High time CRH got the appreciation it deserves

Remember the rule, if you can't invest in stock for 10 years, you can't invest for 10 seconds,
writes Patrick Lawless
Sunday Independent - November 27th 2006

IT was good to see CRH appreciate again last week. While the stock has grown over 15 per cent in 2006, CRH has still underperformed the ISEQ by 4 per cent and the sector by almost 10 per cent and is on a P/E of 12 times 2007 earnings.

As Warren Buffett, the world's greatest investor, would say, if you can't invest in a stock for 10 years, then you should not invest for 10 seconds.   CRH, led by chief executive Liam O'Mahony, has consistently delivered -- both in terms of quality of earnings and in actual earnings growth -- through organic and low risk bolt-on acquisitions, over time. The fact that CRH is involved in 14 separate product areas in 23 countries shows its diversification over its peer group.

So why the underperformance? The exposure to the US housing sector is a common answer. However, only 8 per cent of earnings at CRH are exposed to the new US housing sector. This would be more than offset by 50 per cent exposure to recovering EU markets, as highlighted by recent results from the German building materials company, Wienerberger, whose 3Q revenues is up 18 per cent and profit growth up 6 per cent.

This scenario is further underpinned by cement manufacturer Holcim, whose third quarter net profit was up 43 per cent, over the same period last year. Interestingly, they cited strong markets in Europe. The US dollar is also mentioned as a concern for CRH and like many, we believe that the dollar may go lower, due to the twin deficits and the likelihood that US interest rates are peaking. However, this is a translation effect which we believe will even itself out over time.

Lack of exposure to emerging markets is another concern. However, its second Chinese investment within weeks signals that CRH intends to be a player here. Perhaps what we should remember is that CRH is involved in long-term infrastructure projects, whether they are based in California, or our own road-building programme, over the next 10 years.

All in all, it is hard to justify a low rating for stock that has delivered 17 per cent earnings growth, unbroken, in the last 12 years. It is forecast to grow earnings by 17 per cent in 2006 and consensus forecasts are for at least 10 per cent earnings growth in 2007. The 2007 figure looks undemanding.

Given the high free cashflow, strong acquisition pipeline and strong organic growth, its discount to its peers seems unjustified.

TNT

There was more activity at the Dutch postal company, TNT. Following the sale of its poorly performing freight management business, giving the company a book gain of some €150m, the Dutch government last week sold its remaining 10.9 per cent stake for almost €600m. The majority of the stake was purchased by TNT in their €1bn buy-back programme and the balance was bought by the market. Going forward, it appears, with its high free cashflow yield, greater share buy-backs and increased capital will be returned to shareholders at TNT.

This follows solid results in August, which showed that revenues were rising, costs were under control and that capital discipline was firmly in place. In particular, the margin improvement caught the market by surprise.

Going forward, the management of TNT announced last December several strategic steps to focus on the company's networks, mainly mail in Europe and Express in Europe and Asia.

The company has also announced significant Asian contracts and acquisitions with respect to their Express side. However, it is the capital optimisation that has been most impressive. In addition, the company has announced a cost savings programme to save up to €75m in overheads as of 2008 and we believe the company is well on track to deliver these targets.

Decent revenue growth and significant cost savings have generated a significant free cashflow per share; along with the divestment of the freight business, the company has announced several substantial share buy-backs in the last year and we believe that they can continue to announce further share buy-backs in the not-to-distant future.

In early December, TNT will host its annual analysts' meeting to update the financial market on a strategy going forward.

While we would not share the unbridled optimism of some brokers who believe that the company could be a takeover candidate, following the sale of the Government stake, there is no doubt that a significant hurdle has been removed.

On a P/E ratio of 13, with a dividend yield of 2.9 per cent, with smart capital allocation and significant increases in free cashflow, the shares should deliver good returns.

Global equities

While global equities have rallied 14 per cent since the middle of the year, investors are beginning to wonder if this run can continue. More particularly, can this bull run of the last three years continue? Much of the answer lies in the US equity and bond markets.

Leading indicators have often paused after four or five years into the cycle, as they are doing at present. They only get second wind if inflation stays mild. At present, it is expected that CPI will stay in a narrow band of between 2 per cent and 2.5 per cent.

The inflation figures have been helped by the fall inoil prices from its high, but the raw material index has picked up recently. Hourly earnings, another key indicator, have moved significantly since 2004 but this has not had a significant effect on corporate profits.

It appears that interest rates in the US may be peaking as the yield curve has inverted slightly. Many believe that an inverted yield curve is a sign of recession. However, this inversion is not significant enough to warrant a full recession.

Thus far, a slowdown is more likely. The current situation in the bond market is more like 1998, which had a mild inversion rather than the steep inversions of 1973 or 1981, which led to significant recessions.

So all appears well so far. The kernel issue for the US equity market is: will profits remain strong? Profits as a percentage of GDP have reached a 40-year high. Neither increases in interest rates or commodity prices -- mainly oil -- have dented corporate profit growth.

The key risk is the housing market slowdown. If this continues, it may spill over into rising unemployment, then the consumer.

It should be remembered the consumer makes up 70 per cent of US GDP. Accordingly, housing starts and building permit figures should be watched acutely to see if they will bottom soon.

What is clear is that corporates have coped well with change, structured and economic, over the last 10 years and that debt levels appear low on balance sheets. At present, the possibility of a significant drop in corporate profits seems unlikely. While risk remains, think safety and invest in large caps over small caps and value companies over growth companies.

Patrick Lawless is MD of Appian Asset Management, one of Ireland's top private investment firms.