The cost of building a home is rising at its fastest pace since the GST was introduced in 2000. Interest rates are going up and housing values are going down. Construction companies are going bust due to labour shortages, lack of access to building materials, and the rising cost of these materials. And fewer people are choosing to build new houses, with approvals down 14.4% over the past 12 months.
Yet fund manager Allan Gray says it's a great time to buy this ASX 200 share in the construction game. That share is Fletcher Building Limited (ASX: FBU).
Allan Gray managing director and chief investment officer, Simon Mawhinney says Fletcher Building is trading "at a discount to fair value":
Most investors shy away from buying companies that are likely to exhibit a decline in earnings in the short term, regardless of the price at which the company trades. This creates the opportunity for us to
invest in companies at a discount to fair value. Fletcher Building Limited is one such company.
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Why is this ASX 200 share falling?
The Fletcher Building share price is down 0.7% to $4.38 in late afternoon trading on Friday. The ASX 200 share has fallen 37.4% in 2022 so far and 36.5% over the past 12 months.
Allan Gray analyst Sudhir Kissun says:
While we can't be sure exactly why Fletcher Building's share price has been falling for the past year, the prospect of a downturn in building activity is a likely explanation.
Even though it might be tempting to sit on the sidelines and wait for the cycle to hit rock bottom, it is important to remember that sharemarkets are forward looking.
Share prices usually hit the bottom well before the cycle is at its lowest. In the case of Fletcher Building, its share price may already factor in the impact of a modest economic downturn.
A 'compelling opportunity'
Allan Gray outlines the case to buy this ASX 200 share in its September 2022 quarterly commentary.
Firstly, Kissun reckons the business metrics look good. By the way, these numbers are in New Zealand currency because Fletcher is headquartered in New Zealand.
Kissun explains:
With a share price at the time of writing in late-September of NZ$5.16 per share, Fletcher Building has a market value of NZ$4.0b. Added to its very manageable net debt of NZ$0.9b, its enterprise value is NZ$4.9b.
… we estimate that its lowest EBIT in the past 15 years was around NZ$420m (this is after adjusting for businesses that Fletcher Building has disposed of and therefore will not contribute to earnings in the future). The market is valuing the company at a little less than 12 times this depressed level of EBIT.
Not only is this meaningfully below the broader sharemarket multiple today, but it is also likely that earnings from this depressed level would grow significantly faster than the market (and therefore
warrant a higher multiple than the market).In our experience, this type of situation, in which the market is offering us a company at a lower-than-market multiple of depressed earnings, has the makings of a compelling investment opportunity.
Is the Fletcher Building share price a buy?
Kissun says:
When we value cyclical companies, we try to gauge what the company might earn on average through the cycle, across good times and bad. We believe a sustainable mid-cycle EBIT for Fletcher Building should be in the region of NZ$600m, which is almost 30% below management's guided EBIT for FY23 of NZ$820m.
Mid-cycle EBIT of NZ$600m would result in net earnings after interest and tax of approximately NZ$400m. It might not be unreasonable to ascribe a price-to-earnings (P/E) multiple of 16 times to these mid-cycle earnings, which would equate to a market value of NZ$6.4b or approximately NZ$8.15 per share. Compared to the share price of NZ$5.16, this represents potential upside of over 50%.
The Allan Gray Australia Equity Fund holds $61.7 million worth of Fletcher Building shares.
The ASX 200 share represents 3% of the fund's value as at 30 September.
