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Date : 28/09/2022

Brickworks

ASX :

BKW

Market Cap : $3.20 Billion

Dividend Per Share : $0.63

Dividend Yield : 2.97 %

Buy

52 Week Range : $17.00 - $25.30

Share Price : $21.15

Brickworks has delivered a fantastic FY22 result and its outlook is robust with all segments expected to continue performing well. We maintain our 'Buy' rating.

Company Analysis

Brickworks (ASX: BKW) has delivered an outstanding result in FY2022, achieving record earnings amidst the backdrop of continued volatile economic conditions. If you have been with us through the past year here at Shares in Value, chances are you have read a couple of reports on Brickworks. Our latest was before the earnings season, on the 29th of June when BKW shares were trading at $19.08.

Brickworks has all the attributes that make it a quality dividend stock, and its share price has held up despite the turbulent and concerning tumbles we are witnessing in global markets. In our June report, we expected a bullish FY22 financial performance, and Brickworks did not disappoint. Since then, BKW shares have returned 11%.


Source: Tradingview.com

Brickworks’ Strategy delivers against several challenges

In addition to the record earnings, BKW has made strong progress in delivering its strategy. This is illustrated by initiatives such as the launch of the Brickworks Manufacturing Trust, the purchase of strategic land assets in western Sydney, the completion of the first facilities at the new Oakdale West Estate, the commissioning of the new masonry plant in Sydney, and the completion of further bolt-on acquisitions in North America.

During the year, demand for Brickworks’ building products was strong, with housing markets in Australia and the United States supported by government stimulus packages implemented in the aftermath of the COVID-19 pandemic. Meanwhile, the continued growth of online shopping and subsequent demand for well-located logistics facilities has increased the value of BKW’s industrial property assets.

Whilst conditions have been broadly supportive for the business; the year has also been highlighted by several challenges that BKW has overcome. In the first half, the building products businesses in Australia and North America were still being significantly impacted by COVID-related issues – including restrictions on building activity and workforce absenteeism.

Then in the second half, unprecedented wet weather along the east coast of Australia, and severe labour shortages, impacted operations in many ways. In addition to reducing building activity, the inclement weather caused significant delays to development activity within the Industrial JV Trust and to the construction of the new brick plant in Sydney.

Late in the financial year, high inflation and rising interest rates in Australia and the United States have reduced consumer sentiment levels. Whilst this threatens to impact the economy over the next 12-24 months, Brickworks remains well placed to meet these challenges and continue to deliver strong returns for shareholders – and this sentiment is being reflected in the share price’s resilience to the downswing.

Company Updates

There are four divisions within the Brickworks Group structure, and all of these have had a robust FY22.

  1. Property,
  2. Building Products Australia,
  3. Building Products North America, and
  4. Investments (such as Washington H. Soul Pattinson (ASX: WHSP)).


Source: BKW

Landmark Year for the Property Segment

The Property segment had a tremendous year, generating a record EBIT of $644 million, up 155% from the prior year. Earnings from the Industrial JV Trust were again the key driver of the result. All assets were revalued during the year, resulting in a strong revaluation profit of $227 million (representing Brickworks’ 50% share of the overall valuation gain).

Significant development profits were also recorded, including completing several new facilities. A highlight for the year was the completion of the state-of-the-art Amazon distribution centre, the first facility at Oakdale West (Sydney). This follows many years of planning and investment in site preparation and infrastructure at this Estate. With additional facilities now close to completion, Oakdale West is well on the way to becoming one of the most prestigious industrial property precincts in the southern hemisphere.

Other Estates at Oakdale South (Sydney) and Rochedale (Brisbane) have now been fully built out, following the completion of final developments at these precincts during the second half. The revaluations and developments during the year have resulted in total gross assets within the Industrial JV Trust increasing by around $1.5 billion to $4.2 billion. After including debt, Brickworks’ 50% share of net asset value held within the trust was $1,543 million at the end of the financial year.


Source: BKW

Launch of Brickworks Manufacturing Trust

In July, BKW announced the launch of the Brickworks Manufacturing Trust, a new Joint Venture manufacturing property trust with Goodman Group (“Goodman”). This trust will initially house a portfolio of 15 manufacturing plants, tenanted by Brickworks’ Building Products Australia businesses such as Austral Bricks, Bristile Roofing and Austral Masonry.

The market value of assets sold into the trust of $416 million represents a premium of $280 million to the book value before the sale (including transaction costs and provisions). A pre-tax profit of $89 million was recorded by Building Products Australia in FY2022, with the remaining benefit to be recognised through reduced right-of-use asset depreciation over the life of each lease.

Gross cash proceeds of $207 million, representing 49.9% of the asset value, were used to pay down Group debt. These properties’ partial sale and lease back allow Brickworks to realise value for shareholders and capitalise on the strong growth in industrial land values over the past few years.

Importantly, the lease terms have been structured to ensure minimal impact on the operational flexibility of the Building Products businesses during the lease period. Together with Goodman, Brickworks plans to actively manage the new Brickworks Manufacturing Trust, in which several properties have the potential for additional development and greater utilisation.

