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UK brick maker , unlikely to be replaced by Amazon.

 

P/E ~ 8

Market cap 380 M (adding shares  sold in recent equity offering)

2019 earnings: 46.8M

 

ROE ~ 22%

Book equity: 156 + 55 (adding cash raised in recent equity offering, although I expect it to be invested to produce more earnings. So this metric should improve.)

 

Minimal debt. I estimate net debt is ~15M, netting previous debt and cash raised recently.

 

The industry is an oligopoly. Which took about 40 years to consolidate. See here for 1938-1982 data, and note that the largest competitors are still the same, although names and ownership has changed repeatedly: http://www.brickbat.co.uk/concentration.htm

 

Somehow FORT earns better ROE than the competitor Ibstock. I’m not sure why, but they do run fewer, perhaps more modern plants. Would be curious if anyone has any info on why this company has better ROE than the industry. (They all claim to have closed inefficient plants in 2008/9.)

 

ROE was even better before the equity raise. They needed the raise because the banks forced them, and to fund a new factory, which had earlier been planned with debt.

 

The UK imports bricks from Europe! Which is crazy if you think of the value to weight ratio. So it is rational for UK brickmakers to increase capacity to capture that share. From numbers I saw (but can’t find now), the new capacity will still not meet all the domestic demand. So an imported brick price umbrella will remain, unless the oligopolists over supply, or demand crash’s again.

 

Historically volumes have shifted primarily with uk new home building, and secondarily with remodeling. But pricing has been very stable for a commodity industry. Data is available in the IPO prospectus.

https://www.forterraplc.co.uk/plugins/downloads/files/Forterra_Prospectus.pdf

Volume: 94% R square vs housing completions: chart 4, page 47

Pricing: worst year was 2010, down 3%. Best was +16% in 2014. Chart 9, page 50. Chart 10, page 51.

Just eyeballing that price chart, I estimate 35% price increase between 2007 and 2015, over the financial crises and the eurocrisis, which I think produced a double dip in UK.

The company claims that bricks are ~1% of a house cost. So no one decided to not build a house because bricks were too expensive. Thus price increases have no effect on demand.

 

Uk home building has been below the norm for the past 10 years and the government has some programs to encourage it. So brick demand could increase. There is some data in a previous VIC writeup from 2018.

 

So we should see prices hold up, demand can possibly increase, and capacity is being built to capture demand that already existed pre-Covid which was being met by imports. All at a cheap price, but possibly meh management.

 

Known Negatives:

-Insiders don’t own much stock, didn’t buy in large size in the last equity raise.

-Insiders have been pursuing growth in other home building products such as concrete blocks, which do not have the same economics. But all the other companies do it, so perhaps they felt jealous.

-All the positives I listed above apply to the industry. So why don’t the others earn great ROEs. Are FORT’s factories marked down to inflate ROE? Or are they running more modern and efficient plants. Or are they just better operators? I don’t know and that bothers me.

 

Known unknowns:

-Brexit effect on home building

-Corona effect on home building (see chart 1, demand seems to have bounced back: https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/913160/20-cs9_-_Construction_Building_Materials_-_Commentary_August_2020.pdf)

-Capital allocation decisions, factory seems ok, but concrete not so much. The equity raise wouldn’t have pleased longer term shareholders.

-Bricks getting replaced by other stuff, although Britain seems to have local laws to preserve character.

More flats ( British apartments) less single family homes implies lower brick demand, if this happens.

 

Unknown unknowns:

Duh. But perhaps you know something I don’t?

 

Edit: imports were 25% of the market in this 2018 article. https://www.theconstructionindex.co.uk/news/view/uk-brick-makers-are-failing-to-meet-demand

All announced capacity additions are below that.

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Thanks for bringing this stock to our attention.

 

I spent little time on this, but the explanation for the Capital raise seems very flimsy. The brick production expansion costs ~95M GBP of which 35M was already spent and they made 65M operating profit - why can’t they just borrow. Their balance sheet looks pretty good up to 2119. I find it incredulous that banks would not be willing to lend.

ÄI read that Management doesn‘t have a large stock position but participated in the Capital raise. I wonder if they just trashed the stock price to get their piece the company on the cheap on the Capital raise.

