Interactive Investor

Stockwatch: time to buy this industry-leading cyclical share? 

12th May 2023 09:40

by Edmond Jackson from interactive investor

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It took this mid-cap company just over seven years to rise 1,000% but then had a terrible 2022. Analyst Edmond Jackson explains what he’d do with them now.

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Is a surprise warning from Marshalls (LSE:MSLH), a mid-cap supplier of building materials, indicative of new-build housing and home improvements easing, as higher interest rates bite? 

Or is this cyclical stock now in value range, where it could improve now that the Bank of England (BoE) has flipped its UK recession warning to one of growth? I should not flip either, having argued for caution towards cyclicals in my last piece, if primarily regarding the US. 

At 292p this morning, Marshalls stock is up from a 225p low last October but remains 65% down since last August. If forecasts are fair, it trades on a 12-month forward price/earnings (PE) ratio of around 12 times and yields a bit over 4%, twice covered by those expected earnings.  

That is pretty much what you might expect of a quality cyclical possibly at the early stage of business slowing. 

I would tend to distinguish housing-related stocks from, say, the hospitality trade – if the new narrative is not to be so negative about recession. Interest rate rises are likely to stick, because so might inflation as wage awards bake it in. This will affect purchasing power on homes to some extent, despite relatively affluent people continuing to spend on improving their properties.

Landscaping products account for much of the shortfall  

My hunch is supported by segmental performance within the latest update, in respect of the four months to end-April (in context of a December year-end). 

Revenue is up 12% year-on-year, albeit benefiting from the April 2022 acquisition of Marley roofing. Otherwise, like-for-like sales eased 14%, “reflecting the uncertain macro-economic climate and a reduction in new house building.” 

Group revenue appears still to have a slight majority exposure to landscape products, arguably a more discretionary aspect of home improvement and building. This fell 21% to £140 million versus building products down 9% to £55 million (as bricks, masonry and mortars were affected and aggregates held back by deferred new housing starts). Roofing products eased 6% to £61 million as integrated solar revenues helped by regulation changes offset lower new-build housing. 

Marshalls said: “In the near term, the macro-economic climate is expected to remain challenging and 2023 trading has been weaker than anticipated.” 

That rather contrasts with Ibstock (LSE:IBST), a peer building materials group, saying a fortnight ago: 

“...a good start to 2023 despite a subdued demand environment; first quarter EBITDA was marginally ahead of our expectations; the pace of cost inflation was more modest than the levels seen in 2022.” 

And even more positively, Brickability (LSE:BRCK) saying in respect of its year to end-March: 

“...pleased to confirm that despite the macro-economic environment remaining uncertain, final-quarter performance has remained resilient...a 4% like-for-like, full-year revenue rise, and adjusted EBITDA not less than £50 million, ahead of market expectations.” 

It is therefore mixed signals from the sector; perhaps understandably given the effects of 12 consecutive rises in UK interest rates take time to work through. But I think Marshalls’ weighting toward landscaping makes it the relatively more discretionary stock.  

Consensus forecasts are relatively jumbled 

The share price initially fell 16% to below 270p, but at 292p it has essentially recovered from the update. I suspect part of this is UK cyclicals being overall sensitive yesterday to the BoE switching from a UK recession to 0.25% growth forecast. 

No one has a crystal ball; we all need humility. It is possible, the BoE is making a similar mistake like when it guided for “transient” inflation, under-estimating the time for macro change to manifest. The slowdown Marshalls cites could easily continue. 

I would treat forecasts for this stock with a pinch of salt. It’s unclear quite what extent they involve guidance, but Marshalls has changed its tune from the mid-March annual results, when the board was confident of delivering near-term progress in line with its expectations.  

Consensus numbers are jumbled and somewhat hard to reconcile with the April 2022 acquisition of Marley.  

After a 22% rise in revenue last year, it is expected to edge up just 2% to £732 million this year, followed by 3% in 2024. Fair enough. 

Yet net profit is expected to more than double over £59 million then advance near £66 million in 2024.  

The effects of issuing 29 million shares at 650p to buy Marley means earnings per share (EPS) is expected to fall around 30% to around 23p. But what if profit hopes are too high? An 11% rise to 25.6p is then targeted for 2024, but precision is fanciful when the BoE is well off-beam with its own predictions.  

The financial summary table shows a circa 13%, medium-term operating margin near-halving last year. The 2022 results statement appeared to blame the Ukraine conflict pushing up materials prices, without saying (like Brickability) whether Marshalls is succeeding to pass on costs. This is essential for confidence in the profit forecasts. 

Marshalls- financial summary
Year end 31 Dec201720182019202020212022
Turnover (£ million)430491542469589719
Operating profit (£m)53.464.873.79.476.247.9
Net profit (£m)42.552.058.22.454.826.8
Operating margin (%)12.413.
Reported earnings/share (p)21.326.
Normalised earnings/share (p)21.726.329.511.227.733.1
Operational cashflow/share (p)28.731.643.96.232.636.1
Capital expenditure/share (p)10.314.611.47.310.912.7
Free cashflow/share (p)18.417.032.5-1.121.723.3
Dividend per share (p)
Covered by earnings (x)
Return on total capital (%)17.517.418.
Cash (£m)19.845.753.310441.256.3
Net debt (£m)24.337.460.075.641.1237
Net assets (£m)236266295287343660
Net assets per share (p)118132147143171261
Source: historic Company REFS and company accounts

Dividend projections simply appear consistent with EPS assumptions, with two times cover. Mind the record is quite erratic anyway, falling 70% in respect of 2019 before Covid took the dividend per share slightly lower to 4.3p, then 14-15p was recovered. 

So a 25% fall in 2023 dividend to 11.7p is assumed, then a rise to 12.8p in 2024 – for a yield just over 4% at 287p currently. That to me is fair pricing for a cyclical like this. 

Marshalls can appear, trading close to 261p net asset value per share, as a potential takeover target. Yet this is constituted 85% by intangibles given an acquisitive history. 

Mind, the Marley acquisition also hiked long-term debt from £39 million to £247 million, such that the year-end balance sheet changed from slightly cash-positive to £191 million net debt. The net interest charge rose from £6.9 million to £10.7 million, against £47.9 million operating profit, and will be greater under a full-year charge plus higher interest rates. 

It is therefore rather merciful that the BoE has ditched its recession forecast, otherwise Marshalls would have over-extended itself financially as well as strategically, with its late-cycle purchase of Marley.  

CEO and director spouses, buy modestly 

After the latest update, the CEO has bought 10,000 shares at 256p, the chief operating officer’s wife 1,062 shares at 280p, and the CFO’s wife 3,763 shares at 264p.  

While hardly “backing up the truck”, it reflects belief in long-term value, where an averaging-in approach can work against the hazards of investment timing.  

Yes, the Marley acquisition should help Marshalls achieve its strategic aim as “the UK’s leading manufacturer of products for the built environment”, and indeed there is a good strategic fit that might offer synergy when combining customer bases. 

But I think Inflexion private equity has shown the better timing and overall execution: buying Marley only in August 2019 from a Belgian owner, and selling on within three years – making a 350% return.  

Inflexion probably decided not to hope for even greater gains as the interest rate environment changes. They followed the astute trading adage, to “leave something on the table for the next owner” - in Marshalls’ case, strategic hopes. 

Hence there are reasons existing holders can take comfort, although as a “buy” this stock is tentative. I would await more updates from building materials companies as the slowdown could persist despite the BoE now predicting overall UK growth. Hold. 

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

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