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Summary: A REIT, Telecom, Miner and Building Products Manufacturer All In One!

Brickworks is a very well managed company with interests in a diverse range of industries. Most of the company’s value comes from its industrial property and 39.4% stake in Washington H. Soul Pattinson (ASX: SOL). Soul Pattinson’s investments are concentrated in TPG Telecom and New Hope Corporation. Brickworks is a conservatively managed company which can be expected to provide an investor with a steadily growing income stream and capital appreciation. The company has a cross-shareholding arrangement with Soul Pattinson which the market occasionally finds difficult to value. These times when the market is irrational provide investors with a good opportunity to establish a position in the company. Ultra-Conservative Value: $8.36 per share. Conservative Value: $10.80 per share. Fair Value Range with more realistic assumptions: $13.35 – $16.70.

Contents

  • Summary
  • Introduction
  • Company Overview
  • Building Products
    • How Brickworks Was Built
    • The Economics of Brick Manufacturing
    • Australian Brick Manufacturing Market
  • Property
  • Investments – Washington H. Soul Pattinson
    • TPG Telecom (ASX: TPM)
    • New Hope Corporation (ASX: NHC)
  • Financial Performance
  • Cross-shareholding Drama
    • Reasons For Not Unwinding Cross-shareholding
    • Reasons For Unwinding Cross-shareholding
  • Valuation
    • Valuing the investment in Washington H. Soul Pattinson
      • Method 1: Multiply the Washington H. Soul Pattinson share price by the number of shares owned by Brickworks
      • Method 2: Look-Through Asset Value
      • Method 3: Ignore Soul Pattinson’s Stake in Brickworks
    • Valuation: Putting It All Together
      • Building Products Australia
      • Building Products North America
      • Property
      • Investments
      • Final Ultra Conservative Value
      • Final Conservative Value
      • Valuation Summary
  • Conclusion
  • Sources

Introduction

After a mammoth effort, I finally finished reading all 448 pages of The Brickmasters: 1788 – 2008 by Ron Ringer. The book is a complete history of Australian clay brick manufacturing from settlement to 2008 commissioned by Brickworks as part of their centenary celebrations in 2008. As the book’s blurb states:

“The Brickmasters explores the impact of social, economic, technological and architectural change on one of Australia’s most historic and vital industries. It also examines the profound effect on brickmaking of figure William King Dawes, 1898-1981. Austral Bricks (1908) and its parent, Brickworks Limited (1934) can rightly lay claim to be the oldest surviving and most influential manufacturers of clay products in Australia since federation in 1901.”

Admittedly reading this book was overkill since I probably did not need to read it in order to effectively analyse the company. Nevertheless, I know now more about bricks than I ever thought I would need to know.

The Brickmasters 1788 – 2008 by Ron Ringer. This book is the size of a brick. Source: Author

I first became interested in Brickworks via hearing about its sister company, Washington H. Soul Pattinson (ASX: SOL). Soul Patts initially piqued my interest due to its conservative management, enviable dividend history, family management, long history, market beating returns and diversified portfolio. Not to mention some people consider Soul Patts to be the Berkshire Hathaway of Australia. Brickworks only got on my radar after I discovered that Brickworks’s share in Soul Patts alone was worth more than Brickworks entire market capitalisation. You were essentially getting the industrial property and the decades old building products business for free (a value investors dream!). I was initially reluctant to consider an investment in a such a cyclical company as a building products manufacturer, I instead preferred to invest in the more diversified Washington H. Soul Pattinson. When I actually started researching Brickworks though I found that only a small fraction of Brickworks profit comes from making bricks and other building products…

Company Overview

Brickworks has three business segments: Building Products, Property and Investments. The investments segment is by far the most significant in terms of asset value consisting of a 39.4% stake in Washington H. Soul Pattinson.  Property consists of Brickworks 50% interest in an industrial property trust with Goodman Group (ASX: GMG) developed using surplus land from the building products business and the operational land used by the building products business. The building products business is Brickworks legacy business. They manufacture bricks (clay and concrete), precast concrete panels, masonry products, roofing tiles, specialised building systems and also import cement for internal use. The brick division has the highest margins within the building products segment.

Source: Brickworks

The investment in Soul Pattinson and the property segment account for the majority of Brickworks asset value. Soul Pattinson’s major investments are TPG Telecom, Brickworks and New Hope Corporation in addition to a share portfolio containing many different companies (more on that later). One factor which really complicates things is the Brickworks-Soul Pattinson cross-shareholding. Brickworks owns 39.4% of Soul Pattinson and Soul Pattinson in-turn owns 43.9% of Brickworks. I will talk more about this structure later.

Source: Author
Brickworks is more than just a brick maker. Source: Brickworks 2019 AGM Presentation Slide 10

For those interested, I have uploaded a collection of Brickworks Annual Reports since the older ones can be difficult to find.

Brickworks Annual Reports 1981-2018

Building Products

I will first analyse Brickworks smallest business – building products – before analysing the property and investments segments.

The Australian building products segment manufactures, sells and distributes bricks, pavers, masonry blocks, roof tiles, precast concrete panels, retaining wall systems and building systems for the construction industry throughout Australia. The North American building products segment sells brick and stone products in north-eastern parts of the United States – with a home base in Pennsylvania. This business was established in November 2018 when Brickworks acquired Glen-Gery, the fourth largest brick manufacturer in the United States. I have already done an in-depth analysis on the entire North American brick manufacturing industry here.

Glen-Gery is also part of this business segment. The Auswest Timbers hardwood business has been sold while the softwood business has been integrated into Bristile Roofing. Source: Brickworks

This business is Brickworks legacy business so its development has a long history. It is also the only part of Brickworks which Brickworks directly controls on a day-to-day basis: the industrial property trust is managed by Goodman and Brickworks is not involved in the day-to-day management of Soul Pattinson or the companies it is invested in.

Source: Brickworks

Understanding Brickworks long history is useful in understanding the company, how it approaches business, its competitive advantages and the culture of management. This section borrows heavily from the Brickmasters book mentioned above – I wasn’t even alive when most of the following events occurred so most insights are those of the author Ron Ringer.

How Brickworks Was Built

Brickworks was incorporated in New South Wales in 1934 and was listed on the ASX in 1962. Brickworks was initially created by ten Sydney brick manufacturers joining forces during the depression. Over the years Brickworks acquired many other Sydney brick manufacturers including Brickworks most famous brand Austral Bricks during the 1940s. Brickworks also entered the Queensland market in 1959 when they bought a plant at Rochedale.

Throughout this entire period Brickworks was led by William King Dawes who by the end of his life could rightfully be called the ‘king of bricks’. The influence of Dawes on the Australian brick industry, and Brickworks in particular, cannot be understated. He was the man largely responsible for Brickworks success over five decades and helped ensure Brickworks continued success long into the future.

