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Stephen, a qualified engineer, formed Solas Financial Sept 2004. Stephen is an active investor and trader in equities, futures and options. Prior to forming Solas Financial, from 1996 – 2004 Stephen served as operations director of Trade Signal Corporation Limited which develops and delivers... More
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  • CRH Plc Investment Report

    Rating: Buy

    Target price: 15.35

     

    Market Data

     

    € millions

    2010a

    2011f

    2012f

    2013f

    2014f

    Recent price, €

    15.25

    Revenue

    17,173.0

    17,914.8

    19,267.5

    20,621.9

    21,879.9

    Market Cap, € mn

    9,301.5

    Operating income

    698.0

    824.5

    907.5

    1,128.7

    1,364.6

    Shares out., mn

    716.5

    Operating margin

    4%

    5%

    5%

    5%

    6%

    52wk range, €

    10.28 - 17.40

    Net Income

    432.0

    529.7

    582.8

    764.9

    958.1

     

     

    Net margin

    3%

    3%

    3%

    4%

    4%

     

     

    EPS, €

    0.61

    0.74

    0.81

    1.05

    1.31

    Source: company reports, analyst estimates, Reuters

    Summary

    CRH Plc is a large multinational company selling construction materials and products in much of Europe, North America and in some Latin American countries, as well China and India. Like most companies in the construction industry, CRH was hit hard by the global recession. However, the company remains financially strong, while its past acquisitions have both diversified the company’s markets and have provided an alternative source of revenue growth. CRH has announced like-for-like revenue growth during H1-2011, driven by Products and Distribution operations in Europe and the Americas, but growth is very fragile amid uncertain economic environment. CRH is also less indebted than its peers, which is quite important in the current market conditions when getting additional financing may be difficult.

    The main risk for CRH, in our view, comes from the significant uncertainty associated with the current state of the global economy: is the recovery seen since the beginning of the year sustainable? How fast will the global economy recover? etc. We have no doubt that full recovery will eventually happen, but the answers to these questions will largely determine the company’s success.

    Investment Highlights

    Revenue recovery

    CRH has reported that in the first six months of 2011, business has shown signs of recovery, with like-for-like sales growth reaching 5% year-on-year. European sales grew by 7% year-on-year, while Americas – by 2% year-on-year (like-for-like). Operating margin improved from 1.5% in H1-2010 to 2.3% in H1-2011.

    Acquisitions

    CRH follows a growth-through-acquisitions strategy that significantly increases the pace of the company’s overall growth. In the past, CRH was spending up to €2 billion per year on acquisitions alone, significantly expanding its outreach in the global market. Acquisitions are an important tool when entering new geographic markets and in addition they bring the much needed diversification, as well as some economies of scale, access to new resource bases and market share. CRH has expressed its intention to continue pursuing acquisition opportunities, having spent €380 million in January-August 2011 on 28 acquisitions and investment initiatives.

    Historical profitability and healthy cash generation

    CRH has shown good profit and cash generating ability in past years. Its net income had grown from €866 million in 2004 to €1.4 billion in 2007, only suffering declines in recessionary years – 2008-2010, when net margin fell from the historical average of 6.7% to the low of 2.5% in 2010. Considering that CRH operates in a cyclical industry, not suffering a decline would have been close to a miracle. But remaining profitable, even with a lower margin, is worth noting. Similarly, cash flows from operations have remained strong, although less stable and somewhat lower than before the recession. Operating cash inflows finance much of the company’s investment activities, acquisitions being the most significant amount-wise. CRH has continued to pay dividends, although dividend per share has remained flat in recent periods.

    Cost cutting initiatives

    CRH continues to implement cost cutting measures to improve its profitability. The company has announced that it expects to realise gross savings of €136 million in 2011 and that it is on track to achieve this goal (implementation costs totalled €16 million in H1-2011).

    CRH is diversified across regions and markets

    CRH is relatively well diversified as it covers both sides of the Atlantic: Europe (including Eastern), North America, Argentina and Chile, as well as Asia (India and China). The company operates in three major segments: Primary materials, Value-added building products, and Specialist building materials distribution. Although ideally we would like to see CRH operate more in regions that are less integrated with Western economies, the current diversification is still beneficial.

