Seek refuge in Ferguson

It’s not difficult to see why some investors have taken fright. Ferguson generates about half of its US revenues from residential building and just over a third from commercial projects, with the remainder coming from industrial, civil and infrastructure projects. Since midway through 2018, markets have been digesting a general weakening in data on new building permits, new private housing starts and new housing sales. However, the US is some way off a full-blown cyclical downturn.

Among reasons to be positive on the outlook is a fall in US mortgage rates since November 2018, which could help boost the US housing market, providing a better backdrop for Ferguson's sales. And it is easy to understand why investors may be overly sensitive to signs of a turn in the cycle given the length of the recovery since the 2008 financial crisis.

Guessing the housing market is ultimately a fool’s game, though. The group’s activities are underpinned by a strong balance sheet that supports acquisitions, with a net debt to cash profits multiple of 1.1, which is at the bottom end of its target range of between 1 and 2. Ferguson made 10 bolt-on acquisitions in its first half, with total annualised revenues of $611m (£468m). In a sign of Ferguson’s confidence in the outlook for the US, all but one of these were conducted in the the country (Ferguson also acquired James Electric Motor Services in Canada in September 2018). These included deals in plumbing supply, installation services, and heating and cooling products. By way of comparison, Ferguson only made 13 acquisitions across its whole prior year. The group aims for the majority of its growth to be organic, but precedent suggests further deals in its second half could add value and contribute to better share price performance. Analysts expect Ferguson’s mergers and acquisitions spend to fall over the second half, however.

Ferguson also significantly increased capital expenditure in the first half to $244m, against a prior year level of $175m. Given this spending, it's fortunate that return on capital employed looks healthy, coming in just shy of 20 per cent last year, based on S&P Capital IQ data, or 17 per cent making an adjustment for lease obligations. Cyclical considerations aside, returns should stand to benefit in the longer term from restructuring in the UK and the potential to improve the sales mix.

Broker Peel Hunt forecasts 2019 full-year pre-tax profits and earnings per share of $1.6bn and 498¢, respectively, rising to $1.7bn and 523¢ in 2020.