Under Dawes’ leadership Brickworks entered into a share swap with Washington H. Soul Pattinson in 1969 to protect Brickworks from unwanted hostile takeovers and cushion the company against building trade fluctuations. Since 1998, section 259D of the Corporations Act (Cth) has prohibited the creation of such an arrangement, meaning that if the cross-holding were to be unwound it could not be reinstated.

Source: The Canberra Times, Friday April 25 1969

Towards the end of Dawes’ life he was unable to oversee the company to the same standard he would have when he was in better health. As a result Brickworks’ plants suffered from severe lack of investment and the company became a much less dominant force compared to what it once was.

W.K. Dawes died in 1981 at the age of 83. Following his death the newly elected chairman of the board, Jim Millner, set about determining the state of the company. What Millner’s audit found was that almost all of the plants were poorly maintained with one exception: the Punchbowl Brick and Pipe yard. The Punchbowl yard was a highly successful business run by Albert Burgis. On the advice of Ray Dawes (a relative of W.K. Dawes), Millner appointed Burgis General Manager in 1982 and a year later he became a director.

Burgis – eager to find competent senior managers – appointed Alan Bentley as General Manager of Austral’s New South Wales operations in 1984. Bentley had been general manager of PGH’s brick operations and was responsible for developing the skills and careers of many people in Australia’s brick industry. Leading from the front, Bentley (literally) cleaned up the plants by conducting unannounced cleaning blitzes. When Bentley moved over from PGH to Brickworks many of the young men he helped train also moved over with him. This gave Brickworks access to a steady supply of managers who were technically qualified, loyal and reliable. One of the people who came over from PGH was current Brickworks Managing Director Lindsay Partridge.

Brickworks Eras. The actual start date for the Burgis Era was 1982 due to a delay in finding a suitable replacement. Source: Author & Ron Ringer

When Albert Burgis retired in 1988, he had overseen a substantial capital investment program which resulted in Austral Bricks being the most dominant brick maker in Queensland and New South Wales. Alan Bentley succeed Burgis as Managing Director. During Bentley’s tenure Austral Bricks regained its place as the leader in the industry with Australia’s most efficient and modern plants. This achievement was in no small part due to Burgis’ team, especially Lindsay Partridge who over Bentley’s 10 year tenure developed considerable leadership experience. Bentley ended his tenure at Brickworks in 1998 and on Bentley’s recommendation Partridge was appointed Managing Director. Partridge is still managing director today.

Partridge has left a significant mark on Brickworks. During the almost two decades he’s been Managing Director he has overseen Brickworks transformation from a regional brick manufacturer in New South Wales and Queensland to a national brick maker with operations on both sides of the continent thanks to the acquisition of Bristile Limited. Brickworks has diversified its building products offering and now has a substantial presence in the precast concrete panel and masonry market. The company also provides roofing services, imports cement and has a building systems business. These additional business segments: roofing, precast concrete and masonry – were built through a steady program of acquisitions. This is in addition to making capital investments in the Austral Bricks business.

Brickworks Building Products Acquisitions 1999-2019. Source: Author based on Brickworks information

As a result of these acquisitions, Brickworks is the largest clay brick manufacturer, second largest masonry manufacturer, second largest roof tile business and fourth largest concrete product manufacturer in Australia. The company has an estimated 53% share of the clay brick manufacturing market, at least a 20% market share of the masonry market on the east coast and an 11% share of the Australian concrete product manufacturing market.

Source: Author

Bristile Roofing is Australia’s second largest roof tile business. I could not find industry information for the roof tile industry, I could only find information for the Roofing Services Market.

Source: IBISWorld and Author

As well as making acquisitions, Brickworks has substantially rationalised its brick manufacturing footprint by closing down old inefficient plants and upgrading existing ones. Brickworks now has just eleven plants across the whole of Australia.

Source: Brickworks

Next I will discuss the economics of brick manufacturing. I won’t cover the economics of precast concrete panel or masonry manufacturing as I don’t want this article to be too long. In short – the precast panels business has similar economic characteristics to brick manufacturing (high fixed costs, cyclicality, operating leverage) but also has inherently lower margins due to the supply and install nature of the business. Masonry manufacturing is similar to brick manufacturing.

The Economics of Brick Manufacturing

Brick manufacturing is a capital intensive high fixed cost business – this is both a good and bad thing. The capital intensity of the business makes it difficult for competitors to build new brick plants but it also dries up capital which could be used elsewhere. The high capital costs of modernising plants gives larger players a competitive advantage over their smaller rivals since they can produce bricks from their modernised plants at a lower cost compared to their competitors. The costs of innovation in the brick business are too high for many small businesses to keep up with.

High fixed costs (and high gross margins) amplify the effect of a recession but also give the firm operating leverage which increases profits considerably during the good times. This means that it is important to have low debt levels since interest repayments are a fixed cost regardless of the state of the economy. Other capital-intensive businesses also have this characteristic – think Cleanaway.

The best concise explanation of the economics of brick manufacturing I’ve found is by R Matthews in his PhD thesis titled ‘The Economics Of The Brick Cycle and Its Effects on Firm and Industry Structure’:

“The long-term costs facing individual firms in the brick industry are somewhat unusual. This is because brick plants have a very long working life, occasionally being kept in use for over 50 years without extensive repair work. This longevity of plants within the industry has three main causes:

i) rates of technological progress are relatively slow, within such a “basic” industry and thus existing plants do not become outdated very quickly;

ii) high capital costs of new plants give the old plants considerable cost advantages;

iii) the machinery used is of a “heavy” but simple nature, pug mills for example, and as such, have quite long working lives anyway and are cheap to maintain.

Existing plants however, are impossible to change in layout or design. Therefore, it is possible to design new “greenfield” brick-yards that can produce bricks with lower unit variable costs because they incorporate modern handling techniques. However, the high capital costs of these new yards mean that many of these running cost savings are lost and total-unit costs are sometimes higher in modern plants than they are in older ones”.

Brick plants (also called brickyards or yards) are built with a maximum production capacity in mind, measured in millions of bricks per annum. The most efficient way to operate a brick plant is to operate it as close to full capacity as possible. Plants can be run at 50-60% capacity for an extended period but operating at this capacity is uneconomical in the long term because the cost of operating a plant at 50-60% capacity is almost the same as operating a plant at 80-100% capacity due to high fixed costs. It is generally cheaper to stop production completely for a few weeks (for example during Christmas or major maintenance works) than run at a reduced capacity for extended periods. In the long run, plants are either used near full capacity or moth-balled.

If there is excess capacity in the brick market the most inefficient plants are mothballed, and the remaining plants are operated at the maximum capacity possible. Mothballed plants can be brought back into production when demand increases but once a plant has been closed for six months it is unlikely to reopen without considerable expenditure. Brick plants with more than one kiln also have the option of mothballing individual kilns rather than the whole plant.