    Source: company reports.

    Investment Risks

    Global recession

    CRH’s business is significantly affected by the health of the economy, and this has deteriorated significantly in most, if not all, of the company’s markets. All of CRH’s segments suffered organic revenue and profitability declines, with 2011 showing the first signs of recovery. We must remain cautious however, as H1-2011 full-period growth was one percentage point slower than for the first four months of the year, pointing to a weakening in the markets and a very uncertain economic environment. Slow recovery of CRH’s end markets (synonymous with European and American economies) will mean slow recovery of the company’s performance. Return to historical revenues and profitability levels could take years, while another recession will most likely significantly impact the company’s financial performance.

    Acquisitions

    Acquisitions require considerable amounts of cash, time and management attention. Additionally, acquisitions by such a large corporation may raise competition-related concerns with authorities, increasing the costs of acquisitions as well as affecting their success. Such an issue prompted CRH to drop its proposed acquisition of Pavestone Group LP in January 2009, meaning that all costs and management attention associated with this transaction, announced on 13 March 2008, had been wasted – almost one year’s worth of efforts!  Acquisitions also mask the company’s organic performance. For example, in 2010, CRH’s total revenue fell by 1.2%, or about €0.2 billion, but organic decline was €1.2 billion. It is important that CRH maintains a healthy financial structure and watches its consolidated performance as it acquires new subsidiaries, to avoid making acquisitions just for the sake of top line growth, as careless purchases can become a liability and may erode shareholder value.

    Valuation

    Our valuation is based on a combination of absolute (DCF) and relative (P/E, EV/S and EV/EBITDA) valuation techniques.

    We estimate that in H2-2011, organic growth will slow down, based on the weakening of the growth in May and June. We also expect that margins will improve in the next several years from the recent lows, but not quite to the highs of pre-crisis levels. We forecast the following performance in the next several years:

    CRH performance forecast:

     

    Source: company reports, analyst estimates.

    Much of the revenue growth above (up to 60% of new revenues) is expected to come from acquisitions.

    DCF valuation

    Our DCF model suggests a fair value of CRH stock of €17.38.

    Our DCF model uses a beta of 0.86, which is below what is reported for peers, whose betas range between 0.92 and 2.13, as reported by Reuters. A beta of 1 would have resulted in a fair price of €14.45.

    The sensitivity of our DCF model to the WACC and terminal growth rate assumptions is shown below:

     

     

    WACC

     

    LT Growth ↓

    7.4%

    8.4%

    9.4%

    1.0%

    €19.13

    €15.30

    €12.40

    2.0%

    €22.24

    €17.38

    €13.86

    3.0%

    €26.79

    €20.25

    €15.78

    Source: analyst estimates.

    Relative valuation

    For relative valuation, we picked the following competitors of CRH in European and North American markets:

    ·         CEMEX SAB de CV (ADS);

    ·         Lafarge SA;

    ·         Holcim Ltd;

    ·         HeidelbergCement AG;

    ·         Italcementi Group;

    ·         Vulcan Materials Co.

    Because the construction industry uses significant amounts of debt to finance its operations, we used EV/Sales ratio instead of the more traditional Price/Sales ratio, as it better reflects the relationship between debt and equity.

    The resulting valuations are shown below:

    EV/Sales valuation

    € millions

    Sales FY2012e

    19,267.5

    Peers' multiple (median), 2012

    1.44

    Premium assumed

    0%

    Target multiple

    1.44

    Enterprise value

    27,797.4

    (Less) Net Debt

    4,486.0

    Equity Value

    23,311.4

    Price target, €

    31.62

     

    P/S valuation would have given us €11.69 per share, but it ignores the fact that CRH is less indebted than its peers, whose debt/market cap ratio is much larger – a median of 2.26 versus CRH’s 0.61.

