Key points

• The building materials stocks are caught between a housing boom in Australia, and a slowdown in mining and infrastructure activity.
• CSR has performed strongly – total return of 50.6% a year over three years – and analysts see further gains possible, of close to 15% from the current price.
• Adelaide Brighton and Nufarm could be potential takeover targets.

Combined as they are in a sector with the big mining stocks, it is sometimes difficult to notice the building and agricultural chemical material stocks, but with the miners struggling in recent years, these stocks have been holding up the materials index’s performance.

The non-mining materials sector in Australia is a mixed bag, containing the big building materials stocks such as Adelaide Brighton (ABC), Boral (BLD), Brickworks (BKW), CSR (CSR), Fletcher Building (FBU), James Hardie (JHX) and paint maker DuluxGroup (DLX), as well as the nation’s last two makers of steel products, Arrium (ARI) and Bluescope Steel (BSL); and the two agricultural chemicals businesses, Nufarm (NUF) and Incitec Pivot (IPL).

The outlook

The building materials stocks are caught between a housing boom in Australia, and a slowdown in mining and infrastructure activity. According to the latest Australian Bureau of Statistics (ABS) data, work started on a record 203,760 new dwellings over the year to March, up 15.6% on the previous year. Dwelling starts rose by 8.6% in the March quarter to 53,901. The activity is being driven by apartments – in the March quarter, for example, new private sector house approvals rose by just 0.2%, while apartment starts surged by 19.7%. In its full-year result (to March 2015), CSR said that apartments and unit developments now represented 40% of all housing activity.

Unfortunately, the strength in housing is being offset by a decline in Australian engineering construction. Research firm BIS Shrapnel expects activity to fall 40% from its 2012-13 peak of $130.3 billion to $79.6 billion by 2017-18, due to the end of the mining investment boom and a lack of new state and federal government infrastructure projects. BIS Shrapnel says total work will fall by a steeper than expected 13% in 2014-15 and another 15% in 2015-16, with further substantial declines in the subsequent two years.

Analysts expect this decline to hurt the share prices of Adelaide Brighton and James Hardie the most. ABC has delivered total return of 18.1% a year over the past three years, but according to FN Arena, the analysts’ consensus target price, at $4.13, implies 11.2% downside. Likewise, James Hardie has done even better – up 40% a year over three years – but its analysts have a consensus target price of $17.26, projecting an 8.1% slide.

Although CSR has performed even more strongly than this pair – total return of 50.6% a year over three years – analysts see further gains possible, of close to 15% from the current price. CSR also offers an unfranked FY16 prospective yield of 6.1%.

DuluxGroup, which has generated 27.6% a year over three years, is considered fairly fully valued (0.9% upside), while Boral, which has returned a handy 29.9% a year over three years, is seen as having 0.3% downside from its current price. Fletcher Building, which has barely generated a profit to shareholders over the last three years – up just 1.3% a year – is viewed as having small (3.3%) room to move higher.

Brickworks is not a pure-play building materials exposure, but that can give it diversification appeal. Analysts consider BKW capable of moving 6% higher from its current price.

Analysts are much more positive on Incitec Pivot than Nufarm: the former is seen as having 7.2% upside from the current share price, while Nufarm is positioned for a fall, with the analysts’ consensus target price 9.8% below the current price.

Merger and acquisition potential

As in any sector, merger and acquisition (M&A) activity could be the wild card in materials.

Adelaide Brighton could be involved in any such activity. Boral made a failed $867 million takeover bid for ABC ten years ago, but the rationale for such a move has not gone away: the two companies would make a natural fit as a larger construction materials business. A potential hurdle could be the fact that the privately owned concrete construction products business Barro Group owns 32% of ABC – while that is a potential blocking stake, it also means that a full bid from Barro for Adelaide Brighton cannot be ruled out.

In a similar vein, Nufarm is one of the best examples on the ASX of a company with a large foreign shareholder that could look to move to full control. Sumitomo Chemicals Group of Japan owns 23% of Nufarm, with which it has a major distribution deal in the UK and Ireland. Announcement of that deal in May lifted Nufarm’s shares to a five-year high: the stock market likes the tie-up, and is keeping a close eye on Sumitomo’s intentions for Nufarm.

Finally, either Incitec Pivot or Orica would make sense as a pick-up for Wesfarmers, which is still flush with cash from selling its insurance businesses last year, and looking for new revenue streams. However, Wesfarmers is probably more likely to be looking at financial services acquisitions.

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