Hunting for value among construction materials stocks

In a recent piece, I looked at the potential investment appeal of UK housebuilders. I concluded that they might still offer some value, but are probably not at truly compelling valuations anymore.

In the interests of disclosure, I still hold shares in one well-known UK housebuilder. But I’m a little wary about the political exposure of these businesses. Although the new government clearly wants to encourage more housebuilding, this doesn’t necessarily mean that it will support a return to the supernormal profits of the Help to Buy era (2013-23).

My caution may be unwarranted. More houses may mean more profit. But I’m cautious about investing in businesses that can be used as political footballs, unless I’m convinced they’re dirt cheap.

For these reasons, I’ve become more interested in the building materials sector, with a particular focus on companies whose products tend to be used in UK housebuilding.

Where are the opportunities?

While many of these shares have staged something of a recovery already, I think value still exists in this sector.

Last week’s profit warning from premium brickmaker Michelmersh Brick Holdings (LON:MBH)  was also a reminder that the construction sector isn’t out of the woods yet. A recovery may not really get underway until well into 2025.

For this piece, I’ve selected four building materials stocks that look interesting to me right now. I used the following broad criteria to help me choose:

• Reasonable valuation

• Strong balance sheet, preferably net cash

• StockRank of 60 or higher

• Pays a dividend covered by earnings

• Market cap over £25m

I should point out that my positive view on this sector is based on my belief that the UK construction and housebuilding markets are close to the bottom of the cycle. I expect conditions to improve at some point – probably next year – probably aided by further interest rate cuts.

If I’m wrong, and conditions worsen for some reason, then the opinions here won’t necessarily hold, so please DYOR and form your own views.

With that said, here are the companies I’ve chosen:

• Eurocell (LON:ECEL)

• Michelmersh Brick Holdings

• James Latham (LON:LTHM)

• Alumasc (LON:ALU)

• Honourable mentions – stocks that came close to inclusion and look attractive to me

Eurocell (LON:ECEL)

This £160m business manufactures and distributes PVC window, door and roofline products. It’s scored highly by the StockRanks and styled as a Super Stock at the time of writing, a positive style.

Recent trading: sales fell by 5% to £175.7m for the first half of the year, but adjusted pre-tax profit rose by 33% to £8.0m.

The increase in profits was achieved thanks to lower input costs in areas such as electricity and PVC resin. Gross margin rose from 46.0% in H1 last year to 52.5% during H1 2024.

Labour costs have continued to rise despite a redundancy programme last year, but the company says these have been offset by higher selling prices.

The balance sheet looks good to me, with net debt excluding lease liabilities of just £4.3m at the end of June. Average net debt in H1 was just £0.5m. It’s always nice to see a company quote average net debt, to allay any suspicions of window dressing at the period end.

While market conditions are said to be challenging, management remain confident:

our expectations for the full year remain unchanged

My view: Eurocell shares have performed well over the last year and I think management deserves credit for controlling the cost base early on in the downturn.

The shares currently trade on 10 times 2024 forecast earnings and offer a 4% dividend yield. The payout should still be covered twice by earnings and the company is also using surplus cash to fund buybacks.

When market conditions improve, I would expect Eurocell’s sales and profits to improve accordingly.

Michelmersh Brick Holdings (LON:MBH)

Michelmersh is a premium brick manufacturer with approximately a 6% share of the UK market.

I have written about this company previously, so I apologise for not providing a new idea. But I am a long-term fan of this business, which I think is differentiated by having strong brands and an excellent balance sheet.

Stockopedia’s computers have a broadly neutral view of this business at the moment:

Recent trading: Michelmersh’s half-year results were not that bad in themselves, but were marred by a profit warning. Management previously expected an improvement in trading during the second half, but this is no longer the case:

given the current challenges in our sector and uncertainty of a market recovery the Board expect our second half outturn to be broadly reflective of our first half performance.

As Paul discussed here, Michelmersh’s share price was surprisingly unmoved by the warning, given that the house broker cut FY24 profit estimates by 28%. I suspect this may be justified partly by the stock’s tangible asset backing, as I discuss below.

The numbers themselves reflected a wider market slump, with sales down 15.7% to £35.4m and pre-tax profit down by 33% to £4.1m. Net cash fell from £11.8m to £4.1m, although the company says this was largely due to restocking depleted inventories, so possibly not a concern.

Indeed, the company claims to have gained market share in the current slump and says its order intake is now running ahead of manufacturing capacity, allowing it to build a healthier backlog of work.

Outlook: while H2 results are expected to be flat on H1, the company says new order intake is improving and has now returned to 2022 levels.

Updated broker forecasts suggest earnings of 8p per share this year, rising to 9.8p per share in 2025.

My view: The main short-term risk I can see is that the timing of a recovery is still uncertain. I think there’s a chance that another profit warning may be needed.

Stockopedia’s profit warning research provides evidence to support the view that companies often underperform for a while, following a profit warning. That could happen here, if a recovery in demand takes longer than expected.

However, my feeling at the moment is that Michelmersh’s modest valuation and asset-backed balance sheet may offset this risk.

Unusually, Michelmersh reports its fixed assets (brickworks and land) at fair value, having them independently valued at the end of each year.

This should mean that the property, plant and equipment line on the balance sheet is representative of the market value of these assets.

The June 2024 balance sheet shows PP&E of £64.8m. Together with inventories of £19.6m, these tangible assets cover 90% of the current £93m market cap.