Brick manufacturers tend to purchase their kilns from specialised manufacturers. These manufacturers are primarily based in the US (such as Swindell Dressler) or Europe (such as Keller HCW GmbH). The largest brick manufacturers often develop strong relationships with their suppliers which gives them a competitive advantage over smaller rivals.

Source: Brick Industry Association (United States)

Since plants can have operating lives of over 50 years, when a new plant is being built great care must be taken to ensure that there are suitable clay and shale reserves available to supply the plant for at least 20 years. Brickworks has a policy of ensuring the business has enough reserves for an entire generation (20 years or so). The bigger the reserves the bigger the maximum production capacity of the plant. For example, North America’s largest brick plant (operated by Brampton Brick) which produces 200 million bricks per annum in Ontario, Canada is supplied by a large quarry which has enough clay reserves to supply the facility for the next 21 years.

The necessity of ensuring decades worth of shale and clay supplies are accessible mean that brick companies end up acquiring large banks of land (although in Europe they often dredge rivers and flood plains to get their clay and shale). Once this land has been mined the land can be used as a landfill (many brick pits around Sydney were used for this) or rehabilitated and developed for residential or industrial use. This has become a major source of income for all major Australian brick manufacturers such as Boral, CSR and Brickworks. In fact the property segments of Boral, CSR and Brickworks are now as large or larger than their respective brick manufacturing businesses. W.K Dawes predicted this when in the early 1970s Dawes remarked that the value of the land occupied by Brickworks’ yards would one day be as significant as the brick business itself.

The location of a brick plant is determined by access to suitable clay and shale reserves, proximity to major brick markets, access to transportation infrastructure, supply of reliable and cheap natural gas and availability of skilled labour. Brick prices for the end user are a function of distance from production site, volume and brick type. The two major costs for brick manufacturers are gas and labour. Brickworks has stated in the past that gas costs account for 20% of the total cost of manufacturing bricks. This is why Brickworks has been so vocal about east coast gas price increases as any increase directly hits the bottom line. In 2017 Brickworks used 5.15 PJ of energy, most of which was natural gas.

Brickworks Energy Usage 2017. Source: Brickworks

International trade in bricks is relatively limited because of high transport costs and bricks low value relative to their bulk. This has protected the Australian brick manufacturing industry from competition from imports but has also limited Australian brick exports. Rising gas prices, transport costs and labour costs have increased local brick production costs to the point where imported bricks are now cost competitive. Brickworks has stated that they import about 1 million bricks a month from Spain to save on transport costs.

Dwelling commencements are a key driver of overall brick demand. Detached housing is particularly important since bricks are the favoured cladding type for detached dwellings. James Hardie, a fiber cement manufacturer and competitor to Brickworks, described the key factors which influence residential construction markets in their 2018 Statutory Accounts:

The level of activity in residential construction markets depends on new housing starts and residential remodeling projects, which are a function of many factors outside our control, including general economic conditions, the availability of financing, mortgage and other interest rates, inflation, household income and wage growth, unemployment, the inventory of unsold homes, the level of foreclosures, home resale rates, housing affordability, demographic trends, gross domestic product growth and consumer confidence in each of the countries and regions in which we operate (p. 171) (Source).

There are three main types of bricks: face bricks, common bricks and engineering bricks. Face bricks are bricks used as external cladding while common bricks are bricks whose aesthetic appearance is unsatisfactory but have good load bearing qualities. Engineering bricks are a special type of brick designed for engineering purposes. Clay pavers are sometimes also considered a type of brick. Face bricks account for 65% of all bricks manufactured in Australia while common bricks account for 22% and pavers account for just 12%. The remaining 1% are engineering bricks and other niche products.

Source: Author

Since face bricks have the highest margins, manufacturers try to encourage their use in external cladding. The choice of cladding material is chosen by architects, developers, builders or the end-user. The use of brick is also sometimes mandated by town planners aiming to maintain the aesthetic appeal of a suburb. Architects play a key role in ensuring bricks are used in construction and consequently Brickworks Building Products regularly holds seminars for architects and publishes books written for architects.  The company’s focus on architects is also evident in their Instagram. Another innovation pioneered by Brickworks is the development of Brickworks Design Studios which showcase many different designs which use predominately brick.

Brick is not the only option for external cladding material. James Hardie described the competitive dynamics of the industry in their 2018 Statutory Accounts as follows:

Competition in the building products industry is based largely on price, quality, performance and service. Our products compete with products manufactured from natural and engineered wood, vinyl, stucco, masonry, brick, gypsum and other materials, as well as fiber cement and fiber gypsum products offered by other manufacturers. Some of our competitors may have greater product diversity, greater financial and other resources, and better access to raw materials than we do and, among other factors, may be less affected by reductions in margins resulting from price competition (page 171) (Source).

Another important consideration is the availability of bricklayers, since in the past shortages of brick layers have significantly impacted brick sales. Brickworks is combating this by investing in bricklayer apprenticeship programs and forming a joint venture with Fast Brick Robotics, a company who uses a robot called the Hadrian X to lay concrete masonry blocks.

Australian Brick Manufacturing Market

The brick manufacturing industry tends to be highly concentrated due to its cyclicality and the high capital intensity of the business. For example, in Australia there are only four substantial brick manufacturers (Brickworks, CSR, Boral, BGC Australia) and a handful of small boutique regionally based manufacturers (Selkirk Bricks, Geraldton Brick, Krause Bricks, Advance Bricks & Pavers, Littlehampton Clay Bricks and Pavers, Glen Thompson, Claypave, Namoi Valley Bricks, and Lincoln Brickworks).

The Australian brick industry tends to be divided between west coast and east coast manufacturers. Only Brickworks has a truly national presence while CSR has a presence in the east coast. Boral and BGC only have a presence in Western Australia. The three largest manufacturers control 83% of the Australian market, with Brickworks alone accounting for 53% of it. Brickworks dominance in Australia is one of the reasons they have decided to expand into the United States.

September 2019 Update: Since writing this article Boral has sold Midland Bricks, its Western Australia brick business, to a consortium consisting of Linc Property, Birchmead, and Fini Group. The sale price was $86 million.

Brick industry consolidation is occurring in all developed countries. The American brick industry has consolidated substantially over many decades and this process is still underway today. Other countries such as the UK have already undergone consolidation and as a result have a similar industry structure to Australia.

In the UK three brick manufacturers control 92% of the market. The three largest UK manufacturers are Ibstock (the company Brickworks bought Glen-Gery from), Forterra and Wienerberger – the world’s largest brick manufacturer. The rest of the industry consists of one medium size player (Michelmersh) and nine small manufacturers who generally operate a single plant. Back in 2007 there were 29 brick manufacturers in the UK (compared to ≈ 13 in 2019), with 25 of them being small single plant companies (Source). The three big players in the UK have benefited enormously from industry consolidation and the same can be said for Brickworks in Australia and Glen-Gery in the US.

