New Zealand Professional Investment Services Firm

Forsyth Barr

We are proud to be a New Zealand owned firm, with 21 offices throughout the country and over 300 employees. We assist personal, institutional and corporate clients providing a full range of investment services.

Forsyth Barr is a foundation New Zealand Exchange firm (NZX) and accredited market participant. We have been confirmed by the Financial Markets Authority as a Qualifying Financial Entity (QFE).

Research is the cornerstone of our advice. We have one of New Zealand's leading teams of analysts. Our global affiliations ensure comprehensive research coverage of all major investment markets.

New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Fletcher Building</h2>
<p><strong>Preparing for the Unknown</strong></p>
<p><strong>NEUTRAL</strong></p>
<p>Fletcher Building (FBU) has outlined its response to an expected sharp downturn in construction activity. Unfortunately,&nbsp;FBU&nbsp;did not enter the crisis in fighting shape. NZ margins have long been under pressure. Australian turnaround efforts have delivered little tangible reward. Necessary reinvestment has elevated&nbsp;capex. The risk is this downturn is not only cyclical, but leads to a further erosion in the business's underlying quality. Whilst&nbsp;FBU's&nbsp;share price remains down sharply from pre&nbsp;COVID-19&nbsp;levels, it's&nbsp;not at a level where we see clear value. Maintain NEUTRAL.</p>
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/134/720/original/image_48791401721590018950464.png?1590018953" class="editor-image img-responsive" data-smartkarma-image-id="134720"></figure>
<p><strong>Locked out in Level 4; a grind through Levels 3 and 2</strong></p>
<div id="m_-6260839725587174867ibkqe-2">
<p>Unsurprisingly, FBU has been materially impacted by COVID-19 restrictions. Through Level 4 lockdown NZ revenues were minimal. Since construction has recommenced, activity has recovered to c.80% of FBU's pre COVID-19 forecasts. In Australia, where construction is deemed an essential service and was not closed, constraints have reduced revenue to c.90% of FBU's pre COVID-19 expectations.</p>
<p>In April, FBU recorded aNZ EBIT loss of NZ$55m (net of NZ$22m of wage subsidies and, we estimate, c.NZ$12m of wage reductions), and was breakeven in Australia. Despite the bounce back in activity, earnings remain materially impacted. FBU stated it expects to be broadly breakeven in the 4Q net of the April loss, wage reductions, and a total NZ$66m (12 weeks) of wage subsidies. We estimate FBU's update implies FY20 EBIT of c.NZ$275–300m (cf. 1H20 NZ$219m/prior guidance NZ$515–565m/FY19 NZ$631m).</p>
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<p><strong>Planning for a sharp downturn ahead</strong></p>
<div id="m_-6260839725587174867icbki-2">
<p>FBU expects COVID-19 "to have a significant impact" on construction activity in NZ/AU. It has acknowledged the extreme level of uncertainty at this time, but has outlined a (in our view, not unreasonable) base case in which construction falls by c.10–30% across the various NZ/AU segments. FBU does expect government infrastructure investment to provide some medium-term offset, but there will be a lag before projects commence. FBU is responding to the expected downturn with a number of cost reduction initiatives, including a 10% reduction in its workforce. We estimate the plans outlined amount to targeted savings of c.NZ$235m pa (or c.NZ$170m in FY21 net of wage subsidies received in FY20).</p>
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<p><strong>Risk&nbsp;COVID-19 causes further underlying deterioration in&nbsp;FBU's&nbsp;businesses</strong></p>
<div id="m_-6260839725587174867imn3q-2">
<p>Our forecasts are revised by EPS FY20/21E -11%/+10% (really just tweaks when near-term forecasts include a lot of guesswork). Construction is a later-cycle industry. We anticipate activity and FBU's revenue will bounce once lockdown restrictions are fully lifted, but fade as current projects are completed and the pipeline empties. There is risk both around the magnitude of the downturn, and, more significantly, of further underlying deterioration in FBU's businesses. Competition may continue (or compound) margin pressures. Falling demand exacerbates the challenges of executing on turnaround initiatives. And a pullback in capex may starve the business of necessary investment. Our concern is FBU may emerge from the downturn weaker than when it went in.</p>
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<div><strong>Matt Henry CFA</strong></div>
<div><a href="mailto:matthew.henry@forsythbarr.co.nz" target="_blank" rel="noopener">matthew.henry@forsythbarr.co.<wbr>nz</a></div>
<div>+64 9 368 0115</div>
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<div><strong>Rohan Koreman-Smit</strong></div>
<div><a href="mailto:rohan.koreman-smit@forsythbarr.co.nz" target="_blank" rel="noopener">rohan.koreman-smit@<wbr>forsythbarr.co.nz</a></div>
<div>+64 9 368 0085</div>
<div></div>
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<div><strong>Ashton Olds</strong></div>
<div><a href="mailto:ashton.olds@forsythbarr.co.nz" target="_blank" rel="noopener">ashton.olds@forsythbarr.co.nz</a></div>
<div>+64 9 368 0127</div>
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Fletcher Building
Preparing for the Unknown
NEUTRAL
Fletcher Building (FBU) has outlined its response to an expected sharp downturn in construction activity. Unfortunately,&nbsp;FBU&nbsp;did not enter the crisis in fighting shape. NZ margins have long been under pressure. Australian turnaround efforts have delivered little tangible reward. Necessary reinvestment has elevated&nbsp;capex. The risk is this downturn is not only cyclical, but leads to a further erosion in the business's underlying quality. Whilst&nbsp;FBU's&nbsp;share price remains down sharply from pre&nbsp;COVID-19&nbsp;levels, it's&nbsp;not at a level where we see clear value. Maintain NEUTRAL.

