Stock Takes: How much will Fletcher Building shares fall?

Western Australian builder BGC estimates it will cost A$1.8b ($1.92b) to fix issues associated with Fletcher Building's Iplex pipes subsidiary. Photo / Paul Estcourt

Fletcher Building shares are expected to fall in value when they come off a trading halt, likely to be today, as the company prepares to respond to claims by Western Australian builder BGC that it will cost an estimated A$1.8 billion ($1.92b) to fix problems caused by its Iplex Pro-fit pipes.

BGC alleges it is the pipes themselves that are at issue while Fletcher has pointed to the installation as being at fault. Some 15,000 homes in Western Australia are said to have used the pipes, with BGC involved in 12,000 of those built.

Forsyth Barr’s Rohan Koreman-Smit and Paul Koraua said their target price and rating were unchanged while they awaited a response from Fletchers, but they “expect a negative share price reaction when FBU [Fletcher Building Ltd - NZX designation] starts trading with the severity dependent on the credibility of FBU’s rebuttal.”

The analysts currently have an outperform rating with a target price of $5.70 - well above the $4.90 the company was trading at before it was placed in a halt on Wednesday.

Fletcher Building currently has a provision of A$15m ($16m) in place for the pipes issue. But the analysts said BGC’s estimate of A$1.8b ($1.92b) could equate to $1.70 per share after tax or $1.10 per share on a net present value basis, assuming it took 10 years to remediate the issue.

The company has already traded down around 60c since its FY23 result was released due to concerns around the issue, the analysts said.

“Our current forecasts only include A$15m of costs to remediate Pro-fit pipes. Any increased cost will drag on already-anemic cash generation and pressure gearing which is already expected to rise into the top half of FBU’s 1-2x Ebitda target range in the short term.”

Koreman-Smit and Koraua pointed to unanswered questions, including how strong Fletcher’s evidence was in terms of proving it was an installation issue and how much of any liability its insurance would cover.

“Whilst FBU is likely to provide a fulsome rebuttal, the market may place little weight on it, given recent provisioning issues.”

Sticky situation

Jarden analysts Grant Swanepoel and Luan Nguyen have also maintained their buy rating with a target price of $6.60. The Jarden analysts said BGC’s presentation appeared to be a “compelling argument”, with the company pinning the blame on the resin used in the pipes.

“BGC believe the issues started with IPLEX changing a resin ingredient in their product in 2017.”

Around 10 per cent of the 11,800 homes in which the pipes were installed have had pipes burst. The analysts also noted that BGC indicated they had given the presentation to Fletcher on June 2.

“So FBU [was] well aware of these claims prior to their comments at their strategy day and FY23 results in August, continuing to claim that their product was not at fault.

“We remind ourselves that FBU and BGC will likely be the two key combatants if this goes to litigation, and we still need to hear the detail behind FBU’s assertion.”

BGC were pushing for a full product recall and were working with WA Consumer Protection and the Australian Competition and Consumer Commission (ACCC) as the fastest way to resolve the issue.

“BGC advice is that litigation at this time will result in the regulators stepping away, so BGC encourages affected parties to let the recall process play out rather than engage in a three-to-seven-year litigation process.”

BGC would be presenting to the ACCC and WA Consumer Protection in two weeks, the analysts noted.

Not sorry

Ryman Healthcare had to raise money to pay back its US private placement debt. Photo / NZME

We all know that saying sorry is hard to do when we make a mistake, and it seems that companies find it just as hard to admit when they’ve mucked up and lost investors’ money.

Castle Point’s Stephen Bennie says there seems to be a corporate code of silence when it comes to dealing with errors of judgment.

“I must admit that while it’s not surprising, it’s concerning because if you don’t own a mistake, there is a higher chance of repeating the mistake or at least a close version of it.”

Bennie says Ryman Healthcare could be at risk of this.

“Ryman Healthcare appears quite capable in the future of re-entering the US Private Debt market. Despite the high cost to shareholders of their first venture into that market, no public acknowledgment of misjudgment appears to have been made. Which must leave shareholders wondering if a repeat could more readily occur in the future.”

Earlier this year, Ryman asked shareholders to stump up $902 million to help repay the company’s uncomfortable level of debt. Analysts said the offer was the amount needed to repay its US Private Placement (USPP), and the $134m of costs associated with the repayment.