 

If that true, Management  isn’t trustworthy although maybe shareholders are now aligned for a while. This seems to be a decent business that even idiots should be able to run, but then again, never underestimate idiots.

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Spek,

 

The CEO earned £1M last year, and bought a token £20k shares in the offering. The CEO already had £0.3M in direct holdings, £0.24M in unvested options and lots more performance based options which are probably worthless now. All of these holdings are much smaller than the annual compensation. The amount bought during the offering is even more insignificant. So I doubt the offering was engineered to give management shares on the cheap.

 

About the reason for the equity issuance, yes it’s strange that they had to issue when the balance sheet was lower than 1x net debt/EBITDA, but those were pre-Covid earnings. They expected to reach >7x in a slow recovery and break covenants till June 2022, with the credit facility expiring the next month in July 2022. That could put the company at risk, but one can argue that they were too quick to get scared. They seem to be implying that the bank’s conditions for covenant relief were to stop Capex, and they didn’t want to delay the capex.

 

But whatever the reason, it doesn’t seem to be to steal from shareholders and make management rich. The positive for new shareholders is that they don’t have to pick between covenant relief and growth capex, and buy in even cheaper than the investors in the secondary. (1.6/7 vs 1.95)

 

See shares bought here: https://otp.investis.com/Utilities/PDFDownload.aspx?Newsid=1410188

For CEO comp and shares: https://www.forterraplc.co.uk/plugins/downloads/files/Annual_Report__Accounts_2019.pdf

Pages 73 & 78

 

Scenarios about secondary and covenants are here: https://otp.investis.com/Utilities/PDFDownload.aspx?Newsid=1400127

 

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^ Samwise, thanks for the Detail, this makes a lot of sense.

 

One unrelated question thought: If a company with the financial profile of Forterra cannot borrow at reasonable conditions, than the economy in U.K. is in deep trouble, because many smaller companies without access to capital markets are probably credit starved..

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^Thank you samwise for this write-up.

After reading the initial posts, i did not add anything but, given a recent development, here are some thoughts.

 

In 2008-9, i built a stake in Brampton Brick (BBL on TSE) based on the idea of pent-up demand to come and planned capacity addition. In that specific case, it turned out to be a mistake as additional demand did not materialize to the extent expected and the new Indiana plant had to be gradually written down in value. I sold shortly after buying, realizing the mistake with a small loss and re-invested the proceeds in better opportunities. The UK Forterra opportunity now may be different.

 

BBL is the number two brick manufacturer in Canada with presence in the US northeast and expanded with a plant in Indiana. Over time, they have tried to diversify, to compensate with the painfully cyclical nature of their core business, with limited success except for a sharp objects disposition healthcare venture which they sold for a profit at some point. The concrete block side of the business can make sense (return on capital wise), even if commoditized, if a regional oligopoly exists. They've also secured long term access to quarries which is important. BBL also have significant commercial activity on the landscape side of the business.

 

i bought (and sold) at 0.3 to BV and it took a long time for this gap to close only partly and fundamentals started to deteriorate in 2018 so that share price has been hovering at pretty much the same level forever it seems as a result essentially of the supply-demand mismatch that persisted and low returns on capital as a result (they have paid a small dividend over time). Recently the stock traded at 0.4 to BV with book value at similar levels as about 12 years ago (!). i even had sent a fairly detailed write-up to Hamblin-Watsa suggesting that they build a minority stake, an idea that had looked really stupid up to recently.

 

A few days ago, a management-type buyout was announced at 12$ per share (shares trading now at 11.65 with low volume for the arbitragers), which is a 100% premium to market but still only 0.7 to BV (!). Still, based on the recent announcement, the return obtained over time would have been low but still better than what FFH has achieved in equities since then.

 

The idea is that brick manufacturing is capital intensive and additional capacity must be met with demand if rewarding returns are expected. Good luck.

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Thanks for bringing BBL to my attention CB. Will look into it later. I don’t think I’ve seen much brick usage in Toronto new builds. So not sure what market they serve.

 

I completely agree that the brick business is not a growth business, and one must sell at the right price eventually.

 

It is a commodity and supply/demand matters a lot, but it’s currently favourable.

 

Currently, demand is back to within 5% of pre-Covid levels per the last trading update from the company. That demand was overwhelming local capacity and bricks were being imported from Europe! So the capacity additions are currently way behind local demand. Even after the new factories are built, Britain will need to import bricks.

