Many investors see scant difference between Grafton and Travis Perkins, but they should. Shares in both FTSE 250 groups trade at near-identical forward earnings multiples. And it’s true to say their pressures are the same: rising borrowing costs and a subsequent slide in the housing market and spending on improvements have led to a dramatic comedown for building materials suppliers. But compared with its beleaguered peer, maintaining a holding in Grafton looks less futile.
Like-for-like sales over the second quarter edged back into positive territory, up 0.8 per cent against a 0.7 per cent decline in the first three months of the year. Granted, that’s a meagre gain and, given the rates of prices inflation, it means sales volumes were solidly negative. Yet it is still better than the lack of progress that forced Travis Perkins to warn that its profits would be lower than previous forecasts this year.
The lack of a warning explains a near-5 per cent rise in Grafton’s shares on the day, a small relief in the context of the heavy sell-off in the shares over the past two years. A forward earnings multiple of 11 is almost half the level during the summer of 2021, but borrowing costs in Britain and Europe at that time are dwarfed by rates today.
Piled-up savings and the stamp duty break were easy catalysts for sales that are now absent. The owner of Selco in the UK and Woodies in Ireland expects operating profit of £205 million this year, below the £286 million of last year. Deflation in timber and steel prices has led to more competition in the UK and Ireland, hurting margins this year. Analysts at Investec have cut earnings forecasts throughout the building materials sector. The investment bank now expects a fall of about 20 per cent in profits this year, before gains from the sale of any property, to about £207 million.
However, in that harsher context, Grafton has several advantages. One is less exposure to the domestic housing market. Analysts at Stifel put domestic housebuilding at 6 per cent of Grafton’s sales, versus 19 per cent for Travis Perkins and 11 per cent for SIG. Ireland accounts for 38 per cent of its revenue. Similar forces are in action in Ireland, but the rise in mortgage borrowing costs has been less severe here. The Netherlands comprises another 15 per cent.
International expansion plans are built on firmer ground than those of Travis Perkins. The latter is pursuing a greenfield expansion in Europe, rolling out Toolstation branches in the Benelux region, the cost of which has dragged on profits. It means Grafton’s margins are far superior, at 10.9 per cent last year, more than double the 4.9 per cent from its beleaguered peer.
Grafton’s balance sheet can be appreciated without qualifications. Shedding its lower British general merchanting business last year boosted the coffers and, with the benefit of hindsight, proved an excellently timed move. At the end of last year it had net cash of £458 million. A third share buyback for up to £50 million was initiated in May.
Deploying more cash in acquisitions and/or more share buybacks would help to improve returns for shareholders. It has taken a piecemeal approach to the former, buying a business that is already profitable and using it as a platform to expand in that market. Its purchase of IKH in Finland in 2021 is a case in point, taking it into a new market without betting the farm.
A fresh warning of more pain for borrowers from the Bank of England is a reminder that the slide in the housing market and consumer spending is unlikely to reverse any time soon. But Grafton has a low bar to surpass to gain any plaudits.
ADVICE Hold
WHY The risk of weak sales is already adequately reflected in the shares’ poor valuation
HgCapital
Even a swingeing 23 per cent discount puts HgCapital Trust’s shares among the most resilient in its sector, such is the mistrust of private equity funds in a much higher interest rate environment.
The FTSE 250 investment trust has some decent counterpoints to any doubters. The 25 per cent stake it sold in one mid-sized fund to another private equity investor was at a par with the valuation at the end of last year. HgCapital didn’t go backwards over that time, either — sales last year were made at an aggregate 30 per cent premium to net asset values and were higher in quantum than the historic average.
That doesn’t mean earnings multiples used to value its companies have not been lowered to reflect the higher cost of financing. But the uplift on sales made, and rising cashflows from its portfolio of companies, still pushed the net asset value up 4 per cent to 471p a share during the first quarter.
The trust is the largest investor across the three classes of buyout funds operated by HgCapital, owning a stake of about a 10 per cent in each. It specialises in technology — hardly the whizzy kind, more software companies with recurring cashflows. Those include Iris, the tax-filing specialist, and Visma, akin to Sage, an accounting, human resources and payroll software provider operating in northern Europe.
Private equity’s startling comedown is tough to ignore. Cash raised across the industry stands at only $333 billion this year, which puts funds on course to lag the $855 billion recorded over the entirety of last year, according to Preqin, the data provider. The returns banked over the 12 months to September were a mere 3.5 per cent, compared with 34.8 per cent in 2021.
It means the HgCapital strategy of recycling cash back into new investments is far from risk-free. The trust has available funding of £647 million, which means it is relying on selling assets over the next three to four years to hit its investment target. The market for M&A is more subdued. Without signs of a revival in activity, it will be tough for HgCapital and its peers to close the valuation gap.
ADVICE Hold
WHY A subdued private equity market will probably cause the discount for the shares to persist