Source: Michelmersh
Side Note: Warren Buffett and Investing in Brick Manufacturers - Click to view

It was the above economic characteristics which eventually attracted the world’s most famous investor – Warren Buffett – to the industry. In the year 2000 Buffett’s Berkshire Hathaway purchased one of America’s largest brick manufacturers: Acme Brick Company.

Source: Acme Brick Company

At that time Acme manufactured 11.7% of all bricks in the US and in 2008 Acme Brick became the largest brick manufacturer in the United States before it was overtaken by Meridian Brick in 2016 (a joint venture between Boral and Forterra). Acme Brick Company described Warren Buffett’s decision to purchase the company like so:

Warren Buffett’s decision to add Acme Brick Company to his Berkshire Hathaway portfolio was typical of the Omaha investor’s approach to acquisitions. He has often reiterated that his investment strategy is based on the philosophy of only investing in companies and products that the average person can understand.

And Warren Buffett understood brick. Describing his first meeting with Acme Brick Company President and CEO Harrold Melton, Buffett noted that “when Harrold and I first met, he talked about how a home is the largest single investment made by most families. I must say, that like most people, I took the beauty and permanence of my brick home, purchased in 1958, for granted. Then I realized that my total expenditure in maintaining the brick exterior of my home for forty-two years was zero! How many thousands of dollars would I have spent maintaining another type of exterior during the ensuing four decades? Early in my business career, that money spent on maintenance would have been unavailable to invest in quality stocks and companies.

Buffett went on to say that “this incredible value that brick delivers has made Acme a household name in their primary market. We place a high value on investing in companies like these with strong brand positions in their markets like Coke, Gillette, GEICO, and American Express. We know that these companies achieve strong brand preference by consistently delivering superior products, service, and value (Source: ACME BRICK COMPANY: 125 YEARS ACROSS THREE CENTURIES, p. 113).

Buffet had this to say about Acme Brick in the 2000 Berkshire Hathaway Annual Report:

Acme produces more than one billion bricks per year at its 22 plants, about 11.7% of the industry’s national output. The brick business, however, is necessarily regional, and in its territory Acme enjoys unquestioned leadership. When Texans are asked to name a brand of brick, 75% respond Acme, compared to 16% for the runner-up. (Before our purchase, I couldn’t have named a brand of brick. Could you have?) This brand recognition is not only due to Acme’s product quality, but also reflects many decades of extraordinary community service by both the company and John Justin. I can’t resist pointing out that Berkshire — whose top management has long been mired in the 19th century — is now one of the very few authentic “clicks-and-bricks” businesses around. We went into 2000 with GEICO doing significant business on the Internet, and then we added Acme. You can bet this move by Berkshire is making them sweat in Silicon Valley.

While all this is quite irrelevant to Brickworks, it is interesting to know that Warren Buffett thought that a brick manufacturer was a good investment.

Property

Brickworks first started tapping into the potential of its large land bank in the early 2000s. Prior to this Brickworks land was either compulsorily acquired by local governments or sold to a developer. Today Brickworks strategy is more sophisticated.

Brickworks land can be divided into two categories: land which is owned by the property trust and land which is owned by Brickworks. The land which is owned by Brickworks is either operational land required for use by the building products business (about 3500 hectares) or non-operational ‘development land’ which is being assessed for future development opportunities. This latter type of land is rehabilitated, re-zoned residential or industrial and sold to a developer for a one-off profit or sold into the industrial property trust at market value. Brickworks does not develop residential property as far as I can tell.

Source: Brickworks

Land which is suitable for industrial property development is sold into the industrial property trust and developed into warehouses, logistics facilities etc.. The amount of land being sold into the trust has increased in the past decade due to the substantial rationalisation program undertaken at Austral Bricks resulting in the closure of many plants and the subsequent sale of the surplus land into the property trust. Austral Bricks has also been using larger amounts of recycled clay which reduces the amount of operational land required for clay reserves.

Source: Brickworks

Brickworks currently has five industrial properties, four are located in western Sydney and one is located near Brisbane. The value of these properties plus land to be developed is $1.25 billion, Brickworks 50% share is worth $625 million. The asset value of the properties is determined by independent valuers.

Source: Brickworks Half Year Report 2019
Source: Brickworks Half Year Report 2019

The Oakdale industrial estate in western Sydney is the most substantial asset and is the source of most of the future growth of the property trust.

Oakdale Industrial Estate Sydney. Source: Goodman Group
Oakdale Industrial Estate Key Metrics. Source: Goodman Group
Brickworks Industrial Property Pipeline. Source: Brickworks

The industrial property trust gives Brickworks exposure to the growing e-commerce sector and the logistics centres and warehouses required to support it. Brickworks has also benefited from a shortage of industrial property in Sydney and the consequent capitalisation rate compression and asset value appreciation.

Goodman Group Australian Industrial Property Trends. Source: Goodman Group
Source: Brickworks

Investments – Washington H. Soul Pattinson

Brickworks owns 39.4% of Washington H. Soul Pattinson. Soul Pattinson has been listed on the ASX since 1903. It started out as a pharmacy but has since diversified into telecommunications, coal mining and other activities. They are currently focussing on investing in financial services.

Source: Washington H. Soul Pattinson

Soul Pattinson has a history of share price out-performance relative to the index and has provided shareholders with a 17.3% compound annual return for 40 years. The company’s massive out-performance in 2018-2019 is due to a Goldilocks period where Brickworks, New Hope Corporation and TPG Telecom all performed very well.

Source: Washington H. Soul Pattinson

Soul Pattinson has increased dividends for 21 consecutive years which makes them the best dividend paying company on the ASX along with Ramsay Healthcare (ASX: RHC).

Source: Washington H. Soul Pattinson

Soul Pattinson’s three primary investments are TPG Telecom, New Hope Corporation and Brickworks. They also have a substantial share portfolio worth around $470 million, a financial services portfolio worth $360 million and a pharmaceutical portfolio worth $240 million. The pharmaceutical business is Soul Pattinson’s original business.

Soul Pattinson Portfolio. Source: Washington H. Soul Pattinson

TPG Telecom (ASX: TPM) (SOL Stake: 25.26%)

TPG Telecom is an Australian telecommunication company which focuses on offering low cost high value telecommunication services. They offer voice, internet and data solutions to wholesale and retail customers throughout Australia. In 2018-19 TPG started building its own mobile network to compete with Telstra. Unfortunately for TPG this technology was built using Huawei equipment which was recently banned by the Australian Government. TPG has now ceased its mobile network roll-out. TPG is also building a mobile network in Singapore which is progressing well.

At the time of writing TPG is seeking to merge with Vodafone Hutchison Australia but was blocked by the ACCC. They are currently before the courts seeking to get this overturned. If the merger goes ahead TPG will become Australia’s third largest telecommunication company in Australia. This will be the most practical way for TPG to get its own mobile network.

