EUR 850.00 For Business Accounts Only

Morningstar | Boral’s Returns Close in On Cost of Capital But Still No Moat; FVE Increased 10% on Analyst Transfer. See Updated Analyst Note from 19 Nov 2018

We increase our fair value estimate of no-moat Boral by 10% to AUD 6.30 per share following a transfer of analyst. Returns on invested capital are now expected to be lower over the coming five years, averaging 7.3% versus our prior forecast of 9.6%. We’ve also trimmed our estimate of Boral’s cost of capital, now assessed at 7.7% and down from our prior estimate of 9.6%. The sale and exit of a number of high fixed-cost, highly cyclical businesses, in particular, the reduction of bricks exposure, led to our reassessment of Boral’s systematic risk. The lower discount rate buoys Boral’s valuation in spite of our reduced return forecasts.

Expectations for the Australian segment are largely unchanged. We continue to expect Boral Australia’s top line to grow at an average of 3.3% annually over the five-year forecast period. Nonetheless, we marginally upgrade our expectations for Australian margins over the forecast period to an average of 12% from a prior 11%, with operating leverage expected to deliver slightly better margins.

Sales expectations for Boral North America also remain largely intact and we forecast growth to average 4.6% over the coming five years. But we reduce our margin expectations for the segment to an average of 12.8% over the coming decade, down from 16.2%. While we continue to see synergies flowing from the Headwaters acquisition as margin-accretive, we no longer see operating leverage quite so robust, limiting margin upside.

We’ve reduced our uncertainty rating to medium, down from our prior assessment of very high. Boral’s efforts to back away from higher fixed-cost building products exposures leads us to revise our uncertainty rating. We also upgrade our assessment of stewardship, to Standard from Poor. Since taking the CEO role in late 2012, Mike Kane has made significant inroads to improve the group’s capital allocation, divesting higher fixed-cost businesses with significant earnings cyclicality where Boral has no competitive advantage.

While we continue to rate Boral as no-moat at the group level, we acknowledge a number of businesses within the group do enjoy sustainable competitive advantages. Specifically, the Australian construction materials business, vertically integrated through quarrying, cement manufacture and concrete and asphalt production activities, enjoys a cost-led economic moat. Boral’s quarry assets, with superior proximity to Australian concrete consuming markets, deliver the majority of this cost advantage. Similarly, the recently acquired fly ash business in North America possesses a cost advantage-led moat which is supported by long-dated supply contracts with coal-fired power stations. While earnings from these businesses will constitute around two thirds of group earnings going forward, the lofty 10.3 times multiple paid for Headwaters will result in excess ROICs that would have been enjoyed by Boral being overwhelmed by excessive goodwill.