CRH - DEPARTING FOR THE US?

5th July 2021

Share price: €42.91 ($51.12)

P/E ratio: 35.7 times (based on 2020 earnings per share of $1.429 post impairment ie after write downs of assets due to Covid - this rises to $2.433 when these exceptional impairments are excluded, bringing the adjusted P/E down to a more resonable 21 times)

Dividend yield: 2.25%

CRH was one of the stocks that was highlighted as having a very bullish chart, in our technical analysis of the Irish market in early June. Back in 2018, the hedge fund founded by Ray Dalio, Bridgewater Associates was shorting the shares ie betting on a share price fall, and the shares were slightly underperforming the market.

And then suddenly, when the market broke out of the Covid influenced wobble, CRH shares were noticably strong - moving briskly, like a Tour de France cyclist after a round of blood doping!

This burst of excitement in CRH shares appears to have been caused, at least in part, by the decision to report the results for 2020 in US dollars. CRH shares have traded for some time on three markets - on the Irish market (now called EuroNext Dublin), on the London market and on the New York Stock Exchange. A few years back, CRH decided to nominate London as its primary listing, instead of Dublin. This gave the shares an immediate boost, as the stock then became eligible for inclusion in UK tracker funds.

A further change of the primary listing from London to New York, which would appear to be imminent given the recent decision to report figures in dollars, and this would give the shares a further boost due to US tracker funds being forced to buy the stock.

Moving the primary share listing to the New York Stock Exchange would be a logical move for CRH, as slightly more than half of its fixed assets (and turnover) are now located, or generated, in the US per the 2020 annual report.

But that is not all that's happening with CRH. It has bought back $2 billion of its own shares since April 2018. These were initallly held as treasury shares, but most of them have since been cancelled, leaving $386 million of them still on the balance sheet as at 31st December 2020. This indicates that CRH is a mature business, with no plans for major expansion, otherwise it would use this surplus cash to make an earnings enhancing acquisition.

A share buyback and cancellation, is the most tax efficient way of returning surplus cash to shareholders.  The alternative is to pay out a special dividend, but this means deducting tax at source and also many of the recipients would have to pay further tax on this income.

A share buyback and cancellation enhances earnings per share (as there are fewer shares in issue  afterward) and this normally results in an increase in the share price, so the shareholders receive additional value in that way.

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There is plenty of scope for CRH to do a further buyback of shares, as it has relatively low debt. As at 31st December 2020, the total debt was $12.2 billion and the total equity (share capital and reserves) was $20 billion. A further buy back of almost $8 billion worth of shares could be done quite comfortably, giving a 50:50 debt to equity ratio, which would be considered normal - even in times past when interest rates were much higher.

Also, the structure of CRH is quite unwieldly. The main products are aggregates (sand and gravel), cement and asphalt (also known as bitumen, which is used in road construction). CRH has two main divisions producing these, the 'America's' division (US, Canadian & Brazilian operations) and the 'European & Other' division.

However, CRH also has a third division called 'Building Materials' that engages is all sorts of other construction activities. It makes architectural products, infrastructure products, construction accesories and building envelope solutions. This is a different type of business, with a large number of lower value retail customers and CRH is not a big player in this market, unlike say Grafton Group in the UK. A few small disposals have been made in Europe, but nothing in the US where CRH has a diverse collection of these businesses but insufficient scale to give it any real muscle in the market.

This third division of CRH makes the shares less attractive to fund managers. The main two divisions make CRH an infrastructure type of stock (currently in vogue due to the extensive road rebuilding and repair that is planned by the Biden administration), but this third division is an unnecessary complication, as it has little connection with the core business.

The quick way to generate value for shareholders would be to sell the 'Building Materials' division lock, stock and barrel to a bigger player in that sector, and use this cash together with the surplus cash already on the balance sheet, to do a gargantuan share buyback and cancellation.

It is not surprising therefore to see one high profile activist investor stirring things up for management. Cevian Capital raised its stake to 3.14% in March 2020, during the Covid wobble. Cevian's CEO, Christer Gardell said that CRH has become "too complex, both structurally and operationally, which hampers performance and traps value" and that "far-reaching structural and operational improvements are needed for the group's assets to reach full potential". He may have something similar to what I have outlined above in mind.

This puts some pressure on CRH CEO Albert Manifold, who had a fairly cushy number before Cevian appeared on the shareholders register. He has engineered a situation where some current and former CEO's of other Irish plcs (Richie Boucher, ex Bank of Ireland and Siobhan Talbot of Glanbia) are on the board of directors. They are likely to take his side if he comes under pressure, either externally or internally. The improvements in earnings per share resulting from the buyback will trigger huge bonuses for the directors under their 'long term incentive plans' which invariably features this as a key criteria.

US investment bank, Morgan Stanley are forecasting a significant uplift in CRH shares as it is likely to benefit from the US infrastructure program recently agreed by congress. The US bankers go so far as to say that there will be a "super-cycle similar to the 1950's due to the underinvestment in infrastructure in the past few decades".
 

Brokers, Berenberg are predicting a 20% rise in CRH shares from the current level due to a probable change of the primary listing to the US, under pressure from Gardell (who is known as "the butcher" in his native Sweden due to his robust methods).
 

I am inclined to share their optimism. CRH shares look a good buy, despite their recent advance, for those of us with a modest amount to invest and are willing to take a calculated risk in search of a reasonable return.
 

Activists investors Cevian will make considerably more, by investing other people's money. And the directors will trouser huge bonuses for taking no risk at all, and doing absolutely nothing. Such is life on the market!