The Great Sharemarket Return: Cementing value in Brickworks

It is a major part of one of Australia’s oldest listed conglomerates.  And for that reason alone, it is one of the more controversial companies on the Australian Securities Exchange.

Brickworks has been a regular inclusion on the Clime Value table and this week was moved up a notch to 9^th spot, just behind stable mate Washington H Soul Pattinson.

For a relatively staid outfit that concentrates on building materials, Brickworks has attracted more than its fair share of publicity, the bulk of which has little to do with its operations.

It is its relationship with Soul Patts, and more specifically, the cross shareholdings between the pair and the attempt by funds manager Perpetual to unwind that relationship, that has dominated the headlines for more than a year.

Many have tried this before and failed. Decades ago, GPG’s Sir Ron Brierley and Gary Weiss mounted a similar campaign with the very same rationale as Perpetual: to unlock the hidden wealth tied up within the conglomerate.

Clime’s attraction, however, is based not upon the short-term potential profit involved in a break-up but rather on the concept that the conglomerate is a stable structure with sound management that has proven itself as a vehicle for building long-term wealth.

Brickworks this week reported its interim earnings, which again were subdued with a 3.7% rise in the first half to $56.08 million. Before significant items, the result was up 13.1%.

Brickworks has been a drag on Soul Patts’ earnings for the past few years as the housing slump and the downturn in construction has weighed on the company.

But Brickworks pointed to a recovery in the housing market, particularly in NSW, Western Australia and South Australia, which it hoped would lead to improved sales in the second half. That was enough to push its shares sharply higher to around $12.88.

Despite the relatively lacklustre earnings performance, Brickworks’ share price has surged ahead since October last year when it was fetching around $9.70.

Few investment banks bother to rate Brickworks, possibly because of the structure and the controversy surrounding it. But Macquarie analysts have called Brickworks a buy for months and has maintained its outperform recommendation on the company following the results.

“Brickworks’ earnings diversity has buffered it during the residential housing market downturn and it remains well positioned for a housing recovery,” they argued.

That earnings diversity, and its exposure to an industry at a cyclical low point, are major attractions for Clime.

In addition to its building materials, it has extensive property developments on old brick pits located on the fringes of capital cities.

But the real attraction for Clime is the conglomerate.  The cross shareholding between Soul Patts and Brickworks delivers exposure to a diversified array of industries and, by definition, to rising equity markets.  It also has a large exposure to coal, through New Hope Coal.

Detractors of the structure complain that it no longer conforms to modern style governance standards, which imposes a discount on the value of the assets. That very discount is what attracts Clime.

Clime analysts argue that Brickworks’ flow-through ownership of Soul Patts (42.7%) accounts for almost all its market valuation, meaning investors are getting a significant land bank and building supply business at an enormous discount.

Like many Clime recommendations, the company has a conservative approach to debt with a net debt to equity ratio of just 17%.

Given the enormous run on the domestic equity market since June last year, undervalued stocks are hard to find.

And so it is with Brickworks. Before the earnings result, Clime had a valuation on the stock of $12.03, below its current market price. That valuation is in the process of being recalculated.

Brickworks and Soul Patts entered into their cross shareholding arrangement in 1969 to ward off attacks from corporate raiders. It is a structure that has delivered control of the conglomerate to chairman Robert Millner.

After prolonged agitation, an internal review has been conducted on ways to maximise value for investors. Whether this results in a split of the group remains to be seen given one director at this week’s presentation indicated there could be substantial tax costs from unravelling the structure.

The core of the dispute may be about modern governance standards and the need for independent directors to maximise returns for all shareholders.

But supporters point to a broader issue: that committed, long-term, family dominated corporations are better suited to cater for the interests of long-term investors.

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Figures are sourced courtesy of Clime Asset Management. http://www.clime.com.au/. To experience MyClime and the insights they can offer, click here www.clime.com.au/eureka.