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Morningstar | Strike Action Against Brickworks Provides CSR With Near-Term Upside Potential; FVEs Unchanged

Ongoing negotiations between no-moat Brickworks and the Construction Forestry Maritime Mining and Energy Union, or CFMMEU, have resulted in brick production employees threatening strike action. The strike is scheduled to commence on Sept 13, 2018 for an undefined period and currently involves just two of Brickworks’ nine brick plants taking part. The two plants affected are located in New South Wales, or NSW, while the remaining operating plants should allow Brickworks to put in place strategies to minimise the strike’s impact on sales. We expect a pragmatic approach from both sides to see the matter resolved without significant disruption to production and therefore retain our AUD 15.30 per share fair value estimate. Further, we continue to expect diluted earnings per share of AUD 1.10 in fiscal 2019 and await additional disclosure likely to eventuate at the fiscal 2018 full year result on September 20, 2018. Should the strike become a protracted affair, near-term revenue upside exists for no-moat CSR’s building products segment, with its PGH Bricks capable of capturing lost Brickworks sales. With an expedient resolution to the strike expected, we view this scenario as unlikely, however, and maintain our fair value estimate for CSR of AUD 4.10 per share while also maintaining our expectations for 5.1% EPS growth in fiscal 2019 to AUD 0.40 per share.

We see downside risks to Brickwork’s fiscal 2019 building product sales growth and operating margin should a strike persist for longer than we expect, but expect any disruption to prove temporary, limiting the impact to our valuation. While Brickworks will implement strategies to minimise supply disruption in NSW, we note that east coast brick manufacturing sites are already running at high capacity. Potential therefore exists for lost brick sales in fiscal 2019, depending upon the duration of the strike, with CSR the beneficiary of any lost demand under this scenario. Meanwhile, increased freight costs for Brickworks to transport replacement supply to NSW markets served by the two affected plants make for further risk to fiscal 2019 EBIT margins. However, any impact on sales and margins should abate once agreement is reached, leading us to maintain our long-term forecasts.

While the new Brickworks labour agreement carries risk for margins over the medium term, we see risk as relatively muted. Manufacturing labour, while not separately disclosed, is a significant share of the cost structure with total wages and salaries--which also include sales, administrative and executive remuneration--representing around 21% of the cost structure in fiscal 2017. Although near-term margins could be affected by greater-than-expected wage inflation as a result of a settled dispute, we believe that pricing power stemming from the duopoly brick market structure will allow labour cost inflation to be passed on over the longer term, minimising valuation impact. Further, we estimate the majority of Brickworks’ value is attributable to its cross-holding of Washington H. Soul Pattinson, making the labour dispute outcome less material to our fair value estimate.