European upturn spells growth for CRH

Investor/An insider's guide to the market Data released last week showed that Irish retailers enjoyed their best year in six in 2006. Retail sales volumes grew by 6.2 per cent for the full year helped by a pick-up in the rate of growth to 7.6 per cent in the final quarter.

An examination of the sectoral composition shows that car sales acted as a drag on growth in 2006. However, activity in the motor trade picked up in the final quarter and January 2007 was exceptionally busy. With the SSIA effect just beginning to kick in, 2007 could well be a bumper year for the motor industry.

In fact the indications are that most categories of spending went into 2007 on an improving trend. Economists expect consumption to be the key driving force in the Irish economy during 2007, with most forecasters pencilling in consumption growth of approximately 7 per cent. On the basis of the momentum evident in the final quarter of last year, forecasts of consumption growth may well be revised up as the year progresses.

The political cycle may also boost the feel-good factor in 2007. The early signals from the various political party conferences are that tax-cutting policies will take centre stage during the election campaign.

On top of the positive stimulus to the economy from domestic demand, external demand will benefit from strength in the European economy. Statistics covering the final quarter of last year confirm that there is very strong momentum being carried forward into 2007. Euro-zone GDP growth of 3.3 per cent year-on-year was the fastest pace of quarterly growth since the 3.6 per cent recorded in the third quarter of 2001. The labour market is also improving and the euro zone's unemployment rate is now at a record low of 7.5 per cent.

The Irish market's largest industrial stock - CRH - has substantial operations in Europe. During 2006 the share price was held back somewhat by the slowdown in the US housing market. Although the share price has improved somewhat in recent months, it has still modestly under-performed the Iseq Overall index over the past 12 months. With close to 50 per cent of profits being generated in the Americas it is not surprising that worries about US construction should create some negative investor sentiment towards the stock.

However, Europe accounts for approximately 37 per cent of group profits with Ireland accounting for another 11 per cent. Therefore, Europe, including Ireland, accounts for just as large a share of overall profits as do the Americas. There are now increasing signs that the European construction sector is recovering strongly. Indicators of construction confidence in three of CRH's key markets - the Netherlands, Germany and Poland - are now close to five-year highs. The residential sector is particularly strong across Europe with house completions expected to continue to increase in most markets during 2007.

In the Americas, despite the housing slowdown, prospects for overall construction are positive with growth expected in infrastructure and non-residential markets. Peers of CRH in the US have announced increases in materials/aggregates prices which, taken with lower energy prices, should lead to an improvement in profit margins. US construction is, in fact, in quite good shape with good growth expected in several important sectors. Federal highway funding, which accounts for half of all highway funding, is set to increase by 9 per cent in 2007 while state funding is expected to increase at an even faster rate. Recent economic and company news points towards a recovery in homebuilding in the second half of the year.

These generally benign business conditions have produced in brokers' forecasts of earnings per share growth in the 10 per cent range for CRH for this financial year. If the shares are evaluated on a price-earnings ratio (PER) basis, they look cheap relative to comparable international companies. CRH currently trades on PER of just over 13 compared with the PER of 14.1 for the European building materials sector. Ratings are even higher in the US where the PER for the US building materials sector is 19.0.

With virtually all of the key regions in which CRH operates now growing strongly, profit growth for the next two years seems to be well underpinned. Indeed when the potential from ongoing acquisition activity is added in there is significant scope for upgrades to earnings forecasts as the year progresses.

Investor says...

Indicators of construction confidence in three of CRH's key markets - the Netherlands, Germany and Poland - are now close to five-year highs. With virtually all of the regions in which CRH operates growing strongly, profit growth for the next two years seems well underpinned.