New Hope Corporation (ASX: NHC) (SOL Stake: 50.01%)

New Hope Corporation is an energy company whose primary assets are an 80% interest in the Bengalla Coal Mine in the Hunter Valley and a 100% interest in the New Acland Coal Mine in south-east Queensland. At the time of writing the company is currently waiting for approval for Stage 3 of the New Acland Mine. I have already written an in-depth guide to investing in the coal industry and given an overview of coal stocks on the ASX including New Hope.

Note that this presentation was prepared prior to the purchase of Bengalla. Source: New Hope Corporation

The Bengalla Mine is a particularly high quality asset; as you can see below it is the fifth most productive open cut coal mine in New South Wales based on saleable coal production per employee. The mine produces high quality thermal coal which is valued by Asian customers since it produces less carbon emissions per unit of energy and it is suitable for High-Efficiency-Low-Emission power plants.

Source: 2014 New South Wales Coal Industry Profile Volume 1
Side Note: New Hope Corporation and Climate Change - Click to view

When investing in a coal miner climate change is an extremely important risk to consider. For the reasons discussed below, I believe that thermal coal will still be in demand for the life of the Bengalla Coal Mine although natural gas and to a lesser extent renewables will continue to displace coal fired electricity generation. Renewables will be become much more prevalent, they just have some limitations which should be considered when extrapolating their future adoption. The below analysis borrows heavily from Natural Gas: Fuel for the 21st Century by Vaclav Smil, Power Density: A Key to Understanding Energy Sources and Uses by Vaclav Smil and Energy and Civilization: A History also by Vaclav Smil.

Power Density

Asia’s current and projected power density usage means that renewables can only supply so much of their electricity due to renewable energy’s inherently low power density. In the case of solar the amount of electricity produced is limited by the sun’s irradiance. The amount of power provided by the sun’s irradiance is ≈200W per m² in sunny areas with 100W/m² the average in populated northern hemisphere latitudes and 266W/m² the maxima in the sunniest climates of the Earth’s arid subtropical belt. Solar panels have relatively low capacity factors, meaning that only a small fraction of the earth’s solar irradiance is captured and converted into usable electricity (in sunny Spain capacity factors are less than 20%).

In the case of wind turbines their ability to convert wind to electricity is subject to the inherently low power density of wind. Only a small proportion of the earth’s solar irradiance goes into energising the global atmospheric circulation. Thus, the availability of wind energy is much less than for solar. Due to the spacing requirements of wind turbines power density of this form of electricity generation is necessarily low reaching maxima of 1 W/m², and 50W/m² if you only include the footprint of the actual turbines.

Power Density of different energy sources. Source: Vaclav Smil

This compares to the power demand densities of many Asian cities reaching 1300W/m² of urban land during the extremes of Summer and Winter. How this power would be supplied using renewables, even with greatly improved battery storage and transmission infrastructure, is currently unknown. Large swathes of India and Africa still use biomass as their main source of energy and are still yet to convert to more energy intensive modern society. This means that electricity usage, and in turn the power demand density, is still increasing. If electric vehicles become ubiquitous in Asia, power density will become an even more important consideration.

Another factor which is rarely considered by renewable advocates is that the industrial processes underpinning modern civilisation are inherently energy intensive. This energy intensity extends to products which are part of the ‘Renewable Economy’, such as solar panels and wind turbines. By way of example, aluminium requires 175-200 MJ/kg to produce, copper requires 90-100 MJ/kg, steel from pig iron requires 20-25 MJ/kg and cement requires 2-5 MJ/kg to produce. Aluminium, copper, steel and cement are all essential (to varying degrees) for the manufacture of electric vehicles, the infrastructure cars drive on, houses, solar panels, hydro-electric dams and wind turbines. This all points to energy use increasing, or at least being maintained, throughout Asia. A country such as India cannot modernise without utilising these energy intensive materials.

Even if developed economies are run entirely on renewable energy, that country’s indirect coal use will still be quite high due to the embodied energy in imports from developing economies. Coal use embodied in imported products is explained succinctly in an academic article published in the Renewable and Sustainable Energy Reviews journal:

With regard to the indirect coal use or trade, i.e., the consumption or transaction of commodities and services that require coal inputs in their production processes, few studies have ever given due consideration. Coal as a basic natural resource provides numerous industries with energy and material support, and considerable amounts of indirect coal use is hidden in these industrial products and services. For example, a telephone requires electricity during its manufacturing course, while coal in some countries, like China, is the major fuel for the generation of electricity. Coal is therefore indirectly used by the telephone made in China. As a matter of fact, many high-income nations get a decline in domestic coal use and carbon emissions through importing coal intensive goods and services from the middle- and low-income areas. With the aid of international trade, those net-importing countries successfully transfer the pressures on resources and environment to the foreign regions.

For example, Sydney’s indirect energy use is 2.3 times greater than its direct energy consumption (Lenzen et al., Energy Requirements of Sydney Households, Ecological Economics (2004) pp. 375-399).

Other Factors

An energy source’s utility is just not just determined by its density; it is also judged by its transportability, storability, combustion efficiency, convenience, cleanliness, flexibility of use, contribution to the generation of greenhouse gases and the reliability and durability of supply. Natural Gas scores well on all of these fronts other than energy density, since the specific density of methane at 0°C is just 0.718 kg/m³. Typical liquid fuels have specific densities 1000 times higher with diesel having a specific density of 840 kg/m³ and petrol having a specific density of 745 kg/m³. Bituminous coals have specific densities ranging from 1200 to 1400 kg/m³. Liquified methane (at – 162°C) has a more competitive specific density of 428 kg/m³. The transportability of natural gas is also an issue – although many pipelines are currently being built throughout Asia to minimise this problem.

On all other fronts natural gas is superior. As a result rising natural gas use is what I am most concerned about due to its superior attributes as an energy source relative to coal (this is why Brickworks switched from coal to oil and then eventually to gas for firing its kilns – each energy source was superior to the other). Despite this, coal use will continue, with demand for Australia’s less polluting coal expected to be remain steady even when its share of aggregate electricity production decreases.

If you still feel that it is unethical to invest in a coal company, even indirectly, then that is perfectly fine. There are plenty of other fish in the sea :).

Financial Performance

Brickworks has performed strongly over the past two decades. Brickworks has never made a loss and has maintained or increased its divided every year since 1976. The dividend is underpinned by the dividends Brickworks receives from Soul Patts. Brickworks has also maintained a low debt level throughout the whole period, usually around $200 – $250 million with the maximum historical debt being about $550 million.

Earnings are somewhat volatile due to the property trust earnings from property sales being lumpy, the equity accounted earnings of Soul Pattinson and the cyclical nature of the building products business. As a result Brickworks free cash flow does not always align with their profits since the revaluation profit from land revaluations are non-cash profits and the equity accounted earnings are also non-cash. Dividends are nice and steady due to Brickworks dividend payout ratio only being around 30-40% of profit on any given year. The 2018 dividend payout ratio was just 26%.

