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Morningstar | Narrow-Moat Adelaide Brighton Reveals Successor CEO; Reducing FVE by 9% on Transfer of Analyst

We reduce our fair value estimate for narrow-moat Adelaide Brighton by 9% to AUD 5.00 per share following a transfer of analyst, while maintaining our Standard stewardship and medium uncertainty ratings. Despite a cooling residential construction market, which represents around one third of group sales, demand is expected to remain strong, owing to a significant pipeline of Australian infrastructure projects over the coming five years. With infrastructure markets also representing around one third of sales mix, we now expect sales growth to average 4.9% over the coming five years, up from a prior 3.6% with price increases implemented to offset surging Australian energy prices. However, we have also trimmed our midcycle operating margin assumption to 16.5%, down from a prior 20% forecast, and compared with 13.7% in 2017. With Adelaide Brighton’s domestic clinker plants already running at capacity, margin upside from operating leverage will be limited. Without material margin expansion out of reach, Adelaide Brighton shares currently screen as overvalued.

Adelaide Brighton’s narrow moat is driven by cost advantage from its superior scale in grinding and processing of clinker in its major markets of South Australia, Western Australia, and the Northern Territory. Economies of scale, from the spreading of fixed costs associated with the clinker grinding and processing, are available to the player with superior grinding capacity within discrete cement consuming markets. Upfront capital costs for grinding capacity are modest and thus not prohibitive of new entry. However, without the ability to capture production volumes that are similar or better than the regional incumbent, which currently supplies the market in full, it is not possible for a new entrant to compete on price due to inferior unit costs. Thus, the limited cement demand within Australia’s regionally discrete markets provides a cost advantage to incumbents who have substantial existing capacity.

Nick Miller has been named as successor to current CEO, Martin Brydon who announced his intention to retire in August 2018. Miller is currently serving as CEO of Broadspectrum, a diversified group with expertise in infrastructure design, construction and management and facilities management. We are encouraged by his depth of experience in construction and infrastructure markets which Adelaide Brighton supplies.