more prepared and able to respond to the Covid-19 crisis now compared with where it was two years ago. With a business turnaround process in the midst of implementation, Fletcher is likely to use this crisis to its advantage to optimise the business and improve performance, likely to show up to investors in the 2021 year. Better late than never!
The workforce is predominantly female which is reflected in the company's leadership.