BKW - Patience is a Virtue

Brickworks (ASX:BKW) can trace its history back to 1908, when their heritage business, Austral Bricks, was incorporated in Sydney. In 1962 the company listed on the ASX as Brickworks Limited.

Today, they have a market capitalization of $4.3 billion, with a portfolio of diversified assets that comprises of a 26% stake in Washington H Soul Pattinson (ASX:SOL), a property division which comprises of two Joint Venture Property Trusts with Goodman Group (GMG), and two Substantial building products businesses in Australia and North America.

The company has four distinct divisions.

Source: Brickworks Website

Building Products, Australia: Is a manufacturer and distributor of building products across all Australian states. Since 2002, the Building Products Group has grown from a two-state brick manufacturer, in New South Wales and Queensland, to a diversified national building products business. In total, Building Products Australia comprises 20 manufacturing sites (currently operating), 33 company-owned design centres and studios and a vast network of resellers across the country.

Building Products, North America: was established upon the acquisition of Glen-Gery in November 2018. This was followed by further bolt-on acquisitions of Sioux City Brick in August 2019, Redland Brick assets in February 2020 and Illinois Brick Co assets in August 2021. Brickworks North America now has a leading position in the Midwest, Northeast and Mid-Atlantic states, and has a strong focus on architectural and premium products. It has seven currently operating brick manufacturing sites and one manufactured stone plant. This is complemented by a network of 26 company-operated distribution outlets, three design studios (New York, Philadelphia and Baltimore) and a vast reseller network.

Property: The Property division was originally established to maximise the value of land that is surplus to the Building Products business. Over time, the Property division has evolved and now consists of two Joint Venture Property Trusts with Goodman Group, plus 100%-owned land holdings, both operational and for development. Brickworks holds a 50% interest in the Industrial JV Trust. As of 31st Dec 2023, BKW’s share of net asset value in the property segment was $1.9bn.

Investment: Consists primarily of a 26.1% interest in SOL, which sits on BKW’s balance sheet with a value of $3.2bn as of 31st Jan 2024. This shareholding in SOL is an important source of earnings and cashflow diversification for the company and has been a key contributor to BKW success for more than four decades. As of their HY24 report BKW investment segment comprised of 94.3 million shares in SOL and 731.7 million shares in FBR Limited (ASX: FBR), representing a 16.5% shareholding in FBR.

By far their largest business segment in terms of revenue is Building Products Australia which contributed $733.7m to FY23 revenue of $1.1bn. But when it comes to earnings, the major contributors to this are BKW’s Property and Investment segments which contributed a combined $394m to total underlying EBIT of $477.0m in FY23, and with consolidated profit after tax of $394.6m in FY23, it’s not hard to see where the bulk of BKW’s profits are generated.

Source: Brickworks FY23 Annual Report

So as any willing investor can see, BKW are made up of more than just bricks. BKW are a diversified asset rich company with $6.1bn worth of total assets on their balance sheet in FY23 and a current market cap of $4.3bn. The effects of this business structure were on show in their HY24 report, when BKW reported a HY24 underlying net-loss of $37.m (statutory loss $52m) verses a net underlying HY23 profit of $410.0m (statutory profit $354.0m).

According to BKW the bulk of the HY24 loss was due to property sales and revaluations (note: these have to be captured on the income statement.):

“Earnings were adversely impacted by a non-cash property devaluation of $233 million (vs. $114 million gain in 1H23) and a $16 million loss on property sales (vs. $263 million profit in 1H23), as announced to the market on 22 December 2023. Group Underlying Earnings Before Interest, Tax, Depreciation and Amortisation (‘EBITDA’) was a loss of $40 million in the first half, compared to a gain of $607 million in the prior corresponding period. Excluding the impact of the property revaluations and property sales, EBITDA was $210 million, down 9%. Building Products EBITDA was higher in both Australia and North America. A period of significant investment and portfolio rationalisation has been completed over the past five years, and this is now supporting higher margins, despite the impact of inflationary pressures and lower building activity in some key markets.”

Encouragingly though, HY24 cash flow from operations was up 16% to $54m, compared to HY23 and net-trust income earned from the property segment increased by 4% to $25.0m in HY24. Highlighting an investor needs to understand BKW’s business structure and how property revaluations and sales impact reported and underlying revenue, earnings, profits, and the value of assets.

StockRank:

BKW has managed to increase their share price from $14.3 in FY14 to $29.0 FY25, their book value by nearly $1.5bn since 2018, and have only added an additional 4m shares to average shares in this time.

