Description

Overview

Breedon, new to VIC, is a £1.2bn market cap British and Irish cement and aggregates producer. The company announced in March its intentions to move from the AIM market (smaller companies) to the more liquid Main Market of the London Stock Exchange. It was admitted and started trading on the Main Market in May and it will most probably be included in the Mid-cap index FTSE250 in September. About 5-6% of free float will need to be bought due to benchmarking. The index admission will increase liquidity which should help with value disclosure. In the meantime, Breedon, a business with solid fundamentals and a stable position in a consolidated market, with a great track record of growth and profitability, is trading at 10x PE and 8x EBIT on conservative estimates, near its ten-year low valuation.  

Investment Thesis

Aggregates are industrial minerals that are quarried, processed, and provided to customers in their natural state or used to manufacture other products. Sand and gravel and crushed rock are the two basic types of aggregates. Sand and gravel often simply require screening, whereas rock is created through blasting, crushing, and screening. Different aggregate sizes are produced for different applications. Aggregates can be supplied to customers direct or mixed with cement to create RMX (ready mixed concrete) or mixed with bitumen and heated to produce asphalt for roads and car parks. Breedon produces all these products. Due to the wide variety of uses, the customer base is diverse, from infrastructure, to industrial, commercial, and residential RMI and new build.  

Breedon is the largest independent building materials company in the UK and Ireland. The company operates with a vertically integrated model backed by assets: 1bn tonnes of reserves and resources, >100 aggregates quarries, 2 cement plants, >170 ready-mixed concrete plants and >50 asphalt plants. Breedon also offers surfacing solutions to market its materials. The company operates through three segments: Great Britain (64% of sales), Ireland (17% of sales) and Cement (19% of sales).

• In Great Britain Breedon operates a network of quarries and downstream operations, backed by mineral reserves and resources, and supported by a fleet of delivery vehicles for all products. The division supplies asphalt, ready mix concrete and mortar and concrete blocks.
• In Ireland Breedon trades as Whitemountain in Northern Ireland and as Lagan in the Republic of Ireland. In addition to a network of quarries and downstream operations, Breedon operates a significant surfacing business. The division produces aggregates, asphalt, ready-mixed concrete, bitumen and then provides contract surfacing, highway maintenance, civil engineering, including specialist expertise in airport runway surfacing (they recently completed the Cork Airport runway).
• In Cement, Breedon operates two plants in GB (Hope) and Ireland (Kinnegad) with two million tonnes capacity. The Hope business also operates a network of four import/export terminals, a bagging plant and rail-linked distribution network. It complements bulk supply with higher margin bagged products.

An overview of the company (chart from 2021):

The company was created in 2008 by industry veterans backed by private equity as Marwyn Materials Limited, with the idea to consolidate the smaller end of the heavyside building materials industry, focusing on the UK, Europe and the US. The founders included the then-chairman Peter Tom, formerly of Bardon Group Plc. Peter Tom expanded Bardon internationally with a series of acquisitions in the US in the late 80s and then merged Bardon with Evered in 1991. In 1997, then Aggregate Industry was formed with the merger or Bardon and CAMAS. The company was then sold to Holcim in 2005 for £1.8bn. Another director, Simon Vivian, started as the CEO of Marwyn Materials. He had been CEO of Mowlem plc, which was bought by Carillion plc in 2005 for £390m.

The underlying idea was that whilst the UK and international building materials markets were generally well consolidated and controlled by a small number of key global players, the smaller end of the market remained fragmented, with 200+ businesses, some of which were up for sale. Before the market consolidated, there were many publicly listed companies in the industry. Companies like Blue Circle, Rugby, RMC, Tarmac, Redland, and others disappeared. Lafarge, Cemex, Holcim and Heidelberg became the dominant global players with a market share of 70-80% in all main product categories.

In addition, the consolidation of larger players was set to continue and become increasingly important especially in the cement vertical. This would have led to disposals of non-core assets which didn’t fit the larger companies’ strategies and would provide acquisition opportunities for Breedon. And a roll up strategy would create value, with expert management there to extract synergies.

The heavy building materials industry benefits from natural barriers to entry: markets are local as most products do not travel more than 30 miles before becoming uncompetitive due to transport costs. 80% of product is sold within proximity to the quarry. This proximity of the operational unit to the end-user or customer is key: it limits competition and drives pricing power. Consolidating local players can help in terms of transportation planning and reducing costs.

Other barriers to entry include high up front capital costs and permitting requirements: planning consent for new quarries is rarely granted which drives pricing power.

From its origins as Marwyin Materials (and listing on the AIM market) in 2008, the company went on to acquire Breedon Holdings for £160m EV in 2010, and the creation of Breedon Aggregates. Since then, Breedon has completed 19 acquisitions:

The non-weighted average multiple paid for these has been 6.1x EV/EBITDA, but the biggest acquisitions commanded a higher multiple (also because they brought two cement plants) so the weighted average is 8.6x. These multiples were at a discount to Breedon’s own valuation (≈30%) but also at a discount compared to the average UK building product peers (≈14%). Considering synergies, the weighted average multiple goes from 8.6x to 7.2x.

