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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Fletcher Building</h2>
Pressures Reiterated
Fletcher Building’s (FBU) initial FY20 guidance reemphasises that earnings remain pressured from a combination of competition, cost, easing NZ demand, and the Australian residential downturn. Guidance was modestly below our expectation, and looking through the balance of the fiscal year, we view risks as clearly down weighted. In our view, value remains insufficient to compensate for risks; maintain UNDERPERFORM.
What’s changed?
<ul>
<li>Earnings: EBIT FY20/21/22E -3%/-4%/-3%. (Our forecasts are not yet adjusted for IFRS 16.)</li>
</ul>
Guidance midpoint modestly below expectation
FBU’s initial FY20 guidance of EBIT NZ$515–565m includes a +NZ$50m benefit from IFRS 16. Excluding this IFRS 16 impact, the midpoint of the NZ$465–515m range was modestly below our prior NZ$505m forecast (revised NZ$489m), and our NZ$512m estimate of FY19 normalised for one-off impacts.
There was little that surprised us in FBU’s trading commentary:
<ul>
<li>In NZ the performance of “core divisions” (Building Products, Concrete, Distribution) “remains on track against a solid market backdrop”, underpinned by continued “strong” activity for residential and commercial finishing trades. Civil, infrastructure, and starting trades “is trending slightly lower as expected”. The Residential division is benefiting from “strong” demand for housing and “supportive” prices and FBU expects it to deliver “slight” earnings growth yoy. “The steel market remains highly competitive”.</li>
<li>In Australia, the “cost-out programme is progressing to plan and there is good turnaround momentum in Laminex and Fletcher Insulation”. “Intense competitor activity in the declining residential market is placing ongoing pressure on price and margin in Stramit and Tradelink, while infrastructure project delays are expected to have some near-term impact on Iplex and Rocla in FY20”.</li>
</ul>
FBU expects Australian earnings “will be weighted to the 2H as benefits of the cost out programmes ramp up”.
Risks remain negative
FBU’s guidance reinforces the reasons for our concern. Despite ambitious cost-out objectives, earnings continue to slip under a combination of competition, cost, and demand pressures. We do not expect these to relent. In NZ infrastructure and larger scale commercial is moderating, and Australian residential work will fall further following the sharp decline in approvals. Our concern in Australia is exacerbated by (1) FBU’s expectation that earnings will be 2H weighted, and (2) the likely sharp pending volume decline for its late-cycle businesses (Laminex, Tradelink). At FY20/21E FCF yields of -1%/+2% on peak-cycle NZ volumes we see insufficient value to compensate investors for these risks.&nbsp;
<div class="content-highlight">
Investment View
We view the medium-term risks for FBU as negative from competitive, cost, and demand pressures. The stock’s valuation “discount” vs. sector peers and the broader market masks weak free cash flow and peak cycle demand. UNDERPERFORM.&nbsp;
</div>
Matt Henry, CFA matt.henry@forsythbarr.co.nz +64 9 368 0115

Fletcher Building
Pressures Reiterated
Fletcher Building’s (FBU) initial FY20 guidance reemphasises that earnings remain pressured from a combination of competition, cost, easing NZ demand, and the Australian residential downturn. Guidance was modestly below our expectation, and looking through the balance of the fiscal year, we view risks as clearly down weighted. In our view, value remains insufficient to compensate for risks; maintain UNDERPERFORM.
What’s changed?

Earnings: EBIT FY20/21/22E -3%/-4%/-3%. (Our forecasts are not yet adjusted for IFRS 16.)

Guidance midpoint modestly below expectation
FBU’s initial FY20 guidance of EBIT NZ$515–565m includes a +NZ$50m benefit from IFRS 16. Excluding this IFRS 16 impact, the midpoint of the NZ$465–515m range was modestly below our prior NZ$505m forecast (revised NZ$489m), and our NZ$512m estimate of FY19 normalised for one-off impacts.
There was little that surprised us in FBU’s trading commentary:

In NZ the performance of “core divisions” (Building Products, Concrete, Distribution) “remains on track against a solid market backdrop”, underpinned by continued “strong” activity for residential and commercial finishing trades. Civil, infrastructure, and starting trades “is trending slightly lower as expected”. The Residential division is benefiting from “strong” demand for housing and “supportive” prices and FBU expects it to deliver “slight” earnings growth yoy. “The steel market remains highly competitive”.
In Australia, the “cost-out programme is progressing to plan and there is good turnaround momentum in Laminex and Fletcher Insulation”. “Intense competitor activity in the declining residential market is placing ongoing pressure on price and margin in Stramit and Tradelink, while infrastructure project delays are expected to have some near-term impact on Iplex and Rocla in FY20”.

FBU expects Australian earnings “will be weighted to the 2H as benefits of the cost out programmes ramp up”.
Risks remain negative
FBU’s guidance reinforces the reasons for our concern. Despite ambitious cost-out objectives, earnings continue to slip under a combination of competition, cost, and demand pressures. We do not expect these to relent. In NZ infrastructure and larger scale commercial is moderating, and Australian residential work will fall further following the sharp decline in approvals. Our concern in Australia is exacerbated by (1) FBU’s expectation that earnings will be 2H weighted, and (2) the likely sharp pending volume decline for its late-cycle businesses (Laminex, Tradelink). At FY20/21E FCF yields of -1%/+2% on peak-cycle NZ volumes we see insufficient value to compensate investors for these risks.&nbsp;

Investment View
We view the medium-term risks for FBU as negative from competitive, cost, and demand pressures. The stock’s valuation “discount” vs. sector peers and the broader market masks weak free cash flow and peak cycle demand. UNDERPERFORM.&nbsp;

Matt Henry, CFA matt.henry@forsythbarr.co.nz +64 9 368 0115

Fletcher Building

Fletcher Building: Pressures Reiterated