Bennie also called out companies reporting mistakes as a “one-off loss”.

“Another favourite way for companies to skirt around acknowledging a mistake is to announce a ‘one-off loss'. It’s the corporate equivalent of playing down the financial impact of major misjudgement.”

Bennie says a classic example was a company paying $250m to acquire another business and then writing its value down by $150m five years later, saying “while it may be non-cash in the period when the write-down occurs, $150m of shareholders’ cash was thoroughly toasted five years ago, i.e. real money, not pretend dollars. An error has been made and has cost shareholders a chunk of change, this should be taken seriously”.

Investors should pay particular attention to those who reported one-off losses on a regular or semi-regular basis.

“If it is a regular or semi-regular occurrence, looking at normalised profit not reported profit is perhaps not a smart move by investors.”

Bennie pointed to SkyCity Entertainment Group as an example of a company that recently used a one-off loss to write down the value of its Adelaide casino licence by $49.7m due to lower expected future earnings as it faces alleged non-compliance with Australian anti-money laundering and counter-terrorism financing laws.

SkyCity has also made provisions of $49m for a potential fine. But Bennie said the company had also “made a starkly chastening statement... explaining that “each contravention of the AML Act has a maximum civil penalty of between A$18m and A$22.2m [$19.2m and $23.7m] per contravention and AUSTRAC alleges that SkyCity made an innumerable (the word that SkyCity uses) number of breaches, it is not possible to determine a maximum penalty”.

“Clearly there is some potential that the NZ$45m provision turns out to be on the light side.”

But Bennie says so far investors appeared to be “playing the game” and allowing SkyCity to play the classic “one-off loss”, nothing to see play, given the share price was virtually unchanged post the announcement.

SkyCity shares opened at $2.02 yesterday and are down more than 20 per cent in the last year.

Birkenstock flop

Birkenstocks have become all the rage again but its public float hasn't been as successful as hoped for. Photo / Katherine Lowe

Shares in sandal maker Birkenstock have flopped in the first day of trading on the New York Stock Exchange. The third-largest US listing this year saw its shares drop more than 10 per cent.

The German company closed at US$40.20, well down on its US$46 a share initial public offer price.

Arm, Instacart and Klaviyo all priced large IPOs at or above the top of their target ranges last month, but trading in the newly listed groups has been choppy in the weeks since, the Financial Times reported.

Still, the company has a market capitalisation of around US$7.6 billion ($12.6b).

Oliver Reichert, Birkenstock chief executive, said: “With our heritage dating back to 1774 we are a company focused on long-term sustainable growth and this is reflected in our shareholder base.”

The deal raised almost US$1.5b ($2.5b) for the company and L. Catterton, its private equity owner. About a third of the proceeds will be used by the company to repay debt, with the rest going to L Catterton.

The listing came less than three years after L. Catterton, which is backed by French luxury fashion house LVMH, bought a majority stake in a deal that valued Birkenstock at about €4b ($7b).

Bryan Wilmot, chief marketing officer at digital investment platform Stake, said Birkenstock’s financials had been strong, and the listing coincided with the brand reaching new levels of fame, including a recent notable appearance in the Barbie movie.

“Yet the challenge for footwear brands is staying in fashion over the long term, which is tough in an incredibly competitive and fickle market. Crocs saw a fashion resurgence that led to a 14 per cent increase over the past 12 months - but this strong return hides the fact it’s also seen a year-to-date pullback of almost 19 per cent. In addition, AllBirds has seen its stock lose over 96 per cent of its value since listing, and Dr Martens continues to disappoint.

“Birkenstock is profitable, which works in its favour, yet its plans to use IPO proceeds to repay debt instead of pursuing further growth has likely dampened expectations. In addition, while revenues increased by 21 per cent between the 2022 and 2023 financial years, there are signs that the rate of sales growth is starting to slow. The macro context doesn’t help either, given the continued weakness in consumer spending across most major economies.”

Wilmot said while Birkenstock has a strong brand and dedicated following that could set it up for success in the long run, it’s difficult to determine the long-term outlook right now.

“Kiwi investors on Stake have primarily stayed away from taking the plunge on Birkenstock so far, and it’s unlikely we’ll see an uptick in activity until the situation is more clear.”