ASX Industrials M&A (and Morgan Stanley’s 3 top sector picks)

A wave of M&A activity has recently swept a few prominent ASX Industrial stocks, most recently seeing 169-year-old local firm CSR gobbled up by centuries-old French conglomerate Saint-Gobain.

On the first of these, CSR (ASX: CSR) shareholders this week approved the $4.3 billion takeover offer proposed by European materials producer Saint-Gobain on 26 February. The deal will see CSR, a former sugar refiner that ranks among Australia’s oldest companies, disappear from the local borse after 62 years.

Morgan Stanley analysts say the deal represented a:

• 13% premium to the last closing price before the deal was announced
• 21.5x P/E, 15.9 X EV/EBIT, and 12.1 X EV/EBITDA – based on Morgan Stanley forecasts.
• 61% premium to MS’s $5.60 price target.

“We see limited competition issues,” say MS analysts. “Any transaction would be subject to FIRB review. We note the sale of the sugar business required undertakings to ensure future asbestos claimants were not disadvantaged.”

Adbri (ASX: ABC)

Existing shareholders Barro Group and Irish building materials firm CRH – which already hold 42.7% and 4.6% ownership stakes in ABC – in December proposed a $2.1 billion takeover of Adbri.

“We see limited meaningful competition challenges for the current proposal given Barro's position on the register and CRH's minimal Australian footprint,” say Morgan Stanley analysts

“Unanimously recommended by ABC's independent Board, the offer is subject to shareholder approval, FIRB, Independent expert review and traditional material adverse change and no prescribed condition clauses, and is subject to a A$21 million break fee in certain circumstances.”

Approval from the FIRB and ACCC are required. “The most significant risk would otherwise be a significant decline in earnings or a potential cost slip at the Kwinana capital project but recent disclosures on both of these provide some comfort,” says Morgan Stanley.

Boral (ASX: BLD)

Seven Group Holdings (ASX: SVW) in February proposed a deal, valued at around $1.9 billion, to acquire the remaining BLD shares it doesn’t already own.

“On April 12, 2024, BLD and the independent Board committee shifted to recommending accepting a revised bid,” say Morgan Stanley analysts.

The changes in the bid are:

1) increase in cash component from $1.50 to $1.70;

2) a 26 cent fully franked dividend, the dividend will be deducted from bid price but investors can take the franking;

3) a $350 million buyback to provide increased liquidity which will operate up until May 10, 2024.

Morgan Stanley’s preferred ASX industrials

Acknowledging all that, MS analysts emphasise they assess the sector according to the following metrics. 

Note: The companies named here are highlighted as preferences in line with some criteria, while the three most favoured are those mentioned further below.

• Industry structure attractiveness
• Surplus asset potential
• Balance sheet strength and capital management potential
• Demand cycle upside potential – “Providing earnings upside and supporting multiple-based valuations. We see Sims Metal (ASX: SGM), James Hardie
• (ASX: JHX), and Orora (ASX: ORA) as best placed.”
• Multiple versus history – “Favouring stocks trading at attractive multiples
• relative to history. Qantas (ASX: QAN) and Orora (ASX: ORA) screen best.”

“Favouring strong franchises with attractive industry structures, cyclical upside, earnings support and reasonable valuations. Our key picks are JHX, ORI and BXB.”

Brambles (ASX: BXB)

• Rating: OVERWEIGHT, from Equal Weight.
• Price target: $16.60, from $15.70

“BXB's valuation now appears more attractive and we see a more favourably balanced risk/reward profile,” say MS analysts.

“While we are yet to see the inflection point for volumes, when this does occur we will likely see a combination of earnings growth and strong cash flows.”

“We think BXB has entered into a period where we expect to see earnings growth and improved cash flow performance, which we think could underpin capital management at the FY24 result.

“While we still view pricing competition as a key risk, the risk reduces as we progress further through the cycle with no evidence of irrational behaviour. We think BXB's current valuation is attractive and supports our more constructive stance.

MLC Asset Management’s Anthony Golowenko recently named Brambles as one of a few quality local companies that has successfully navigated the environment of higher labour, energy, and transport costs.

Brambles shares opened at $14.32 on Friday 14 June.

James Hardie Industries (ASX: JHX)

• Rating: OVERWEIGHT
• Price target: $58

“JHX's position with its product group in North America is relatively unique and highly

valuable. Specifically within the Fibre Cement category, JHX controls >90% of the fibre cement market within North America,” says MS analysts.

Analysts rate its balance sheet strength and capital management potential as “four out of five”, adding:

“JHX offers a strong balance sheet that is likely to support capital management. Net debt at FY24 was US$758m, representing a net leverage ratio of 0.67x. This provides ample headroom to support capital management.”

Taking a different view on the company, Tribeca Investment Partners’ Jun Bei Liu singled out James Hardie as a high-growth company she believes masquerades as a Quality stock.

“I will give it to James Hardie, it's a growth company, and it's done very well growing, but a good quality company doesn't keep investors in the dark, especially on bad news,” she said in a recent episode of Livewire’s Buy Hold Sell.

James Hardie shares closed at $47.65 on Friday 14 June.

Orica (ASX: ORI)

• Rating: OVERWEIGHT
• Price target: $21.50

The global leader in explosives, which is protected by high barriers to entry, MS analysts say ORI “offers favourable industry structures with oligopoly markets in all key regions. It is the only explosives manufacturer with a truly global footprint.”

MS analysts highlight ORI’s strong positioning across the Porter’s Five Forces analysis:

1. Competitive rivalry
2. Supplier power
3. Buyer power
4. Threat of substitution, and
5. Threat of new entry.

On balance sheet strength and capital management potential, MS analysts also rate it a four out of five.

­­Orica shares closed at $17.94 on Friday 14 June.

This article was originally published on Market Index on Thursday 13 June