A disappointing trading update from building materials firm SIG (SHI) on 5 July was the latest bit of bad news from the UK construction sector. It follows a series of negative data points and gloomy commentary from construction companies.

In this article we look at some of the larger businesses in the construction and building materials space and consider how diversified they are geographically and if there are any parts of the space which have firmer foundations.

AN INDUSTRY IN TURMOIL

SIG, which specialises in areas like roofing and insulation, reported a 12.7% drop in like-for-like revenue from its UK operations in the first half of 2019.

This followed hot on the heels of PMI (purchasing managers’ index) data on the UK construction sector which showed June was the industry’s worst month since April 2009. A reading of 43.1 was down from 48.6 in May and well below market expectations of 49.3.

Based on a survey of purchasing managers – who are the people responsible for buying in the goods and services required for a firm’s day-to-day operations – any figure above 50 implies growth whereas any number below this threshold indicates contraction.

Recent wet weather may not have helped the latest reading, but this still represents an alarming slump. Furthermore, the downward pressure is evident across the board. Housebuilding posted its largest decrease in three years while the other two categories – commercial and civil engineering work – also fell.

The news suggests uncertainty over the outcome of Brexit is leading to project delays and this puts suppliers in a tricky spot. They need to reduce capacity to keep control on costs while remaining prepared to service any rebound in demand if there is greater clarity on the political situation.

The uncertain backdrop is not just affecting work in the private sector. Infrastructure play Costain (COST), which works on projects for the likes of Network Rail and Highways England, was another name in this space to take a big hit as it last month warned on profit, citing project delays.

Meanwhile Kier (KIE), once a heavyweight in the space, continues to limp along in heavily diminished fashion, recently suspending dividends and announcing 1,200 job cuts under new CEO Andrew Davies as it tries to get borrowings under control.

STOCKS WITH BIG UK EXPOSURE

The threat of political intervention and the nationalisation of certain assets if the Labour Party wins the next general election is another factor to consider for companies with exposure to the UK public sector.

Construction, regeneration and housebuilding all-rounder Galliford Try (GFRD), paving and road specialist Marshalls (MSLH), pipe specialist Polypipe (PLP) and brick manufacturer Ibstock (IBST) are particularly dependent on the UK for their revenue.

Ibstock benefits from strong market dynamics with a limited supply of bricks in the UK but would be materially affected by a slowdown in housebuilding activity. Its half year results are published on 31 July.

Marshalls has been a consistent performer which is reflected in a strong share price performance. The track record has been built on targeting niche areas which are likely to enjoy growth, however a broad-based slowdown in construction could be negative for the business.

GREATER DIVERSIFICATION

Balfour Beatty (BBY) and road and rail project specialist Hill & Smith (HILS) both have significant footprints in the US, while CRH (CRH) carries the least exposure to the UK, although it is still a material bit of the business at 12% of 2018 revenue.

Kingspan made 21% of its revenue from the UK in 2018. It is a leading operator in high performance insulation. It has focused on playing the energy efficiency theme and has been boosted by regulatory drivers in this space.

However, even for businesses with niche specialisms and without substantial domestic exposure, there is a risk they could be caught up in negative investor sentiment towards the wider space. Investment veterans often observe that a good company in an unloved sector will underperform a bad company in a loved sector.

Kingspan and Marshalls could be particularly vulnerable should sector conditions get a lot worse given their premium valuations, trading on 23.4 times and 22.1 times forward earnings respectively.

Key upcoming company and economic data to watch

Galliford Try trading update: 17 July

Construction PMI data: 2 August

Balfour Beatty first half results: 14 August

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