Morningstar | Ferguson Stepping Up Capital Allocation on Acquisitions; Shares Fairly Valued
Our main takeaways from Ferguson's fiscal 2019 first-quarter results were (1) U.S. organic revenue is holding up, although we are still modelling in about half the growth this year versus last to reflect the natural turn in the new construction and remodelling cycle, (2) cost inflation, including 4% on labour, continues to prevent meaningful operating leverage benefits from high-single-digit revenue growth with EBIT margins stable at around 7%, and (3) the company is more aggressively allocating capital to acquisitions this year, including own-brand businesses, with spending around $700 million this year versus $435 million last year. While first-quarter 6.7% revenue growth is ahead of our full-year 3.6% forecast, we believe it is too early in the year to rule out a moderation in demand. The company's order book visibility tends to be around two months, so any given quarter is not necessarily a good indicator of the next. Given the high level of U.S. housing prices as well as industry expectations for a moderation in the U.S. remodelling market later this year, we are maintaining our forecasts for now with a fair value estimate of GBX 4,500 for the local shares and $5.90 for the ADRs. The shares appear fairly valued, and our no-moat rating is intact.Most of Ferguson's acquisitions are too small to require reporting financial information on the target, so we don't have a great sense of the quality of the businesses in terms of returns and profits, but at the group level we haven't seen recent acquisitions manifest in worsening profits or returns. However, we see the risk of dilution on margins or returns increasing this year with substantial acquisitions, two of which might be around $200 million. We hope to gain more insight into the financial health of the larger acquisitions once they are announced.
Ferguson is a holding company. Through its subsidiaries, Co. is a distributor of plumbing and heating products in the U.S. Co. operates nationally serving the residential, commercial, civil and industrial markets. Co. operates seven business units in the U.S.: Blended Branches, which provides plumbing and heating solutions ; Waterworks standalone, which distributes pipe, valves and fittings, hydrants, meters and related water management products; B2C e-commerce, which sells directly to consumers via websites using the product range and distribution network of the Blended Branches business; as well as Other, which comprises industrial standalone, fire and fabrication, and facilities supply.
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