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Company Update | Building value, brick by brick

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Adrian Ezquerro's picture
Analyst: Adrian Ezquerro, Head of Investments

Warren Buffett once famously remarked ‘I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years’. In a way, Buffett poses a curious hypothetical: what would you buy if the market were indeed to close for many years?

In such a scenario, we would suggest investors consider companies with wonderful long term track records, built on strong fundamental foundations, while offering attractive long-term growth prospects. On this basis, Brickworks (ASX: BKW) would surely be a contender.

 

The Austral Brick Co. Source: www.brickworks.com.au

 

BKW was established in the 1930s, listed on the ASX in 1962 and is today one of Australia’s most significant diversified building products businesses. The company’s origins lie in building products, largely through the brand Austral Bricks, however the business is far more diversified today. It now also encompasses significant equity investments and industrial property assets. BKW has four divisions, as presented below.

 

BKW Divisional Overview. Source: BKW 1H FY21 Presentation.

 

Investments

While BKW has been involved in brickmaking for the best part of a century, its name is actually somewhat of a misnomer. Today, BKW’s 39.4% shareholding in diversified investment house Washington H Soul Pattinson (ASX: SOL) forms approximately 60% of group assets, with a market value of about $2.9 billion. For context, BKW’s current market capitalisation is about $3 billion.

In some respects, BKW represents a throwback to another era. During the 1960s, BKW and SOL famously entered into a cross-holding agreement that has since added strength and diversity to each organisation. From time to time, agitators have argued that the long-standing agreement has locked up embedded value but nonetheless it has endured, backed by management teams each focused firmly on long dated horizons.

On a look through basis, BKW has exposure to telecommunications, mining and energy, financial services, pharmaceuticals, and agriculture. Shareholders have greatly benefited over the long term, with SOL delivering annual total shareholder returns of 13.6% and 14.2% over the past 20 and 40 years, respectively. A $1000 investment in SOL in 1981 would be worth about $200,000 today.

 

SOL Asset Exposure. Source: BKW 1H FY21 Presentation.

 

 

Property

BKW’s property division was established to maximise the value of land deemed surplus to the Building Products business unit. For decades, BKW has owned large tracts of land across Australia, most typically on the fringe of metropolitan areas. Land that was once ‘operational’ in nature is transferred to the property division, where it is either rezoned to residential and sold, or transferred into the Industrial Property Trust and developed.

In 2005, BKW set up a 50/50 Joint Venture Property Trust (with Goodman Group, ASX: GMG) for this very purpose. There are two key value drivers for BKW with such a strategy; an initial valuation uplift is captured as the land is rezoned, repurposed, and developed. Following this, a stable rental income stream is derived from the developed assets.

From a standing start, the property strategy has yielded a property trust whose asset value now exceeds $2 billion, with the equity attributable to BKW now totaling $777 million. But this still appears to be just the start for the property division. We expect the rental income stream from the property trust to increase by approximately 40% over the coming two years, largely reflecting the completion of large pre-committed industrial facilities servicing the likes of Amazon, Woolworths, and Coles.

In turn, we expect this to take BKW’s share of the asset value to well beyond $1 billion, and that is before any further potential cap rate compression. Assets within the Property Trust are currently valued on an average capitalisation rate (cap rate) of 4.8%. Recent transactional evidence in the industrial sector, which saw a high-quality industrial portfolio sell on a cap rate of just 4%, suggests further positive revaluations to be probable.

 

BKW Property Trust Asset Value. Source: BKW 1H FY21 Presentation.

As highlighted above, BKW’s property division and building products have a distinct link. It is worth noting that the Building Products asset value includes some parcels of surplus land, currently held at book value, but with a significantly higher market value.

 

Building Products

While much of the heritage of BKW’s Australian building products division has an East Coast focus, the division today has a truly national footprint and encompasses Austral Bricks, Austral Masonry, Bristle Roofing and Austral Precast.

In total Building Products Australia comprises 29 manufacturing sites and more than 40 design centres and design studios across the country. This is complemented by an extensive reseller network that includes over 100 additional displays.

Australian housing dynamics are strongly favouring BKW’s brick and tile focused portfolio of building product assets. As detached housing has a far greater usage intensity of bricks and tile, BKW is well positioned to benefit from the recent surge in detached housing building activity.

 

Building Approvals, detached and higher-density housing. Source: RBA, ABS.

Recent profitability from the building products (BP) division has been modest, but BKW’s first half result provided an early indication of the expected upswing in divisional profitability. BP Australia 1HFY2021 EBIT was up 60% to $16m, with management commenting ‘With demand across the country gathering momentum in recent months, we have re-started our previously mothballed brick kiln at Plant 3 in New South Wales, and all east coast brick, roof tile and masonry plants are now operating at capacity.’

BKW management added: ‘Whilst conditions in Western Australia remained challenging during the period, prospects are improving, with a sharp increase in building activity and consolidation of the brick market to two players.’ When coupled with an improved WA industry structure, we expect further strong growth in BP profitability in the near to medium term.

Building Products North America (BPNA) was established upon the acquisition of Glen-Gery in November 2018. This was followed by further bolt-on acquisitions of Sioux City Brick in August 2019 and Redland Brick assets in February 2020. BPNA endured a particularly difficult Covid affected 2020, with first half FY2021 divisional EBIT receding 33% to just $4m. As the pandemic cloud clears, however, future prospects remain sound.

At the recent first half results announcement, management expressed optimism, noting ‘In North America, we have seen a strong recovery in demand during March, with improved weather and increased optimism of a stimulus led recovery. Daily order intake is now back to pre-pandemic levels, and as conditions continue to normalise, we are confident that our North American operations will deliver improved earnings and growth for many years to come’.

 

Dividend Track Record

BKW has paid a dividend every year since its listing on the ASX, with ordinary dividends either maintained or increased over an extraordinary period that now spans 45 years. At current prices, BKW offers investors a solid fully franked yield of about 3.1%.