Boral's shift to the US

Mike Kane is the CEO of Boral. The company recently announced their results which were not that great; not that terrible, but just fairly ordinary. 

Here's Mike Kane, CEO of Boral.

Listen to the podcast or read the full transcript below:

Mike, I was struck looking at your presentation.  The balance of your business now, in Australia you're mostly roads, highways and bridges, as you call it RHS&B.  And in America it's mostly housing, mostly single family.  It just strikes me that maybe, just looking at that, you need another acquisition in America to rebalance your business towards infrastructure because infrastructure growth is potentially where the growth is going to be in America in the future, as America starts to renew its infrastructure, as Australia is doing, or it hasn't done yet and you're not really in that business. 

Of course, we are, Alan.  Our fly ash business supplies for cement substitutions in the concrete industry.  Fly ash is our largest business in the US, and it goes across all, the entire built environment.  All the infrastructure work that we know is ultimately on the foot in the US will impact our fly ash business profoundly.  You need to understand about US business, our largest business is fly ash.  Fly ash will take full advantage of the infrastructure build in the US.

Are you saying you're happy with the structure of your business, your portfolio in the US, and that you don't think you need to...  And what about scale in the US, do you think you have enough scale?

We're making some investments in the last 18 months to scale up our fly ash business in preparation for what we believe to be a sizeable infrastructure build.  We currently do a little more than seven million tonnes of fly ash a year, which is a direct substitute for Portland cement.  We're intent on scaling it up substantially in the next five to 10 years.  We think that will be sufficient.  It's also our highest margin business in the US, and it's our most profitable business.  It's a great business for us.  It was one of the larger motivations to do the Headwaters acquisition; was to pick up their fly ash business and marry it to the one that we already had.

Seven million tonnes did you say of fly ash?

Yes.

What proportion of the market is that?

We have about 50% market share in the fly ash market in the US.

The other striking thing I saw in the presentation was the return on funds employed from your North American business.  Basically, I suppose, means fly ash is much lower than in Australia; 4.6% return on funds employed versus 16 or so percent.

That's simply an accountant's complication having to do with the fact that by purchasing the Headwaters business we marked the entire business to market on the acquisition.  The Australia business, if it was sold tomorrow, its return on funds employed would be similarly low single digits once you've marked the business to market.  Of course, we've owned that business first, built it over the last 70 years, and so the book value of the business is quite different than the book value of the US business. 

I think what you really need to look at is EBITDA margins of the business to compare them.  We get a two percent better EBITDA margin for return in the US than we do in Australia.

Yes, I can see that, and you're also getting a better growth in the US than Australia, as well, aren't you?  At some point fairly soon, I guess, the US business overtakes the Australian business in terms of the sizing within the company.

Absolutely. 

Obviously, that's fine.  Do you think their much growth left in the Australian market?

I do.  The infrastructure piece is by no means played out.  There's at least eight years plus of infrastructure work in Australia.  I think housing, we've looked at the detached housing market and it's still underserved in this country.  We think that housing will decline perhaps another 30,000 starts in the next three years, but we think it will bottom at that point and turn back.

What we see is a housing market that has been achieving levels of performance in the last several years much higher than anything post World War II.  We see it staying up above the typical levels for housing that you've seen in the past.  We think we're looking at 170,000 starts as the trough, and it's stabilising after that, possibly returning back.

Clearly, the multi-family market has been overdone a bit, and the apartment market, but with population growth that should be fairly quickly absorbed in time.

What sort of difference is there with the American housing market?  That seems to have been softening lately in the US.

The housing market in the US hasn't stalled, it's slowed.  We're still below the 50-year average, so that's the difference.  The historic average in Australia is 150,000 starts.  We're sitting at close to 200,000 starts today.  In the US market we're at about 1.2 to 1.3 million housing starts.  The 50-year average is 1.5, so we're below the historic average in the US, and there's quite a considerable run to go before the US housing market turns back.

Is the difference between the two immigration?

Immigration is part of the story, sure.  In the last 30 years we've had a substantial probably almost 30 million people through the US population, something the size of Australia, and so clearly immigration has a continuing impact on the vitality of the construction markets in the US.  But Australia's earning in population, as well, on a relative basis.  It's just the scale is so extraordinarily different, the two economies.

Can you talk us through, moving onto infrastructure, what's going on in the American infrastructure situation?  It seems to me that they're way behind in terms of rebuilding infrastructure, not that I've visited there lately.  If you go there is it visible that the infrastructure is deteriorating in the US and they need to fix it?

Yeah, there's no question.  They're probably 10 years behind in what they should've made in investments in infrastructure in the US.  In order to get infrastructure kicked off in the US, it requires a bipartisan congressional approval of Omnibus highway and infrastructure bills.  Congress has been in deadlock certainly for the last two years if not before that, and so it's a political issue that will require us getting past that to the next presidential election for any hope of a bipartisan effort on infrastructure. 

What they're talking about in terms of the size and scope of infrastructure spend is a bill that begins at something like $1 trillion.  That's an awful lot of work and that would take quite a bit of time to absorb but when it comes, we want to be in a position to take full advantage of it.

