Brickworks gets boost from TPG
Recommendation
You’ve probably seen the cranes in the sky and soon you will see the towers. In Sydney’s CBD, they are building the tallest residential tower in the state; at Barangaroo, work will soon begin on 900 apartments (the first tranche was sold within hours); in Melbourne, ugly office blocks will now stand with residential skyscrapers and, in Brisbane, the city’s tallest tower was recently completed. There is a building boom underway and it is transforming Australia’s cities.
For the country’s building material groups, however, the effect has been less profound. High rise developments are less material intensive than stand-alone dwellings and they consume fewer bricks and tiles in favour of steel and stone. For Brickworks, high-rise construction is a source of marginal demand but hardly a bounty. Yet we don’t need a building boom to find value in the business.
Despite the deceptive moniker, most of the value of Brickworks comes from its stake in Soul Pattinson, which, in turn, holds a stake in Brickworks. We estimate the core Brickworks business accounts for between $2 and $4 of the share price. The rest of the value reflects Brickworks’ holding in Soul Patts. Confused? We recommend reading part 1, part 2 and part 3 of Brickworks and Soul Patts: The great unwinding for detail about how to value these cross holdings.
Key Points
- There is a new building boom
- Brickworks valuation rises
- Upgraded to Buy
Cheap | Fair | Dear | |
---|---|---|---|
Building products $m | 150 | 300 | 300 |
Property Trust $m | 240 | 285 | 285 |
Operating property $m | 320 | 420 | 420 |
Land bank $m | 70 | 130 | 130 |
Sub total $m | 780 | 1,135 | 1,135 |
less debt $m | 316 | 316 | 316 |
DTL $m | 187 | 187 | 187 |
Total $m | 277 | 632 | 632 |
Shares on issue, m | 147 | 147 | 147 |
Value per share excl. SOL, $ | 1.88 | 4.30 | 4.30 |
Inlcuding SOL value $m | 2,773 | 3,415 | 4,063 |
BKW equity value $m | 1,840 | 2,577 | 2,919 |
Value per share, $ | 12.52 | 17.53 | 19.86 |
We've produced an updated valuation in Table 1. Fair value for the company rises from previous estimates of $16 to about $17. In our ‘Fair’ and ‘Dear’ case, we’ve valued Brickworks’ land bank at a premium to book value (but a steep discount to development value) to reflect likely development gains.
This adds only about 40 cents to our valuation. The larger portion of the increase comes from how we've treated Brickworks' indirect holding in growing telecoms titan, TPG Telecom.
TPG goes to market
In a typically canny move, Soul Patts purchased a 26.9% stake in TPG more than a decade ago. That stake is now worth about $1.2bn, or a third of Soul Patts' market capitalisation. We have, in the past, valued this stake using prices in our TPG recommendation guide. This time, we're using the market price and attaching a discount.
Why the change? As the price of TPG has increased, so has the value of Soul Patts' (and therefore Brickworks') holding. As an investor, Soul Patts can sell it at any time for cash. Indeed, management has fine form in selling investments and ignoring market prices ignores that option. In accounting parlance, the stake is ‘available for sale’ and should be anchored to a market price, albeit with a discount.
In our ‘Fair’ value case, we’ve attached a 30% discount to TPG's market price, adding about 70 cents to our valuation which, in total, increases by about $1 a share.
We're recommending a portfolio limit of 6% for Brickworks and 6% for Soul Pattinson. Since most of Brickworks' value comes from the stake in Soul Patts, however, owning both stocks should incur a lower portfolio weighting. We recommend limiting your stake to 10% for both. |
Happily, while our estimate of Brickworks' value has increased slightly, its share price has fallen. From highs of over $15 earlier this year, Brickworks today trades at $13.45, enough to earn a spot on our Buy list.
The proposal to break up the cross shareholding, as suggested by a consortium of investors, plays no part in our valuation. If successful, it is likely to add further gains but that is a tale still unfolding. At the same time, although the building materials business is cyclically glum, any improvement is unlikely to light a rocket under the share price.
The investment case doesn’t turn on a cyclical turnaround; this is an asset play. Brickworks trades at a near 30% discount to fair value and we expect that gap to narrow and the value of its assets to grow over time. With the share price down 6% since Soul Patts and Brickworks: Interims 2014, we’re upgrading to BUY.
Note: Our model Growth and Income portfolios own shares in Washington H Soul Pattinson.