How Albert is reshaping CRH - Ireland's biggest company

CRH, Ireland's largest industrial company, is gearing up for a €4bn-plus acquisition spree following its strong first-half results. With regulators set to force rivals Holcim and Lefarge to sell more than €5bn of assets before approving their merger, CRH is set to pounce.

In the jargon favoured by financial analysts CRH is highly "operationally leveraged". Translated into plain English it has high fixed costs. This means even relatively modest falls in sales can result in sharp falls in profits.

This is exactly what happened to CRH following the 2008 economic bust. Operating (pre-interest) profits, which had peaked at €2.08bn in 2007, fell by over 95pc to just €100m in 2013. However, CRH's sales fell by less than 15pc from €21bn to €18bn over the same period.

While operational leverage is a killer in the bad times it works the other way when the market begins to recover. This is precisely what happened to CRH in the first half of 2014 when a mere 4pc increase in sales to €8.32bn delivered a quadrupling in operating profits from €41m to €171m.

During the downturn CRH has been ruthlessly cutting costs. It shaved a further €45m off its operating costs in the first half with total annual cost savings of €100m targeted for the full year. Cumulative cost savings at CRH since the bust now stand at €2.6bn.

This combination of cutting costs and rising profits will allow CRH to pay down debt very quickly. Indeed this is already beginning to happen. Net debt at the company stood at €3.7bn at the end of June. While this was up from €3bn at the end of December, CRH's mid-year debt figure is boosted by increased working capital requirements as cash temporarily flows out of the company during the peak summer building season.

A better comparison is with mid-2013 when CRH's net debt stood at €4.2bn meaning that the group's underlying indebtedness has fallen by €500m over the past year. And it could fall by a lot more.

As construction markets in Europe and North America recover, CRH's profits will continue to grow. This will allow it to pay down debt even more quickly. In addition CRH has announced that it hopes to raise €1.5bn-€2bn from the sale of non-core assets. The combination of higher profits and disposal proceeds could allow CRH to repay virtually all of its borrowings over the next few years.

But of course it won't. CRH's rock-solid balance sheet means that it can now borrow at extremely low interest rates. Last month CRH raised €600m by issuing a seven-year bond at an annual interest rate of just 1.75pc, the lowest interest rate ever achieved by the group in the bond markets. CRH can now borrow more cheaply than the Irish State.

CRH's average annual interest rate has fallen from over 5pc in 2012 to just over 4pc today and is set to fall further over the next few years. Lower funding costs mean that many more acquisition targets will meet CRH's stringent return-on-capital-invested criteria.

Even before it books any disposal proceeds CRH already has the financial firepower to consummate several major acquisitions. At the end of June it has gross cash balances of €1.1bn as well as €2.6bn of unused lending facilities, giving it a potential war chest of up to €4bn.

Expect CRH to use this financial firepower sooner rather than later.

In April two of CRH's largest European rivals, Holcim of Switzerland and Lafarge of France announced plans for a merger to create the world's largest cement manufacturer with annual sales of more than €30bn.

From the moment the deal was announced it was clear that it would encounter significant regulatory hurdles and that significant asset disposals would be required if it was to be approved by the competition authorities in Europe, North America and elsewhere.

Last month Holcim and Lafarge unveiled plans to dispose of assets with annual sales of up to €5bn in an effort to secure regulatory approval for the merger. Businesses in Austria, Hungary, Romania, Serbia, the UK, Canada, the 
Philippines, Mauritius and Brazil have all been put up for sale.

Analysts have already linked CRH with one of the Holcim/Lafarge businesses up for sale, Lafarge Tarmac. Previously a joint venture between Lafarge and mining giant Anglo American, Anglo has agreed to sell its 50pc stake to Lafarge for £885m (€1.1bn).

This price indicates that Lafarge/Holcim will be looking for a price somewhere in the region of €2.2bn for the whole of Tarmac when it is sold by the merged group.

Another possible CRH acquisition is Heidelberg Cement's building materials business.The German company has already announced that it plans to sell this division before the end of the year, with the proceeds most likely to be used to acquire some of the cement manufacturing capacity being offloaded by Lafarge/Holcim.

The Heidelberg building materials division is concentrated in the US and the UK and makes bricks, concrete pipes and roofing tiles. It has been valued by analysts at €1bn. With new CRH boss Albert Manifold keener on the US rather than Europe, the Heidelberg business might prove to be a better fit for the group than Tarmac.

Regardless of whether he chooses to buy both, either or none of these businesses, the pressure on Mr Manifold to do something on the acquisition front is likely to increase. Barry Dixon, CRH analyst at stockbroker Davy, calculates that, absent acquisitions, the company could be debt-free as soon as the end of 2015.

That's clearly not a desirable position for CRH. With Mr Manifold having committed himself to return CRH's returns on capital and margins to peak levels, a debt-free balance sheet would be financially grossly inefficient for the company.

At last week's analysts' conference Mr Manifold gave off apparently contradictory signals: On the one hand he waxed lyrical about CRH's traditional practice of buying medium-sized owner-managed business. The average price of a CRH acquisition has been just €50m, he pointed out.

However, as Mr Manifold himself knows only too well, a company of CRH's size needs an awful of lot of these mom-and-pop acquisitions to keep growing its earnings - spending the €4bn currently available would mean 80 such deals.

At the same meeting Mr Manifold also pointed out that, historically two-thirds of CRH's growth had come from acquisitions, clearly holding out at least the possibility of super-charging its mom-and-pop deals with some bigger purchases.This has been the pattern at CRH in the past. In 2003 it paid €690m for Dutch firm Cementbouw and in 2006 shelled out $1.3bn (then worth €1bn) for Ashland Paving and Construction in the US.

Quite clearly, if the numbers stack up, CRH isn't gun-shy about doing the big deals.

At the same time the group is acutely aware of the dangers of over-paying. With private-equity buyers flush with the cash the competition for the big deals that come on the market is intense. Warren Buffet's Berkshire Hathaway has already been touted as a possible buyer of the Heidelberg business.

As Mr Manifold ruefully observed to his audience of analysts last week, overpay for a business and you end up paying for it for the rest of your life!

While his caution can hardly be faulted, quite clearly doing nothing is no longer an option for Mr Manifold. Unless CRH can crank up the level of its mom-and-pop dealmaking to previously unimagined levels of hyperactivity, Mr Manifold must start doing bigger deals.

If he doesn't and the cash starts piling up in the CRH balance sheet, pressure on the company to return that cash to its shareholders will become intense.

Further complicating matters is the fact that the two largest building materials companies currently on the market, Tarmac and the Heidelberg building materials division, both have a distinctly shop-soiled appearance.

Tarmac was an unloved subsidiary of Anglo American before it was shunted into a joint venture with Lafarge in 2011 after Anglo had spent the previous four years unsuccessfully seeking a buyer for the business. Questions have also been asked about the quality of the Heidelberg business, formerly Hanson.

Maybe Mr Manifold is right to be cautious.

So, damned if he does and damned if he doesn't, what is Mr Manifold to do?

Davy's Barry Dixon suggests a possible way out of this dilemma. "The building materials market is still very fragmented in Europe and the United States. There are many companies worth a couple of hundred million euro that we know nothing about", he says.

We may know nothing about these medium-sized companies but we can take it as read that CRH, which closely monitors the markets in which it operates, does.

"There is a big opportunity for CRH to do something. If the cost of funds is 1.75pc it could generate very handsome returns for shareholders. Over time CRH will find deals. They won't do anything rash".