RBC Capital starts Forterra and Ibstock at ‘outperform’

RBC Capital Markets initiated coverage of the UK's two largest clay brick manufacturers on Thursday - Forterra and Ibstock - both at ‘outperform’.

It noted that they have market shares of 42% and 28%, respectively.

The bank said both Forterra and Ibstock are "significantly" underearning with adjusted earnings per share around 60-70% below 2022 levels and adjusted EBITDA margins around 700 basis and 400bps below for Ibstock and Forterra, respectively.

RBC forecast 2024 to 2028 adjusted EPS compound annual growth rates of 31% and 41% for Ibstock and Forterra respectively, driven by volume recovery, incremental earnings from near-complete multi-year capex cycle and a highly consolidated and rational sector.

The bank expects a cyclical recovery in UK housebuilding to drive a recovery in clay brick demand back to 2022 levels by 2028. It expects a 5% CAGR in housing completions to drive an 11% CAGR in brick demand as customers rebuild inventory levels.

"Whilst we think there is a possibility for a quicker recovery, particularly if a Labour government overhauls the planning environment, we think this is a prudent assumption," it said.

"We expect 2H 2024 to mark the starting point. As high operating leverage businesses, we think initial drop through from volumes should be in the 30% to 45% range for both companies."

In addition, RBC said both companies are close to the end of multi-year growth capex cycles.

"Incremental earnings are yet to kick in but we see the potential to generate 25% and 40% higher adj. EBITDA versus 2022 for Ibstock and Forterra, respectively," it said.

The bank’s base cases are around 10% and 15% below Ibstock’s and Forterra’s full potential.

RBC also said that both have proven to be highly cash generative, with average operating cash flow conversion over 70% since 2016.

"Whilst cyclically weaker earnings, increased inventories and leverage has weighed on cash generation, we expect this to unwind. This combined with tapering growth capex should lead to a period of bumper free cash flow generation," it said.

RBC has a price target of 210p for Forterra and 200p for Ibstock.