Stockwatch: a share to track after baptism of fire

After a strong first year as a public company, despite the pandemic, our companies analyst asks whether it is too late, or the perfect time, to back the building supplies sector? 

Last April, I noted a director of a subsidiary of AIM-listed Brickability Group (LSE:BRCK) snapping up 100,000 shares at 46p after a drop from their 65p flotation price in August 2019. Although private equity had sold its stake (potentially an amber light to other investors) their modus operandi is usually finding new situations, so perhaps there was something worth watching here. 

Adopting a strategy of buying up building supplies companies – this Plc had already swallowed five – is risky if acquisitions happen too fast and if the house-building cycle is late-stage. But if the Johnson government is set on boosting the number of homes, also construction generally, Brickability’s concept is timely. 

I thought the stock was speculative and disciplined investors would insist on a lengthier track record. Yet Brickability is well-established in its industry, so averaging into this circa £100 million company could work for those appreciating the risks. 

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Flat underlying revenue but a “strong” market

Brickability’s share price reached 54.5p in June but has drifted back to trade sideways and sits at around 45p currently. In its results for the year to 31 March 2020, just published, it reported strong profits growth, up nearly 42% at the pre-tax level to £12.2 million on revenue up nearly 15% to £187.1 million. Seven acquisitions made during the financial year, plus a near halving of the interest charge, have given a boost.

Like-for-like revenue is up only 0.6%, so flat when adjusting for slight inflation, and that is before the effects of Covid-19. Sites were shut in April and May, although the crux is how housebuilding pans out in the years ahead. The narrative does however cite the Brexit process and general election approach as hurting the sector, plus the unusually wet weather in late January and February. 

Unless my perspective is skewed by living in the South East of England, builders appear busy and new housing developments keep appearing. A Covid-19 life of domesticity has certainly boosted home improvements although new build is likely key to overall demand for supplies.

Brickability’s chairman cites a “pandemic dependent” outlook as you might expect, however, he adds: “our core market looks strong and this is reflected in current trading levels.”

Double-digit operating margin

Looking at the income statement, the gross margin has only edged up from 20% to 20.1%, and the normalised operating margin is down from 11.2% to 10.7%. This is after £17.8 million administrative expenses but before £433,000 “impairment losses on financial assets”, plus £4.4 million charged for depreciation/amortisation to derive operating profit of around £20 million.

Finance charges are 48% lower at £2.5 million, where linking the balance sheet shows longer-term debt slashed 60% to £24.9 million and £3 million short-term debt eliminated. This was achieved partly with £57 million raised at flotation. End-March cash of £27.3 million cash more than offsets the debt, and £10 million headroom under a bank facility also positions Brickability well for further acquisitions. 

While regional lockdowns may yet undermine domestic UK equities, especially if worsening over winter, a lot of smaller firms in financial trouble would boost the acquisitions pipeline here. Quality matters too though. Angling Direct (LSE:ANG) is another AIM-listed company that went on an acquisitions spree after flotation, but had to write down inventory valuations of retail stores it bought. If a Plc gets short of market expectations it can be tempting to buy another company, but this is also how strains can develop. 

For example, on 11 March, Brickability announced the £6 million acquisition of U Plastics, a facia, soffits and guttering supply company. Coming soon after buying a roofing products specialist, it shows how building materials offer plenty scope in a fragmented industry and on the face of it seems appropriate diversification. But it is imperative to prove economic rationale for agglomerating firms like this, beyond a Plc reporting financial growth.  

Trade payables in good balance with trade receivables

After working capital changes, net cash generated from operations has eased 11% to £20.9 million. The chief dynamic has been a £5 million decrease in trade payables where the balance sheet shows a 1.1x ratio with trade receivables – up on 1.0x for the 2018/19 year, but is in good balance compared with enough Plc’s carrying heavy trade payables. (You then have to worry if profit is boosted by delaying money due.) Good house-keeping therefore explains lower cash generation.

Intangible assets are up 17% to £78.1 million representing the bulk of £80.1 million net assets, so you take your view as to how “strong” a balance sheet this amounts to. But as an agile intermediary chiefly between UK/European brick manufacturers and housebuilders, Brickability does not currently need much of a tangible assets base; inventories are just 5% of turnover. 

A risk would be if manufacturers and housebuilders alike seek to raise their margins by co-operating directly, but that would need logistics skills Brickability represents. If the group continues to diversify in building supplies, its business model, hence balance sheet, may also adjust. 

Curiously, the balance sheet does not show any contingent liabilities, although I would expect them to grow given the acquisitions policy is to pay a maximum 60% upfront – then according to performance, i.e. “earn-outs” which are typically two to three years.  

Resorted to furlough but still proposes final dividend 

A niggle for me is how cash-rich companies like Brickability were swift to exploit the government jobs support scheme – a 4 August update cited “the majority of the group’s employees placed on furlough during April and May” – then having audacity to a dividend payment. Yes, the final dividend was in respect of the October to March period and will be 1.085p instead of 1.74p, but since in cash terms the timing will be this 23 October, it can be seen as public subsidy helping preserve an acquisitions war chest. 

I am however expressing taxpayer frustration. The Treasury decided on terms of the scheme and Plc boards’ responsibility is to steward the business on behalf of shareholders. So, if they did not swiftly engage furlough some would accuse the directors of complacency. 

Watch for the outcome of government house-building plans 

Perhaps the chief driver for this stock is government policy. Boris Johnson has radical plans to boost housebuilding, hence local authorities are required to achieve more than 30,600 new homes a year. In August he declared radical reform by restricting councils’ power to oppose new development. But this has run into opposition from Tory MP’s outside London amid a cry of “concreting over the countryside”, and a 30-strong rebel group aims to thwart this. 

It is therefore hard to give a firm stance on this stock ahead of this potential crux for housebuilding, if right to be commenting now.  

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On another political angle it is good how management says: “advanced preparations have been put in place for business continuity post EU withdrawal”. While I cannot see they have disclosed what extent of items are imported, as least they have taken initiative versus too many companies with nothing to say.  

We are nowhere near a “post Covid” market though

I am less impressed how they talk about a post Covid market. Dr David Nabarro, World Health Organisation special envoy on the virus and a UK medic of stature, was telling MP’s this week the pandemic remains at an early stage. It has also leaked out how government scientific advisers have cautioned about the possibility of a two-week national lockdown involving October’s school half-term.

But I agree how there is “pent-up demand for houses post lockdown” and for a “preference for houses over flats,” which I think should drive building supplies in the medium term. I would be wary about the stamp duty reduction lasting while government finances deteriorate, although the chancellor may retain the 2021-23 Help to Buy scheme and the 2021-26 Affordable homes programme.

Overall, I retain my stance on this stock for enterprising investors able to keep up with the dynamics involved. Buy. 

Edmond Jackson is a freelance contributor and not a direct employee of interactive investor.