BORAL LIMITED

Fat Prophets

Friday 20th March 2015

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Fat Prophets

BORAL LIMITED

What’s new?

There have been a number of positive developments at construction company Boral over the last few months. This included the ACCC’s decision late last year to allow the proposed merger of Boral’s Australian east coast brick operations with CSR Limited to proceed as planned. While the ACCC had initially stated that it was less than enthused by the proposed deal, common sense appears to have prevailed, and as such represents a significant step forward for Boral (and the sector in general).

Boral has also recently announced the sale of its non-core Western Landfill business in Melbourne to Transpacific Industries (TPI). As per the terms of the sale agreement, TPI will pay Boral $150 million upfront plus $15 million for site preparation work. In addition, TPI will also pay Boral a long-term earnings stream comprising of fixed payments and volume-based royalties for the life of the landfill, with management expecting this to amount to around $15 million per annum.

Adding to recent positive news flow was the release of Boral’s 1H15 results in mid-February, with this showing that the company has continued to deliver an improved earnings performance. In terms of the headline result, Boral reported an adjusted net profit after tax of $105 million, which compares to the $26 million loss reported in 1H14. The interim dividend was increased by 21 percent to 8.5 cents per share.

While operating momentum remains positive, 1H15 results quality was adversely impacted by Boral’s lower cash flow conversion rate, with net operating cash flow falling around 50 percent to $115 million on a similar earnings base (due in part to higher working capital). This, in combination with the DRP suspension and adverse US denominated debt translations resulted in a $169 million increase in net debt. However, Boral’s gearing remains comfortably within its requisite covenants.

Outlook

Management has provided some positive guidance for 2H15. In particular, it expects (i) improved earnings from Construction Materials & Cement segment, with higher property earnings expected to offset seasonal weakness, (ii) underlying improvements from Building Products and USG Boral, and (iii) a break-even result from Boral USA. With Boral USA’s earnings still well below mid-cycle, we continue to view this segment as the key medium-term catalyst for Boral’s share price.

In relation to Boral’s 2H15 guidance, it is interesting to note 1H15 comments from management that “the Fix phase of Boral’s Fix, Execute, Transform program is now well-advanced, resulting in a significantly improved cost base” and that “We are now moving firmly into the Execute and Transform phases of the program, which will help deliver further improvements and more sustainable returns”. Cyclical tailwinds will certainly help in this regard.

Price?

Boral is currently trading around 22 times FY15 earnings forecasts and a yield of 3.0 percent, with this falling to 17.5 times the FY16 earnings forecast. Despite the evident improvement in Boral’s operating performance over the last 12 months and its leverage to a rebound in US residential construction, the company’s shares have traded in line with the broader market over this period. In our view, this is somewhat surprising, particularly given the overarching AUD thematic.

Worth buying?

Recent news flow on Boral highlights the positive tailwinds now pushing earnings higher. Having had roadblocks to its proposed Australian east coast bricks merger with CSR Limited removed and sold more non-core assets on favourable terms, Boral has continued to progress its transformation plans. While the company’s US business remains loss making, it is trending in the right direction and in our view remains the key swing factor to a future step change in earnings.

Disclosure: Interests associated with Fat Prophets and the author declares a holding in Boral Limited.

Greg Smith is the Head of Research at Fat Prophets share market research.

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