Boral builds momentum but warnings abound

THE building materials sector has jumped back to life in recent weeks as the risk trade takes hold. Boral has spiked 19 per cent since its last profit warning in late June. Similarly, its competitor CSR, after a long time in the sin bin, has leapt 25 per cent since late June.

We heard a plethora of reasons from Boral in late June why its profit would be weaker than previously thought including adverse weather, a soft property market and the tapering off of the resources boom. Likewise, CSR played down any imminent recovery at its annual meeting in July.

These bearish comments though have been ignored, with investors attempting to pick a recovery down the track. Boral has a market capitalisation of $2.4 billion but will only make a profit of around $100 million for the year to June 30. This puts it on a price to earnings ratio of 24 times, or about double the market average. This high PE is not unusual for a cyclical building materials stock, but if investors are going to buy the stock today they are betting the earnings will increase up to four times in the next three years. At the peak of a residential building boom building material companies should trade at a substantial discount to the overall market. So the theory is buy on high PEs at the bottom of the cycle and sell at low PEs at the top of the cycle.

This all sounds great but James Hardie Industries may have thrown some cold water on proceedings at its annual general meeting earlier this week. CEO Louis Gries said this week that James Hardie was pulling back its exposure to Australian due to weak demand. This suggests that a bottom has not been found and those investors hoping for a recovery in the near to medium term in the local market may be slightly disappointed.

Boom Logistics (BOL)

ON MOST occasions I'm a big believer in buying companies that manage to surpass earnings expectations. We have had many of them in the early stages of the reporting season, including Downer EDI, Computershare, Carsales.com and Webjet. The response from the investment community has been swift, with a major share price re-ratings taking place. If history is any guide these companies will outperform the overall market for some months, or until further news on each of them comes to light.

One company that beat the street but I'm not so sure about is crane hire company Boom Logistics. The company beat forecasts by about 10 per cent and gave a rousing forecast for 2013, with earnings before interest and tax (EBIT) expected to rise by about 25 per cent. The market responded on day one by pumping the share price 31 per cent higher to 31.5? a share. On the face of it the company looks cheap trading on an EBIT multiple of less than five times 2013 earnings.

In its presentation the company trumpeted its return on capital had increased from 5 per cent in 2011 to 8 per cent in 2012. This is obviously heading in the right direction and should improve again in 2013. But with a cost of debt of close to 9 per cent and a cost of equity somewhere in the mid teens, the company needs to get an overall return on capital closer to 12 to 13 per cent just to cover its cost of capital. This is a mighty task given how capital intensive the crane business is.

The company also stated that its net tangible asset backing, mainly cranes, sits at 52? a share. It is hard to believe investors would pay up to this price and receive about an 8 per cent return on the overall capital. Maybe the stock rallies a little more, but reaching the NTA level might be a stretch unless the returns improve substantially this year.

Primary Health Care (PRY)

BACK in June we discussed the possibility of the medical centre and pathology group re-rating on the back of a climbing earnings profile and improving cash flow. At the time Primary was trading at about $3 a share and yesterday the stock popped to $3.36 on the back of its full-year profit result.

The latest numbers revealed improving trends on both earnings and cash flows. The company provided earnings guidance of 29? for 2013 but operational momentum may see it creep up to 30?. Given Primary's peers trade on price to earnings multiples of around 15 times, Primary could easily trade up to $4 a share.

Primary's recent history has been chequered with many institutional investors baling out. Some of these investors will have to begrudgingly reconsider the investment in the coming weeks.

Telstra Corp (TLS)

THE Telstra result last week was a reality check for many shareholders. The company reported numbers that were close to forecast and confirmed its bulging fully franked dividend of 28? a share for 2013. But the share price sank.

You can dress Telstra up any way you want, and the company does, but it struggles to generate growth. The forecast for 2013 was vague but uninspiring, with low single-digit revenue and earnings before interest and tax growth.

Telstra is trading on 14 times 2013 earnings per share, which is generous. Its share price is held up by a 28? fully franked dividend that equates to 100 per cent of earnings. Unless something changes it is difficult to justify the shares trading above $3.80.

matthewjkidman@gmail.com

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