Balancing Brickworks and Soul Patts
Recommendation
Brickworks holds a 43% stake in Washington H Soul Pattinson (Soul Patts) and Soul Patts holds a 44% stake in Brickworks. This cross-shareholding ensured that, for a long time, the fortunes of both businesses were tied to each other and that a move in the share price of one was shadowed by the other.
With Brickworks share price up over 20% so far this year compared to a 4% increase for Soul Patts, that simple relationship appears to have broken down.
That gap can be explained by strong performance of Brickworks' building materials business, bolstered by a building boom. For the first time in 7 years, profits from the building materials business have overtaken profits from the investment arm, a trend that could continue as construction activity swells.
Key Points
Brickworks up on building profits
Soul Patts get cheaper
Upgrade Soul Patts. Buy.
Brickworks bourgeoning price suggests that improvement from the building materials business is being capitalised into the share price. This is not irrational or a mispricing – earnings are rising after all – but we should recall that the division is worth far less than the stake in Soul Patts which accounts for about 80% of Brickworks' value.
For the first time in a long time, diverging valuations mean that our long held indifference between Brickworks and Soul Patts has been replaced by a clear favourite. Soul Patts is now better value and it's cheap enough in its own right to upgrade to Buy.
The favourite
Soul Patts isn't an exciting business nor is it likely to make a quick fortune. What it lacks in flair, however, it makes up in durability and conservatism; this is one of Australia's oldest listed businesses and it perennially rejects using debt.
Although Soul Patts has stakes in a maze of businesses and funds, over 90% of its value comes from just four sources: stakes in TPG, New Hope Corporation, Brickworks and its equity investments.
Holding | SOL share (%) | Market cap. ($m) | Market value to SOL ($m) | Discounted value to SOL ($m) |
New Hope Corp | 59.7 | 1,604 | 957 | 670 |
TPG Telecom | 26.9 | 6,866 | 1,847 | 1,293 |
Brickworks | 44.2 | 2,149 | 1,229 | 718 |
BKI Investment | 11.1 | 949 | 105 | 74 |
Ruralco | 20.6 | 291 | 60 | 42 |
API | 24.6 | 842 | 207 | 145 |
Clover Corp | 28.6 | 29 | 8 | 6 |
Apex | 30.3 | 158 | 48 | 34 |
Equity portfolio | 580 | 406 | ||
Net cash | 161 | 161 | ||
Subtotal | 5,202 | 3,549 | ||
Deferred tax | (255) | (255) | ||
Corp. costs | (100) | (100) | ||
Total | 4,847 | 3,194 | ||
Shares (m) | 239 | 239 | ||
$/share | 20.24 | 13.34 | ||
Note: Brickworks' valuation has been adjusted for its cross-shareholding |
On a per share basis, after adjusting for tax and corporate costs, these four assets suggest a per share value roughly between $14 at $20. With Soul Patts currently trading at just $14, the business is available at our low end valuation.
In comparison, Brickworks sits closer to the middle of our suggested valuation of between $12 and $18 (see Brickworks, Soul Patts: Interim update). Equity multiples suggest Soul Patts is cheaper: Brickworks trades at 1.4x net asset value; Soul Patts at just 1.1 times. Yields tell the same tale: Brickworks yields 2.8% at today's price and Soul Patts 3.4%. We don't expect Brickwork dividends to rise faster than Soul Patts. Whatever way you cut it, Soul Patts is the cheaper business today.
The value of Soul Patts is inextricably tied to progress at TPG and New Hope and there is some nervousness about both holdings.
TPG faces a larger and more effective rival if, as expected, the merger of Amcom and Vocus is completed. Although we remain committed coal bears (see Coal: A dark future ahead), we note that most of New Hope's value come from its port operations and its cash pile. New Hope will benefit from higher coal prices but it is not dependent on them.
These concerns, however, don't justify the discount implicit in the Soul Patts share price. Brickworks remains a HOLD but we're upgrading Soul Patts to BUY.
Note: The original version of this article contained an error regarding Soul Patts cash balance that has now been corrected. You can read our rueful admission and apology here.
Note: The Growth and Income portfolios owns shares in Washington H. Soul Pattinson.
We are adding 1,000 shares of Soul Patts at $13.93 worth $13,930 to the Growth Portfolio and 300 shares worth $4,179 to the Income Portfolio. To maintain cash levels in the Income Portfolio, we are selling 11,100 Transpacific shares at $0.82 to raise $9,102. With dividend prospects lower than they were and the share price bumping higher, Transpacific no longer meets the criteria for our Income Portfolio although we will maintain our holdings in the Growth Portfolio.