An attractive entry point for this deal-hungry mid cap

Breedon had started quoted life on London’s junior market 15 years earlier as Marwyn Materials, having raised £13.6mn to buy stakes in building materials companies. It became Breedon in 2010, following a £160mn reverse takeover of a bunch of quarries and other assets owned by the former Ennstone business. 

At the time, it had less than 200mn tonnes of reserves and resources in 29 quarries, but further acquisitions have seen it expand to a group operating more than 300 sites, including 100 quarries, 170 ready-mixed concrete plants and 50 asphalt plants. Revenue has grown from £169mn in 2011 to £1.4bn last year, while underlying earnings before interest and tax grew from £6mn to £155mn over the same period.

It now has 1bn tonnes of aggregate reserves and resources at its disposal, which is enough for 30 years of operations. This is important given the difficulty in securing planning permission for new quarries. Breedon is one of five big mineral producers in the UK, which between them control around 78 per cent of approved reserves. 

Its most notable deals include the £336mn purchase of Derbyshire-based Hope Construction Materials in 2016 and the £455mn buyout of Lagan Group two years later. It also secured more than 100 sites from Mexican cement giant Cemex after buying its UK assets in 2020 for £178mn. 

More deals were announced last week. It acquired three separate businesses for around £19mn, which offer a decent demonstration of its business model. One is Robinson Quarry Masters, a family-owned quarrying and concrete block business in Antrim, north of Belfast. The second is a concrete block maker, Broome Bros in Doncaster, which has its operations next door to one of Breedon's concrete plants. The third is a Lincoln-based road surfacing business, Minster Surfacing.

Margin building

The three were all family-owned firms and show how Breedon has built an acquisition pipeline “through our local knowledge and personal engagement with the owners”, says Rob Wood. 

They also demonstrate the group's ability to “pull through upstream building materials while extending our downstream footprint to deliver profitable growth”, he adds. Or, to put it in simpler terms, to use the materials it digs out of its quarries in higher-margin processes to eke out more profit.

The crushed rock, sand or gravel dug out of the ground is first converted into higher-value material, such as concrete or asphalt, at one of its plants. This can then be used by another group company, such as the concrete block maker or a road surfacing contractor. Therefore, although a road surfacer's profit margins are slim, it is a capital-light business and Breedon earns an additional margin from supplying the aggregate and producing the asphalt itself. As a result, for a group handling fairly basic building materials, Breedon has managed to generate a double-digit operating margin in seven of the past eight years; the only exception being a Covid-interrupted 2020. Its return on invested capital last year was also above management's 10 per cent target.

Although Breedon has largely grown through acquisitions, management has been careful not to overburden the balance sheet, repaying debt quickly. Net debt (excluding leases) was cut from 5.6 times underlying cash profit following the Breedon reverse takeover in 2011 to 1.9 times two years later and the multiple has remained below two ever since.

The group makes 87 per cent of its revenue in the UK and the rest in the Republic of Ireland. In both markets, it offers exposure to some ambitious government spending plans on infrastructure. In the UK, government capex on infrastructure rose to £93bn last year and is forecast to increase by a further £20bn to £113bn this year, as part of plans to invest £600bn in infrastructure over the lifespan of the current parliament. In Ireland, capital investment is forecast to increase by 5 per cent this year to €12bn (£10.4bn) under the country’s €165bn National Development Plan.

Given that infrastructure represents around half of Breedon’s revenue in terms of end markets, one might have expected a little more enthusiasm from investors. However, its share price has followed a similar path to other building materials companies. Although the shares trade around 50 per cent higher than they did at last year’s nadir, just after former chancellor Kwasi Kwarteng’s disastrous mini-Budget, this represents a price/earnings ratio of just 11.5, below their five-year average of almost 15 times. The company’s enterprise value (equity plus debt) of £1.28bn is less than one year’s sales, and only around 5.5 times its cash profit – lower than the five-year average of 9.6 times. 

Some apprehension is understandable, given the dire forecast the Construction Products Association (CPA) gave for the sector in its spring forecast last month. The trade body forecasts that construction output will contract by 6.4 per cent this year, worse than its earlier estimate of a 4.7 per cent shrinkage. A 17 per cent drop in private housing activity is the main driver for this, as well as weaker DIY spending.

The Mineral Products Association forecasts a 3 per cent decline in demand for primary aggregates and ready-mixed concrete this year, and a recovery in 2024 as the housing market revives. However, housing only represents 20 per cent of Breedon’s customer base, and the CPA expects infrastructure demand to keep growing, albeit at a slower rate of just 0.7 per cent this year and 1.2 per cent next. 

Moving upmarket

The remaining 30 per cent of Breedon’s business by end markets is industrial and commercial property projects. Although investment in warehousing projects appears to have peaked, “there’s still a pipeline” of existing projects that will be delivered over the next 12-18 months, Wood told analysts in March.

Besides, there are other potential short-term drivers for Breedon’s share price; in particular, a reversal of recent share sales driven by technical factors. Analysts at investment bank UBS estimate that around 5-6 per cent of those who held Breedon shares on Aim would have been forced to sell after the stock left the junior market. Breedon's shares were then consolidated at the ratio of one new for five old shares, but the new Breedon shares will only be eligible for inclusion in the FTSE 250 index in September. This provides “an attractive entry point” before passive funds that track the index are allowed to buy Breedon shares. Once they do, UBS analysts expect passive buying of 5-6 per cent, “with active flows (ie, buying) incremental to this”.

There are other incentives. Although the company only paid its maiden dividend in 2021, it increased this last year to 30 per cent of underlying earnings per share as part of a progressive dividend policy, with the aim of hitting a payout ratio of 40 per cent. Moreover, after introducing more price increases in the early part of this year, Breedon achieved first-quarter revenue growth for 2023 of 10 per cent, suggesting City analysts’ forecasts of revenue growth of just 3 per cent for this year is a little conservative. 

And with a strong balance sheet (net debt had fallen to 0.7 times underlying cash profit by its December year-end), management has plenty of firepower to go out and do other deals, or even put into practice its longer-term ambition to break into the US market. The prospectus for its move to the main market says Breedon “outlined the possibility of selectively establishing a platform in the US”, citing a similar cultural and regulatory environment. It adds that the directors believe a move into the US could “play to the group’s experience and strong track record of acquisition integration”.

That said, cracking the American market has been an ambition of many UK-listed companies, with varying results but it it has benefited peers such as CRH (CRH) and Ferguson (FERG).

Breedon’s biggest shareholder certainly seems supportive, though. Abicad Holding, which until recently was represented on the board by company chairman Amit Bhatia, upped its stake in Breedon in March and owned a 12.5 per cent stake in the company ahead of its main market listing.

And even if Breedon takes its time with its Stateside ambitions, there are still plenty of opportunities to put its money to work on this side of the Atlantic. Management hasn't exactly been shy in making acquisitions over the past decade and, with 300-or-so quarries still owned by family firms as well as scores of regional road surfacing businesses in operation, it won't be short of opportunities to build on some fairly solid foundations. Buy.