    P/E valuation

    EPS FY2012e

    0.81

    Peers' multiple (median), 2010

    11.3

    Premium assumed

    0%

    Target multiple

    11.3

    Price target, €

    9.16

     

    EV/EBITDA valuation

    € millions

    EBITDA TTM

    1,687.0

    Peers' multiple (median),TTM

    7.8

    Premium assumed

    0%

    Target multiple

    7.8

    Equity value

    13,176.3

    (Less) Net debt

    4,486.0

    Enterprise value

    8,690.3

    Price target, €

    11.79

     

    P/B valuation

    € millions

    Book value of equity

    9,815.0

    Peers' multiple (median)

    0.5

    Equity value

    5,004.9

    Price target, €

    6.79

     
    Final valuation

    The equal-weighted average of the five valuation techniques is €15.35 per share, or 18% above the current market price.


    Quant Analysis Nov 2011

    The Solas Trend Finder is currently long on CRH.

    Note: Chart denoted in Sterling. £12.75p  GBP                  


     

    About the Solas Trend Finder

    The Solas Trend Finder Software (Equities & Etfs) is designed for traders and investors who want to take advantage of short, medium and longer term trends across multiple timeframes on Global Equities and Exchange Traded Funds (Etfs).

     

    The Solas Trend Finder analyses price action on an individual price bar basis, identifies statistically significant levels in price action and generates buy and sell signals at optimum price levels.

    For more information on our systematic trading models please visit

    http://solastrader.com/solas-trend-finder/trend-finder-equities-etfs/

    About SolasTrader.com

    www.solastrader.com/about

     

    Jan 06 12:26 PM | Link | Comment!
  • Bank of Ireland Analysis
    Banks of Ireland Investment Analysis

    Rating: Sell

    Target price: €0.052

     

    Market Data

     

    € millions

    2010a

    2011f

    2012f

    2013f

    2014f

    Recent price, €

    0.09

    Interest income

    5,179.0

    4,583.2

    4,494.6

    5,003.6

    5,617.3

    Market Cap, € mn

    3,103.6

    Operating income

    -3,134.0

    -939.6

    541.5

    532.2

    818.5

    Shares out., mn

    30,132.5

    Net Income

    -614.0

    -726.2

    463.1

    466.1

    708.4

    52wk range, €

    0.06 - 0.67

    EPS, €

    -0.16

    -0.03

    0.01

    0.01

    0.02

    Source: company reports, analyst estimates, Reuters

     

    Summary

    Bank of Ireland (BOI) is one of the largest banks in Ireland and hence bears huge importance for the country’s financial system. It is no secret that financial systems of many developed nations across the world took a serious hit as a result of the US subprime mortgage meltdown and the global recession that followed, but for Ireland the impact is compounded by seriously deteriorated financial stability of the whole country. Our valuation suggests that BOI is currently overvalued.

     

    Capitalisation

    On 31 March 2011, the Central Bank announced the results of the 2011 Prudential Capital Assessment Review (PCAR), requiring BOI to generate incremental equity capital of €4.2 billion. According to BOI, the capital requirement would cover:

              the higher target capital ratios set by the Central Bank of a minimum Core tier 1 ratio of 10.5% on an ongoing basis and a Core tier 1 ratio of 6% under the adverse stress scenario;

              a regulatory buffer of €0.5 billion;

              the adverse stress scenario loan loss estimates.

    In addition, contingent capital worth €1.0 billion was also required through the issue of a debt instrument which “under certain circumstances” would convert to equity capital.


    In July, BOI carried out actions to meet the regulatory requirements. The most controversial was the “Liability Management Exercise” (LME), whereby BOI passed on a large amount of losses onto subordinated debt holders, by exchanging about €2.6 billion (nominal value) of outstanding notes for equity or cash at heavy discounts (reaching as much as 80-90%). Total equity capital contribution from this transaction was estimated at about €1.96 billion.