Given that ongoing profits are expected to support a P/E of 12 and a 4.9% dividend yield this year, my feeling is that Michelmersh looks decent value at current levels, despite the downside risk to profits.

The shares are on my watch list at the moment.

James Latham (LON:LTHM)

This venerable AIM-listed company is a timber merchant that was founded in 1757 and remains under the control of the Latham family today. In my opinion, it’s also a very high-quality business with some wonderful characteristics.

Stockopedia’s algorithms have a highly favourable view of the business, too:

Recent trading: August’s AGM statement showed revenue almost flat for the four months to 31 July, but volumes up by 3.1%. This seems to support management’s previous comments that some customers are trading down to cheaper products while maintaining volumes.

Costs and profits and cash generation were said to be in line with expectations for the first part of the year, and the company sounded a relatively bullish note on industry demand:

Most of our customers remain busy and are more confident than at the same time last year.

Last year saw Latham’s operating profit fall from £43.7m to £26.1m, but this has to be seen in the context of the exceptional profits earned in 2022/23. Looking at the medium-term trend, profits seem to have resumed their pre-pandemic growth trajectory:

Outlook: broker forecasts price the stock on a forecast P/E of 12.5 with a 2.7% dividend yield.

My view: Latham ended the last financial year with net cash of £75m – more than a quarter of the current £265m market cap.

This level of cash is paired with freehold property that provides wonderful security and flexibility for the business. For example, Latham used cash to increase inventory during the supply chain crisis and is routinely able to take advantage of early payment discounts with its own suppliers.

Now that interest rates have risen, cash is generating a positive return, too. Last year’s accounts show net finance income of £4.1m. This resulted in a pre-tax profit 16% higher than operating profit.

Near-term growth prospects appear limited, based on broker forecasts:

However, expectations have already been upgraded once this year. I would expect further upgrades when construction market conditions start to strengthen again. I see this as a long term sleep-at-night stock that’s likely to continue delivering reliable results.

Alumasc (LON:ALU)

This building products group describes itself as a “premium sustainable building products, systems and solutions group”. It operates in three segments, water management, building envelope (mainly roofing products) and housebuilding.

Housebuilding products are sold under the Timloc brand and include a large range of individual components that are generally related to roofing, drainage and ventilation.

Performance is much improved at this business in recent years and a troublesome pension deficit is also now under control. Stockopedia’s algorithms have a fairly high opinion of Alumasc:

Recent trading: Much of Alumasc’s business is in the commercial sector and this remained more resilient than housebuilding last year.

The company’s results for the year to 31 March 2024 showed revenue up by 13% to £100.7m. Of this, 6.5% was organic growth against a decline in UK-wide construction activity of 2.9%. Acquisitions contributed the remainder.

Profits were up, too. Underlying pre-tax profit rose 16.1% to a record of £13.0m, ahead of expectations.

Net bank debt was just £7.5m despite a recent acquisition and cash generation was strong.

Paul covered these results in more depth here.

Outlook: broker forecasts were upgraded following Alumasc’s recent results:

Consensus estimates now suggest adjusted earnings will rise by 9% to 29.4p per share this year. A dividend of 11.1p per share is expected.

These estimates price Alumasc on 10 times forecast earnings, with a 4% dividend yield. That doesn’t seem expensive to me given the relatively depressed state of UK construction at the moment, especially housebuilding.

My view: housebuilding products only accounted for 15% of Alumasc’s revenue last year. But revenue was flat and the divisional operating profit for housebuilding was an impressive 25%, more than 11% above the group-wide figure of 14.1%.

The result from housebuilding looks like a strong performance to me given the weakness in this sector over the last year. The higher margins on housebuilding products also suggest to me that when market conditions improve, this division could make an outsized contribution to the group’s overall profits.

On balance, Alumasc shares look decent value to me. I think the business could have significant further growth potential when market conditions improve.

Honourable mentions

I couldn’t cover every company of interest here due to space constraints. So here’s a quick mention of some other stocks that look interesting to me at the moment.

Breedon (LON:BREE) - this supplier of aggregates and cement is expanding into the US, but has a strong base in the UK and Ireland. Housebuilding exposure comes through associated infrastructure construction. This sector is capital intensive, but quarry assets are hard to replace and tend to provide strong localised market share.

There’s some debt, due to a recent US acquisition. But I think this could be a slow-and-steady business at a reasonable price.

Brickability (LON:BRCK) - this distribution group is now managed by Frank Hanna, who was previously co-CEO of Michelmersh. As Graham discussed recently, Brickability appears to be performing well in a tough market and looks very reasonably valued.

Stelrad (LON:SRAD) - I came close to including this company, which is a market-leading producer of central heating radiators under a number of brands. CEO Trevor Harvey is the second-largest shareholder and the valuation looks attractive to me, with a useful 5% dividend yield. My only reservation is that there’s a little bit more debt here than I’d like. On balance though, I can see a lot to like. Paul covered Stelrad’s 2024 half-year results here.

Volution (LON:FAN) makes branded ventilation equipment such as bathroom extractor fans and has a similar appeal to Stelrad, for me. The valuation looks more demanding, though.

In the mid-large cap sector of the market, I like both Howden Joinery (LON:HWDN) and Genuit (LON:GEN) , but don’t see that much value at the moment – although perhaps that is a reflection of their higher quality, especially at Howden?

As always, please let me know what you think of the companies mentioned and the wider sector in the comments below!