I will leave a few graphs below for you to peruse below – a picture tells a thousand words! Please note that the two graphs plotting Brickworks profit use different keys on the y-axis.

Source: Author
2012 was Brickworks most difficult year in the past 20 years. Source: Author and Brickworks
Source: Author
Source: Morningstar
Source: Brickworks

 

Source: Brickworks
Source: Morningstar

Cross-shareholding Drama

The Brickworks-Soul Pattinson cross-shareholding has caused a lot of drama in the last few years. This culminated in a law suit lead by Perpetual against Brickworks in 2017. Perpetual alleged that the cross share-holding prejudiced other shareholders, reduced shareholder value and entrenched Millner family control of the company. The case was decided in Brickworks favour and can be read here.

Source: Author based on Brickworks and Soul Pattinson Annual Reports

One of the benefits of the court case was its discussion on how to value the cross-shareholding, whether it should be unwound to unlock shareholder value, how it would be unwound and the corporate governance implications of the structure. For example it provided potential investors with a handy list of the arguments for and against maintaining the cross-shareholding.

Reasons For Not Unwinding Cross-shareholding

Paragraphs 251, 255 and 381 of the Perpetual case:

The letter to Perpetual signed by the directors on the independent committee identifies a series of problems with the second proposal and the overall position that it would materially reduce shareholder value in Brickworks. The problems are explained at some length in the letter including:

      • significant resulting tax liabilities;
      • higher debt for the company;
      • more Soul Pattinson shares than Hunter Green had assumed would need to be sold to offset the tax and debt payments which raised discounting of the shares as an issue;
      • Brickworks had insufficient franking credits to pay the distribution as fully franked dividend causing tax liabilities for shareholders;
      • the business would be left smaller and severely weakened;
      • Perpetual may need to reduce its holding in Soul Pattinson which would drive the share price of those shares down further diminishing the value to Brickworks’ shareholders of the shares; and
      • the proposal could not be implemented without approval of Brickworks’ shareholders and regulatory approvals.
      • shareholder composition post unwinding (could result in a change of control or create an overhang)” and another was “loss of control and vulnerability to takeover”
      • for a shareholder in Brickworks, the shares in Soul Pattinson provide a buffer against the cyclical nature of the building and construction industry. For the shareholder in Soul Pattinson, the shares in Brickworks provide exposure to the building and construction industry. 

Reasons For Unwinding The Cross-shareholding

Paragraph 357 of the Perpetual case:

By contrast, maintenance of the cross shareholding, apart from its inherently oppressive effect, and as recognised at various times by the advisors to the companies:

      1. limits the capacity of the companies to raise capital by the issue of shares (Lion Capital referred to this in a report of 24 March 2015 as share issues would dilute the holdings of each company in the other and thus, as Perpetual put it, detrimentally affect [the cross shareholding’s] control purpose);
      2. makes it difficult for the market to recognise the true value of the shares in each company on a “look through” basis by use of simultaneous equations to solve the otherwise endless valuation circle (as Grant Samuels noted in advice to Brickworks while these equations could be done to allow for the circularity of value created by the cross shareholding, they are “rarely done” by market participants for reasons which are not apparent);
      3. results in complexity of corporate structure which deters investors including institutional investors;
      4. deters “potential takeover investors, investors seeking to take advantage of another entities takeover bid, investors who do not regard the control by one family via a cross-shareholding as attractive and seek to have some influence in a general meeting, by way of example, dampens competition for shares in each company which is plainly price depressive”; and
      5. “creates significant liquidity issues to the detriment of volume of trades and, as the internal reports recognise, is a deterrent for investors, particularly institutional investors that desire the capacity to divest readily”.

At the heart of the cross-holding issue is corporate governance. Some institutional investors and proxy advisors take one look at Brickworks corporate governance framework and run for the hills, which can in part explain why Brickworks trades at a discounted valuation relative to Soul Pattinson. For example, in the Perpetual case a report prepared by a proxy advisory service was discussed at paragraph 207:

“A report of ISS Proxy Advisory Services Australia dated 17 November 2011 expressed the view that the composition of the Soul Pattinson board was “inconsistent with local market standards. All three sets of governance guidelines in Australia …recommend a majority independent board.”

The lack of institutional investors is evident in Brickworks 20 largest shareholders. Additionally, Millner family associated entities control or have influence over approximately 49% of Brickworks outstanding shares. According to Lindsay Partridge, the dearth of institutional investors on Brickworks share registry in part explains the differences in how Soul Patts and Brickworks are valued since retail investors are less capable of adequately valuing Brickworks’ complex structure.

Source: Brickworks 2018 Annual Report, commentary by Author

One of the major corporate governance concerns of institutional investors is the independence of directors. In their Corporate Governance Statement, Brickworks states that they consider Deborah Page, Brendan Crotty, David Gilham and Robert Webster to be independent members of the Board. Robert Webster is the lead independent director. Robert Millner (Chairman) and Michael Millner (Deputy Chairman) are not considered independent due to their associations with Soul Pattinson.

Update: Since writing this article Brickworks has appointed Malcolm Bundey as an independent non-executive director since David Gilham retired. Note that the below picture has not been updated. Bundey will likely be considered by institutional investors to be more independent than Gilham so this is a positive for improving corporate governance. In October 2019 Robyn Stubbs was appointed a Non-Executive Director effective January 2020. This is also a good thing for corporate governance.

Source: Author based on Brickworks Annual Reports

I can understand why institutional investors such as the Australian Future Fund might consider the influence of the Millner family – particularly Robert Millner – to be contrary to good corporate governance and potentially discriminatory against minor shareholders. Even though the above named directors are considered independent by Brickworks some institutions consider that these directors would not – practically speaking – be able to disagree with Robert Millner and therefore they are not actually independent. Personally, I see no reason to say that these directors are not independent. I see little indication that the Millner family has had a negative influence on Brickworks, if anything Robert Millner’s extensive experience is one of the reasons Brickworks has been so successful during the previous two decades. Nevertheless, these corporate governance concerns should be considered.

Brickworks Corporate Governance Framework. Source: Brickworks

Another aspect of the cross-holding which is not discussed often enough is the hostile-takeover protection it provides. Since Brickworks operates in a highly cyclical industry it is vulnerable to hostile takeovers by larger companies during downturns. I’m sure the world’s largest brick maker, Wienerberger would love to buy Austral Bricks if it could do so for a bargain price. The cross-holding ensures that a takeover offer will only be successful if it is in the long term interests of shareholders to accept it. This protection allows Brickworks to make decisions with a long term focus.

Valuation

Valuing Brickworks is a bit of a pain. The cross-shareholding is the only one of its kind on the ASX so not many people – including myself – have much experience valuing such structures. And I would be the first to admit that valuation is not my strong suit. Nevertheless, I will try. I’ve gotten this far.

