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Morningstar | Volumes Strong for Narrow-Moat Adelaide Brighton; Energy Prices and Sales Mix Affect Margins

While narrow-moat Adelaide Brighton’s top line remained strong in first-half fiscal 2018, energy prices and unfavourable mix shift constrained margins. Revenue increased 12% to AUD 807.2 million and came in 4% ahead of our expectations. Organic volume growth in cement and concrete of 7% outstripped our expectations for 3% growth, and led to the top-line beat. In spite of this, operating income underwhelmed at AUD 123.5 million, and while EBIT margins of 15.3% were a mild improvement from a year earlier, they remained short of our forecast of 18.8%. While we reduce fiscal 2018 earnings accordingly, our fair value estimate is intact at AUD 5.50 per share.

Construction activity in Australia remains buoyant, driving strong year-to-date cement and concrete volume growth of 7%, ahead of our prior expectations for 3%. With cement and concrete representing circa 80% of total business volumes, we upgrade our full-year forecast to reflect 5.0% growth in cement and concrete volumes in fiscal 2018, consisting of flat residential volumes and infrastructure and industrial/commercial volume growth of 10% and 6%, respectively.

Concrete and cement pricing strengthened, with average selling price growth ahead of CPI. While pricing for aggregates is also increasing in the majority of Adelaide Brighton’s regional markets, sales mix shift toward lower-value and lower-margin "fill" sales reduced average selling prices and dragged on quarry margins. This was the consequence of sales to a number of large, infrastructure projects requiring fill materials at their early project development stages. We expect the impact on margins to reverse out in fiscal 2019, however, as projects progress and require higher-value aggregates during later development stages. As such, we reduce our full-year fiscal 2018 EBIT forecast by 16% to AUD 267 million, with corresponding operating margins of 15.4%. We expect margins to then improve to 19.1% in fiscal 2019 as mix and energy headwinds abate.

Lime sales volumes, representing approximately 15% of sales mix, were flat relative to the prior period, while selling prices were slightly lower, reflecting pricing contracts that move with a lag to natural gas cost savings achieved in fiscal 2017. While not broken out individually, lime margins were further negatively affected by increased new coal fuel contract prices that were introduced in January 2018. Customer contract pricing mechanisms will allow for the recovery of lost margin in the second half of fiscal 2018, however.

Balance sheet flexibility remains, with net debt/EBITDA continuing in line with year-end fiscal 2017 at 1.25. Net debt remains well within the board’s range of 25%-45% of equity book value, ending first-half fiscal 2018 at 33%. Thus, Adelaide Brighton proceeded to return excess capital to shareholders, declaring a special dividend of AUD 0.04 per share. With management conceding that no major acquisitions are likely in the second half of fiscal 2018, we expect further return of capital via special dividends, and we still forecast a further AUD 0.04 per share special dividend in the second half.