After the acquisition of Hope in 2015 and Cemex in 2020, Breedon is now one of the top 4 operators which operate 75% of all sites. Most operators still operate only 1-2 sites and small operators still make up ≈25-30% of the market. Also, according to a 2014 study by the Competition Commission in the UK (available here https://assets.publishing.service.gov.uk/media/552ce1d5ed915d15db000001/Aggregates_final_report.pdf) the market for construction aggregates is local, hence competition and market shares need to be considered specifically for a specific region, as opposed to nation-wide. Overall, there remains room to grow in the UK as even if 75% of the market is controlled by the largest 4 players, the remaining tail is represented by more than 200 individual companies which operate more than 400 quarries. In addition, Breedon has potential and has mentioned the possibility to consolidate the asphalt market. Another option also mentioned by management, and one which the founder Peter Tom had successfully executed at Bardon in the 80s is expanding in the US. It’s an opportunity to replicate this model, as the market remains fragmented with ≈60% of aggregate volumes sold by private players (and a much larger market compared to Breedon’s own size), but multiples paid can be higher in the US, so management has to execute carefully. In recent meetings, management has highlighted that deals sub $1bn happen at a ≈9x EV/EBITDA multiple.

Thanks to this acquisitive strategy and organic growth, revenues from 2011 to 2022 compounded at 21.2% and operating profit at 35%.

In the last five years, from a higher base, the compounded growth rate has been 16.5% and 14% for revenues and EBIT, respectively. Top line organic growth in the same period averaged ≈6%. Organic growth depends on market demand, where Breedon is exposed to infrastructure (50% of sales), commercial projects (30%) and housing (20%).

In 2023, the company expects EBIT in line with consensus roughly £150m, flat to slightly negative vs last year, considering the macro backdrop in the UK, with rising rates and declining growth in construction activity: especially in residential housebuilding in the UK, with resilience in infrastructure and non-residential. More structurally however, the UK government has committed to investments to support infrastructure growth with some major projects underpinning demand: in 2021 the government has set £650bn of public and private investments with the National Infrastructure and Construction Pipeline which outlined ≈£60bn of spend per year (mostly in roads, rail and electricity, all end markets served by Breedon). UK housing also (as seen in other VIC write ups) is in structural shortage in the country and the major housebuilders are all targeting higher outputs. In Ireland, the operating environment in the last few quarters was similar to the UK, but with more encouraging sings for construction output. Structurally, the RoI government has outlined its National Development Plan in 2021 which sets out €165bn for investments in large public housing programmes and transport. The Irish housing sector (as also highlighted by other VIC write ups) is characterised by an even more imbalanced housing supply/demand environment.  

The business is quite cash generative with an average free cash flow to EBIT ratio of 108% from 2011 to 2022. Cash that has historically been allocated mostly to M&A and capex. Current net debt ex IFRS16 at H1 is £171m, or 0.7x EBITDA, which gives the company some firepower to deploy in its favourite activity. Year to date they completed three acquisitions for £19m.

Let’s say that in 2023, Breedon generates £150m of EBIT. This implies a ≈10% operating margin. In November 2021, the company at their capital markets day set targets of revenue growth in excess of its end markets, EBIT margins between 12% and 15%, FCF conversion above 50% (FCF/EBITDA), leverage between 1x and 2x, ROIC above 10% and a payout ratio of 40%.

If I assume the company to grow 4% organically in the next 3 years, reaching the lower range of its profitability target, I get EPS of 38.8p and 41p in 2024 and 2025 (from 35p in 2022 and ≈31p in 2023). That turns into the following multiples:

Assuming 3.5% growth and margins below target at 11%, Breedon still looks cheap.

This is at a ten-year trough compared to its history:

As a reference here’s also some peers, also in part trading at cheap multiples. By the way, we also like some of these:

In addition, considering that leverage is at an historical low and that management targets 1x to 2x, assuming Breedon can execute at 7.2x EBITDA they could add £35m-£40m of EBIT levering up the balance sheet. The cash generative nature of the business and the ability to reinvest the cash in a proven roll up strategy, enable the company to delever quickly which lowers the forward looking multiples.

Management (CEO Rob Wood and CFO James Brotherton) are incentivised in terms of EBIT, EPS and TSR.

Catalyst

Breedon has moved from its AIM listing to Premium listing and trading on the Main Market in the UK in May. This has been done to reflect the company’s changed scale compared to when it was first listed in the AIM market. When Breedon was first acquired in they owned 180m tonnes of mineral reserves and operated 29 quarries in Great Britain. Now they operate more than 300 sites and own one billion tonnes of mineral reserves. As a more established business the company believed the Main Market offers a more appropriate listing which will most probably increase liquidity and could serve as a catalyst for value disclosure. In March, with AIM investors selling, the main shareholder Abicad, a vehicle connected to Breedon Chairman, has launched an ABB to buy the equivalent of £65m. This has been only taken up in a small part (only about £4m) and subsequently Abicad bought £13m in April at levels close to the current share price.

In addition to the move to the Main Market, Breedon is changing jurisdiction from a Jersey company to an English company.

Overall, I believe the market is focusing too much on the short term economic and construction outlook for the UK and discounting the business characteristics of the industry and of Breedon specifically and that today we have the opportunity to buy at low double digit multiples a solid operator in a concentrated market with the opportunity to keep consolidating the fragmented tail of the market.  

Catalyst

increased liquidy. Index inclusion with about 5% of shares outstanding needed to be purchased by passive players