The two companies I’m looking at today have risen by an average of 36% over the last year. One has attracted the backing of star fund manager Neil Woodford.
Today I’ll explain why I remain bullish on these stocks, even after several years of growth.
Operating at capacity
The UK brick manufacturing industry is “operating at capacity” with “limited options for expansion”. That’s the view of Martin Warner, chairman of Michelmersh Brick Holdings (LSE: MBH).
Shares of this £64m firm edged higher today after the group said revenue rose by 26% to £37.9m last year. Underlying operating profit climbed 42% to £6.5m during the period. This implies an operating margin of 17.5%, highlighting the strong pricing power enjoyed by brick manufacturers at the moment.
Last year’s growth was helped by the £31.2m acquisition of brick-maker Carlton, which the company says has “significantly strengthened” the group’s market position. One downside to this is that this large deal left Michelmersh with net debt of £17.5m at the end of 2017, versus net cash of £4.7m one year earlier.
I estimate that it could take two years to reduce these borrowings to a more comfortable level. If the market slows during this time, shareholders could face elevated risks.
This could still be a buy
The outlook for 2018 seems safe enough at the moment. Mr Warner says that “2018 promises to be busy” and that the group’s order book, at 60m units, is “strong”.
Consensus forecasts suggest that earnings per share could rise by 40% to 8.2p this year, as the Carlton acquisition contributes a full year of profits. The dividend is expected to climb 44%, to 3.1p per share.
These numbers put the stock on a forecast P/E of 10, with a prospective yield of 3.7%. The shares remain attractive in my view, although I’d prefer a stock with less debt at this stage in the market cycle.
This Woodford pick has soared
One possible choice is brick and block maker Forterra (LSE: FORT). Shares in this firm have risen by 71% since its flotation in April 2016. It’s been a strong performer for fund manager Neil Woodford, but are the shares still worth buying?
Forterra around nine times larger than Michelmersh, measured by market cap and sales.
The group’s larger size means that acquisition opportunities are limited, but I’m not bothered by this. At this point in the market cycle, I’m happy to see management focusing on profitability and cash generation.
A cash machine
Last week’s 2017 results suggested that’s exactly what’s happening. The group’s underlying operating margin was largely unchanged at about 20% in 2017, but operating cash flow rose by 29% to £90m. This equates to 140% of operating profit, compared to 118% in 2016.
As a result, net debt fell by £31.5m to £60.8m, despite the firm spending £20m on the acquisition of Bison Manufacturing. Forterra now trades on a price/free cash flow ratio of 9, which is unusually low.
Analysts expect both earnings per share and the dividend to rise by about 9% this year. These forecasts put the stock on a 2018 P/E of 11.5, with a prospective yield of 3.5%.
I’d rate Forterra as a buy at these levels and would probably choose it over Michelmersh, thanks to the larger firm’s lower debt levels.