 

And lookup the recent VIC writeup on Bellway which again makes the case that more houses will be built in Britain. Bricks is a derivative bet on the same macro outcome. So it’s possible demand rises even more.

 

Supply will be slow to come on, simply because it takes years to build. There has got to be some barriers which ensured the same players are around for the last 40 years.  they could rationally build enough to keep market share, ensuring no oversupply. However it’s also possible that over time they could build enough capacity to destroy their own returns. Wouldn’t be the first commodity industry to do it, despite an oligopoly. That is a risk worth watching for.

 

You mentioned “painfully cyclical nature of business “. You might be interested in some of the history sections on the brickbat website in my first post. It does mention how the boom bust cycle first caused consolidation into an oligopoly, then conglomerates bought the brickmakers. After the history covered in the website, we had the losses and write down in the GFC, and finally (after the GFC) private equity, then IPOs.

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I took a tiny position in this during the sell off. I wanted to do more but as you have pointed out management skin in the game for commodity businesses is important for me because it means they back their ability to beat the competition in terms of cost leadership and return on capital employed. Think Michael O'Leary. Their equity raise seemed like a total panic. That is a polite way of saying, it looked really dumb given their balance sheet is more than healthy enough to tap a debt facility. if they had owned the car they certainly wouldnt have scratched it to the same extent. I do not have more to add, I wanted to own more but you have highlighted the problem.

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...

Supply will be slow to come on, simply because it takes years to build. There has got to be some barriers which ensured the same players are around for the last 40 years.  they could rationally build enough to keep market share, ensuring no oversupply. However it’s also possible that over time they could build enough capacity to destroy their own returns. Wouldn’t be the first commodity industry to do it, despite an oligopoly. That is a risk worth watching for.

You mentioned “painfully cyclical nature of business “. You might be interested in some of the history sections on the brickbat website in my first post. It does mention how the boom bust cycle first caused consolidation into an oligopoly, then conglomerates bought the brickmakers. After the history covered in the website, we had the losses and write down in the GFC, and finally (after the GFC) private equity, then IPOs.

i spent a few minutes on this today. This is unlikely to drive popular interest but the brick manufacturing dynamics are interesting. Maybe the UK market has a supply-demand mismatch and these plants are, by definition, regional businesses with a relatively well defined radius. And if ever pent-up demand for housing shows up, there may be real price power, at least for a while.

The US (and Canada) is also going through some kind of adjustment of capacity through consolidation. While reviewing old notes and looking around, i saw the following which is interesting and this helped to remember that Mr. Buffett had bought Acme Bricks in 2000. Nothing is set in stone and it's possible that he regrets the investment.

https://www.capitalisticman.com/can-brickworks-succeed-in-the-north-american-brick-market/

Investing in a UK brick manufacturer doesn't come naturally but please eventually report the outcome.

Note: another input to consider is the long run availability of affordable source(s) of energy.

 

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I’ll try to add to this thread and would appreciate questions.  Today ,  the US brick business in the US is booming because of residential demand.  Is this the case in the UK? It seems that low rates (nothing new) and somehow Covid are spurring an increase in home ownership. I’m told profits are back to 2007 levels.  We may want to see what percent of Forterra’s sales are in the US as part of this discussion.  These (brick manufacturing) are cyclical businesses and not for the long term buy and hold investor.  In the US Acme is the price leader and dominates Forterra in the marketplace.  Last I knew Acme’s prices were about 5% above Forterra’s here in the States.  Another factor is sales mix.  Acme was above 2/3rds residential.

 

Valuation is a multiple of gross profits minus relatively fixed S,G,and A and when you are selling all you can make at a historically higher price with lower costs of production these businesses print money. When you are selling 70-80% of production at a lousy price and higher unit production costs you do well to make money.  And, even though brick makes up 1% of a homes cost pricing is elastic when selling to the large volume tract builders if the industry is not in a basically “sold out” condition with long lead times for product.  It isn’t elastic in the short term relative to non-brick siding, but elastic in that another brick manufacturer competes with price.  Does Forterra publish bookings and average price over a long period of time?

