CRH: Still Under Construction

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About: CRH, plc (CRH)
by: Gavin Fourie
Summary

The firm has been 'under the radar' for a few years now, despite their impressive financials, which could make them a good buy for value investors.

They rely heavily on M&A activity, which pumps up the growth numbers significantly.

An activist investor has entered the ranks of shareholders and now holds a large number of shares.

What Is CRH?

CRH (CRH) is an Irish building materials company with strong market positions in Europe and North America. They supply just about everything to the construction industry. On the heavy side, they’re the largest in Europe and supply cement, lime, concrete products, and asphalt. On the light side, they manufacture and supply innovative products and solutions such as glass and glazing systems for customers in construction. Essentially, if you see any construction in Europe or the US, there’s a large probability that the materials were manufactured or supplied by CRH.

Chart Data by YCharts

The company has no doubt been flying under the radar for quite some time now. However, management has worked hard, and the company now boasts one of the highest profit margins in the industry. With these margin improvements, they've also grown the top-line, which isn't as easy as it might seem. Increasing revenue and margins at the same time has proven to be difficult in the past. In fact, only about 32% of companies succeed at achieving both simultaneously. So, how did they achieve this?

Strong M&A Activity

Through some organic growth, but also acquisitions - lots and lots of strategic acquisitions!

To give an idea, the total value of the company's acquisitions between 2013 and 2017, net of disposals, was roughly €8.3 Billion.

Here are some of their more notable acquisitions and investments over the years:

1.) My Home Industries for €290 Million (India)

2.) Pavestone Group LP for €348 Million (US)

3.) Yatai Cement for €224 Million (China)

4.) Bauking Distribution for €126 Million (Germany)

6.) Mykolaiv Cement for €96 Million (Ukraine)

7.) C.R. Laurence Co., Inc. for €1.4 Billion (US)

9.) Ash Grove Cement Company for €4.1 Billion (US)

Clearly, this firm is no stranger to significant M&A activity, relying heavily on bolt-on acquisitions for growth, and it’s working. The ROIC has increased to 12.83% over the previous 5 years, not bad for a mature, building materials company.

Chart Data by YCharts

From where I'm standing, as an outsider of the company, it almost appears as if they have found the secret to 'sustainable' acquisitions. With no sign of this trend slowing down, I'd expect this growth to continue into the foreseeable future.

Also interesting is that the firm has been buying back shares recently. Returning €350 Million to shareholders in phase 1, Another €350 Million in phase 2, and then €100 Million in phase 3. They announced back in December that they have entered the 4th phase of their program and expect to use a further €200 Million to repurchase shares.

One of the largest potential headwinds I see for the company would have to be an economic slowdown, which would be likely to also affect the construction sector and, therefore, CRH, particularly in the US, where a large amount of the revenues are generated. Now, I'm no economist and will never claim to be, so commenting on the state of the US economy, or even the global economy for that matter, is not something I will do. I do, however, urge investors to keep the economy in mind when investing in CRH as they are typically a play on the large-cap construction market, which tends to slow down with economic downturns (obviously).

Taking all this into consideration, I think it's safe to assume that CRH is a great investment opportunity if their stock can be purchased at the right price. This leads us to the next question, what is the right price?

Enter Cevian

Our first clue comes from Cevian Capital. On Feb. 6, news broke claiming that the activist investor has been building its stake in CRH and is now the second largest shareholder. Why is this important? Well, to understand, I have to explain what it is that Cevian does first.

Cevian is one of Europe’s largest activist investors with about €13 Billion in AUM. On their website, they claim to primarily target “sound companies that are overlooked, misunderstood, or out of favour with investors”. Is the company sound? If the financials are accurate, then yes! Is the company overlooked? Based on the coverage it receives here and elsewhere, it might just be. Is the company misunderstood or out of favour? Possible, but unlikely.

Once Cevian identifies these companies, as they've done with CRH, they buy significant stakes in them and work with management and the board to increase competitiveness in an attempt to unlock value.

Cevian also claims that, prior to investment, they spend considerable amounts of time and resources in order to develop an understanding of targets’ fundamentals and their “value-enhancement potential”. My key takeaway here is the word “potential”. Does CRH have potential? With their method of growth, of course! They have a proven track record when it comes to bolt-on acquisitions. Management has also shown their competence in terms of sustainable acquisitions which we can see from the lack of significant merger reversals/divestitures.

So, now that we've established that the company is financially sound and overlooked (i.e. a great investment opportunity), all that remains is to determine a fair price. Anything can be a great investment opportunity at the right price. The fact that Cevian is interested could very well mean that the company might be trading at a discount.

Valuation

As always, I'll provide the input values I used first. Broken down into a growth period of 5 years and then the terminal value numbers in brackets ():

Growth rate: 9.15% (2%) [Based on fundamentals]

Beta: 1.19 (1.06)

Risk-free rate: 1.47%

Risk premium: 6.22%

Pre-tax cost of debt: 2.46%

Return on capital: 7.26% (6.37%)

Reinvestment rate: 126.09% (31.40%) [Terminal value number reflects industry averages]

All these inputs were calculated from TTM numbers obtained from both the last quarter and previous years' earnings reports available from the company's website here. The growth beta was obtained from Reuters, while the terminal beta is from industry averages.

From these inputs, I get the following output from my FCFF DCF model (in Millions except per share values):

CRH FCFF DCF Output

Please note that all these numbers are in euros, and based on the stock trading on the Irish Stock Exchange, or ISEQ. I chose to do this because it is where the highest volume of shares are traded typically and also where the company HQ is located, which helped in calculating the risk-free rate.

Therefore, I view the company as trading at fair value currently, but Cevian might be able to add value and change all that. All in all, if investors are interested to see what Cevian wants to accomplish with this company, now would be a good time to invest.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.