At the end of the financial year, the equity accounted value of the Brickworks Manufacturing Trust was $211 million, including capitalised stamp duty costs.

Building Products Australia

Building Products Australia recorded an EBITDA from continuing operations of $205 million in FY2022. After including depreciation and amortisation, EBIT was $153 million. This includes a profit of $89 million from the sale of operational land to the Brickworks Manufacturing Trust.

Excluding this impact, EBITDA from continuing operations was $116 million, up 19%, and EBIT was $64 million, up 34%. Whilst the underlying performance and financial results from Building Products Australia are pleasing, it was a frustrating year for the business in many ways. Demand has been strong, with many detached housing construction projects under construction.

However, sales momentum was repeatedly stifled throughout the year, resulting in the business not reaching its full potential. Most notably, this includes COVID-related building restrictions imposed in the early months of the financial year, supply chain pressures that have slowed the speed of construction across the industry, and unprecedented wet weather events in key east coast markets during the second half.

Despite these many challenges, a number of the state operating divisions delivered record earnings during the year.

The performance of Austral Bricks was particularly strong, with a broad-based improvement in earnings across all regions, due to higher sales and improved margins. The margin expansion achieved by Austral Bricks was particularly pleasing in light of the high inflation environment. This was underpinned by a proactive price rise strategy to fully recover the impact of increasing costs.

BKW has not been significantly impacted by the extreme gas and electricity prices that have hit many manufacturers in the second half. Brickworks is well placed in this regard, with a fixed-price wholesale gas contract with Santos on the East Coast, extending until December 2024. The major investment program continues to progress despite being significantly impacted by the same challenges BKW’s operating divisions faced. Construction of the new brick plant at Horsley Park has suffered multiple flooding events, shipping delays, a lack of critical parts and significant cost increases in steel and other materials.

On a more positive note, the construction of the Oakdale East Masonry Plant was completed and commissioned during the year. However, the associated value-added plant remains under construction, following lengthy delays. Brickworks made a strategic investment in FBR Limited (ASX: FBR) in July. FBR has developed a bricklaying robot that has the potential to build walls faster than traditional methods and with much-reduced labour. With an ongoing bricklayer shortage exacerbated by the tight labour market, this technology has a strong market opportunity. As the largest brick maker in the country, BKW has much to benefit from its successful commercialisation.

Building Products North America

Building Products North America delivered EBITDA of $48 million and EBIT of $25 million. This result includes a contribution of $13 million from the sale of several surplus land holdings – predominantly quarry lands associated with closed brick plants. Land sales profit of $10 million was recorded in the prior year.

Excluding the impact of land sales, EBITDA of $35 million was more than double the prior year. This was achieved despite the lingering impacts of the pandemic, with the first half beset by repeated disruption to manufacturing operations and sales activity across the country, as COVID’s Delta and Omicron strains impacted workforce availability.

Whilst pandemic-related impacts eased in the second half, new challenges emerged with surging inflation impacting costs across the supply chain. In particular, labour constraints have increased wage rates to attract and retain staff. Like in Australia, BKW has long-term fixed-price gas contracts across most of its plants, sheltering us from the impact of soaring energy costs.

The business has made strong progress on key strategic priorities over the year, including completing two acquisitions to bolster the company’s retail distribution network. This vertical integration strategy provides Glen-Gery with enhanced customer relationships and underpins sales volume to support manufacturing operations.

Investments

The investment in WHSP provides a cash flow stream via dividends that provide stability and allows long-term strategic decision-making. Cash dividends of $61 million were received during the year, up 5% from the prior year. EBIT from Investments was up 86% to $181 million.


Source: BKW

In the year’s first half, WHSP completed a merger with Milton, another large ASX-listed investment company. The larger WHSP has increased scale, diversification, and liquidity to pursue additional investment opportunities. Brickworks retains 94.3 million shares in WHSP, but due to the addition of new shareholders to the register, BKW’s ownership stake has reduced to 26.1% (previously 39.4%).

Investment Thesis

With all segments chipping in, Brickworks’ group results were fantastic without any surprises, such as one-off costs. Highlights included:


Source: BKW

  • Continuing operations revenue up 28% to $1.09 billion
  • Continuing operations underlying EBITDA up 133% to $1.06 billion
  • Record statutory NPAT of $854 million, up 257%
  • Record underlying NPAT from continuing operations of $746 million, up 159%
  • EBIT from Investments up 86% to $181 million
  • Final dividend of 41 cents per share, continuing 46-year record of maintaining or increasing dividends
  • Total full-year dividend up 3% to 63 cents

Balance Sheet – Gearing Reduced

During the year, BKW refinanced two tranches of its existing syndicated debt facility and added two additional US dollar tranches. This increased the committed debt facilities from $830 million to around $1 billion. BKW has around $510 million in funding headroom, based on committed debt facilities and cash on hand, and significant headroom within banking covenants.

Net debt decreased by $25 million to $493 million. Together with the significant increase in equity, this resulted in a decrease in gearing to 15%.


