Five big construction plays to watch

The construction market is nervous, that much is for sure. With economic uncertainty spreading to consumers' pockets, the buzzing activity in the UK building sector is tipped to unwind over the next year. Luckily for investors, these risks shouldn't derail the entire sector any time soon and investment bank UBS has given its latest view on five of the big movers and shakers.

There's a ray of light shining from across the pond, with exposure to the recovering US market keeping the industry here above water. It seems like it's the only region with pricing power, which positions CRH and Wolseley well, and its recovery still has a way to go. Trends are also stabilising in emerging markets, although margin pressure will continue to weigh.

Of course, UK uncertainty has triggered a spate of downgrades to forecasts as 2017 volume guidance has fallen 5-10%, with Ibstock and Travis Perkins expected to suffer most. Although this slowdown shouldn't be mirrored across Europe, UBS's forecast of 2% growth already reflects caution.

Still, the risk to the UK shouldn't be ignored entirely.

"The immediate trends since the end of June in the UK will be a key focus and to what extent, if any, Europe remains in a slower growth environment over coming years," analyst Gregor Kuglitsch warns.

CRH

'Buy', target price (TP) 2,450p

The building materials group reckons it's generated around €1.1 billion (£925 million) of cash profit in its first half, which beats City expectations thanks to a strong second quarter. Friday's profit beat sent CRH's share price sailing 4% higher to a nine-year high of 2,281p.

Broker UBS has just upgraded its target price on the shares by 7% to 2,450p after sterling's devaluation, which offers 7% further upside from current levels.

With an attractive geographical mix between the US and Europe, nearly half of its earnings are generated in the US. So, while a UK downturn could knock sales by 7% in 2017, its recovery markets should still have a couple of years to run to offset this. There are also risks over the sustainability of Americas Materials margins and new capacity in Canada, but a strong balance sheet should be enough to win investors over.

Trading on a free cash flow yield of around 7%, a 1.4 times net debt/cash profit ratio makes it the least geared major in UBS's coverage, and its firm large-cap favourite.

Ibstock

'Buy', TP 175p

Just because forecasts have been cut doesn't mean valuations cannot look attractive. Take Ibstock: UBS has slashed earnings expectations by 40% from 2017 due to Brexit-inspired lower new build volume forecasts, with the analysts pencilling in the 5% drop in brick volumes widening to 11% in 2017. That's nasty stuff.

Falling 28% since the referendum and 36% since the beginning of the year, the market is pricing in more of a horror story and the shares look oversold. A price/earnings (PE) multiple of 11.5 times and 5% dividend yield look attractive, supported by a 7.5% free cash flow yield. The balance sheet is robust, too, with a 2017 net debt/cash profit multiple of 1.3 times. The group's target price falls by a quarter to 175p, but still offers 19% upside to its current price.

Travis Perkins

'Buy', TP 1,800p

Although Travis Perkins is highly exposed to the housing cycle, the builder's business model and balance sheet looks well positioned to weather a downturn in the residential and non-residential markets, reckons UBS, although it needs to prove that it can outperform is peers.

Against a nervous economic backdrop and after stamp duty tax changes in the first quarter, housing sales are expected to slow over the next few months. Still, two-thirds of sales are from the less-volatile repair, maintenance and improvement (RMI) markets.

So, like-for-like sales are expected to fall 1% in 2016 and 5% in 2017, with a 4% and 25% crash in cash profit pencilled in respectively. While bosses had looked forward to double-digit growth in underlying operating profit to £445 million this year, this is likely to soften.

Trading on a PE of 14 and with a 6% free cash flow yield, the group's strong balance sheet should help it capitalise on any near-term opportunities to improve profitability. Although its target price has fallen by a fifth, this offers 20% upside to the current 1,506p after a severe post-referendum sell-off.

"The next 18 months will likely prove testing, in our view, but we believe a high quality management team, market dominance and still some growth levers available leaves Travis best placed across the industry to outperform," says UBS. "We expect volatility to continue but think the current entry point is attractive for long-term focussed investors."

Wolseley

'Buy', TP 4660p

But sterling's devaluation isn't bad news for everyone. Plumbing and heating supplier Wolseley should make more money as it captures mark-to-market translational currency movements, reckons UBS. With North America generating 85% of its cash profit and the UK only 5%, the broker has upgraded its forecasts by 7% on average.

As a pure US play, management are going to have to quickly turn around slowing US like-for-like growth. The group should return to its historical 5% average by 2017 as deflationary pressures and competition ease.

Trading on 13 times 2017 earnings, the group looks attractively valued, especially as UBS reckons the group could return £300-350 million to shareholders. Bumping its target price up 8% to 4,660p, the analysts reckon the shares could be worth 14% more than their current 4,076p pricing.

SIG

'Sell', TP 95p

With many forecasters factoring in a UK slowdown, or possible recession, it's no surprise that cyclical stocks dependent on economic health have been downgraded since the referendum. Competition in UK building materials will remain high as construction declines, which is going to make achieving cost-cutting targets even harder. So an already tough backdrop will remain challenging for roofing and insulator supplier SIG.

UBS has trimmed like-for-like sales forecasts to 1.5%, minus 5% and 0% for 2016/17/18, from 2.5%, 1% and 1% respectively. After a slower-than-expected margin gain of five basis points in 2016, this measure is now likely to be flat in the two years after, quite a downgrade from the 10-20 basis point growth previously factored in. This year's £89 million of pre-tax profit guidance is likely to fall by a quarter to £75 million in 2017.

Of course, UBS has downgraded its target price for the firm from 115p to 95p, which suggests SIG is overpriced at its current 102p.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.