Adelaide Brighton Ltd. (ASX: ABC) was established in 1882 and is a leading Australian supplier and producer of construction materials, primarily lime and cement. One major use of lime is to neutralise the acidic waste generated when mining gold and alumina, and around 15 % of the company's sales are to the mining industry. Cement is primarily used in the production of concrete, so Adelaide Brighton's fortunes are also dependent on the building industry.
Management pursues a vertical integration strategy, meaning that it aims to control its entire supply chain from the quarry of sand and rock to distribution of finished concrete products. In theory, this enables it to eliminate inefficiencies that exist in a fragmented supply chain and therefore earn superior profit margins.
Interestingly, Adelaide Brighton's peers prefer a different strategic approach. For example, CSR Limited (ASX: CSR) has a more diversified product offering, combining its property and aluminium subsidiaries with its construction materials business. Boral Limited (ASX: BLD), on the other hand, is geographically widespread with a strong presence in the U.S. and other parts of the world.
Adelaide Brighton acquired businesses in South Australia and Queensland for a total of $174 million in 2014. The price represents less than 10 times earnings before interest tax depreciation and amortisation (EBITDA). Adelaide Brighton's EBITDA was $293 million in 2013 and so the acquisition should increase profits by around 6%. However, more important than current profits are the quarry reserves that accompany the newly acquired businesses. Indeed, management attributes 80% of the value of the deal to these assets because they believe that competitor reserves in South Australia are likely to be exhausted over the next decade.
Group revenues have risen from $1.07 billion to $1.23 billion over the past four years, but earnings remained flat over the same period at around $151 million. Whilst this consistent performance is a strength of the business, it is also slightly disappointing given management's stated goal of improving profits through cost reduction.
Around 80% of profits have been returned to shareholders as dividends in the last four years, with the remaining 20%, representing $120 million, reinvested back into the business. Debt has risen from $148 million to $248 million. This means that a total of $220 million has been injected over this time. However, profits have not risen, so it is questionable whether the funds have been used wisely. Alternatively, this may reflect current weakness in the mining industry.
Adelaide Brighton is currently priced at around 15 times its most recent earnings result. This is not cheap for a mature business with limited growth prospects. It has a dividend yield of around 4.6%, which is attractive given the current low interest rate environment. When interest rates eventually rise, this could put pressure on the share price as investors switch out of income stocks and into safer asset classes.
Should you buy?
Adelaide Brighton is a high quality vertically diversified company with a rich history and enviable, market leading position. But growth has stalled and the stock looks expensive on an income basis. It may be wise for investors to wait for a cheaper entry price or for conditions in the mining industry to improve before considering buying shares.
