Earnings and cash flow are expected to advance significantly in 2018
Thursday 29 Mar 2018 Author: Tom Sieber

Demand for new homes continues apace but the investment case for the housebuilders is muddied by legitimate concern their margins may have peaked. We believe a better way to participate in new housing growth is through the brickmakers.

The most attractive of the three UK-listed outfits, which encompasses Forterra (FORT), Ibstock (IBST) and Michelmersh Brick (MBH:AIM), is the third one.

Michelmersh is poised to deliver a year of significant earnings growth in 2018 and yet trades on the lowest earnings multiple of the trio.

Established in 1997, Michelmersh is focused on the manufacture of premium bricks used in quality new homes, RMI (repair, maintenance and improvement) and urban regeneration projects. The company has a landfill operation and has several land assets which could yield future development opportunities.

Last year the company made its largest acquisition, the £38.4m purchase of Barnsley’s Carlton Main Brickworks. Now more or less fully integrated, the acquisition is expected to result in a big increase in earnings and cash flow in 2018.

Forecasts for 2018 by stockbroker Cenkos imply a price-to-earnings (PE) ratio of 10.2-times and earnings growth of 34%. This compares with a PE of 12.9 for Ibstock and 11.3-times for Forterra.

Michelmersh’s free cash flow is expected to increase from £3.8m in 2017 to £6.2m in 2018. The stock also offers a prospective dividend yield of 3.7%.

BUILDING THE CASE FOR MARGIN IMPROVEMENT

The scope for the brickmakers to improve their profitability is demonstrated by the current supply and demand dynamics in the industry.

According to Office for National Statistics data, UK brick sales were up 11% last year, well ahead of output growth of just 4%. This resulted in the utilisation of stockpiles, which fell 28% year-on-year, and greater use of imports.

Although Ibstock and Forterra are bringing on some new capacity, this is unlikely to shift the balance of the market significantly.

Cenkos analyst James Fletcher says: ‘Pricing (in 2017) remained flattish, although larger peers have recently confirmed intention to pass on cost inflation to customers in 2018.

‘Given the demand/supply imbalance, this should lead to material price growth and margin improvement in the industry at some point.’

Risks to consider with Michelmersh include rising production costs and more elevated borrowing levels post the acquisition of Carlton.

A net debt-to-EBITDA (earnings before interest, tax, depreciation and amortisation) ratio of slightly more than two times should reduce rapidly in the coming months, down to 1.2 times by the end of the year according to Cenkos. (TS)

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