CRH may be in the right place at the right time

In an increasingly complex world, the simplicity of cement has its attractions for many investors. Instead of fretting about patents pending or grappling with concepts like encryption, all investors need to get to grips with in relation to the building materials sector is a basic understanding of the economic cycle and a firm knowledge of a company's regional exposure.

The other good news for Irish investors is that they don't have to stray far from home to find a top-quality building materials stock with a global presence. CRH, long a star in its home market, is fast becoming a favourite with investors across Europe.

Along with France's Lafarge and the Swiss company, Holderbank, the Irish firm dominates the European building materials sector. There is a relatively big gap between the top three companies and the next tier of firms involved in the supply of products like cement, aggregates, concrete and other building materials. Lafarge is the largest company in the sector, with a market capitalisation of around €8.5 billion (£6.7 billion), followed by Holderbank at around €6.7 billion and then CRH at €6 billion.

Behind them comes a range of smaller players including Blue Circle, RMC and Hanson in Britain, Heidelberger and Dyckerhoff in Germany, Italcementi and Unicem in Italy, Cimpor in Portugal and CBR in Belgium.

CRH's current popularity in the sector is underlined by the significant premium at which it is trading relative to others in the industry. According to Mr John Mattimoe, analyst with NCB Stockbrokers, CRH is currently on a price/earnings ratio of about 18.5 times 1999 forecast earnings compared to an average of 13.5 to 14 in the sector.

Its high rating is primarily due to the expectation that it will maintain its track record of delivering strong earnings growth, especially as 75 per cent of its profits come from the US and Ireland - currently two of the strongest construction markets. TEA21, a US government road and infrastructure programme which is set to increase spending by $218 billion (€193 billion) between 1998 and 2003, is particularly good news for the company.

"CRH is in the right place at the right time," says Mr Andrew Melrose, European building materials analysts with Paribas in London. A well-regarded management team and strong investor relations programmes are other factors supporting the CRH price, analysts say.

By contrast, Lafarge and Holderbank have fallen from favour with some investors of late, mainly because of their exposure to emerging markets. Some 38 per cent of the Swiss firm's profits come from such markets, with over 30 per cent derived from Latin America alone, while Lafarge earns around 16 per cent of its income from developing economies.

However, there are concerns in some quarters that CRH may be missing out on an opportunity to pick up assets in emerging markets at a time when prices are depressed. Both Lafarge and Holderbank have been on buying sprees in south-east Asia, a region that is not flavour of the month at present but could stand them in good stead in the long run.

Analysts note that cement consumption in emerging markets, with a lot of infrastructure catch-up to do, usually runs at twice the rate of GDP compared to much lower consumption rates in mature markets like the US and western Europe. "You need to be in growth markets to generate long-term organic growth," says Mr Melrose, who recently downgraded CRH from a "buy" to "no action".

But Mr Ken Rumph, building materials analyst with Merrill Lynch in London, remains keen on the Irish company, arguing that CRH has more scope to grow in mature markets than Lafarge and Holderbank, which are already the number one and number two supplier of cement in the US market.

Meanwhile, analysts remain cautious about other building materials stocks in Europe, saying it is too early to say the European construction industry is on the road to recovery. A further interest rate cut from the European Central Bank might be needed to really spur the sector into action, they say.

"In Europe, GDP of 1 to 2 per cent is as good as nothing for the building industry," says Mr Rumph. "Growth of 2 to 3 per cent or more is needed to stimulate building activity."

The German construction market, Europe's largest, remains sluggish, particularly in eastern Germany, as do other large markets such as Italy and Britain.

As a result, analysts are not so keen on firms such as Heidelberger, Italcementi and Unicem. Portuguese firm Cimpor benefited from the decision to hold the Expo in Lisbon, but recent expansion into markets like Morocco and Brazil has put a dampener on its popularity.

However, the exposure of certain British companies like Blue Circle and Hanson to the US market has made them more attractive. Deutsche Bank recently gave both British firms an "outperform" rating.

The other disadvantage in investing in some of the continental European building materials companies is the large shareholdings held by family interests or other building materials companies.

Italcementi is controlled by the Pesenti family; Unicem by the Buzzi family; while CBR, a Benelux-based company, is 50 per cent owned by the German firm Heidelberger, more than half of whose shares are held by German banks or private companies.

On the upside, these large shareholders can ensure decisions are made in the long-term interests of the company rather than dictated by the sometimes short-term interests of financial markets. But being a minority shareholder may also mean decisions are taken which are not in the interest of the smaller stakeholder, while it also limits or removes the takeover potential.

Like many other areas, moves towards consolidation have picked up in the building materials sector of late. Lafarge's purchase of British firm Redland and CRH's recent acquisition of Ibstock, a brick manufacturer, are just two examples. Meanwhile, a 73.5 per cent stake in Swedish cement group, Scancem, has been put up for sale by its owners, the Norwegian group Aker and Swedish firm Skanska. CRH is among the parties that might be interested in buying all or part of the company.

However, analysts say that most of the merger and takeover activity is likely to revolve around the larger firms snapping up the smaller to medium-sized ones or around streamlining of products as seen in Blue Circle's recent decision to sell its bath and toilet-making unit, Armitage Shanks, and concentrate on its core business.

Link-ups between the heavyweights - as has happened in other industries such as banking - are not seen as likely, however. This is mainly because such mergers are unlikely to deliver serious cost savings in an industry where most of the large companies comprise a collection of regional businesses.