 

New plant capital expansion projects have an initially low ROI.  In my career it was interesting historically as new plants were built when business was good, thus adding supply and making the next down cycle tough. Please let me go back and review Samwise’s initial post further. I do think there is always interest rate risk in these investments and many long term financial investors don’t care for “lumpy” earnings.

 

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Hi willie2013, Thanks for providing your insight into the Brick business. I wonder if some US brickworks also enjoy local oligopolies like the UK ones and thus good overall results? You raised some questions about Forterra. I've tried to provide you some more context and information below.

 

The UK Forterra is a different entity than the US Forterra. Both were bought by private Equity (Lone Star Funds) from Heidelberg Cement in 2015, and the UK company was IPO-ed separately in 2016.

 

FORT is domestically focused on the UK market, which is pretty concentrated among 4 players with ~95% share. All players seem to have mid-high 20% EBITDA Margins, but FORT stands out on ROE. The UK brick market was sold out for the last few years, with extra bricks imported from Europe. So its the ideal period to print money, as you said. Infact there have been news articles on the brick shortage since 2014. One large builder even built its own concrete brick factory. They didn't build a clay brick factory, so I wonder that there are some barriers to entry.

 

Forterra did publish longer term brick deliveries and prices in its prospectus. The UK bricks don't really seem to compete much on price, not even in 2008-10 when they were closing capacity. But the deliveries do float with housebuilding. I'm copying the relevant portion from my first post above.

 

_______________

Historically volumes have shifted primarily with uk new home building, and secondarily with remodeling. But pricing has been very stable for a commodity industry. Data is available in the IPO prospectus.

https://www.forterraplc.co.uk/plugins/downloads/files/Forterra_Prospectus.pdf

Volume varies with housing: 94% R square vs housing completions: chart 4, page 47

Pricing is stable to up: worst year was 2010, down 3%. Best was +16% in 2014. Chart 9, page 50. Chart 10, page 51.

_________________________

 

Agree about capacity expansion only happening in boom times. This is classic commodity market economics. So far the UK brickworks seem to have resisted building more than just a bit to eat into imports. And end demand seems low... no one is claiming there is a UK homebuilding boom. It seems to be much below household formation. So far the macro factors are lining uo. But yes in the end one makes money on demand here. We need demand to be sustained, new capacity to fulfill that demand, and ideally end market demand to rise.

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There are local oligopolies in the US brick market. Last I knew one plant near Denver produced most (over 3/4ths) of the brick made in Colorado. And Acme’s share of the largest brick market in the US, Texas, was over fifty percent.  I had forgotten about Forterra US being a separate company.  Individual plants that have good results produce brick at a low cost and are located on clay sources near (within fifty miles) major housing markets.  Acme’s returns were traditionally higher than our competitors because (1) they sold direct to builders/other customers, (2) they had a high quality sales organization  and (3) they had brand equity.  Low cost plants that produce desirable products is very important too.

 

You mention that four companies have a 95% share.  Are there dozens of distributors that buy brick and sell them to the end users and only a handful of companies that produce brick?  The concrete versus clay plant discussion is pretty involved.  Clay brick plants can require 50-100 years of clay reserves and a lengthy and involved permitting process.  And, the capital commitment is a multiple of the cost of a concrete plant.  Acme’s original plant site from 1891 still has a production facility located on it!  It has been rebuilt many times of course.

 

You mentioned remodeling business for FORT and I find that interesting. The remodeling market is less than one percent of US brick manufacturing shipments. I’m wondering if they make tile or clay pavers .  One thing that I’m pretty confident about is that high ROE is more dependent on a brick shortage than the UK being an oligopoly.  If a US brick plant operator is faced with the decision to maintain high prices and derate/slow down production rates or reduce price to remain at capacity, they would rather take the future orders at a lower price.

 

One macro factor in the UK that might be worth taking a look at is Covid’s effect on home building.  WFH and the fact that young people aren’t traveling as much has been a positive for single family construction here in the States.  I guess the overly simplified explanation is that if you need a home office, and are saving money on travel/bars/restaurants... why not buy a house with a backyard outside the crowded and viral city!  Also, if you can be sure that the UK construction square footage that drives FORT’s sales will be 10-20% higher in 2021 than 2020 I would think there EBIT will be 15 to 25% higher because of price increases that basically almost completely fall to the bottom line.

 

I saw the latest annual report was linked in your original post.  I plan to read it soon.

