BUY. Breedon. Building & Property. Structural shift. For FSA purposes this is a Marketing Communication 15 May Initiating Coverage

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1 Building & Property For FSA purposes this is a Marketing Communication BUY Current Share Price Target Price 22p 27p Market Capitalisation 152m Shares In Issue RIC/BLBG 692m BREE.L/BREE LN Avg. Daily Volume (3M) 562,378 Net Cash (Debt) (12/12F) (74.5)m Current share price(s) timed at 12:00PM on 15/05/12 Share Price (p) May-11 Aug-11 Nov-11 Feb-12 May-12 Breedon Relative to FTSE (ALL SHARE) Performance % 1M 3M 12M Absolute Relative Analysts Howard Seymour +44 (0) h.seymour@numis.com Chris Millington +44 (0) c.millington@numis.com Source: Datastream Breedon Initiating Coverage Structural shift The acquisition of much of the UK primary aggregates market by international players over the 2000's looks set to see some reversal going forward, and the proposed Tarmac/Lafarge JV is perhaps the most tangible example of this as the Competition Commission now requires asset disposals for the JV to proceed. We outline in this document that we believe Breedon is the natural beneficiary of this structural shift through further bolt-on acquisitions, plus potential transformational purchases in this environment. However, we would also highlight good success to date both on organic profit growth and benefits from opportunistic acquisitions, which underpin strong growth potential from here. Breedon is a special situation as the short-term valuation does not reflect its potential positioning in our view. We initiate on the company with a 26.5p/share target price and positive recommendation. We initiate coverage on Breedon outlining key aspects of the industry structure, divisional profile and short-term plus normalised estimates and valuations. Organic growth in the short term will take place against a difficult macro environment, but we expect Breedon to outperform this as self-help measures take effect. We believe this will mainly be in Breedon England, where best practice measures plus benefits of acquisitions will drive profits, while in Breedon Scotland we expect a flatter profile. Breedon's management expertise, market positioning and potential financial fire-power suggest it could be a prime candidate to benefit from the structural changes emerging in the UK primary aggregates market. The placing in early April 2012 to raise 15m demonstrates that Breedon is looking to continue to make bolt-on acquisitions to complement its existing operations, which we believe will further drive profit growth. However, recent news from the Competition Commission that the Tarmac/Lafarge JV can only go ahead with significant primary aggregates and value-added activities disposals suggests to us that more transformational deals could be possible. We would expect any major purchase to be funded through share issuance. Valuation is problematic given the relatively short trading history, current outlook and inability to model scope for major acquisitions impact. However, applying a mid-cycle EV/EBITDA multiple to normalised earnings leads to a target price of 26.5p. Year to Dec Sales ( m) EBITDA ( m) PBT ( m) EPS (p) EV/ EBITDA (x) P/E (x) Net Cash /(Debt) ( m) 2010A (4.5) (1.6) 17.8 n/m (97.5) 2011A n/m (96.2) 2012F (74.5) 2013F (67.7) Source: Breedon (historical) and Numis Securities Research Department (forecast) This research was prepared and approved by Numis Securities Ltd The London Stock Exchange Building 10 Paternoster Square London EC4M 7LT, UK Tel +44 (0) Fax +44 (0) mail@numis.com

2 Contents Investment case 3 Valuation 4 Risks 5 The market opportunity for growth 6 Current status and organic potential 10 Scotland 10 England 11 Group 12 Pre-tax and cash flow forecasts 16 2

