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Forterra solid as a brick

Demand for bricks is holding up well
January 3, 2019

With 93 per cent of sales generated from the residential sector, including 60 per cent from new-build, brick company Forterra (FORT) is largely dependent on the health of the home construction market. While there are signs that the housing market is cooling, demand for bricks is likely to remain high given the government's ambitious target for 300,000 new homes a year, which compares with the near-200,000 that are expected to have been built in 2018. Meanwhile, planning constraints for new brick plants and the expense of importing bricks means brick supply remains relatively tight while inventories are relatively low.

IC TIP: Buy at 219.5p
Tip style
Value
Risk rating
Medium
Timescale
Long Term
Bull points

Constrained UK brick supply
Solid demand
Plans for capacity increase
Falling debt

Bear points

Heavy exposure to new-build
Vulnerable to weather-related delays

It seems harsh, then, that Forterra's share price has fallen by a quarter this year against a 14 per cent decline by the wider materials sector. Priced at just eight times 2019 forecast earnings, with a healthy free-cash-flow yield of 11.3 per cent and forecast 5 per cent dividend yield, we think too much focus is being put on several one-off issues encountered during 2018, as well as on the signs of a slowdown at some big housebuilders.

Profits for the year to December 2018 will have been trimmed by £2m-£3m because overheating at Forterra's Desford plant requires a full rebuild of the damaged section, and the closure of the plant for around six weeks. Poor weather also hit trading at the start of last year, disrupted integration of an acquisition and pushed up half-year working capital. A further problem in 2018 has been a significant rise in cost pressures from energy prices as well as fuel and carbon credits that Forterra is required to buy under the terms of the EU Emissions Trading Scheme. While these cost increases are expected to continue into 2019, Forterra reckons this will be more than covered by higher selling prices.

In the short term, price rises are likely to be the main growth driver because Forterra's production is running near to capacity. However, there is a new brick facility being built alongside the existing plant at Desford, which is expected to cost up to £95m, but will more than double the existing site capacity by 2022 to 180m bricks a year. The investment is expected to produce a 15 per cent after-tax internal rate of return over 20 years and increase total group production by 16 per cent, from 590m to 685m bricks. This is significant when considering that the industry's monthly average production in the 12 months to May 2018 was 160.9m.

Running at full capacity means that Forterra is generating a lot of cash that will help finance the planned investment. Since floating in April 2016 through to June 2018 net debt has fallen from £155m to £51.9m, or just 0.7 times cash profits.

As well as bricks, Forterra also produces aircrete and aggregate blocks that can be used for a variety of construction processes such as retaining wall projects, housing and other structural projects. The blocks produced offer high thermal and sound insulation and are easy to install. These account for around a quarter of group revenue.

FORTERRA (FORT)   
ORD PRICE:219.5pMARKET VALUE:£440m
TOUCH:219-219.5p12-MONTH HIGH:340pLOW: 210p
FORWARD DIVIDEND YIELD:5%FORWARD PE RATIO:8
     
NET ASSET VALUE:58pNET DEBT:44%

 

Year to 31 DecTurnover (£m)Pre-tax profit (£m)Earnings per share (p)Dividend per share (p)
201529033.813.7nil
201629454.322.35.8
201733161.124.19.5
2018*36266.026.110.5
2019*37969.527.611
% change+5+5+6+5
Normal market size:1,500   
     
Beta:0.85   
*Peel Hunt forecasts, adjusted PTP and EPS

One potential growth area in the coming year is the bespoke products division. This provides specialist pre-cast products such as box culverts, bridge parapets and escape shafts. Trading started the year in a bad way because the weather put a lot of projects on hold, and first-half cash profits slid from £3m a year earlier to just £0.7m. At the same time, it was trying to integrate its Bison acquisition made in late 2017. The situation was further complicated, for while capacity utilisation at the Bison Swadlincote plant was increased, this was hampered by a lack of yard space as customer site construction delays resulted in a build-up of inventories. However, this side of the business has successfully played catch-up since then, and barring another nasty winter should provide room for growth. There has already been a steady conversion of the order book into deliveries,

Forterra is reliant on the repair, maintenance and improvement (RMI) market for around one-third of group revenue. While RMI activity in the residential sector remains weak, demand is underpinned by the Fletton brick sold under the London Brick, which only Forterra supplies. As the brick has been used in around one-quarter of England’s existing housing stock, it is also used by homeowners carrying out extension or improvement work. Encouragingly, planning applications of £100,000 or less – a good indicator of RMI demand for Forterra's bricks – has held flat despite the weakness in other areas of RMI.