We recently caught up with Boral investor relations to discuss the growth outlook for the business. Boral is Australia’s largest construction materials supplier. The stock has performed well over the past 5 years, benefiting from the growth in Australian residential construction, as illustrated by the two charts below. While Australian residential construction is now peaking, the next leg of growth is coming from US residential and Australian transport infrastructure construction. Combined with cost out following a major US acquisition in May 2017, these factors are expected to result in approximately 20% per annum earnings per share growth for Boral over the next two years.
|BLD 5 year share price chart||Australian residential construction work done (quarterly $bn)|
|Source: IRESS||Source: Australian Bureau of Statistics|
Boral now generates approximately 40% of its revenues in the US. The chart below shows US residential investment as a share of GDP, which remains below mid-cycle levels. The experience of past cycles, as illustrated, suggests that US residential construction is set to expand for a number of years yet.
US residential investment share of GDP
Source: Macquarie Research, November 2017
The volume of work done in US housing is growing at 4-5% per annum and, importantly, prices for building materials are increasing by at least as much again. This is important because building materials companies have high fixed costs and therefore strong operating leverage when prices increase. 35% of Boral’s US business is in fly ash, an ingredient in concrete which is a partial substitute for cement. Boral is achieving price increases of 8-10% per annum in this product.
The wave of Australian transport infrastructure projects commencing in coming years is a well-understood thematic. The below chart from Macromonitor shows the identified pipeline as at August 2017, which shows significant growth through to 2020. We note that further projects will be added to this outlook over time. Boral currently generates just over 20% of its revenues from Australian transport infrastructure and this is a key source of growth for the business.
Source: CIMIC result presentation, Macromonitor, August 2017
Australian residential construction also accounts for just over 20% of Boral’s revenues and the anticipated decline in this part of the business is expected to partly offset the growth in transport infrastructure. In the year to November 2017, the number of dwelling units approved for construction in Australian was down 6% over the prior year, as illustrated below. Positively, Boral has approximately double the exposure to detached houses as compared to apartments, with detached housing approvals holding up relatively better.
Source: Australian Bureau of Statistics
Risks to be aware of when analysing Boral include the relative growth in Australian transport infrastructure compared to the decline in Australian residential construction; the pricing environment for building materials and cost pressures from higher energy prices. Management has quantified the expected impact of higher energy prices in the 2018 financial year as being up to $20 million for the Australian business, which equates to a 6% earnings headwind. However, this should be more than offset by targeted year one cost synergies following the acquisition of Headwaters in the US.
Building materials is a cyclical business and the course of Boral’s share price will be heavily influenced by how the macro themes discussed above develop over the coming years. Given this earnings cyclicality, a reasonable approach to valuation is to focus on earnings for the next 2-3 years and apply an earnings multiple. Boral is currently trading around its 5-year average 12-month forward PE of 18.5x. Given the multi-year nature of the anticipated expansions in US housing and Australian transport infrastructure, the market may continue to value Boral on a similar multiple, which equates to an attractive PE/growth ratio of less than 1.0. Based on our earnings per share forecasts, if Boral trades on a forward PE of 18.5x in 12 months’ time, this translates to a share price of $8.75, which is our price target.