Locked out in Level 4; a grind through Levels 3 and 2

Unsurprisingly, FBU has been materially impacted by COVID-19 restrictions. Through Level 4 lockdown NZ revenues were minimal. Since construction has recommenced, activity has recovered to c.80% of FBU's pre COVID-19 forecasts. In Australia, where construction is deemed an essential service and was not closed, constraints have reduced revenue to c.90% of FBU's pre COVID-19 expectations.
In April, FBU recorded aNZ EBIT loss of NZ$55m (net of NZ$22m of wage subsidies and, we estimate, c.NZ$12m of wage reductions), and was breakeven in Australia. Despite the bounce back in activity, earnings remain materially impacted. FBU stated it expects to be broadly breakeven in the 4Q net of the April loss, wage reductions, and a total NZ$66m (12 weeks) of wage subsidies. We estimate FBU's update implies FY20 EBIT of c.NZ$275–300m (cf. 1H20 NZ$219m/prior guidance NZ$515–565m/FY19 NZ$631m).

Planning for a sharp downturn ahead

FBU expects COVID-19 "to have a significant impact" on construction activity in NZ/AU. It has acknowledged the extreme level of uncertainty at this time, but has outlined a (in our view, not unreasonable) base case in which construction falls by c.10–30% across the various NZ/AU segments. FBU does expect government infrastructure investment to provide some medium-term offset, but there will be a lag before projects commence. FBU is responding to the expected downturn with a number of cost reduction initiatives, including a 10% reduction in its workforce. We estimate the plans outlined amount to targeted savings of c.NZ$235m pa (or c.NZ$170m in FY21 net of wage subsidies received in FY20).

Risk&nbsp;COVID-19 causes further underlying deterioration in&nbsp;FBU's&nbsp;businesses

Our forecasts are revised by EPS FY20/21E -11%/+10% (really just tweaks when near-term forecasts include a lot of guesswork). Construction is a later-cycle industry. We anticipate activity and FBU's revenue will bounce once lockdown restrictions are fully lifted, but fade as current projects are completed and the pipeline empties. There is risk both around the magnitude of the downturn, and, more significantly, of further underlying deterioration in FBU's businesses. Competition may continue (or compound) margin pressures. Falling demand exacerbates the challenges of executing on turnaround initiatives. And a pullback in capex may starve the business of necessary investment. Our concern is FBU may emerge from the downturn weaker than when it went in.



Matt Henry CFA
matthew.henry@forsythbarr.co.nz
+64 9 368 0115





Rohan Koreman-Smit
rohan.koreman-smit@forsythbarr.co.nz
+64 9 368 0085





Ashton Olds
ashton.olds@forsythbarr.co.nz
+64 9 368 0127




Fletcher Building: Preparing for the Unknown