Cracking the US market has the power to turbo-charge returns — FTSE 100 constituent Ferguson is a case in point. But the plumbing and heating products specialist, which now makes almost all its money Stateside, doesn’t have the market valuation to match.
That’s despite rising housebuilding activity, a booming home repairs, maintenance and improvement market and a bounceback in commercial construction activity that have accelerated revenue growth. Organic sales were 24.5 per cent higher in the first quarter, up from 23.6 per cent in the prior three months and ahead of the 20 per cent forecast by analysts. That rate of growth is expected to continue during the current quarter, so management’s full-year expectations have increased despite the fact that gains should slow later this year.
Interest rates might rise but slowly and from a low base, which means mortgage rates look set to stay cheap by historical standards. That should buoy demand within the US housing market, where Ferguson makes more than half its US revenue.
The group’s competitive power lies in the scale it has built, helped by a stream of bolt-on deals. Gaining dominance in several distribution markets has strengthened agreements with suppliers and helped the group to navigate supply chain disruption, taking business from smaller distributors that have been left with stock shortages. But the vast size of the US housing and construction industries means even the largest players don’t have to “kick each other to death” on pricing in order to secure a greater share of the market, said analysts at Peel Hunt.
Rising input costs haven’t been a burden to be managed but a boon. Higher raw material and freight costs have been passed on to customers, meaning average price inflation in the low teens during the first quarter, from 8 per cent in the three months to July. That pushed the operating margin up to 10.9 per cent, from 8.4 per cent the same period last year.
A turn in construction demand is a natural risk for companies like Ferguson. But the group has learnt its lesson about the dangers of carrying high leverage when the economy takes a dive. At the start of 2009, net debt stood at £2.5 billion, up to 3.1 times adjusted earnings before tax and other charges, as demand for building materials collapsed in the wake of the financial crisis. That prompted the group to launch a £1 billion fundraising via a rights issue and share placing and brutal cost cutting measures.
At the end of October this year, net debt stood at just £1.4 billion, or 0.6 times adjusted earnings, which leaves room for more bolt-on deals.
A vote on switching the group’s main listing to the US is due to take place in the spring but seems likely to go through. There is a risk exiting the FTSE 100 will force institutional investors to sell holdings. But the shift Stateside has been well-flagged.
Investors might have had an inkling when it switched to reporting in dollars in 2017. Plans for a US listing were first mooted more than two years ago, after agitation from activist Trian Partners. Columbia Threadneedle, a former top ten shareholder and a vocal opponents of the switch, has sold down some of its holding. The potential downside for holders of the UK shares? A lower level of liquidity in the stock.
At 20 times forecast earnings for this year, the shares look pricey compared with UK-listed rivals. But that multiple looks less toppy judged against major US peers, which values Ferguson at a discount. That’s despite it generating 94 per cent of revenue in the US and the rest in Canada, after the sale of UK business Wolseley earlier this year. Ferguson’s shares may well catch up.
Advice Buy
Why Growing market share in the US could boost earnings and prompt a further re-rating in the shares
Premier Miton
A relatively fixed cost base makes the asset management business a scale game. So it should be no surprise that market minnows Premier Asset Management and Miton scored favour with investors with a merger completed last year. Shares in the asset manager have outperformed larger rivals such as Jupiter or Abrdn since last year’s market crash and are now valued at a superior forward earnings multiple than the former.
Hedging its bets has paid off. Net inflows totalled £830 million over the 12 months to the end of September, representing four quarters of net new business, against an aggregate £619 million of net outflows the prior year. A recovery in markets played some part in sentiment recovering, but more buoyant markets haven’t been enough to entice investors into funds managed by the likes of both its aforementioned peers.
The asset mix is now more diversified, part of efforts to reduce reliance on any one strategy, or investment team. Premier brought more multi-asset funds to the party, while Miton contributed a greater proportion of equities so the combination is a fund manager with 59 per cent of assets weighted towards equities, just over a quarter in multi-asset funds and the rest in fixed income and investment trusts.
That doesn’t mean there aren’t still some sore spots. Multi-asset funds are losing more cash than they are taking in. A trend that the manager blames on weak performance in 2018 and 2019, and has sought to reverse by reducing the charges attached to some of those products.
The threat from cheaper passive strategies is one particularly prescient for managers like Premier Miton, which have a skew towards retail investors. An all-share approach for River & Mercantile was made last month, with securing access to the institutional market in mind, although it might need to fend off competition from Martin Gilbert’s AssetCo vehicle.
That could spur a further re-rating in the shares, which trade at almost 11 times forecast earnings for this year. For now investors can be satisfied with a beefy dividend, which totals 10p a share for the past financial year, equating to a yield of roughly 5.9 per cent.
Advice Buy
Why Generous dividend at an undemanding rating
