Reece: Result 2017
Recommendation
For one of Australia's best businesses, Reece loves leaving its results until the last minute. This year the company released its 2017 results on the last possible day of reporting season. Perhaps management had better things to do – like running the business.
Because running the business is what Reece's management does exceptionally well. The company's reason for being is to make life easier for its tradie customers, and in 2017 it made further progress down that road.
Two years ago Reece had only two distribution centres in Australia. Today it has four – in Melbourne, Brisbane, Perth and Sydney – covering a total area of 125,000 square metres. That's more than 16 times the floor space of your average Bunnings warehouse.
Key Points
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Another solid result
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Company investing in network
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Minor earnings downturn expected
Reece's thing is to have stock available for its tradie customers when they need it. Its distribution centres hold stock before the company delivers it to a network of almost 600 branches across Australia and New Zealand. Logistics – moving stuff around – is what this company does, which is why it has $64m of motor vehicles on the balance sheet (trucks, mainly).
Branching out
Having sufficient space for its inventory has become even more important since the acquisition of Actrol (see Reece: Three reasons from April 2016). HVAC-R technicians can now obtain parts from all branches in the network (including Reece plumbing supplies outlets). It's all part of Reece's long-term plan: become the dominant wholesaler to the HVAC-R industry just as it already is for plumbing supplies.
HVAC-R: Heating, ventilation, air-conditioning and refrigeration. |
While Reece keeps its cards close to its chest, we suspect this latent potential is behind the following management comment in the 2017 annual report: ‘Despite a view in some areas of the market that housing activity is past its peak, we expect growth overall. We see a strong Australian economy, record housing prices and a market that presents many opportunities.' It's a surprisingly bullish statement.
There's no doubt that Reece has benefited from strong housing activity. Revenues rose 6% to $2,431m in the year to 30 June 2017, while earnings before interest, tax, depreciation and amortisation (EBITDA) rose 7% to $359m. Net profit rose by 10% to $212m.
Year to Jun | 2017 | 2016 | /– (%) |
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Revenue ($m) | 2,431 | 2,292 | 6 |
EBITDA ($m) | 359 | 334 | 7 |
Net profit ($m) | 212 | 192 | 10 |
EPS (cents) | 213 | 193 | 10 |
DPS* (cents) | 100 | 92 | 9 |
Franking (%) | 100 | 100 | N/a |
* Final div of 71 cents, fully franked, up 9%, ex date 10 Oct. |
Over the past five years, EBITDA has risen 83%, while EBITDA margins have expanded from 13% to 15%. Some of the increase in earnings came from the Actrol acquisition, but margin expansion has occurred in previous booms, so there's a risk of minor contraction as housing activity cools.
Nevertheless, we're expecting another earnings increase in 2018. That's mainly because Reece's exposure to housing activity is ‘late cycle'. Taps, toilets and baths are fitted as houses and apartments near completion. This is consistent with management's view above.
The long goodbye
Where the problems might occur is in the 2019 financial year and beyond. The peak for dwelling commencements looks to have been in 2016 – when there were 232,000 – so it will take a few years for building activity to subside. By 2019 commencements are expected to be in the order of 25% lower than the 2016 peak.
So are we worried?
Yes and no. Most of Reece's business comes from less cyclical activity, such as maintenance, repairs, and renovations. Reece is more cyclical than in the past, simply by virtue of being larger. But we'd expect any weakening of sales and earnings to be minimal – absent a housing market crash, anyway.
The sharemarket being the forward-looking mechanism that it is, it's already anticipating a slowdown. At Reece's current price the stock is trading on a 2018 forecast price-earnings ratio of 18. That's about as low as the stock ever trades; Reece has traditionally commanded a market premium because of its top-notch management, excellent record and bulletproof balance sheet. Our view is the market is already anticipating an earnings fall of perhaps 15% in 2019 (similar to what occurred in 2009).
We continue to think the long-term upside from HVAC-R wholesaling is underappreciated. It's clear Reece has spent the years since the 2014 acquisition of Actrol building the foundations for the business to take market share. Further ‘bolt-on' acquisitions are possible as weaker players leave the industry.
Despite a looming downturn in housing construction activity, we believe Reece's intrinsic value has increased since we upgraded the stock eighteen months ago in Reece: Three reasons. We're therefore lifting our price guide to Buy up to $40.00 and Sell above $60.00. We're not a long way from an upgrade, and housing market concerns could help us get there. HOLD.