Will Fletcher Building ever regain its mojo?by Jonathan Underhill
Fletcher’s Building + Interiors business plunged to a $630 million loss in the six months to the end of December.
“Fletcher companies provide by far the biggest supply of building materials in the New Zealand market, including to Arrow,” says Ken Forrest, chief executive of Arrow International, which won the 2017 Supreme Award at the NZ Commercial Project Awards for The Remarkables Base Building near Queenstown.
Although Fletcher’s Building + Interiors (B+I) business plunged to a $630 million loss in the six months to the end of December, its building products division earnings fell a modest 9% to $118 million. Building Products includes Winstone Wallboards, maker of the ubiquitous Gib board, which dominates the segment but claims no pricing power in a global market. Knauf, the world’s second-largest plasterboard maker, failed in 2014 to convince the Commerce Commission that Winstone froze it out of the market at every turn.
The Fletcher name is connected with some of New Zealand’s most iconic buildings, including the Chateau Tongariro, Wellington’s ornate Central Railway Station and, in more recent times, the Museum of New Zealand Te Papa Tongarewa and the Sky Tower. All were built before Fletcher Building was created as a standalone company in 2001, and in each case, Fletcher was hired as builder only. Fletcher was also a member of the partnership that built the Waterview Tunnel.
But the company’s design-and-build contract with SkyCity Entertainment Group to construct the International Convention Centre is a different story. This is Fletcher’s most problematic project and the greatest remaining risk on its balance sheet, since it runs through until mid-2019 (the Justice Precinct in Christchurch was due to wind up in February).
On the plus side, Commercial Bay, the $425 million Auckland CBD development contract it has with Precinct Properties, also runs through to mid-2019 but is rare among major B+I design-and-build projects in being profitable. Another $500-600 million in key projects Fletcher hasn’t identified publicly will run into next year and are in the red.
Ross Taylor, who took the reins at the company in November after former chief executive Mark Adamson left abruptly, is focusing on completing the remaining contracts and is not taking on new business. “Fletcher is predominantly a builder, but it got into design-and-build contracts. If you don’t control that, you can get very significant cost blowouts,” he says.
Design and build required “a level of complexity and sophistication” that Fletcher didn’t have in-house, he says. That’s not to say vertical construction isn’t a viable market, provided a company “is very disciplined and works the variations and contractual angles”. That’s not the way he works or the way he sees Fletcher, and the whole debacle has damaged the company’s brand, he says.
It’s a striking admission for a listed company that has had a phalanx of knights at the boardroom table over the years. Rod Deane, now Sir Roderick, joined Fletcher Challenge in 1994 and, with the separate listing of Fletcher Building, became its chairman, with Australian Ralph Waters as CEO. There followed, by some measures, six glorious years. Between 2001 and May 2007, the shares rose 469% as Fletcher Building became a global name, buying businesses as far away as the US and Europe.
In an analyst presentation in early 2004, Waters said Fletcher was not a construction company, not a distribution business but “a building materials manufacturer which controls its channels to market”. At the time, Winstone Wallboards had 94% of the New Zealand market.
A 20-year chart of Fletcher’s stock price shows that after tumbling from its peak $13.42 in May 2007, it has never quite regained its mojo. Like many global companies, it was left reeling by the global financial crisis. Its total shareholder return for 2008 was minus 43%, taking some of the cream off what Boston Consulting Group assessed as a five-year run in which Fletcher “was found to have created $4.8 billion of wealth for its shareholders”.
In the past five years, Fletcher stock has fallen 26%, at the same time as the S&P/NZX 50 index has climbed 96%. The enterprise that Deane and Waters built into the largest local company by market value today ranks seventh, at about $4.6 billion, or about half A2 Milk’s capitalisation.
That coincides with Adamson’s appointment in 2012, and an era in which the company became too sprawling, investors say.
“Fletcher Building is an iconic New Zealand business and an important member of our stock exchange,” says Slade Robertson, a portfolio manager at Devon Funds Management. “Over the years, through a number of acquisitions, the complexity of this company has increased and the challenges of managing it have similarly evolved.”
Robertson acknowledges he is being circumspect in his comments so as not to be seen to add to Fletcher’s whipping-boy status on the local bourse.
“We have been disappointed with its operating performance in recent years, but believe that Ross Taylor has the skills and experience necessary to drive an improvement in shareholder outcomes and business sustainability,” Robertson says. Taylor’s recent allowance for ongoing B+I losses “appears comprehensive, and the strategic review that he is performing across the group should result in improvements being made in the business’s structure”.
Adamson left last July in the wake of the unprofitable B+I contracts. The chairman of the board that oversaw his departure, Sir Ralph Norris, resigned in February after it became clear the company hadn’t provisioned enough for B+I.
Based on reported email leaks and unsourced anecdotal reports, Adamson had been frustrated with executives in B+I and construction as a whole and may have chased out its experienced operators and left it with a relatively inexperienced team. Taylor calls it “the wrong team”.
Unless the economics of vertical construction improve, Fletcher’s construction division is winding down B+I. All the remaining financial pain is recognised in the current year, and the market appears to have confidence that Taylor has now accounted for unprofitable B+I contracts that are still running.
Stock rated a “hold”
First NZ Capital analyst Kar Yue Yeo has slashed his forecast for Fletcher’s full-year 2018 earnings before interest and tax by 93% to $540 million, but he has left his forecasts for 2019 and 2020 pretty much intact. Morningstar analysts rate the stock a “hold”, not a sell, and noted on February 14 that the shares now look “attractive”.
Hawkins, Fletcher’s biggest competitor in vertical construction, is keeping its head down and declining to comment. Hawkins was acquired by Australian infrastructure and mining firm Downer EDI for A$55.4 million ($60 million) last year – a deal that was announced in early March, just weeks before Fletcher first slashed its 2017 earnings forecast. It was Downer’s entry into vertical construction, less than a year before Fletcher signalled its retreat. Hawkins is part of Downer’s engineering, construction and maintenance division, and in its first-half results, the company says it “has been performing well since its acquisition in March 2017”.
Arrow’s Forrest says he is “cautiously optimistic” that the construction industry will remain buoyant in the foreseeable short term. “We’ve been in the market for more than 40 years and it’s not our first rodeo; we have learnt to be nimble in variable markets,” he says. “There certainly is life in commercial construction, and today’s market presents an opportunity to look for better margins.”
The challenge for the industry is one of supply to meet current high demand. The industry “is heavily fragmented, which tends to result in lower-margin business overall, and the Fletcher news may be an indicator of how that can play out,” he says.
Taylor says he balked at the margins on offer in some recent vertical-infrastructure tenders. “I’m quite comfortable we could reposition B+I to do $200-300 million of vertical construction [contracts]. But for Fletcher, it’s just madness to have $200-300 million of revenue with that amount of risk. There’s plenty of other construction work that makes sense with bigger margins.”
Taylor made it his first task when he began as CEO to launch a broader review of B+I contracts. This led the company to crystallise its latest losses.
He hasn’t completed a wider assessment of the company and says he will announce details of “quite an exciting opportunity” when the review is complete in June. But on a recent analyst call, he indicated non-core assets could be sold.
“The main question for me is the balance sheet. That’s the discipline I’m going through,” he says.
Morningstar identified the Formica business, bought with great fanfare in 2007, as a sale candidate because it fell into the category of “earning low returns with no synergies across the rest of the business”.
Taylor told the analyst call he is upbeat about the rest of the company and “wouldn’t be here” if he didn’t believe in its potential.
This article was first published in the March 10, 2018 issue of the New Zealand Listener.
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