Valuing the investment in Washington H. Soul Pattinson

Valuing the investment in Soul Pattinson is inherently difficult because of the circular reasoning. In order to value Brickworks we must also value Soul Pattinson but Soul Pattinson’s value is in part determined by Brickworks value.

There are a number of ways to value the investment in Soul Pattinson:

  1. Multiply the Washington H. Soul Pattinson share price by the number of shares owned by Brickworks
  2. Look Through Asset Value calculated by multiplying the value of Soul Pattinson’s individual investments by 39.4%, which is equivalent to Brickworks share of Soul Pattinson.
  3. Ignore Soul Pattinson’s stake in Brickworks
  4. Simultaneous Equations

I will not be using the simultaneous equation method since I don’t quite understand it. I will use a combination of methods two and three.

Method 1: Multiply the Washington H. Soul Pattinson share price by the number of shares owned by Brickworks

This is by far the simplest option and is the method used by Brickworks to determine its inferred asset value in its corporate presentation slide below. Value using this method:

94.3 million SOL shares owned by Brickworks x SOL share price ($22.00) = $2,074,600,000 or $13.85 per share. This value means that at Brickworks current $2.5 billion valuation the industrial property and building products business is valued at around $500 million. The value of the industrial property alone is $625 million. But we aren’t done yet – we now have to add the net asset value of Brickworks share of the property trust, deduct net debt and then add the value of Brickworks Building Products net tangible assets.  Obviously this valuation will change as the SOL share price changes. When the below corporate presentation slide was made the inferred asset backing of Brickworks was $2.7 billion.

Brickworks wasn’t always trading at a discount to its asset value. Source: Brickworks

Method 2: Look-Through Asset Value

The easiest way to determine Brickworks look-through asset value is to manually calculate the value of Brickworks share of Soul Pattinson’s investments. This is calculated by multiplying the market value of Soul Pattinson’s stake in the particular business by 39.4%, which is the percentage of Soul Pattinson which is owned by Brickworks. Excluding the building products business and the value of Soul Pattinson’s holding in Brickworks, the look through net asset value is $1,676,244,616 or $11.19 per share. The value of just the property trust, TPG and New Hope alone (after subtracting net debt and the deferred tax liability) is $7.37 per share. The value of the property trust is $4.17 per share (before net debt and deferred tax liability subtraction). Keep in mind these values are not set in stone since the value of Soul Pattinson’s portfolio changes with the normal gyrations of the market. Note: TPG’s stock ticker is TPM.

Source: Author

I have not included Soul Pattinson’s investment in Brickworks or the value of Brickworks Building Products business in the above value. At Brickworks current market capitalisation of $2.5 billion the implied value of the Building Products business and the cross-holding is $823,755,383 or 5.50 per share. Keep in mind that the net debt I subtracted before was mainly used for the Building Products business, so this value is the implied value of the Building Products business and the cross-holding with no debt and no deferred tax liability. For the sake of simplicity, I will not consider Soul Pattinson’s investment in Brickworks due to the circular reasoning inherent in the valuation. The building products business is valued later.

Method 3: Ignore Soul Pattinson’s Stake in Brickworks

This is the method I used in the above valuation. If we can manage to buy Brickworks at a price which gives us a margin of safety based on the valuation of all assets other than Soul Pattinson’s stake in Brickworks, then valuing it is unnecessary. Soul Pattinson’s stake in Brickworks is just a bonus.

Valuation – Putting it all together

Building Products Australia

The near-term outlook for Building Products Australia does not look particularly positive. While the recent RBA rate cuts are a positive for the short term, in the short and medium-term energy price increases will weigh on profitability. Brickworks anticipates the 2019 full year impact of energy price increases to be -$12 million. Labour costs appear reasonable and government spending on infrastructure is strong.

Brickworks Building Products worst financial performance in recent years was in 2012, were the full year’s EBIT was just $28.5 million. If we use 2012 as a worst-case scenario and use a conservative 7 times EBIT as an appropriate multiple, the Building Products business is worth $199,500,000 (conservative case). If we are even more conservative, we could use an EBIT multiple of 5, which values the business at $142,500,000. To be ultra conservative I will value the business at $100 million, which in my opinion would grossly undervalue the business in most economic environments. I’m being conservative here.

Building Products North America

The near-term outlook for Building Products North America looks positive. Building starts are still growing and are yet to match their peak reached before the GFC. Market consolidation, a strong future order book and brick capacity reduction throughout the industry means that Glen-Gery should perform well provided there is not a recession.

In 2017, under Ibstock management, Glen-Gery generated $US115 million in revenue and $US15 million in adjusted EBITDA implying an adjusted EBITDA margin of 13.1%. For the twelve months to August 2018 Glen-Gery had US$118 million in revenue and normalised EBITDA of US$13 million. This is down on 2016 numbers when Glen-Gery had US$122 million in revenue and US$17 million in adjusted EBITDA. It will be interesting to see what Glen-Gery’s first result will be under Brickworks ownership. EBIT, NPAT and unadjusted EBITDA numbers are unavailable.

Determining Glen-Gery’s future NPAT or EBIT is difficult since I have few historical numbers to go off. Brickworks stated that the Glen-Gery acquisition will contribute to low single digit normalised EPS accretion on proforma NPAT in its first full year of operation. For valuation purposes I’ll presume that Glen-Gery produces US$ 5 million in EBIT in current economic conditions. This implies a 4.5% gross ROI, compared to the 3.65% grossed-up dividend yield Brickworks received on their Soul Pattinson shares. My EBIT estimate could be way off, we’ll have to wait and see the September 2019 results release to determine the real numbers. It’s such a small part of the business so minor errors shouldn’t impact the valuation much.

With EBIT of US$ 5 million the value of the Glen-Gery business would be valued at US$ 35 million (AU $50.15 million) at a 7 x EBIT multiple (conservative case). Glen-Gery’s value with an EBIT multiple of 5 would be US$ 25 million. To be ultra conservative I’ll value the company at US$ 20 million (AU$ 28.45 million) (ultra conservative case). This is compared to the recent acquisition price of AU $151 million. Remember, I am being ultra conservative here.

The costs and synergy benefits of planned bolt-on acquisitions are still a big unknown. What we are really betting on with the North America segment is the quality of Brickworks management and their ability to acquire other brick manufacturers for reasonable prices and rationalise these acquired companies to improve their profitability.

Property

The development pipeline for the property division will underpin this segment’s future profitability. The sale of 10 hectares at Oakdale East into the Trust will also be beneficial for the 2019 FY. Free cash flow will be considerably less than this due to a large proportion of property EBIT consisting of non-cash property revaluation profits. Historical EBIT has averaged around $53.5 million per year. At a multiple of 8 (to reflect the Tier 1 Status of these Warehouses) I would come to a value of $428 million. This presumes that there will be property sales as there has been in the previous 10 years.