This performance has not been lost on the market with BKW’s quality sitting at 81 and there is no shortage of interest in BKW with their momentum at 88 (up +5 over the last 30 days). The main detractor and the reason BKW’s StockRank is 71. Is value sitting at 25. This comes as no surprise given BKW’s performance over the long-term and their ability to create wealth for shareholders by growing book value.

Another example of the underlying strength and quality of BKW’s business and assets has been their ability to pay consistent and increasing dividends since 2018. Which is no mean feat given this timeframe takes into account COVID. Furthermore, during this time, BKW have had an average dividend cover of 3.9 times. Indicating management have been prudent with paying dividends with profits easily covering dividend payments and allowing BKW to retain funds for use within the business. Further to this point, BKW has paid a flat or increasing dividend for the last 48-years. This would be music to the ears of many income investors,especially those who can ignore the current yield, and its long-term favour would also be another reason BKW has a low current Value score and high Momentum.

Financials:

Given BKW’s large illiquid asset base and their reported HY24 loss, their F-Score has held up well. The main detractor from BKW’s F-Score is that it is not currently profitable, and their operating margin and ROA were lower in FY23 than FY22. Bearing in mind, in FY22 BKW’s property segment alone generated $644.0m to total underlying EBIT $982.0m and BKW’s share of net-assets in their property segment increased by $631.0m due to increasing property valuations. Helping contribute to an operating margin of 119% and ROA of 18.1% in FY22. Compared to an operating margin of 48% and ROA of 6.9% in FY23.

BKW’s low Z1-score is a direct result of their large illiquid asset base.This results in illiquid assets making up the majority of total assets and BKW’s assets not being productive as sales on a TTM basis have fallen. With HY24 sales falling by 6% to $547.0m being the main driver of this.

If it wasn’t for their large portfolio of diversified quality assets and cash on hand increasing in HY24 due to property sales, I would be more concerned about their low Z1-Score. Especially as gross debt levels have increased and operating cash flow per share have fallen since 2018, plus their liquidity ratios (especially interest coverage) are low and would be of concern if the company was a standalone building materials manufacture and supplier. BKW however are forecast to return to a modest profit in FY24 and FY25 and I would be expecting to see an improvement in their Z1-Score as all the above-mentioned issues will improve with a return to profitability.

Liquidity and Ownership:

BKW is a large cap stock and at the time of writing had 151.9m shares outstanding with 78.9m shares classified as free float. Top shareholders accounting for 50.8% of shares outstanding and their largest shareholder being SOL, who own 43% of BKW. This holding effectively gives SOL strategic control of the company and the final say in any decision that goes to a shareholder vote. One could say buying BKW is a quasi-investment in SOL.

For a large cap stock BKW does not have a significant number of shares on issue, but all things considered, a small DIY investor will have no issue buying or selling. In fact, in my view this works in favour of DIY investors, as there are a low number of shares on issue and one large shareholder accounting for 43% of total shares. This makes it hard for larger institutional investors to buy large parcels, but is ideal for a small DIY investor.

Outlook:

Consensus estimates have BKW returning to a small profit in FY24 of $32.7m and in FY25 of $209.3m and 3 out of 8 analysts that cover BKW have a buy rating with the rest having a hold rating. A positive for me is there are no sell recommendations.

BKW did not provide much in the way of forward guidance in their HY24 report. But here’s what they did say:

“Although macroeconomic conditions may cause some short-term challenges across the portfolio, each of our businesses have a strong longer-term outlook. Within Property, structural trends towards e-commerce and the digital economy will continue to drive demand for our prime industrial facilities for many years to come. Our Building Products business is well placed to meet the demands of the expected building boom over the next decade in Australia and North America. Meanwhile, WHSP is expected to continue to deliver a stable and growing stream of earnings and dividends over the long term. Following a period of significant investment, our short-term priority is to maximise cash generation. With our diversified portfolio of high-quality assets, Brickworks is well placed to meet any future challenges and continue to deliver good performance for shareholders.”

Conclusion:

According to BKW, it looks like they are nearing the bottom of the business cycle and BKW see themselves in prime position to benefit from an upturn in the building industry at home and in North America over the coming decade. A larger contribution to earnings and profits from their building products businesses coupled with their diversified asset backing and large earnings and profit generating property and investment segments bodes well for BKW in the long run.

There is a lot to like about BKW from a long-term investment point of view. However, the large stake in BKW held by SOL and its impacts on how the company is run needs to be considered. Furthermore, patience is required, as short-term property valuations and sales can adversely and positively affect BKW’s results and share price.

Their track record however suggests, shareholders that stay the course will eventually be rewarded.

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