Brickworks: Interim result 2018

For the last decade or so Brickworks' building materials business – comprising bricks, masonry, timber and cement products – dragged on the company. Profits were low, margins were miserly and returns on capital woeful. What a difference a boom makes. 

Earnings before interest and tax (EBIT) from the buildings products business has almost tripled over the past five years to $39m and return on assets has doubled to a respectable 12%.

We think this is a well-managed business of average quality and the stunning performance is clearly linked to a booming construction market.

Keeps going

That boom has endured longer than most thought possible, especially in NSW and Victoria where bricks are now precious and bricklayers have never made so much money. Brickworks again raised brick prices over the half-year and will do so again later this year to offset soaring energy costs.

The business is fortunate that higher energy costs have coincided with a boom. At any other time, raising prices would be unthinkable. A boom often makes the impossible ordinary.

To be fair to the business, it has exploited conditions cleverly by recognising that bricks are less like other building materials and more like fashion accessories.

Brickworks has built design studios in capital cities to host architects and developers and showcase new designs and, like Zara and other fast fashion merchants, the business quickly turns around new designs and borrows trends from around the world. This is one reason bricks are again fashionable cladding.

Despite the bumper profit, though, building materials is arguably the least valuable part of the business.

Developing property

As we have argued previously, Brickworks' property business is underappreciated and of excellent quality, generating a growing stream of annuity income by developing exhausted quarries into commercial property.

The property trust generated $50m of EBIT, 26% lower than last year and a deceptive figure. Breaking that number apart we can see that rental income rose 20% to $11m and revaluations contributed $7m to earnings.

Development profits are realised when new assets are completed and, along with land sales, are lumpy and drive volatility in total property earnings.

Brickworks realised $34m in development profits over the period compared to $3m last year. Don't read too much into that.

With a bank of surplus property yet to be developed, income from the property business should grow for years to come. Brickworks' share of the property trust is now worth $511m, up 6% from last year.

The final – and most controversial – leg of the asset base is a 42.7% holding in Washington H Soul Pattinson, a listed investment group with which Brickworks shares board members and a cross-shareholding.

We agree that this holding makes little sense inside Brickworks but it has delivered stellar returns over decades and we don't see a case to change it. Successful businesses often don't follow the rules and we are comfortable with the status quo.

Equity accounting rules mean that Brickworks realised $61m in profit from its holding but collected $33m in cash flow as dividends. An increase in both figures came from key holding New Hope Corporation, a coal producer that generated big gains in profit thanks to a recovery in coal prices.

Time to sell?

Booms are generally a good time to offload cyclical businesses but Brickworks is different. For one, it doesn't attract a boom-time valuation. A price-earnings ratio of 13 doesn't sound high but this is not the way to value this business. As we noted in Deconstructing Brickworks, we need to use a sum of parts approach, and this suggests there is still value on the table.

Brickworks isn't a typical building materials business either. With a steadily growing property business and a large investment portfolio, this is hardly a cyclical pig. The downturn didn't scare us away from the business and the boom won't rush us to the exits, at least not yet. HOLD.