 

 

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Willie, those are good questions. Thanks for asking those. I have only partial information. I am in Canada and know little about the uk housing or brick market except what I can find online. I had to go back and refresh a lot I had read before and in also find new information.

 

Thanks for the information about clay vs concrete. Makes sense. Forterra mentions 50 years of reserves in their annual report. The IPO prospectus did break out that only 30 years was permitted in 2014. Not sure about the situation now.

 

 

 

You mentioned remodeling business for FORT and I find that interesting. The remodeling market is less than one percent of US brick manufacturing shipments.

 

 

Thanks for the information about US. the uk market does seem very different. In the ipo prospectus they mention that the repair & maintenance  market is 36% for uk construction. Forterra’s share overall was the following (by revenue) from page 45 .

 

New build: 55%

Repairs:45%

Commercial: 5%

 

Why does the uk have such a larger repairs market?

There is a large collection of existing brick houses and any additions or repairs to them require bricks, if you want the new build to blend in. So if you repair a wall, or build an extension to your house, you don’t want that portion to be entirely different colours. Trying to get just the right shades? Well then price isn’t the biggest driver of your decision. In fact there are multiple services to help find just the right bricks for your job. Just a sample below. This part of the business is more stable than new-build.

https://www.masonrymagazine.com/blog/2015/05/27/brick-matching-101/

https://www.searchabrick.co.uk/about-us/

 

Why is Forterra’s repairs share even higher?

They are the monopoly producer of fleton  bricks, from which 23% of Uk housing was built. It’s rarely used in new build because of its higher production costs, but was 25% of Forterra’s brick volume in 2015. (Page 25). (7% of over all brick deliveries, page 47). It sells at 60-80% premium price, which would make it a larger share of revenue.(page 51 ).

 

I haven’t seen a breakout of just the fletton brick business. They do claim higher cost, so not all the price premium is margin. Also this is slowly reducing. They laid off 50 people and cut production in 2019, as per their annual report. Even then, it seems this is the best part of their business, as you would expect with any monopoly protected by regulations, but with no price control.

 

 

Regulations?

Yes, local building regulations. E.g. this  document about a borough of London. https://www.barnet.gov.uk/sites/default/files/assets/citizenportal/documents/planningconservationandbuildingcontrol/dgn9materialscolour.pdf

 

What is allowed for your house?

You have to match the character of the neighbourhood. If the neighbouring houses use brick, so do you. Even the choice of bricks is “influenced, but not necessarily determined by the brickwork of neighbouring buildings”

Extension and repairs need to use the same type of bricks.

You can’t paint over brick, as it changes its character.

 

I’ll write more later.

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Not sure how much this relates to Forterra but Meridian (another large brick company located in US and not the UK) was bought for $250 million and hadn’t made any money the last two years according to the excerpt below from their recent annual report.  And, half of Meridian’s joint ownership was more than likely only allowing maintenance cap projects and not making investments for the future .  They were a financial buyer (Lone Star Funds - PE) and not an operational buyer . 

 

 

Meridian Brick joint venture delivered post-tax equity earnings of US$1 million, compared with a loss of US$7 million in the prior period, underpinned by cost reduction and a targeted share recovery program. Meridian Brick generated underlying revenue of US$401 million, up 7% on the prior year, and EBIT of US$2 million, up from a loss of US$15 million in FY2019.

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If a US brick plant operator is faced with the decision to maintain high prices and derate/slow down production rates or reduce price to remain at capacity, they would rather take the future orders at a lower price.

 

Yes it doesn’t seem to make sense to reduce capacity at a brick plant given the high fixed costs. But the UK brickworks seem to get around this by shutting full plants. This gets rid of a lot of the fixed costs for those plants, while the other plants all work at full capacity.

 

Not sure why the US brickworks don’t or can’t adopt this process. I guess it does require everyone to coordinate and support price, and definitely not try to capture market share. Somehow this has worked in the uk market for 40-50 years. If they did start competing on price, it might not help much because Brick demand won’t go up.

 

Sources:

Lowering capacity doesn’t make sense for a single plant, see table 3.5

http://www.brickbat.co.uk/brickproduction.htm

 

 

But with multiple plants you can shut down the marginal ones. See table 4.2

http://www.brickbat.co.uk/concentration5.