     

    The second part of the capital raising activities including a rights issue of €1.91 billion (gross), fully underwritten by NPRFC. The remaining part of the €4.2 billion requirement should come from additional measures. The €1 billion contingent capital was placed with the government in the form of a 5-year Tier 2 subordinated instrument with 10% coupon, with conversion price at the higher of 30-day average price at date of conversion or €0.05 (conversion is mandatory if the Core tier 1 capital of the Group’s falls below 8.25%).

     

    BOI reports that as of 30 June 2011 (before the capital increase), its Core Tier 1, Tier 1 and Total Capital ratios were 9.5%, 9.6% and 11.0%, respectively, almost unchanged from 31 December 2010, when the ratios stood at 9.7%, 9.7% and 11.0% respectively. BOI reports that the capital increase would produce a pro forma Core tier 1 ratio of 15.4% as at 30 June 2011. Moreover, on July 15, BOI announced that it passed the 2011 European Banking Authority (“EBA”) Stress Test. The test allowed for the assumption of BOI’s balance sheet downsizing (normally a constant balance sheet would be considered) as an exemption and was based on full implementation of the €4.2 billion capital increase. The test assessed that in the worst case scenario, BOI’s Core Tier 1 ratio would be 7.1% at 31 December 2012, 2.1 percentage points above the 5% threshold (although a new Europe-wide stress test could consider a 7% threshold).

     

    As a result of the capital raising activities, government’s stake in BOI rose significantly. However, an agreement was reached with a group of shareholders to sell to them part of government’s stake, so that its total holding would be reduced to 15%. At the same time, these shareholders would hold approximately 35% of BOI’s capital (subject to certain approvals).

     

    Deleveraging

    The 2011 PCAR incorporates a deleveraging plan (PLAR) which envisages a loan to deposit ratio of less than 122.5% by 31 December 2013 and below 120% by the end of 2014. This ratio would be significantly lower than 175% registered at the end of 2010, and is planned to be achieved by winding down or disposing of a portion of the company’s loan portfolio over the next three years. ‘Downsizing’ is probably a better term to describe the planned action. Portfolio reductions envisage mainly getting rid of approximately €30 billion of BOI’s non-core loan portfolios (such as UK Intermediary sourced mortgages; selected international niche businesses; certain international commercial investment property portfolios; etc.).

    Impairments

    In H1-2011, BOI registered lower impairments on loans and advances to customers than in H1-2010: €842 million versus €1,082 million, reflecting “Lower impairment charges on the Non–property SME and corporate, Property and construction and Consumer portfolios [...] partly offset by higher impairment charges on Residential mortgages in Ireland”, although the impairment rate (as percentage of average loans during the period) remained the same as in the previous six months. BOI maintains its expectations that the impairment charges on the loans and advances to customers (excluding assets sold or held for sale to NAMA) will continue declining, and has a goal to reach impairments of 55bps – 65bps in 2014 (as percentage of average annual loan book balance).

     

    Credit ratings downgrades

    Since the end of 2010, BOI has had its credit ratings downgraded further.

     

    BOI - Senior Debt

    31 December 2010

    5 April 2011

    18 August 2011

    Standard & Poor’s

    BBB+ (Creditwatch Negative)

    BB+ (Creditwatch Negative)

    BB+ (outlook Negative)

    Moody’s

    Baa2 (Negative)

    Ba1 (Review for possible downgrade)

    Ba2 (outlook Negative)

    Fitch

    BBB (Stable)

    BBB (Ratings watch Negative)

    BBB (outlook Negative)

    DBRS

    A (High) (Negative Trend)

    BBB (High) (Negative Trend)

    BBB (high) (outlook Negative)

     

    Cost reductions                                                                                         

    BOI continues implementing cost-cutting measures in response to the weak economic environment and the planned downsizing. Its operating costs declined by 7.2% year-on-year in H1-2011 and average staff numbers were down by about 350 between H1-2010 and H1-2011 (2.4% reduction). BOI continues looking for additional savings from the renegotiation of outsourcing contracts and in other areas.

