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Bond of the Week: 26 June 2013

New Issue: Grafton Group Plc 5.5.% 2020

    

Grafton Group, primarily a builders’ merchant with a main listing on the Dublin Exchange but also quoted on the LSE, is coming to the ORB with a new bond. This makes a welcome change from the finance and property companies that are the usual diet for retail bond buyers. Here are the terms:

Issuer: Grafton Group Finance plc
Format: Unsecured, pari passu to all existing debt
Target Size: TBC
Coupon: 5.5% p.a., payable semi-annually
Settlement: 15th July 2013
Maturity: 15th July 2020 (7 year)
Listing / Denom: London / minimum subscription £2,000, tradable at face value of £1,000 plus increments of £100 thereafter
Lead: Investec Bank plc
Books Open: 24th June 2013, expected close 8th July 2013 (but may close earlier)
ISIN: XS0947124243

Grafton Group will only be known to those who follow the stock market with a keen eye as the company does not trade under its own name but via a series of branded subsidiaries. With a market capitalisation of EUR1.3bn and trading from 600 locations with over 9,000 employees they are a business of some size. Although listed in Dublin they operate principally in the UK (76% of revenue) but also have a sizeable operation in Ireland (22%) and a small number of outlets in Belgium (just 2%).  Their annual revenue as reported in the last accounts is EUR2.17bn. Being listed in Dublin they report their figures in Euros. By segment “merchanting” accounts for 89%, retailing (ie DIY) 9% and manufacturing 2% of revenue.

Their main business is operating as a builders’ merchants in the UK under a number of different brands (Buildbase, Selco and Macnaughten) and as a plumbers’ merchant (Plumbase). If you do not know the name Grafton, you may well be acquainted with one of its subsidiaries. What is the definition of a builders’ merchant? They supply to the trade rather than the householder – although there is no reason why you cannot visit one and make a purchase. It is all a question of the scale of what you or your builder wish to do. One bag of cement – go to B&Q, twenty bags – go to a builders’ merchant.  I was told by the CEO Gavin Slark that there is surprisingly little crossover between builders merchants and DIY stores although for plumbers Wickes straddles both markets.

Grafton is the third largest builders merchants in the UK and the fourth largest plumbers with an estimated 11% of turnover. Their bigger rivals are Travis Perkins (23%), plumbers only Wolseley (19%) and Jewson with 18%. Independents account for 29% and that percentage is gradually decreasing as economies of scale weigh on small local businesses. This, according to Grafton’s management, gives them scope for steady expansion especially as their largest rivals can often be banned from further takeovers by the Office for Fair Trading owing to fears over creating local monopolies. The OFT typically requires there to be three separate builders merchants in any locality. In a three merchant town if an independent goes to the wall and Travis Perkins and Jewson operate the other two then they cannot put in a bid with the liquidators. I had no idea the OFT’s tentacles spread so far.

In Ireland the company occupies the no. 1 spot (Helton Buckley and Chadwick brands for those who are curious) They are also the no.1 DIY retailer under the brand Woodie (they have no DIY business in the UK).

Since 2008 the market conditions in the UK have been poor, in Ireland dire. So how have Grafton’s been doing? We should start by saying they are still there which is an achievement in itself. More than that, I observe that in the last 6 months the share price is up 38% so equity analysts and investors must like what they are doing. The housing market has not been that poor in the UK and builders merchants have been able to earn bread and butter money on repairs, maintenance and improvements even if new builds have been limited.  In Ireland they are now breaking even (quite an achievement) following re-organisation and cost cutting. The Irish housing market appears to have stabilised and given only 4,500 domestic units were completed in 2012 (unsustainably low) Grafton believes the only way now is up. When I questioned them on the large overhang of unsold housing stock, I was told much of it is in the wrong place. I suppose that ought to give rise to a variant of the old Irish joke of I wouldn’t start from here if I were you.

Now let us look at the all-important financial side. Grafton and Investec were keen to emphasise, when they paid a visit, that these bonds will not be “structurally subordinated”. In other words since Grafton has not pledge any of their assets as security the bonds will rank pari passu with bank debt. This is certainly a major plus point. It does not stop the company getting into trouble but should they do so the recovery value for bond holders would be significantly higher than if their assets had been pledged. They have shareholders’ equity of EUR 997m and with net debt of EUR 202m they told me they have a gearing ratio of 20%. On closer question it appears some of the 997mil is goodwill and other intangibles – “real assets” are around 500 m. That still makes a reasonable gearing ratio of 40%. The majority of the asset value is accounted for by freehold sites (about 40% of the 600 outlets). Given we are in an overcrowded island finding new sites must be difficult so that is likely to create barriers to entry. You can also take comfort that the banks are happy to lend without security so they must view the company as a good risk. Other encouraging financial signs are an interest coverage ratio of 8.6X and net debt to EBITDA of 1.76X.

In terms of trading their operating margin in 2012 was 3.46% which they expect to get above 4% this year. In the boom years they were achieving margins of 7% + but bar a much more buoyant housing market in the UK and Ireland that appears out of reach in the near future. Finally here is a history of revenue from 2007 which illustrate very clearly in figures the shock to the building trade and then the slow steady recovery: 2007 3,205m, 2008 2,673m, 2009 1,980m, 2010 2,004m, 2011 2,054m, 2012 2,171m.

Conclusion: I can give a definite plus to Grafton the company. The business is operating reasonably, debt is low and if they were able to survive the appalling conditions of the property crash in Ireland and the very difficult market here in the UK then you have to have confidence for the future. That bondholders rank pari passu with bank debt is a definite plus.  However, investors have to take account of market conditions. Post Bernanke’s comments about an end in 2014 to money printing all asset classes have been sold off. Grafton is therefore launching its bond into a shark infested sea. Helical Bar with Mike Slade at the helm has managed to steer its bond through the blood red waters and remains bid above issue price so it can be done. However, market conditions have taken another leg down since the Helical Bar issue so Grafton has an even more difficult task. The Grafton issue at 5.5% so also pays ½% less in coupon. That may be justified in terms of credit quality but yield is yield and credit cushion versus gilt yields is credit cushion. Therefore I personally have to remain neutral on this issue although I wish them well. Investors will need to decide whether they can ignore what may be short term volatility before making to make a decision to buy and also they will need to see whether there are better bargains elsewhere, even if some of them are more risky. Of course the issue does not close until 8th July and by then the bond and credit markets may have completely changed direction and the Grafton might then look a positive bargain!

Oliver Butt

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