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Brickworks – Everything is awesome

It’s a tough time out there for a lot of industries and the RBA certainly has a negative view of the current state of play. Sure, consumer confidence is not the best and those modest $1m homes in Port Headland are now being passed in at $390k. But it’s no secret that housing is generally very strong in Australia and so too is the market for building products.

At the time of Brickwork’s full year result announcement, MD Lindsay Partridge forecast a further improvement in 1H15 Building Products earnings on the back of “the strongest market in a decade.” Brickwork’s brick kilns are energy intensive things that can’t be switched off when demand is low. This makes the brick industry a tough one in a downswing, but a great one in the upswing when all that operating leverage turns positive.

So you’d think that Brickwork’s would be trading at its highs. Not so. Since the Carnegie/Perpetual plan to realise $1bn of hidden value from the Soul Pats cross-shareholding got shot down by the ATO, Brickwork’s has been broadly underperforming. This is simply not consistent with the likely growth of the business through the last few months.

Unlike much of the rest of the market, Brickwork’s doesn’t report its 1H15 earnings until late March. But we got some insight into what they might look like through Boral’s result yesterday. Boral reported a 6% uplift in brick volumes on the back of “broad market strength”. Brickworks is a much better business than Boral’s equivalent division and could well have done better. With that operating leverage in effect, volume growth should bring margin growth and a positive surprise relative to market expectations in March.

Looking beyond the next result, the recently approved brick JV between CSR and Boral represents a positive structural shift for the industry. The JV’s basic rationale is to reduce capacity and enhance profitability for the partners. But the flow-on effect of lower industry capacity is also positive for Brickworks in terms of pricing power. The current cycle could very well be a great one for Brickworks, meaning dividends are lifted to a greater degree than the cent or so per annum that the market expects.

So the current consensus for a 3.4% fully franked yield in FY16 and a 14X PE could well be undercooking it. Getting in ahead of the result is the way to play this one.

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