     

    Valuation

    Our valuation is based on two DCF techniques. Relative valuation is not appropriate in BOI’s case: sales-based metrics like P/S are impossible to use because there is no disclosure about the nature of sales for peers on Reuters where we obtain these consensus estimates (i.e. is it gross interest income, net interest income, interest revenues plus non-interest revenues?); EBITDA-based metrics are also out of the question because of the unique nature of financial sector businesses (i.e. little depreciation, interest being part of operating income and costs). Ireland doesn’t have many publicly traded banks, while non-Irish banks are undoubtedly operating in a very different environment at the moment, given Ireland’s significant economic troubles compared to its neighbour – the UK (the most comparable market in terms of peer banks).

     

    We forecast that BOI will return to profitability in 2012 as impairments should decline further. We expect the company’s operations to shrink as a result of the deleveraging and downsizing efforts, but to eventually return to growth as the economy recovers.

     

    BOI performance forecast:


     

    Note: financial periods prior to 9mo09 ended on March 31.

    Source: company reports, analyst estimates.


    DCF valuation

    Since financial institutions are very different from other types of businesses, our DCF valuation will be based on two techniques: the Dividend Discount Model (DDM) and the Excess Return Valuation, as described by A.Damodaran in his book Investment Valuation.

     

    Dividend Discount Model

    Historically, BOI regularly paid a dividend, which averaged at 35.9% of EPS for ordinary shareholders between FY2005-FY2008 (old year end). Since BOI’s EU restructuring plan requires that the company does not pay any dividends “until the earlier of (i) 30

    September 2012; or (ii) 2009 Preference Stock is redeemed or no longer owned by the State through the NPRFC or otherwise”, we assumed that the bank will resume paying dividends in 2013 at a payout ratio of 12%, returning to the historical rate in 2015. We assumed that the payout ratio will remain at this level indefinitely and that net income growth will slow down to 2% by 2020 (the assumed long-term growth rate).

     

    Discounting the expected dividends by the estimated cost of equity of 26.9% results in a price of €0.038 per share (assuming the issuance of approximately 11.5 billion new shares to accommodate the potential conversion of €1 billion contingent capital and assuming the eventual conversion into common shares of the remaining 1.8 billion of preferred shares held by the Irish government.

     

    The sensitivity of the DDM-derived target price to the cost of equity and terminal growth rate assumptions is shown below:

     

    Cost of equity

    LT Growth ↓

    24.9%

    26.9%

    28.9%

    1.0%

    0.044

    0.037

    0.032

    2.0%

    0.044

    0.038

    0.032

    3.0%

    0.045

    0.039

    0.033

    Source: analyst estimates.

     

    Excess Return Valuation

    In such a model, the value of a firm can be written as the sum of capital invested currently in the firm and the present value of excess returns that the firm expects to make in the future: Value of Equity = Equity Capital invested currently + Present Value of Expected Excess Returns to Equity investors.

     

    The model relies on largely the same estimates as DDM: net income, dividend payout, cost of equity. We applied the same assumptions as in the DDM approach above. This approach yielded a higher valuation: €0.067 per share after dilution.

     

    Final valuation

    Taking the average of the two valuations, we obtain €0.052 per share – 49% below the current market price. If we assume that dilution from the €1 billion contingent capital will not be realised, then the final price target is estimated at €0.068 per share – 34% below the current market price.

    Quant Analysis Dec 2011

    The Solas Trend Finder is currently Neutral on Bank of Ireland.

    Note: Chart denoted in Sterling. £0.08p  GBP

     

    About the Solas Trend Finder

    The Solas Trend Finder Software (Equities & Etfs) is designed for traders and investors who want to take advantage of short, medium and longer term trends across multiple timeframes on Global Equities and Exchange Traded Funds (Etfs).

     

    The Solas Trend Finder analyses price action on an individual price bar basis, identifies statistically significant levels in price action and generates buy and sell signals at optimum price levels.

    For more information on our systematic trading models please visit

    http://solastrader.com/solas-trend-finder/trend-finder-equities-etfs/

    About SolasTrader.com

    See www.solastrader.com/about




    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
    Jan 06 3:23 AM | Link | Comment!
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