The recent slew of disappointing updates from the builders' merchanting space have brought sector valuations and expectations back to realistic levels. Recent performance clearly shows how the difficult trading environment remains and sustained competitive pressures are likely to characterise the space going forward.
This is the view of analysts at Dublin-based Davy Research, but the broker's note on 15 December also highlights a handful of bright spots. Both Grafton (GFTU) and SIG (SHI) have had their respective ratings raised from 'Neutral' to 'Outperform,' not exactly a ringing endorsement but a suggestion that hope is not completely absent from the sector.
According to Davy, there is mounting evidence that the demand outlook is set to improve going into 2016. A strong rebound in mortgage approvals – up 17% in October on a year-on-year (yoy) basis – appears to be fuelling a recovery in secondary housing transactions. These rose in October (+6% yoy) for the fifth successive month. On a six-month lag, Davy expects this to stimulate greater RMI activity from the turn of the year.
This will be welcome relief to investors burned by several companies in the sector during the past few months. Travis Perkins (TPK) shocked the market on 22 October when it said third quarter demand had been weaker than expected, saying earnings growth would be at lower end of market forecasts.
Travis fell 6.1% on the day, while peer SIG tumbled 21.8% following its own profit warning. The insulation specialist revealed that demand in the UK RMI market was below expectations, and problems were spotted in Mainland Europe. O'Donoghue still has concerns about SIG’s current performance; 'however, strategic benefits present upside to what are currently depressed earnings expectations.'
Specialist trade distributor of plumbing and heating products Wolseley (WOS) was another victim of apparent demand weakness. Its shares fell 4.7% on 10 November when the £9.7 billion cap posted a trading statement which pointed to slowing construction markets.
Wolseley’s first quarter like-for-like revenue in the UK declined 1.1% where markets remain challenging, as highlighted by recent economic data. Davy downgrades Wolseley to ‘Neutral’ as the US speed bumps leave them struggling to find enough compelling reasons why the stock should outperform in the near term.
A profit warning from Grafton on 12 November confirmed the woes across the broader merchanting space. Grafton continues to seek expansion opportunities and has added to its Lowlands competence with the €91.5 million acquisition of the Dutch tool distributor Isero which completed on 19 November. In their 15 December note, Davy analyst Flor O'Donoghue reckons 'Grafton’s positioning in particular has adjusted to such an extent that it is now our preferred way to play a more constructive outlook on the sector.'
But it hasn’t been all bad news in the merchanting space as Howden Joinery (HWDN) illustrated when the £3.2 billion cap was treated to a round of earnings upgrades after a trading update on 5 November. Howden reported a ‘good sales performance’ since June, including the October trading period which has tested some of its peers.
Peel Hunt raised its recommendation on the kitchen fit-out expert from ‘hold’ to ‘buy’ with a 535p price target. It presently trades at 514.5p.