RBC Capital starts Breedon at ‘outperform’

RBC Capital Markets initiated coverage on construction materials group Breedon on Tuesday with an ‘outperform’ rating and 575p price target.

"Breedon quickly assembled a market leading position in the UK heavy building materials sector," it said.

"Mission accomplished, and in a nod to The Matrix, it is deciding its next move, take the blue pill and become a cash cow or take the red pill and seek transformational growth."

RBC said the value of neither pill is reflected in the current price of the shares, which therefore offers an attractive entry point.

RBC said Breedon's acquisition strategy has been so successful and the barriers to entry it has constructed are so high that the competition authorities are unlikely to allow it to make further transformational acquisitions in the UK or Ireland.

"It could now focus on generating cash and returning cash to shareholders," it said.

"If Breedon takes the 'Blue pill' we believe the dividend per share could be more than doubled as the EBIT margin reaches the higher end of the 12-15% target range and with fewer cashflow calls it could increase the payout ratio from 40% to 60%,” the bank said.

"On this basis the FY2025E price-to-earnings ratio falls to 7.6x and the dividend yield rises to 7.9%.

"Take the red pill for growth Breedon has successfully built two commanding platforms - one in Great Britain and the other in the Republic of Ireland, but as they say, good things come in threes."

RBC said that if Breedon takes the 'Red pill' it will seek to replicate its existing successes and build a third platform.

"It has done its research, it knows what taking the red pill means (expanding into the US), but the outcome is more uncertain," the bank said.

"In the note we assume that Breedon has an initial war chest of £400m, which could add circa £40m of EBITDA (+16%,) but this is just a first step in a new journey. If, over the long run, any US EBITDA grew to match the £250m of the current group, based on current peer group multiples, it creates a US business worth £4bn."

RBC said the red pill and the blue pill options offer attractions for different investor bases, blue for income, red for growth and the value of the shares have been treading water as investors wait for Breedon to choose which pill to swallow and which investors to attract.