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Questor: why you should buy this brick maker even while house building is comatose
Questor share tip: house building may be ‘bouncing along the bottom’ but brick making is hard to break into and seems immune from technological change
Alastair Mundy is one of Britain’s most prominent “value” investors and, in keeping with his value creed, is not normally interested in buying a particular stock unless its shares have fallen severely. But he does make the occasional exception to this rule.
In fact, he told Questor, two of the stocks in his 46-holding Temple Bar investment trust have not undergone the kind of share price collapse that normally precedes his purchases. One is Forterra, Britain’s second-largest brick maker.
“Forterra may operate in a depressed industry – the number of houses being built in Britain is bouncing along the bottom – but it’s not a depressed company,” Mundy said.
Despite the slow pace of house construction, there is very little spare capacity in Britain’s brick making industry, leading to a relatively high level of imports, he added. Forterra therefore plans to increase its production capacity by 16pc by 2022 – replacing its existing Desford facility with a new plant more than twice the size.
Will it be able to sell all these extra bricks? “There is pent-up demand if long-term government plans for home building ever come through. There is a lot of political pressure to build more houses so that young people have more chance to buy,” the fund manager said.
“It’s the local authorities that we’d see as taking up the slack, as the large private housebuilders are already building as much as they ever have.” He said it wasn’t a case of requiring a stronger economy; in fact the opposite could be the case because “if growth is weak, one ‘Keynesian’ response would be to increase public-sector house building”.
Neither is Forterra, unlike the housebuilders, sensitive to property prices. “It just needs houses to be built,” Mundy said.
There are other advantages to being a brick maker. There is no obvious alternative to bricks and no threat from new technology, while the market is oligopolistic, so competition is limited: even as the second-largest maker, after Ibstock, Forterra has a 29pc market share. There are physical barriers against the arrival of new competitors, because you need a clay reserve.
“If you wanted to invent a sector with good characteristics for investors, this would be hard to improve,” Mundy said. He said Forterra’s profit margins were good at about 20pc, which was “high for a low-tech product and a function of the relative lack of competition in the market”.
Returns on capital and cash conversion, two measures this column sets great store by, have also been strong historically, although the former figure has been boosted by the “depreciation” charge booked against the firm’s brickworks. As the stated value of an asset falls, the profits produced by the asset look better by comparison.
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Cash conversion is also likely to decline while Forterra’s new plant is being built: it will, until it’s completed, consume cash without generating any revenue.
“Forterra is in a nice place but its valuation is low because it is not an ‘in vogue’ producer of stable earnings,” Mundy said. “Its 100pc exposure to the UK gives investors the heebie-jeebies: some are avoiding all British stocks and you’ll get some babies thrown out with the bathwater.
“But even in a continuation of the current cycle the valuation is forgiving. If the cycle goes against it, the firm can survive thanks to its low debts.”
He added: “Forterra is a ‘growth cyclical’ – I’d be surprised if it weren’t larger in five to 10 years’ time.”
Questor says: buy
Ticker: FORT
Share price at close: 285p
Update: FairFX
FairFX, the foreign currency firm tipped here on March 13, has changed its name to Equals Group. The ticker is now EQLS but the other means by which the stock is identified, the “Sedol” and “ISIN” numbers, are unchanged.
The company said: “Shareholders will be unaffected by the change of name and existing share certificates should be retained as they will remain valid for all purposes. Any new certificates issued from June 27 will bear the name Equals Group plc.” We have made a gain of 24pc so far and our rating is hold.
Questor says: hold
Ticker: EQLS
Share price at close: 120.5p
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