Even if the Congress agreed, they haven't got the money for it, have they?

I think the US economy is much more robust than you think.  You've got a very attractive taxing regime, very low energy cost, strong employment numbers.  You've got an economy that has, quite frankly, got a lot more strength than I see in the Australian economy.  Can they absorb more debt?  Absolutely.  Can it pay for this thing?  I wish they would pick up the Australia approach, and that is sell government assets to pay for it, but they'll more likely take the typical American approach and take it all on in terms of debt.  I think there's room to absorb that in that US economy, it's quite different than here.

And they don't do toll roads and that very often, do they?

They don't do it the way we do it here.  Once again, I think that's a lesson for them.  I know Joe Hockey has talked about that a bit in the US.  Privatisation of toll roads is a much more efficient way to deliver what's necessary.  The US doesn't always follow the best route.

Can I just turn to the succession situation?  I was a bit puzzled why the company announced it or said that you're going to be around for two or three years.  There was a bit of a flurry then, "He's only going to be around two or three years," which is hardly surprising.  You've been there a while now.  The restructure, you've only got two direct reports now, is that right?

No.  I've got about eight direct reports including the two executives you see in those charts, as well as…executives, HR, investor relations, communications, general counsel for the corporate secretary.  I've got the usual staff.  What we've done is just consolidated into two; the line operating organisation versus essentially four, currently.  It's not unusual to make this type of a change as you're preparing for succession in an organisation like Boral.

When I came in 2012, I committed to staying seven to eight years in the role.  As the board has announced here that I'll be here for two to three years, that puts me somewhere between nine and 10 years, staying beyond what I expected.  One of the key responsibilities that I have, and the board has, is to prepare for executive succession.  Since our intent is to do internal replacement, the prudent thing to do was to put people in a position to get more experience in preparation for this change.  This is not unusual in the US context.  I'm not as familiar with Australia. 

To do this, if you want to have internal succession, you get a recruiter and go outside, and do that.  You have a different route to take but often in these circumstances, and I think James Hardy was a good example of this.  Even when they went outside, they brought someone in for a sufficient period of time before the incumbent retired to get experience with the business.  We consider this a very normal course of business; executing on our responsibility to find a suitable replacement for the CEO role.

Do you think that by the time you leave, Boral will be mainly an American business?

More and more, just because of the size and the growth potential of the US economy.  Our business will be more and more shifting toward North America.  I think in the very long term, the Asia business, may swamp them both.  But right now, 50% of our revenues is offshore outside of Australia.  If you went back just into about 2010 to 2012, 80% of the revenue was in Australia. 

Clearly, the shift is on and it will continue inextricably in that direction.  I don't think it suggests anything imminent about the fact that we trade on the ASX and we're headquartered in Australia.  My successor will be headquartered here and the business will be traded on the ASX.  It's expensive, costly to make that transition.  Instead, what you've seen happen in the last five years is we've shifted.  More and more of share ownership is offshore, and that will continue and will probably mirror our sales revenue.

Yeah.  I haven't talked much about Asia before, and I suppose I sort of ignore it because it's part of a joint venue, but do you think that it's long-term sustainable that your Asian growth, your Asian business, is in a joint venture?

Absolutely.  I think that's what part of the success.  It's been in a joint venture for over 20 years.  It was in a joint venture with Lafarge beginning back in the '90s, and that lasted 15 to 17 years.  Then five years in a joint venture with USG.  This next step gives us the opportunity to take significant step up in market strength to meet the capital requirements to grow in Asia. 

If we do this deal will Knauf, we avoid some capital expenditure that we would have to do if we were going to stay in the market and compete directly against Knauf.  It's to our best advantage and it gives us a chance to concentrate our fire power on the fastest growing plasterboard market in the world.

Is it predominantly plasterboard in Asia, the business?

Absolutely.  That's essentially what the business has been all along.

Right, and it will stay that?  Do you intend to add anything else to that business?

That business alone will take all our time and attention and capital to stay and keep up in the pace of investment that's going to be required.  Just in the last six years we've probably added six or seven plants to keep up with the growth in that market.  That will continue at pace as the markets mature.

I note that your USG Boral margins came down in the latest half year.  What's going on there?

It did.  You can't look at Asia based on a six-month base.  What we had is the Korean market and historically, the Korean market and the Australian market are 60% of the revenue of the business, 40% from the emerging markets.  Well, Korea came off the boil.  Korea came down from an all-time high and that set us back.  We're convinced in the next two years all that will be absorbed in other markets in Asia, and that's the great thing about the Asian market.  Not all markets move in tandem.  It's not like a market the size of the US that tends to move at the same time.  What we're seeing in Korea, I think in the long run will be make up in places like India, Vietnam, Thailand, and Indonesia.

According to Mr Trump, North Korea is going to become one of the world's great economic powerhouses.

I think we're going to wait a while before we make any investments there.  I'll tell you, Korea is a fantastic market for it.  Even with the pullback in the building in Korea, it's still our highest margin business in Asia.

Right.  Great to talk to you, Mike.  Thanks.

Okay, thanks, Alan.

That was Mike Kane, the CEO of Boral.