Too cheap to ignore this ASX 200 share with a 'compelling' valuation: fundie

Fund manager Allan Gray says it's a great time to buy this ASX 200 share in the construction game.

| More on:
A young woman sits on her lounge looking pleasantly surprised at what she's seeing on her laptop screen as she reads about the South32 share price

Image source Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Key points

  • Fund manager Allan Gray says it's a great time to buy Fletcher Building shares 
  • The manager says this ASX 200 share is trading "at a discount to fair value" and represents a "compelling opportunity"  
  • Allan Gray holds $61.7 million worth of Fletcher Building shares in its flagship Australia Equity Fund 

The cost of building a home is rising at its fastest pace since the GST was introduced in 2000. Interest rates are going up and housing values are going down. Construction companies are going bust due to labour shortages, lack of access to building materials, and the rising cost of these materials. And fewer people are choosing to build new houses, with approvals down 14.4% over the past 12 months.

Yet fund manager Allan Gray says it's a great time to buy this ASX 200 share in the construction game. That share is Fletcher Building Limited (ASX: FBU).

Allan Gray managing director and chief investment officer, Simon Mawhinney says Fletcher Building is trading "at a discount to fair value":

Most investors shy away from buying companies that are likely to exhibit a decline in earnings in the short term, regardless of the price at which the company trades. This creates the opportunity for us to
invest in companies at a discount to fair value. Fletcher Building Limited is one such company.

Why is this ASX 200 share falling?

The Fletcher Building share price is down 0.7% to $4.38 in late afternoon trading on Friday. The ASX 200 share has fallen 37.4% in 2022 so far and 36.5% over the past 12 months.

Allan Gray analyst Sudhir Kissun says:

While we can't be sure exactly why Fletcher Building's share price has been falling for the past year, the prospect of a downturn in building activity is a likely explanation.

Even though it might be tempting to sit on the sidelines and wait for the cycle to hit rock bottom, it is important to remember that sharemarkets are forward looking.

Share prices usually hit the bottom well before the cycle is at its lowest. In the case of Fletcher Building, its share price may already factor in the impact of a modest economic downturn.

A 'compelling opportunity'

Allan Gray outlines the case to buy this ASX 200 share in its September 2022 quarterly commentary.

Firstly, Kissun reckons the business metrics look good. By the way, these numbers are in New Zealand currency because Fletcher is headquartered in New Zealand.

Kissun explains:

With a share price at the time of writing in late-September of NZ$5.16 per share, Fletcher Building has a market value of NZ$4.0b. Added to its very manageable net debt of NZ$0.9b, its enterprise value is NZ$4.9b.

… we estimate that its lowest EBIT in the past 15 years was around NZ$420m (this is after adjusting for businesses that Fletcher Building has disposed of and therefore will not contribute to earnings in the future). The market is valuing the company at a little less than 12 times this depressed level of EBIT.

Not only is this meaningfully below the broader sharemarket multiple today, but it is also likely that earnings from this depressed level would grow significantly faster than the market (and therefore
warrant a higher multiple than the market).

In our experience, this type of situation, in which the market is offering us a company at a lower-than-market multiple of depressed earnings, has the makings of a compelling investment opportunity.

Is the Fletcher Building share price a buy?

Kissun says:

When we value cyclical companies, we try to gauge what the company might earn on average through the cycle, across good times and bad. We believe a sustainable mid-cycle EBIT for Fletcher Building should be in the region of NZ$600m, which is almost 30% below management's guided EBIT for FY23 of NZ$820m.

Mid-cycle EBIT of NZ$600m would result in net earnings after interest and tax of approximately NZ$400m. It might not be unreasonable to ascribe a price-to-earnings (P/E) multiple of 16 times to these mid-cycle earnings, which would equate to a market value of NZ$6.4b or approximately NZ$8.15 per share. Compared to the share price of NZ$5.16, this represents potential upside of over 50%.

The Allan Gray Australia Equity Fund holds $61.7 million worth of Fletcher Building shares.

The ASX 200 share represents 3% of the fund's value as at 30 September.

Motley Fool contributor Bronwyn Allen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Industrials Shares

A man in his 30s holds his laptop and operates it with his other hand as he has a look of pleasant surprise on his face as though he is learning something new or finding hidden value in something on the screen.
Broker Notes

How this undervalued ASX All Ords share could rocket 80% in a year

A leading fund manager expects a big turnaround for this beaten-down ASX All Ords stock.

Read more »

A woman sits at her computer with her chin resting on her hand as she contemplates her next potential investment.
Industrials Shares

Key takeaways from ALS shares results according to Macquarie

ALS announced an underlying net profit after tax (NPAT) of $312 million this week.

Read more »

A woman sits crossed legged on seats at an airport holding her ticket and smiling.
Industrials Shares

What does Macquarie think Auckland International Airport shares are worth?

Is it time to invest in this unique holding?

Read more »

A male investor wearing a blue shirt looks off to the side with a miffed look on his face as the share price declines.
Industrials Shares

Guess which ASX 200 share is down 8% on earnings miss

Why are investors selling this stock? Let's dig deeper into things.

Read more »

Two male ASX 200 analysts stand in an office looking at various computer screens showing share prices.
Broker Notes

Macquarie tips 20% upside for this ASX 200 industrials stock

Let's see what the broker is saying about this stock following an update.

Read more »

a woman holds her hands to her temples as she sits in front of a computer screen with a concerned look on her face.
Industrials Shares

Guess which ASX 200 stock is crashing 24% on results day

Investors were not impressed with this result. But why?

Read more »

A man looking at his laptop and thinking.
Industrials Shares

Which ASX 200 industrials stock does Macquarie expect to sink 40% over the next 12 months?

Can this name build it's way out of such negative sentiment?

Read more »

Shocked office worker staring at computer screen with colleagues working in the background.
Industrials Shares

ASX 300 stock falls on shock founder CEO exit

A change of leadership has been announced.

Read more »