Join our community of smart investors

One plus one equals?

As a result, Ferguson’s shares lost 93 per cent of their value. But thanks to brutal cost-cutting, the US Economic Stimulus Act of 2008 and dull-but-prolonged growth in the US economy, Ferguson – it took that name in 2017 – survived and eventually thrived.

So much so that now its bosses plan to turn it into a group wholly focused on North America. They will float off the UK arm, presumably as Wolseley, and, most likely, will domicile the new Ferguson in the US with its sole share listing on a US market. Yet once more the timing looks inauspicious. Recession looms on both sides of the pond, prompting the thought that the exercise won’t conjure extra value.

The market seems undecided. Ferguson’s shares closed at 6,140p the day before the intention to demerge Wolseley UK was announced early last month. They promptly fell to 5,892p before recovering to the current 6,342p, helped by decent results for 2018-19 and management sounding characteristically confident about grabbing more market share.

It does not help that there is always a logical fault in these exercises in corporate value contrivance. They rely on the belief that one plus one somehow equals more than two; that Ferguson North America and Wolseley UK separated will be worth more than in their present form; that investors, operating in an efficient market, can miss factors that would generate measurable amounts of value and then – cursing that they could be so dim – spot them when the businesses are separated.

Yet logic often indicates that two groups should be worth less when they are split apart. After all, fixed costs that could be absorbed across a wider range of subsidiaries will have to burden fewer. Similarly, tax costs are likely to rise as fewer group-wide expenses are available as offsets.

There is also the possibility – although this runs contrary to the point about market efficiency – that it might not be smart to expose Wolseley UK to greater scrutiny from investors. It has neither a marvellous track record nor the prospects of trading against a helpful economic backdrop. Its $2.28bn (£1.87bn) of revenue for the year to the end of July was exactly the same as five years ago, during which period its operating profits have almost halved to run out at $65m in 2018-19. And it’s not as if the UK builders’ merchant has been starved of capital. At least, across the shrinking UK operation, capital spending has averaged 1.4 times depreciation in the five years 2015-19, which is a touch more than the ratio for the much bigger – and growing – US operation. Then there is the UK’s economic outlook about which we need to say little except to note that Wolseley is wholly exposed to an especially cyclical sector.

Meanwhile, the performance of Ferguson in the US has been as lively as the UK has been dull. In the five years to July 2019, US revenue more than doubled from $8.7bn to $18.4bn while operating profits rose even more, from $672m to $1.51bn.

However, much of that growth has been fuelled by acquisitions. Over the same period, Ferguson has shelled out $1.67bn, buying mostly Mom-and-Pop builders’ merchants. In 2018-19, for example – a more active year than most – it spent $657m on 15 acquisitions. This may be proof of practising making perfect deals (see last week’s Bearbull). Alternatively, it may be good, old-fashioned ‘boot-strapping’, where big companies enhance their earnings – but not their per-share value – by acquiring small companies on lower multiples of profits than those on which their own shares trade.

Into which category fall the likes of Dogwood Building Company of North Carolina or Kitchen Art of South Florida – both acquired last year – I could not say. Yet in the long run that will be important because the presumption behind separating out Ferguson North America from the rest is that it will enhance value; that shares in a US-listed Ferguson will trade on a higher rating than the multiple of 17 times 2018-19’s earnings on which Ferguson’s London-listed shares currently trade.

They might do, but it’s not certain. True, shares in most of the US companies with which Ferguson wants to be compared with trade on higher multiples – the likes of Fortune Brands (US:FBHS), AO Smith (US:AOS) and Masco (US:MAS). But there is little in it and another comparator – Whirlpool (US:WHOL) – trades on a much lower multiple. Besides, measured by market capitalisation, Ferguson is usefully bigger than all of those so its lower rating might even lead the others down rather than the other way around.

And what of Wolseley UK when it is abandoned to fend for itself? That hardly looks like a repository of value. Quite possibly, the best that could be hoped for is that it is snaffled up in quick time by a predator keen to spread its overheads across a bigger operation; Travis Perkins (TPK) would be the obvious candidate.

True, UK shareholders should not fear Ferguson being split up, especially as a US listing presents no administrative difficulties (unlike most other overseas listings). But nor should they assume it will magically create value.