Full break-up may be best option for 'under-valued' Fletcher Building, given non NZ operations

Tuesday 2nd February 2016

Fletcher Building shares are worth 25 percent more than their current market price on a sum-of-the-parts valuation and a full break-up of the company may be the best option to lift returns from shareholders faced with under-performing Australian and rest-of-the-world operations, says brokerage First NZ Capital.

In a lengthy analysis of the company, analysts at First NZ put a current discounted cash-flow, sum-of-the-parts value of $8.65 a share on Auckland-based Fletcher, about 24 percent higher than its latest traded price of $7 on the NZX. The analysis likens a break-up to the original carve-up of Fletcher Challenge Group, which was created in 1981 through the merger of Challenge Corp, Fletcher Holdings and Tasman Pulp & Paper, and later acquired Petrocorp. In the 1990s, it was split up into Fletcher Forests, Fletcher Building, Fletcher Paper and Fletcher Energy.

Based on a 9.4 percent after-tax cost of capital, the stock price implies "virtually no growth" in Fletcher's long-term earnings before interest and tax from the company's 2016 guidance of $650 million to $690 million, it says. While Fletcher's New Zealand operations have several years of growth ahead, Australian operations are likely to under-perform cost of capital "in the foreseeable future" and rest-of-the-world businesses aren't expected to meet cost of capital "in the next seven years due to ongoing structural and cyclical headwinds."

"A full break-up of FBU Group should be given serious consideration," the brokerage says. "On our analysis and projections, FBU Australia and Rest of World (ROW) operations will likely continue to deplete shareholder value despite management's best intentions and efforts. The separation of these regional businesses into standalone entities may be a practical approach to achieve this outcome for shareholders' benefit."

First NZ's $8.65 valuation is based on an enterprise valuation of the business of $7.71 billion and net debt of $1.74 billion. The valuation is made up of $4.7 billion for New Zealand, $1.77 billion for Australia and $1.24 billion for the rest-of-the-world operations. Based on its assessment, the company is under-valued by up to $1.2 billion, the Jan. 29 report says.

Looking at the options to crystallise the value of Fletcher, the brokerage says status quo would see growth in New Zealand, a weaker performance in Australia and mixed results in ROW. Instead, it favours a "self-initiated full break-up strategy" which offers the best hopes of minimising further depletion of capital, it says.

"The deeper the discount of FBU stock price to our assessed DCF-based valuation, the more compelling this option becomes," it says. There was a risk that Fletcher would only be prompted to consider a break-up as a last resort, by which time shareholders may have endured "more stock price performance pain" before board and management "have sufficiently strong conviction to exercise this option."

Fletcher could also become a takeover target for an investor seeking to recoup some of its funds by dismantling the group and quickly recycle capital by relisting Fletcher New Zealand and its Formica operations in a separate structure in Australasia and in the US respectively, it said. That would allow the company's residual businesses to be restructured and sold over time in a measured process.

Still, assuming a takeover premium of 15 percent, the company "is not exceedingly cheap" and an accelerated divestment strategy, while avoiding a fire sale, may be a better way to extract value, the brokerage said.

BusinessDesk.co.nz

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