EUR 850.00 For Business Accounts Only

Morningstar | Ferguson FY18: No Signs of U.S. Slowdown but Margins Unlikely to Expand Further Next Year

While Ferguson's full-year results were in line with expectations, we think the stock sold off on concerns about tougher comparables in 2019 and the inevitable turn in the remodeling cycle. We see no indications of the cycle softening for U.S. construction; however, we think the stock has more than priced in the recent value drivers, namely taking share in the U.S., showing more discipline in branch pricing, and importantly, exiting much of its international portfolio. We retain our no-moat rating but expect to make modest changes (less than 5%) to our fair value estimate.

More than 90% of Ferguson's profits come from its U.S. businesses. Here, organic revenue still looks impressive with 11% growth in the fourth quarter and 10% for full-year 2018. Next year, we would expect high-single-digit growth. U.S. consumer debt levels remain at the lower end of the range going back to the 1980s (measured by household debt service payments as a portion of disposable income). While U.S. 30-year mortgage rates have ticked up recently, they remain at low levels relative to the past 30 years. Equally, recent growth figures for U.S. homeowners' remodelling spending looks stable, as indicated by the Leading Indicator of Remodeling Activity, or LIRA.

The U.S. trading profit margin picked up modestly by 40 basis points to 8.4% versus  2017. We would not expect margin expansion in 2019, given inflationary pressures, including from wage growth, and investment in own-brand products.

The company is seeing 3%-4% wage growth. The U.S. labor market remains tight, with unemployment below 4% and rising wages, as evidenced by Walmart and Amazon's recent moves to increase wages for U.S. workers and the 2.9% wage growth rate released by the U.S. government for August.

The U.K. business' performance remains woeful, with a contraction in both revenue and margins in the fourth quarter. However, we see this business as less central to the investment story relative to the U.S. remodeling cycle.