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Morningstar | Infrastructure and Nonresi Activity Buoys Boral in 2018; Improved Outlook Drives 10% Lift in FVE

Strong demand from Australian infrastructure and nonresidential construction drove a solid fiscal 2018 result for no-moat Boral. Revenue rose 39% to AUD 5.73 billion, while underlying EBIT rose 50% to AUD 688 million, largely attributable to the full-year inclusion of the Headwaters acquisition. These results were largely in line with our expectations for AUD 5.55 billion in revenue and operating income of AUD 658 million. A slight upgrade to our near-term infrastructure and nonresidential demand forecasts, along with an upgraded synergy target from the Headwaters acquisition, lifts our fair value estimate by 10% to AUD 5.70. We still view shares as overvalued.

While demand from Australian residential construction was largely flat in fiscal 2018, robust infrastructure and nonresidential construction saw Boral’s Australian segment EBIT increase 24% to AUD 433.4 million, 12% ahead of our forecasts. The infrastructure construction market, Boral’s largest Australian exposure, climbed 15% in fiscal 2018, while growth in nonresidential construction also surprised to the upside at 13%. We expect this dynamic to continue in fiscal 2019, with strong demand from these sources to offset an approximate 5% fall in total residential dwelling completions. Management anticipates operating income will remain roughly flat, including falling contributions from the property division, and our forecast matches this outlook at an EBIT of AUD 436 million.

We remain optimistic about Australian home completions. While we see a sizeable dip to fewer than 170,000 total home completions by fiscal 2023, down from 197,000 in fiscal 2018, we forecast a rise to more than 181,000 by fiscal 2028. EBIT will be buoyed near-term by robust infrastructure demand, and we expect a five-year EBIT CAGR of 1.3% through to fiscal 2023. With the residential market headwind abating in fiscal 2023, segment EBIT growth reaccelerates to a five-year CAGR of 2.3% over fiscal 2024-28.

North America revenue was largely in line with our expectations, but EBIT disappointed at AUD 208.1 million versus our AUD 226 million forecast. Lower construction materials volumes, adverse weather, and operational issues had a combined USD 33 million adverse impact on segment EBIT. Synergy benefits from the Headwaters acquisition of USD 39 million to date came in ahead of Boral’s USD 32.5 million target, however. Total expected yearly synergy benefits were also upgraded, rising 15% to USD 115 million. We expect margins to lift in fiscal 2019 to 11.4%, up from 9.7% in fiscal 2018, driving segment EBIT of AUD 254 million. Synergy benefits, in tandem with a recovering U.S. housing market, are expected to improve segment EBIT margins to 19.0% by fiscal 2028.

While a smaller contributor to group earnings, the USG Boral joint venture in Asia-Pacific markets delivered EBIT of AUD 63.1 million, down 9.2% year on year and below our expectations of AUD 78 million. Growth was stronger in China and South Korea, but softer demand in Southeast Asia affected the result, as did a one-off reserve adjustment of AUD 11 million relating to Indian exposures. Nonetheless, we expect the joint venture to return to growth in fiscal 2019, with EBIT of AUD 88 million forecast.

Meanwhile, capital expenditures of AUD 425 million compared favourably with our forecast of AUD 450 million. Combined with the stronger earnings performance, free cash flow of AUD 233 million was ahead of our expectations for AUD 156 million. While management’s fiscal 2019 capital expenditure guidance of AUD 400 million-AUD 450 million for fiscal 2019 is above our prior expectations, it is broadly in line with fiscal 2018.

The balance sheet remained healthy, with net debt of AUD 2.45 billion representing a multiple of 2.5 times EBITDA. This equates to a 30% gearing ratio, defined as net debt/net debt plus equity, well below Boral’s debt covenant of 60%. We expect free cash flow generation over the forecast period will improve balance sheet strength, with net debt/EBITDA falling towards the 1 times level by fiscal 2022.