Construction industry promises strong returns

Investor An insider's guide to the market: The news regarding the performance of the Irish economy seems to improve on a daily basis. Nearly all sectors of the economy are doing well and economists have been vying with each other to revise their economic forecasts to reflect the latest data.

Building, and construction in particular, is booming, with residential housebuilding proving to be exceptionally strong.

The number of units completed this year is set to soar and will almost certainly well exceed last year's total of 69,000, itself a record.

Companies operating in construction and building materials are well represented on the Irish stock market and the combined market value of the companies represent 13.5 per cent of the ISEQ Overall index.

Although the sector is dwarfed by the much larger quoted financial sector, it nonetheless offers investors a diverse range of investment alternatives.

CRH is the grand-daddy of the group and on its own it accounts for 10.9 per cent of the total Irish market capitalisation. CRH's roots are firmly in Ireland but decades of successful international diversification means the group's Irish operations now only account for approximately 15 per cent of group profits.

The strong construction markets in Ireland over recent years came at a time when some of CRH's overseas markets had slowed down. In particular, several of the company's operations in continental Europe suffered profit declines in recent years. Although the Irish market is expected to remain buoyant, profit margins are under pressure and therefore Irish profits are now expected to stabilise around current levels in the coming year.

Fortunately, mainland Europe is now recovering strongly and profits are forecast to bounce sharply in 2004 and 2005. Generally improved business conditions in Europe and the beneficial impact of its acquisition of the Dutch company Cementbouw in October 2003 lie behind this favourable outlook.

Brokers are now forecasting earnings growth of 13 per cent in 2004 followed by earnings growth of just under 10 per cent in 2005.

At its current share price, the shares are trading on a price-earnings ratio (PER) of 11.3 and a dividend yield of 1.6 per cent. Although the dividend yield is low, this is outweighed by CRH's growth prospects, so the shares offer good investment value.

Grafton and Heiton trade on similar ratings to CRH. They are not as diversified as CRH either geographically or sectorally. They are mainly focused on builders' merchanting and DIY businesses. Heiton is almost entirely reliant on the Irish market, while Grafton now also has a substantial UK business.

Currently, the smaller Heiton group is the subject of a takeover bid from Grafton. The share prices of both Grafton and Heiton have strongly outperformed in recent years due to their heavy dependence on the Irish market.

The economic slowdown in 2001-2003 barely registered as the Irish housing market stayed strong throughout.

The outlook for housing and DIY continues to be very positive and this should enable both companies to enjoy strong earnings growth over the next 12 to 18 months.

Not surprisingly, the two quoted housebuilding companies - Abbey and McInerney - have seen dramatic rises in their share prices in recent years. Abbey recently announced a very strong set of results for the year ending April 2004.

Abbey completed just under 800 units last year and expects to produce a similar number of units this year. It has a land bank equivalent to 2.8 years' output and has a strong balance sheet. It should, therefore, continue to benefit from the booming Irish housing market and the strong UK market.

Abbey trades on a relatively low PER of 6.6. This is in line with McInerney and is, in fact, in line with the average PER of the UK housebuilding sector.

The cyclical nature of the business combined with persistent worries of a house-price bubble in Ireland and the UK are injecting an element of caution into investors' assessment of the sector.

However, if there is a soft landing in both the Irish and UK housing markets, the share prices of housebuilders should improve from current levels.

As long as the economists prove to be correct regarding Irish and UK economic growth, the investment case for these companies is very strong. Profits are growing and stock market valuations are quite low and this combination should ensure that shareholders enjoy good returns over the next 12 to 18 months.