27 Jul 2018

To be or not to be? (A Conglomerate)

In a recent investor update in Sydney, Fletcher Building’s new CEO, Ross Taylor, took the bold step of comparing the company’s performance to global building material giants such as Saint Gobain and CRH, who respectively have revenues of €44b and €28b (10 and 8 times bigger than Fletchers). Mr Taylor chose to make the comparison based on Total Shareholder Returns rather than performance metrics such as cash flow or earnings. Under the TSR metric Fletcher Building sits firmly mid-pack, rewarding shareholders with a relatively meagre 4% return over the previous 10 years.  


Mr Taylor’s point was that this was clearly not good enough, and that material suppliers with a single product focus were able to deliver much more reasonable returns. It was a valid point, but it was hardly a shocking revelation to investors in the room who for decades have been frustrated with Fletcher Building’s underperforming acquisitions. Nevertheless, that was enough preamble to be able to confirm the impending sale of one of the most expensive of those acquisitions, Formica. If things go well, it seems it might be possible to sell Formica for close to what Fletcher Building paid for the company 10 years ago. 


Unfortunately, not all of Fletcher Building’s woes can be blamed on the strategic decision to become a global conglomerate. By referring to the newly disclosed operating segments we can see that in New Zealand operating profit (before construction losses) has increased from $458m in 2008 to $554m in 2017, about 20% over 10 years, whilst the associated capital employed increased from $1.3b to $2.2b, closer to a 70% increase. In Australia, operating profit has gone backwards ($214m to $119m) over the same 10 years. The construction division is set to lose near $600m, which would take 15 years of normal profits from that division to recover from, if it was given the opportunity. Maybe Formica’s $100m pa effort isn’t so bad after all.  


Over the same 10 years, the two global conglomerates mentioned above have followed different directions, but with broadly similar outcomes. Saint Gobain has maintained steady revenues, but increased profits on the same asset base, whilst CRH has successfully deployed an extra 60% of assets, increasing profits by 30%.  


Construction, and supplying construction materials, is a tough business, with the building cycle often taking its toll. All three companies have had volatile earnings, often moving by 50%, and periods of loss has not been uncommon. Over 20 years and at least two construction cycles, they have all performed similarly, making between 3% and 5% return on assets, hardly a compelling opportunity.  


What is important now, however, is what the new “non-global” Fletcher Building will do with its exclusive focus on NZ and Australia. Some of the more alarming initiatives discussed at the presentation included establishing a new Australian head officeand “pursuing new adjacencies”. By Fletcher’s own estimates they have a significant presence in half of the main building materials categories in New Zealand and only a quarter in Australia.  


And what will happen to the billion dollars realised from the Formica sale? The official line is that divestments will create a “resilient balance sheet and headroom for investment”. That investment will look at both organic and non-organic opportunities. Ross Taylor highlighted the most attractive of those opportunities was the expansion of the plasterboard plant in New Zealand, currently running at full capacity. But with non-organic expansion (acquisitions) still on the cards, do not expect a move away from a conglomerate just yet.