Fletcher Building - Ralph Waters

Jenny Ruth

Wednesday 26th November 2003

Fletcher Building chairman Roderick Deane told the annual meeting earlier this week that the outlook for the company is better than expected. Nevertheless, analysts continue to look ahead to the next downturn in the building cycle and to wonder whether chief executive Ralph Waters' medicine will have been strong enough to prevent a collapse in earnings, as has happened in the past.

SC: How long do you think it will be before the Australian and New Zealand housing markets slow?

RW: If there is going to be one, it's not going to affect this financial year. I expect by the second half of 2004 Australia will slow down ahead of New Zealand. Australia's going to be a good six months or more ahead. I don't expect we will see the lows of previous cycles. I suspect New Zealand will not be going back to the number of housing starts we fell to in 2000/2001. Yes, they will come off their peak to more manageable levels. Cement is a real surrogate (of the economy). The tonnage of cement over time, longer term, has continued to rise with GDP. I think it will be a very modest downturn this time. People aren't going to let things fall in a hole with that much money in the bank and where they are in the political cycle.

SC: This has been an exceptionally long upswing in the building cycle. Doesn't that increase the risks of a dramatic and prolonged downturn?

RW: I think New Zealanders have very ordinary expectations of what a normal upswing is. It was only 2001 when we were at the bottom of the cycle. We made $94 million EBIT (earnings before interest and tax) in 2001 and one year later we made $205 million. Everybody thought the cycle had peaked. Heavens above, it's not a long cycle. We've only been going for two and a bit years. Building cycles in most countries run for four years and then there's a bit of a breather. The thing that gives us some comfort in New Zealand is there's not a great excess of stock. You have to wait six months in some places to get a builder.

SC: But won't falling net immigration reduce demand?

RW: It may reduce demand but the big housing corrections have come when people have built far more stock than there's a need for. Most people are building houses to order, not building stock to sit there and see if they're going to sell. It's so funny, the questions we get. On the other side of the Tasman they never keep looking for the sky falling in as everybody does here.

SC: In August when you were predicting a housing softening, you still thought you could produce a higher profit. Was that simply a reflection of the Laminex and Tasman purchases?

RW: We will have an extra five months of Laminex this year - we only had seven months last year. At least the first half was guaranteed to be very strong. If you take Laminex and Tasman out, we will still be up. NBR reported me on Friday as saying I would be disappointed if our EBIT didn't have a four in from of it this year (ie more than $400 million) and then says a fund manager wonders if he and I are living on the same planet. Do you think I would be saying it if I didn't have a high degree of confidence we would do it? I don't know why there would be scepticism. They must think the existing businesses are in decline if we can't get to those numbers, or that we made bad acquisitions. Neither is the case. We had such tremendous earnings from our underlying Fletcher businesses this year. Just maintaining or having a modest increase is nothing to be embarrassed about. On top of that we have the added Laminex earnings and nine months of Tasman.

SC: Analysts say you paid very "full" prices for Laminex and Tasman in a very buoyant part of the cycle. Did you pay too much?

RW: Why are these people so important in the scheme of things? We have to pay at least what anyone else would. We bought Laminex on the day it was going to be released to the market as an IPO and the price range was $A650 million to $A710 million. It looked like raising at least $A675 million. That's what the market was going to pay. We bought it for $645 million and an extra $16 million (because the earnings were higher than Fletcher had expected). Our price was based on it doing $A95 (million in EBITDA)and the IPO was based on $105 million. You could say it was very close to the $105 million, but it didn't quite get there (it made $103 million in EBITDA). It might now be trading a bit below the issue price. If we wanted to buy it today, we would have to pay a premium to the enterprise value. We would still have to pay $A700 million plus to buy it today. I can't understand why the analysts can't do that sort of analysis. We paid 6.1 times (this year's EBITDA). If anybody thinks that's too high, they don't have to be on the ride with us. We need more time to tell, but to date there's no evidence whatsoever that it was too high a price. In the case of Tasman, we had a bit of fortune. When the information memorandum was put together, it assumed the market was going to fall this year and they forecast an earnings decline for Tasman. The price we paid was about six times EBITDA. After four or five months, Tasman is well ahead of both last year and the forecast. We will have paid five times this year's EBITDA. If anyone says that's too high, I would be cautious about what other advice you take from them.
They are two such excellent acquisitions, our difficulty will be in finding anything that's as good a package. The big risk in acquisitions is culture clash when you buy a competitor. We don't have any of those risks. All the (Laminex) management that came with it are good management and they're all there, happy to be part of a big public company instead of a private equity company. It was the lowest risk acquisition you could have. It saved our New Zealand business. If we hadn't bought Laminex, we would have had to save Fletcher wood panels. A $200 million or $300 million business in that category is too small a scale. We didn't have the scale Carters and others have. It saved a business which last year was one of the few under-performers and I think would have struggled in the longer term.

SC: Is Laminex earning its cost of capital yet?

RW: After amortising for goodwill, it's a bit short. If you normalise earnings, as analysts do, it is. In cash terms, it's there in spades. If you go back to EBITDA, and look at that as a proportion of the investment, it's earning the company's cost of capital already. If we can get that far on something we've paid 6.1 times for, it's even more easy to get there on something you've only paid five times for.

SC: You argue Fletcher building is now better placed to weather a downturn but analysts remain sceptical. Why shouldn't they be?

RW: It does say something about some of the analysts you have in this country. They're allowed to have sceptical views. I just wish they would do some arithmetic. When we reported last year, the concensus forecast for this year was $180 million (in EBIT). We made $331 million. If you take out Laminex's contribution from that $331 million, the earnings were more than $100 million above what Fletcher Building earning when it was last at the top of the cycle. One would expect that the least we should do is substantially ahead of what we earned when we were last at the bottom of the cycle which was $94 million in 2001. If we fell from $400 million to $300 million, and I'm not saying we will, we would still be making returns that are higher than companies like Boral are earning at the top of the cycle. I would be dreadfully disappointed if this company dropped from $400 million to $300 million. We have this incentive rule where the senior team have to spend half of their variable bonuses buying shares until their holdings match their base salaries. A 100% of the senior team, for the second year in a row, have invested 100% of their variable money buying stock, including me. There was no necessity for any of our guys to buy any more shares this year. They aren't buying the stock for a six months or 12 months hold. We can't sell while we're still working for the company.

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