Brickworks: Result 2018

Brickworks has reported a record full-year result; each of the company's three divisions generated record profits and the building products division generated twice the profit it did during the cyclical trough. Yet the share price fell 6%.

As always, the market is looking to the future and, for Brickworks, that could mean cyclical profits have peaked.

The building boom has dramatically improved results for the building products business. Yet, seen in isolation, the boom isn't easy to spot in the numbers.

Earnings before interest and tax (EBIT) from the building products business rose 17% to $76m. EBIT margins approaching 10% and returns on tangible assets over 14% aren't excessive but, for a business that typically earns half that rate and is always capital intensive, these are strong outcomes.

Property wobbles

Falling property prices and tighter credit markets have begun to impact construction activity and the company flagged weaker sales in some east coast markets to accompany ongoing weakness in Western Australia.

Housing approvals in NSW and Victoria are now at cyclical peaks and investors are right to prepare for the next downturn. Higher energy costs have also hurt, increasing costs by millions of dollars per month.

Yet building materials is one of three segments in Brickworks and, arguably, the least valuable.

Brickworks owns a 42.7% stake in Washington H. Soul Pattinson which, on market prices, is worth $2.5bn, easily making it the largest part of the business. That stake leaves Brickworks exposed to New Hope Corporation and TPG Telecom as much as it does the east coast building cycle.

High coal prices and TPG's proposed merger with Vodafone delivered 20% higher EBIT to $123m and, via dividends from Soul Patts, $56m in cash flow.

Brickworks has long maintained that the holding in Soul Patts provides cash and stability to offset cyclicality in the building products business but the division has now grown to be the largest source of profit.

The third leg of the company, the property division, delivered rising if unspectacular results. Brickworks' property business generates stable rental income of $22m, a sum that will rise as more land is developed and leased.

Development profits, price revaluations and asset sales all chipped in to generate $94m in total EBIT for the year. With land revaluations contributing $24m, lower property prices may affect divisional profits but the relationship between residential property markets and regional properties held by Brickworks for industrial use isn't clear so it's a mistake to mark down value because residential house prices are falling.

Divisional value

What is clear is that despite capturing the headlines and the attention of investors, the building products business is the smallest part of Brickworks by some measure. We value the division at about $300m, compared to building materials net assets of $700m.

That valuation may appear low against current earnings but takes account of the division's cyclicality and capital intensity.

The property market shouldn't concern investors too much because exposure is relatively small and our valuation more than accounts for it.

The property business remains something of a hidden gem within the portfolio and consistently generates strong and stable returns. Net property assets sit at $574m and that values the land bank at book value. We think it could be worth far more and results in a conservative valuation for the division that has plenty of undeveloped assets to drive higher earnings for years.

Brickworks is a well managed, decent quality business that has been on and off our Buy list for years. A further downturn in property markets shouldn't worry those who understand the business but could panic the many who don't. Another opportunity may well appear if the construction market slows. For now, HOLD.