Reece: Result 2016

Reece’s full-year result exceeded expectations but there’s still growth to come.

Our opportunity to buy plumbing supplies company Reece earlier this year was unfortunately brief (see Reece: Three reasons). Despite the stock being near all-time highs back then, it’s since risen 35%, including 11% on Friday.

Key Points

  • Underlying net profit up 15%

  • Operating margin up from 11.9% to record 12.5%

  • Building activity to slow

The reason was the company’s 2016 result, which was ahead of expectations. Sales rose 9% to $2,276m, while underlying net profit, removing the effect of a property sale and goodwill writedown, rose 15% to $190m (see Table 1).

Reece is traditionally stingy when it comes to dividends. It’s a sensible policy because, with a return on capital employed of 26%, the company can reinvest shareholders’ funds at a high rate of return. But in 2016 it lifted dividends 21% to 92 cents a share, which was considerably more than profit growth. It probably reflects the 22% rise in free cash flow in 2016 and we think it signals management’s confidence in the future.

Table 1: Reece result 2016
Year to 30 June 2016 2015 /(–)
(%)
Revenue ($m) 2,276 2,085 9
EBITDA ($m) 332 292 14
EBIT ($m) 285 248 15
NPAT ($m) 190 166 15
EPS (c) 190.6 166.2 15
DPS (c) 92 76 21
Franking (%) 100 100 N/a
* Final dividend 65 cents, ex date 10 Oct
Note: Figures are underlying results

Margin expansion

Perhaps most surprising was the margin expansion. Reece’s operating margin rose from 11.9% to 12.5%, its highest on record. Managing director Peter Wilson explained the reason without fanfare: ‘FY 2016 saw building activity at record levels’. Reece’s margins have typically expanded during times of buoyant demand but 12.5% margins are indisputably high.

Wilson explained that building activity is ‘expected to slow during the next financial year’ so it’s likely that margins are near their peak. Absent a severe housing downturn, though, Reece’s profits shouldn’t fall sharply, consistent with past contractions. In any case, 2017 should be another decent year given Reece is exposed to ‘late stage’ building activity.

We continue to think Reece’s ability to consolidate the HVAC-R industry is a source of potential growth. But with the share price having risen sharply and the stock on a historical price-earnings ratio of 24, it remains a HOLD.

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