Rainfall pressuring embattled Oz construction sector, 4 stocks likely to lose value: Morgan Stanley

Highlighting earnings downgrades on the back of weather problems self-reported by ASX-listed construction heavyweights Adbri (ASX:ABC) and Boral (ASX:BLD), Morgan Stanley has called for caution on the building materials sector in Australia due to rainfall. 

In a two year period where no shortage of Australian construction companies (large and small) have gone bankrupt due to inflation, supply chain disruption, and workforce problems; the bank’s research on rainfall only further dampens sentiment. 

Rainfall trends causing floods on the east coast have already had impacts on numerous sectors: crops have been smashed in NSW and QLD, and insurance heavyweight Suncorp’s (ASX:SUN) annual FY23 disaster payout fund is already one-third gone before the end of the calendar year. 

Pressure not going anywhere yet 

“With cost pressures unlikely to abate in the near term, the key is the extent to which both [Boral] and [Adbri] and the industry more broadly can offset with price,” Morgan Stanley said. 

It sees weather conditions adding another meaningful headwind to an existing chorus, which is particularly undesirable given that construction companies now need to rely on inflated costs for the materials they supply to offset their own higher bills. 

When fighting inflation with inflation, however, the only winner is….well, inflation. 

Sydney-heavy companies worst hit 

In a breakdown of rain impact state by state, Morgan Stanley notes NSW has been “greatly unfavourable.” 

Morgan Stanley notes two construction companies for which Sydney is the biggest market; Boral and CSR (ASX:CSR) respectively, stand exposed to material (revenue) risk because of the weather. 

The bank also notes while Boral carries a higher degree of weather risk compared to CSR, per its own analysis, the latter “will likely see peak earnings in Building Products from mid CY23.” 

Morgan Stanley is also cautious on Reece Ltd (ASX:REH), as it expects “market conditions to deteriorate” to the extent its 24x price to earnings ratio suffers. The bank went so far as to call that ratio “unsustainable.” 

Price targets 

Morgan Stanley expects the share prices for all four companies in its sights to fall, with Reece Ltd to log the biggest decline.

Morgan Stanley issues the following price targets: 

• Adbri: $1.60 (“expected to range trade until we see evidence of earnings stability and certainty on a long-run CEO.”)

• CSR: $4.70 (“we think CSR is well positioned to benefit from backlogs [but] we expect the market to look past this and focus on the impact of rising interest rates.”) 

• BLD: $2.20 (“Cost headwinds remain for BLD and we question the impact of the recent wet weather on 2H earnings. We need to see evidence of meaningful price traction.”) 

• REH: $11.00 (“we think headwinds on Australian housing coupled with management’s stated view activity in key markets has peaked will put downward pressure on earnings growth.”) 

A look at Boral's five year charts (the steep drop in early 2022 was due to a dividend payout; growth trends over 2021 have failed to replicate in 2022)