An interview with Martin Warner, Managing Director of Michelmersh Brick Holdings.
James Faulkner: Thanks for taking the time to speak to Master Investor. Could you begin by giving our readers a brief overview of Michelmersh Brick Holdings (MBH) and its history for the benefit of the uninitiated?
Martin Warner: We started in 1997 with the acquisition of two brickworks in the Home Counties manufacturing about 10 million bricks serving local markets where the product had been manufactured for generations and supplied product to match the local vernacular.
We made further acquisitions buying three more works over the years so that we now produce 70 million products, having floated on AIM in 2004. We also have significant land assets that come along with the brick making, some of which can be used for landfill and some for residential development.
JF: Most people are aware that the housebuilding and construction sectors are acutely cyclical. Where do you think we are in the cycle right now and what implications does that have for equity investors?
MW: We are in the beginning of a new cycle for brickmaking. These tend to be much longer than in the construction sector because the industry is so capital intensive. Since the 1980s, when the last major investments were made in the industry, the UK market has been oversupplied as construction, especially housebuilding, declined. The last recession saw a brutal reduction in capacity, so imported bricks are now needed to fill the gap.
JF: With interest rate rises apparently on the horizon, does that necessarily entail a cooling off of construction activity? Much attention is paid to the break higher interest rates exert on demand, but very little is mentioned about the positive impact on the supply of credit as banks find it more profitable to lend. What is your take on this?
MW: As noted above we are at the start of a new cycle with brick demand exceeding supply recovering from a very low base. Coupled with an undersupply of new housing the overall dynamics for the industry are pretty resilient even when interest rates do rise. These are long expected and all the pundits seem to think they will be slow and gradual.
JF: From the point of view of a UK equity investor looking to gain exposure to the sector, why not go straight for the jugular and simply invest in one of the housebuilders? What distinguishes building materials suppliers such as Michelmersh as an investment?
MW: We are now at the beginning of this new cycle which is highly capacity-constrained so I think the dynamic is different. We will now see a normalising of the market over the medium term after many difficult years.
JF: Michelmersh puts a strong emphasis on its stable of brands whilst operating in an industry that produces what most people would consider to be a fungible product. What’s the logic behind this?
MW: We started with bricks which fit the local landscape and our products enhance the street scene. The price of a brick is less than the price of a Mars Bar and yet they last at least 150 years longer! Half the market is repair and maintenance. The first thing a potential buyer sees when he drives up is the front of the property and for a small amount of money something that looks absolutely right can be built so our products are also very often favoured by architects and indeed local planners as well as developers.
Probably the best example I can give is that when St Pancras Station was redeveloped there was no other manufacturer who could match the appearance and size of the 100 year old brickwork.
JF: Michelmersh recently returned to the dividend list for the first time since 2007. Given that the recovery in the housing market has been in place for several years, why did it take so long for Michelmersh to resume paying a dividend?
MW: The industry has lagged because when the market crashed in 2008 there was a massive stockpile of bricks on the ground – about 10 months’ supply. It took until 2013 for these to be sold down. This illustrates the point about long cycles.
JF: Whilst turnover climbed by 13% during the first half of this year, the majority of profit growth was accounted for by an increase in margins. Given that the number of brickworks has actually declined since 2007, is there scope for further margin progression on the back of supply constraints?
MW: We are now expecting that this new cycle will start to bring normalised returns. Our focus now is to improve efficiencies in our business by incremental investment – for example we have just finished our new expansion project at our Freshfield Lane works which is bringing extra capacity on stream and we have installed more robots at our Blockleys site. We will continue to invest to improve efficiencies which will bring margin improvement.
JF: The General Election cast a cloud of uncertainty over the housebuilding sector. Now that that cloud has been lifted, has the market responded in kind? Is the current government doing enough to stimulate the sector?
MW: There is stimulus in the sector from the ‘Help to Buy’ scheme, but there are capacity constraints in every part of the market. One of the biggest is the planning system which is certainly not getting any easier and although this is recognised by Government it is difficult to see much change coming.
JF: Hanson and Ibstock, two of the UK’s largest brick manufacturers, were recently acquired by private equity. What implications does this have for the industry?
MW: It is hard to comment on this apart from the fact it should bring a more financially disciplined market place at this point in the cycle.
JF: The UK currently imports around 20% of its bricks. What would it take for domestic manufacturers to plug the supply gap? Is there still a lack of confidence to invest in new capacity in spite of the recovery?
MW: To build a new plant requires a good supply of mineral, planning consent with all the problems this entails, a cheque in the order of £60–70 million for a 100 million unit plant, and several years to bring on stream.
The challenge for a large part of the industry now is to invest in existing plant after a long period of underinvestment and this is likely to be where most resources are directed in the forthcoming period.