I prefer to use the valuations provided by independent valuers rather than my simplistic relative valuation method using EBIT multiples. If we presume the trust performs poorly we could estimate that its value could fall by 25% which means its value is $468,750,000 (conservative case). If we presume that the property trust performs very poorly we could estimate that its value could decrease by 40% which means its value is $375 million (ultra conservative case). The average EBIT of the trust is $53.5 million per year, which implies an historical EBIT multiple of 7 on the above valuation.

Investments

We can probably expect Soul Pattinson to keep paying out increasing dividends for the foreseeable future. A conservative dividend growth rate of 3% should easily be achievable. FY18 dividends received from Soul Pattinson were $62.2 million excluding franking credits compared to $80.8 million excluding franking credits paid out by Brickworks as dividends. The Soul Pattinson dividends will underpin Brickworks future dividends. In the short-term Soul Pattinson’s market value and earnings will mainly be determined by the thermal coal price and whether New Acland Stage 3 and the TPG-Vodafone merger is approved. Glencore’s (the world’s largest seaborne thermal coal exporter) announcement to cap thermal coal production will help ensure that the current thermal coal price is maintained.

If we presume that the market has fairly valued the underlying Soul Pattinson business at $1 billion and apply a 25% lack of direct control discount the value is $750 million (ultra conservative case). For a conservative scenario, if we presume the control discount should only be 10%, then the value of Brickworks stake in Soul Pattinson (ex-Brickworks holding) is $900 million.

Final Ultra Conservative Value:

Building Products Australia = $100 million

Building Products North America = $28.25 million

Industrial Property Trust = $375 million

Investment in Soul Pattinson = $750 million

= $1.253 billion or $8.36 per share (ex-Soul Pattinson Brickworks holding). The last time Brickworks shares were trading at this price was 2004. I don’t think that will ever happen again.

Final Conservative Value:

Building Products Australia = $199.5 million

Building Products North America = $50.15 million

Industrial Property Trust = $468,750,000

Investment in Soul Pattinson = $900 million.

= $1.6184 billion or $10.80 per share (ex-Soul Pattinson Brickworks holding). The last time Brickworks was trading at this price was 2012. Brickworks share price would probably only go down to this price in a severe world-wide recession (if ever).

Valuation Summary

We can conclude that any price below $11.00 indicates a very strong buy. The discount to Brickworks implied asset backing that Brickworks management keeps on talking about likely exists because the market is applying a lack of direct control discount to Brickworks investment in Soul Pattinson – Brickworks does not control the operations of TPG or New Hope Corporation and does not directly control (but does have influence over) what Soul Pattinson invests in. What discount (if any) you choose to give this investment will have a significant bearing on what you consider Brickworks value to be.

The other major assumptions which substantially alter Brickworks valuation are:

  • how much of a discount (if any) you apply to the assets of the property trust;
  • what you think capitalisation rates will be for industrial property in Western Sydney and Rochedale in the future;
  • whether any land in the property trust is sold;
  • how much surplus land is available to sell into the property trust;
  • whether there will be a recession;
  • how you value Soul Pattinson’s investment in Brickworks;
  • whether or not you consider the $294 million future tax liability something one should deduct from Brickworks net asset value;
  • how much of an emphasis you put on the anticipated growth in Building Products North America and the conservative nature of Brickworks and Soul Pattinson’s management;
  • whether you think activist shareholders will one day dismantle the cross-shareholding;
  • whether you think Soul Pattinson’s investment in financial services will pay off in the future;
  • the future thermal coal price;
  • whether TPG’s mobile roll-out will be successful;
  • what you think will happen once Robert Millner and/or Lindsay Partridge retire;
  • the value you place on a consistent and slowly growing income stream; and
  • what you think the long term future of Australian building products manufacturing will be in light of energy, transport and labour cost increases.

It follows then that a less extreme valuation of Brickworks could support a valuation between $2 billion and $2.5 billion, which is more or less the current market capitalisation. You have to make your own mind up about what you think Brickworks value is in light of the above considerations and your personal investment philosophy. As always, keep in mind that all my valuations are extremely conservative. You must do your own research. This is not a recommendation to buy, hold or sell Brickworks Ltd.

Conclusion

What we’re really buying when we buy Brickworks is a telecommunications company which has the potential to become the third largest in the country if the Vodafone merger goes through, a low-cost coal thermal coal mine with great management which will be profitable in almost any coal price environment, an industrial property trust consisting of tier one warehouses and logistics centres with great tenants and an experienced property manager, and a well managed building products company located in Australia and the US. Throw in the assortment of financial services investments and healthcare companies Soul Pattinson is invested in and Brickworks starts to look like a very diversified company. Combine this complicated structure with a market that occasionally likes to value Brickworks like a building products company and you can potentially get a bargain price for a premium company.

Sources

Acme Brick Company: 125 Years Across Three Centuries

Brampton Brick Annual Report 2018.

Brickworks Annual Reports and Presentations

British Geological Survey, Mineral Planning Fact Sheet – Brick Clay (2007).

Case Studies for Sectors Investigated in detail by Vivid Economics (Ceramics Section)

Coal use embodied in globalized world economy: From source to sink through supply chain (2018), X.F Wu and G.Q Chen, Renewable and Sustainable Energy Reviews, pp. 978-973.

Energy and Civilization: A History by Vaclav Smil.

Energy Requirements of Sydney Households (2004), Manfred Lenzen, Christopher Day and Barney Foran, Ecological Economics, pp. 375-399.

Goodman Group Annual Reports and Presentations

IBISWorld Australia

Meet Vaclav Smil, the man who has quietly shaped how the world thinks about energy (2018), Science Magazine by Paul Voosen

Michelmersh Brick Annual Reports and Presentations

Morningstar Australia

Natural Gas : Fuel for the 21st Century by Vaclav Smil

New Hope Corporation Annual Reports and Presentations

Power Density: A Key to Understanding Energy Sources and Uses by Vaclav Smil

RBC Investor Services Australia Nominees Pty Limited v Brickworks Limited [2017] FCA 756 (10 July 2017)

The Brickmasters: 1788 – 2008 by Ron Ringer

The Economics Of The Brick Cycle and Its Effects on Firm and Industry Structure by R Matthews

TPG Annual Reports and Presentations

UK Competition Commission, Wienerberger Finance Service BV and Baggeridge Brick plc: A report on the anticipated acquisition by Wienerberger Finance Service BV of Baggeridge Brick plc (2007).

Washington H. Soul Pattinson Annual Reports and Presentations

2 COMMENTS

  1. very well compiled and interesting to read, thank you.
    I also note that Commsec has the book value as $14.50 as of July 2019,
    so your estimate of $10.80 may be too conservative

    • Thanks Carlos. Yes my conservative valuation was a little too conservative. One could even argue that the NTA of $14.50 is too conservative since (if I remember correctly) the book value of some of BKWs property is below its true market value.

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