Source: BKW

One of the main contributors to Brickworks’ growing dividend is its large holding of Washington H. Soul Pattinson and Co. (ASX: SOL, WHSP), an ASX-100 company. The investment conglomerate owns a diversified portfolio containing several different ASX shares, including TPG Telecom (ASX: TPG), New Hope Corporation (ASX: NHC), and Pengana Capital Group (ASX: PCG).

New Hope pays a very handsome dividend, and the company’s dividend distributions have been boosted further by the surging coal prices. As things stand, New Hope has an 8% dividend yield. Favourable coal prices are expected to remain for most of FY23 as the global energy crisis, particularly in Europe, will be elevated. This will increase New Hope’s cashflows. These dividends will flow through to WHSP and finally to Brickworks.

As we can see from the above chart, BKW has a demonstrated history of dividend growth, and the foundations remain strong for dividends in FY23.

Outlook

The Property segment has a bullish outlook

Activity in the Industrial JV Trust remains strong, with developments at Oakdale West expected to drive rent and asset value growth over the next few years. Four facilities at Oakdale West are expected to be completed in the first half of FY2023, including a 66,000m2 facility to be tenanted by Coles. After completing these facilities, the Oakdale West Estate will be 62% developed. Demand for the remaining 144,000m2 of the gross lettable area is strong, and construction is expected to commence on additional facilities during FY2023.

The completion of the new brick plant at the Horsley Park Plant 2 site in early calendar 2023 will allow the release of additional land at Oakdale East, where Plant 3 is currently located. This land has a market value of around $300 million and is likely to be sold into the Industrial JV Trust during FY2023. As such, it is expected to generate a significant profit on sale and then allow further development to meet the growing demand from tenants.

Once fully developed, this additional parcel of land is expected to add over $1 billion of leased assets to the Industrial JV Trust.

Buildings in the USA and Australia Have strong order pipelines

Turning to Building Products Australia, there remains a significant amount of detached house construction work in the pipeline. This healthy pipeline of work is expected to translate to strong sales for at least the first half of FY2023.

In some areas, sales volume is being limited by the availability of trades, with roof tilers in Victoria in particularly short supply. Once the current backlog of stimulus-induced housing work is completed, a period of softer demand is expected, with the rapid increase in interest rates set to provide challenges for the housing industry in the medium term. This is already priced into the stock price.

In North America, market conditions are similar to Australia, with a strong order book providing confidence in the short-term sales trajectory but rapidly rising interest rates driving a reduced level of new housing starts and a more cautious medium-term outlook.

Based on the strength of the first six weeks of trading and the existing order book, we anticipate increased sales across residential and higher-margin commercial segments in the first half of FY2023. Manufacturing costs will benefit from the extensive plant rationalisation activities and upgrades already undertaken.

Over the long term, North American operations are expected to deliver increased earnings, with Brickworks continuing to implement its proven market strategy centred around style and premium product positioning.

Investments segment will continue to deliver Dividends

The investment in WHSP is expected to continue to deliver superior long-term returns and dividend growth well into the future. In relation to the Brickworks Manufacturing Trust, there will be a range of divisional reporting implications; however, the overall impact on Brickworks Group’s underlying NPAT and cash flow is expected to be less than $2 million, excluding any potential revaluations or development profits/losses.

Looking more broadly, it is clear that BKW is facing an increasingly uncertain global economic outlook. This uncertainty will create both risk and opportunity for Brickworks. For example, supply chain risks are emerging that can impact the availability of critical spare parts to maintain operations. In addition, the European energy crisis has directly impacted several of BKW’s suppliers. Due to the extreme gas and electricity prices, they have been forced to curtail brick and roof tile operations.

Whilst this situation is devastating for BKW’s partners, it also provides an opportunity for Brickworks, in that it has become cost-effective to supply bricks into Europe from the firm’s Australian and North American operations. As such, BKW is known to be actively exploring this opportunity.

3 Reasons why Brickworks should be considered

  • Sustainable Dividends – As we have outlined before, BKW has demonstrated a history of delivering on dividends. Its cash flows are well supported to keep the dividend distributions growing at a healthy rate.
  • All Segments Tipped to Grow – Brickworks is well diversified in its product and region mix. All of these segments are forecasted to keep the momentum going during FY23, which will support earnings.
  • The WHSP Investment is a Gem – Brickworks is the largest shareholder in WHSP, a highly diversified conglomerate that is known for earnings certainty. These earnings flow through to BKW’s income statement and, finally, shareholders without costing a dime in operating costs.

Recommendation

Brickworks has had a fantastic FY22, beating market expectations. The firm has built up a strong order book pipeline across all of its business segments for the next year. This suggests that the earnings expectations will be met, and BKW can once again deliver on its dividends. The investment in WHSP will fortify those earnings and dividends further. Brickworks has also decreased its gearing and is well positioned to operate in a challenging FY23. BKW thus offers growth and dividends, and its share price has also held its ground despite overall market volatility, and we maintain our ‘Buy‘ rating on Brickworks.

 

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