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Reece Ltd announces new $2 billion acquisition

Bathroom and plumbing equipment company Reece Ltd (ASX: REH) just announced a $1.9 billion acquisition.

The target is MORSCO Inc., a leading South-Western US distributor of plumbing, waterworks, heating and cooling products.

Acquisition financing

To fund the transaction, Reece launched a $560 million equity raising at $9.30 per share, a 13.5% discount on the last traded price of $10.75.  The Wilson family – which runs Reece and owns a majority stake in the business – will contribute to the deal with a $300 million subscription.

The results of the equity raising will be announced on Wednesday. Until then, the stock will remain in a trading halt.

The rest of the purchase price will be covered with a US$1,140 million seven-year senior secured credit facility from the US institutional term loan market – an arrangement that offers long-term financing without imposing maintenance covenants. For the acquisition, Reece has a pro-forma net debt to EBITDA ratio of 2.9 at December 31.

Strategy and impact

Reece is betting on a favourable outlook for the US construction sector, particularly in the Sun Belt, a group of Southern US states that are expected to generate strong economic and demographic growth.

MORSCO operates in 16 states, with 171 branches and 2,500 employees. In 2017, it reported sales of US$1.7 billion and EBITDA of US$100 million. The acquisition is expected to be mid-high single digit EPS accretive in the first year of ownership, assuming no synergies.

In fact, Reece plans to run MORSCO as a separate business, maintaining the current management in place.

Aside from the acquisition, the company forecasts a record result in FY2018 thanks to new branch openings and the upgrade of both its branch network and online offer. Sales will be up 10% on the previous year, in a range of $2.65 billion to $2.70 billion. NPAT will increase 5% to 8%, to a range of $223 million to $230 million.

Foolish takeaway

Taking into account the issuance of new shares and the upper end of the earnings forecast, Reece has a PE ratio of around 26, which is not necessarily too much for a company with its recent history of steady growth and good future prospects. However, I would consider also investing in industry peer GWA Group Ltd (ASX: GWA), which trades at around 18x forward earnings on solid fundamentals.

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