Interactive Investor

Stockwatch: big drop in price makes this share interesting

29th November 2022 11:24

Edmond Jackson from interactive investor

The stock market has fallen out of love with this AIM company, but analyst Edmond Jackson thinks the price already reflects much of the risk.

US President Herbert Hoover infamously declared “the fundamentals remain strong” – on the day before Black Thursday during the October 1929 Wall Street Crash that led to the Great Depression.

It was therefore an unfortunate choice of words by an AIM-listed company reporting interim results yesterday – to describe its industry fundamentals as “strong”, while acknowledging UK economic prospects remain “unclear”.  And it is unclear whether a sense of history is being lost, hence the propensity to repeat.

Brickability Group Ordinary Shares (LSE:BRCK) is a supplier of construction materials that floated in September 2019 and issued shares in June 2021 to pay for acquisitive development. It has diversified from a base chiefly in bricks, with better import capability to address UK materials shortages, and wants to introduce new customers with potential for cross-selling. 

Good calls on the stock until October 2021 

It began trading at 68p after a 65p placing and its slide towards 30p during the impact of Covid led me to rate it “buy” at 46p in April 2020 after a director bought 100,000 shares. I tempered my stance to “hold” in June 2021 and it reached 111p that September.  

At 105p in October 2021, I queried whether this and other housing-related stocks had had their best run. Brickability cited an “extremely strong” order book and management said it was coping with higher costs. 

With hindsight, I should have prioritised “macro” instead of upgrade to “buy”, despite adding a caveat of “for risk-tolerant investors” and “unless interest rate rises stall the housing market”.  

Yet force majeure of the Ukraine crisis has added to inflation, hence a belated tough monetary policy response that has pushed up mortgage rates and disrupted expectations for construction. Brickability is UK-focused, where such problems are now relatively more acute.  

The chart shows Brickability on a declining trend since autumn 2021 and not even yesterday’s resilient interim results checked it; the price easing 2% to 69p.

Perhaps anything housing and construction-related is now at relatively higher risk, i.e. best to wait for a 2023 downturn to impact reporting. 

But I would not to dismiss all such stocks, where the industry positioning is strong and stock falls’ price in much risk. 

Profit enhanced by acquisitions, revenue by materials inflation 

In the six months to end-September, Brickability’s pre-tax profit is up 72% to £15 million on revenue up 58% to £353 million. 

Diluted reported earnings per share (EPS) has doubled to 3.8p, although at the adjusted level is up 23% to 5.9p.  

This partly benefits from the £63 million acquisition of Taylor Maxwell Group in June 2021, a supplier of timber and non-combustible cladding doubled the size of Brickability. The deal has also lowered the group operating margin which was 9% in 2019, reducing near 4% 

Yet there was a long-term rationale by way of extending reach in the UK marketplace and deriving synergies. 

Brickability Group - financial summary
Year end 31 Mar

 20182019202020212022
Turnover (£ million)11.7163187181520
Operating margin (%)1.19.08.16.64.4
Operating profit (£m)0.114.715.212.023.1
Net profit (£m)-0.36.59.39.712.4
EPS - reported (p)-0.14.54.04.24.4
EPS - normalised (p)-0.14.57.35.610.1
Operating cashflow/share (p)0.38.24.34.46.7
Capital expenditure/share (p)0.60.30.42.52.4
Free cashflow/share (p)-0.37.93.91.94.3
Dividend/share (p)0.00.02.02.03.0
Covered by earnings (x)  2.12.11.4
Return on total capital (%)0.216.212.610.210.2
Cash (£m)5.417.027.38.625.0
Net debt (£m)59.150.54.215.511.8
Net assets (£m)8.116.480.185.4155
Net assets per share (p)3.57.134.737.151.8

Source: company accounts

Like-for-like interim revenue growth of 9% also largely reflects materials price inflation being passed on – successfully, so far – to customers. Demand has therefore softened to an effectively flat position, which puts in question the consensus estimate for 6% revenue growth in the next financial year, if that is meant to be like-for-like. 

In November 2021, £3.3 million plus £2.2 million deferred consideration was paid for a renewable energy specialist – in solar, battery storage and electric vehicle charging technologies. That looked an astute, contra-cyclical buy, if modest in a circa £200 million group context.  

Then last March, a South East roofing specialist was bought for £6.5 million and last June and October, two clay materials’ specialists for £5 million and £12 million – mainly in bricks and tiles, respectively. 

Clay looks sensible given its demand may be supported by higher-quality builds, hence also sustain margin.  

Yet it is hard to avoid a sense that Brickability got busy expanding during a boom period – at the top of the market – which has seen end-September net debt rise to over £27 million. The interim net finance expense has more than trebled to £2.2 million, which is low versus £18 million operating profit (before depreciation etc) but – together with a low stock price – probably limits scope for much further expansion in a recession, when acquisition prices may become keener. 

Return to Go essentially says Show us the Money 

De-rating the stock near its flotation price, Mr Market is wary of what lies ahead given there is no comparator for how this group performed over the 2009 recession, having founded just six years ago. 

If forecasts are fair, the prospective price/earnings (PE) ratio is only around 6.5x and the yield approaches 5% covered over thrice by earnings. Obviously, there were enticing housebuilder yields last summer, now cut. 

Looking to Ibstock (LSE:IBST) as a comparator, at 164p it offers a 5%-plus yield covered twice by expected earnings, on a 10x PE. Again, this £640 million and quite similar group only floated in 2015 hence no recession performance to see. 

It is also a manufacturer rather than Brickability as distributor, hence I would flag Ibstock for greater takeover prospects if its stock festers, given another company might seek vertical integration. 

Only 21% of Ibstock’s 111p a share, net assets, constitutes intangibles, whereas they represent virtually all Brickability’s 54p a share, net assets value (NAV). This will reflect acquisition values for service type businesses Brickability has acquired, being asset light. 

Mind, therefore, what prop exists for Brickability over a recession is its yield; the market can increase this figure simply by lowering price. 

Management says order intake remains strong, but as I have regularly pointed out, higher interest/mortgage rates need time to have effect. A return to government austerity bodes less well for that aspect of infrastructure spending.   

I still like Brickability given its well-executed acquisitions strategy has long-term logic. The group hardly looks over-stretched like some cyclicals I saw implode during the early 1990s recession. 

Directors retain material shareholdings but there was material selling – nearly £40 million worth – by 10 insiders at 95p in June 2021. That now looks a sensible hedging of exposure when institutional demand existed near a cyclical top.  

Director and institutional buying, more recently 

If director trading here is astute, well, one of those sellers bought back £100,000 worth at 81p last July. 

And on 15 November, Octopus Investments – the largest manager of venture capital trusts - raised its stake from 16% to 17%. This is notable given Octopus was already “locked in” to a relatively illiquid stock, which implies high conviction long-term – otherwise adding just when the economy is turning down is especially risky. 

Like much else cyclical, the decision reduces to timing. Do you wait for the chart to establish a floor and bad news to manifest? Or take a steady averaging-in approach, given much bad news appears discounted?  

I prefer Brickability’s track record over Ibstock’s (helping explain that stock’s discount to a 190p flotation, seven years ago).

Has enough changed since a “buy” rating a year ago, to warrant downgrading? Well, yes, the economy, yet pricing may reflect that. 

This morning’s light stock trading appears to show no buys only sells, hence take care, the technical position hardly implies a rise soon. You might feel you want to see more directors re-purchase.  

Perhaps one should diversify also one’s stock ratings, not wait for all to manifest bad news. Buy.   

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

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