The pandemic could take a much bigger toll on Fletcher Building's future than it already has, causing "further underlying deterioration" and cutting capital expenditure combined with other factors could weaken it, experts say.
Ahead of tomorrow's full-year to June 30, 2020 result, Forsyth Barr analysts Rohan Koreman-Smit and Ashton Olds released research and provided an outlook on the business.
"Risk remains that Covid causes further underlying deterioration in Fletcher Building's business. There remains risk both around the magnitude of the downturn, and more significantly, of further underlying deterioration in Fletcher's businesses," they said.
"Competition may continue or compound margin pressures. Falling demand exacerbates the challenges of executing on turnaround initiatives. And a pullback in capex may starve the business of necessary investment. Our concern is Fletcher may emerge from the downturn weaker than when it went in," they said.
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Citi Research said last week that Fletcher's full-year result was "near our forecasts".
They said the market's attention will rightly turn to earnings in the June 30, 2021 year.
"The company said trading in July had been solid, but remains cautious given the lack of visibility and risk to unemployment and economic growth. We forecast FY21e EBIT of $341m compared with IBES consensus of $373m. Given a potential slowdown in activity in CY21, we see downside to consensus".
Last week, Fletcher said it would make a $196 million loss due to the pandemic's effects. That was a reversal of fortunes after last year's $164m profit.
Chief executive Ross Taylor updated the market ahead of tomorrow's announcement.
He cited three factors which would reduce operating earnings by $150m:
• Half the losses are due to reduced productivities from key legacy projects "significantly disrupted" by Covid-19;
• 20 per cent due to issues from "a handful of historically completed" projects;
• 30 per cent due to "a prudent risk provision" across the portfolio of legacy work.
The result, subject to final audit sign-off and approval by the board, was due predominantly to the impacts of Covid-19, the company's statement said.
The Forsyth Barr analysts said the magnitude of the loss was a "slight improvement on Fletcher's May update, however, given the consistent anecdotes of strong post-lockdown construction activity we suspected it might have been higher."
Taylor said Fletcher had reset its cost base through workforce reduction, ceasing unproductive product lines and the closure of facilities and offices. Fletcher expects that it will lead to about $300m of annual cost savings, starting in FY21.
Taylor also forecast a 25 per cent decline in New Zealand economic activity and 20 per cent in Australia.
"Our modelling assumes costs reduce with volumes, however, we are not confident we'll see net benefits to shareholders. Historically, extensive cost savings initiatives have been more than offset by competition and cost pressures," the analysts said.
They have a neutral rating on the stock and a 12-month target price of $3.70.
Shares are trading around $3.37.
"Unfortunately, Fletcher Building did not enter the Covid-19 crisis in fighting shape. New Zealand margins have long been under pressure," the analysts said.
Australian turnaround efforts had delivered little tangible reward. Necessary reinvestment has elevated capex.
"The risk is this downturn is not only cyclical, but leads to a further erosion in the business's underlying quality. While Fletcher's share price remains down sharply from pre Covid-19 levels, it's not at a level where we see clear value," the analysts said.
Shares were trading at $7 around this time in 2018.
Citi outlined a line of risks to Fletcher's earnings and valuations.
The benefits to come from the company's future residential earnings stream, strength of the Australian and New Zealand construction cycles and benefits from the transformation programme which Taylor has under way were some of those it named.