 

That’s what the uk brick makers did in the GFC, and also how they restarted their plants this year with reduced demand. Note that the website above has data from the 70-80s, but this seems to be traditional behaviour now.

 

https://www.proactiveinvestors.co.uk/companies/news/921024/forterra-encouraged-as-builders-restart-operations-but-will-cut-225-jobs-in-restructuring-921024.html

 

This year Forterra had 12 plants operating out of 18. When demand was about 50% and rising in the summer.

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Are there dozens of distributors that buy brick and sell them to the end users and only a handful of companies that produce brick? 

 

 

Willie, I couldn’t find reliable information about this, but the following article indicates that the large builders “may” buy directly from the brickworks and the smaller buyers go through distributors (called builders merchants in UK).

 

https://www.theconstructionindex.co.uk/news/view/bountiful-bricks

 

I guess you are thinking in terms of concentration among buyers?  The UK does seem to have a few large builders, but they cannot easily substitute away from the brickworks. I think in the US bricks are just one option for facing of a house or building. But in the UK, you get planning permission to build based on choice of brick! This probably reduces competition to just among brickworks, rather than within all different building materials which could be alternatives for bricks. 

 

 

Here is the US thinking about bricks and alternatives. Cost consideration is leading to steel buildings besides old Philadelphia redbricks row houses. Nobody worries about “changing character”.

 

https://whyy.org/segments/we-dont-build-them-like-we-use-to-why-new-houses-arent-made-of-brick/

 

Here is the UK, where a planning authority approved a project based on a brick sample. Then the builder found that the brick wasn’t available and there may be a delay of an year. So they proposed to build with glass and steel. But the planning authority wasn’t happy and hadn’t agreed. So they might delay the project by a year!

 

https://cratus.co.uk/great-british-brick-shortage

 

I guess this means changes in planning regulations can be a risk to brickworks. Which is why the industry association is monitoring the new proposals. https://www.brick.org.uk/news-events/2020-08-06-mhclg-planning-for-the-future-consultative-white-paper

 

The new proposal seems to focus on fast tracking and not on replacing the bricks requirements. E.g. see page 54: local planning authority will still approve aspects of design to ensure they are right for the context (such as materials). https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/907647/MHCLG-Planning-Consultation.pdf

 

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Not sure how much this relates to Forterra but Meridian (another large brick company located in US and not the UK) was bought for $250 million and hadn’t made any money the last two years according to the excerpt below from their recent annual report.  And, half of Meridian’s joint ownership was more than likely only allowing maintenance cap projects and not making investments for the future .  They were a financial buyer (Lone Star Funds - PE) and not an operational buyer . 

 

 

Meridian Brick joint venture delivered post-tax equity earnings of US$1 million, compared with a loss of US$7 million in the prior period, underpinned by cost reduction and a targeted share recovery program. Meridian Brick generated underlying revenue of US$401 million, up 7% on the prior year, and EBIT of US$2 million, up from a loss of US$15 million in FY2019.

 

Yes this isn’t directly related, except historically. This was the other half of Forterra that lone star bought from Heidelberg cement. In 2016 they put the bricks into a joint venture and kept the concrete/drainage pipe business for themselves.

 

Edit: and the new buyer here is a big European brickworks, who are also one of the big three in the UK, and a competitor of Forterra plc. 

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If a US brick plant operator is faced with the decision to maintain high prices and derate/slow down production rates or reduce price to remain at capacity, they would rather take the future orders at a lower price.

 

Yes it doesn’t seem to make sense to reduce capacity at a brick plant given the high fixed costs. But the UK brickworks seem to get around this by shutting full plants. This gets rid of a lot of the fixed costs for those plants, while the other plants all work at full capacity.

 

Not sure why the US brickworks don’t or can’t adopt this process. I guess it does require everyone to coordinate and support price, and definitely not try to capture market share. Somehow this has worked in the uk market for 40-50 years. If they did start competing on price, it might not help much because Brick demand won’t go up.

 

 

Willie, I wonder if US brickworks have ever tried this, or what would be expected if they did?

 

Would customers just substitute away from bricks, or would the other brickworks just take your market?

 

And in a demand drop, how long can plants run at full capacity. They will just build up inventory, even with forward sales, so unless demand bounces back, they have to eventually shutdown or reduce capacity.

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