3 Investment case With the UK primary aggregates and related value-added products industry effectively acquired en-masse by overseas players over , we outline here why we believe deconsolidation is likely to emerge going forward (of non-vertically integrated products at least). The Tarmac/Lafarge joint venture is perhaps the test case in this respect, notably as the Competition Commission has recently (May 2012) ruled that the companies will be required to dispose of a significant portion of existing operations for the joint venture to be allowed to proceed. Organic growth, plus bolt-on and transformational potential through acquisitions We argue here that Breedon Aggregates is in an ideal position to benefit from this structural shift in the market, and going forward we see it having two key growth drivers: Organically, scope for margin enhancement in Breedon England due to the application of best practice is leading to margin enhancement towards margins already attained in Breedon Scotland. Longer term, normalised profits in both areas are appreciably above current levels of profitability (we outline in this document normalised earnings), though accept that some form of macro recovery will be required to attain this. Acquisitions to date have involved successful bolt-ons to the core of Breedon Holdings (itself only acquired by the Breedon management in September 2010). We believe the scope for more opportunistic bolt-ons will add to organic growth, hence the recent 15m fund raise through share placing, which in our view could increase EBITDA by over 12% based on recent acquisitions. Breedon management has gone on record regarding potential disposals relating to Tarmac/Lafarge, indicating that the management has the appetite (and in our view the ability) to consider acquiring significant portions of the assets to be disposed which could clearly be transformational, in our view. Breedon s share price has bounced on the news from the Competition Commission regarding Tarmac/Lafarge, indicating that this is clearly a focal point for investors. While we would not disagree that this could be very significant, we would also point out that benefits from operational improvements plus scope for bolt-ons provide more tangible drivers of growth at this time. Breedon Aggregates in its current form does not have a long financial history, and it is not possible to model the varied possible outcomes resulting from disposals likely to emerge from Tarmac/Lafarge which could be significant. As such, short-term valuation is problematic. We have outlined our view of normalised earnings in this document, and on the premise of EV/EBITDA valuation, we initiate coverage on Breedon with a 26.5p/share target price and positive rating on the shares. It is clearly difficult to be exact about valuation upside in the company on short-term metrics. However, we believe that key attributes for the investor should be that the highly experienced management team has the expertise, inclination and financial firepower (most likely through further share issuance) to exploit the changing shape of the UK primary aggregates industry through greater operational excellence in existing businesses, and as the purchaser of choice in terms of both small and larger primary assets. 3

4 Valuation There are two reasons why valuation of Breedon is difficult at present, in our view: Breedon is still at a formative stage of its development in two regards. First, its existing operations are presently not making the normalised returns we believe are possible. Second, the group clearly has major aspirations in the UK primary aggregates market to be a major consolidator and it is not possible to model the potential outcomes of this, though we accept that these could be very significant. Peer group analysis is hard because all other major players in UK primary aggregates are part of much larger international cement companies where geographic profile and capital intensity will impact valuation and so do not provide meaningful peer analysis. The table below shows traditional short-term valuation metrics for Breedon Aggregates based on forecasts outlined in this document for 2012 and 2013 at the current share price. Short term valuation does not reflect upside potential Table 1. Breedon Aggregates valuation metrics, E Year end December 2011A 2012E 2013E EV EV/sales EV/EBITDA EV/EBIT PE Div Yield (%) FCF Yield (%) (2.1) P/NAV Source: Company, Numis Securities Research Department The table clearly demonstrates that on short-term metrics it is hard to point to a strong buy case for Breedon. The table below outlines P/E and EV/EBITDA metrics for companies that the UK investor would look at relative to Breedon, namely the Builders Merchants (albeit they reside in the Support Services sector) and major building materials companies. Table 2. Sector peer group valuations, E P/E (x) EV/EBITDA incl. pensions (x) 2011A 2012E 2013E 2011A 2012E 2013E Merchants Grafton Howden SIG Travis Perkins Wolseley Materials CRH Low & Bonar Marshalls Norcros Average Merchants Materials Source: Numis Securities Research Department 4

5 Within this table we believe that CRH and Marshalls should be regarded as the nearest peers to Breedon, though CRH s portfolio of activities by geographic and product does limit this comparison. Marshalls, in our view, is also a very attractive way to play the inevitable disposal of non-core assets by the major international cement companies in the UK, but is more focused on concrete product assets (and associated aggregates) rather than the primary aggregates focus of Breedon. However, in the case of both CRH and Marshalls, short-term valuations in the table above look demanding reflecting in fact the lower level of earnings rather than a high share price, which is typical in cyclical sectors and adds a further complexity to the valuation discussion. To get to any meaningful short-term valuation, we highlight in this document that normalised earnings are possible to generate and likely to be a progressive achievement as a result of management actions. The table below outlines the valuation based on normalised earnings, but also what these metrics would be based on a target price of 26.5p, which we justify below. Target price of 26.5p based on EV/EBITDA, Breedon offers good way to play structural change Table 3. Valuation metrics at normalised profits Current share price Target price EV EV/sales EV/EBITDA EV/EBIT PE Div Yield (%) FCF Yield (%) P/NAV Source: Numis Securities Research Department P/E on normalised earnings at the current share price would be 13.9x and EV/EBITDA 5.0x, and applying a target price to normalised earnings would suggest that the P/E would move up to 16.7x, while EV/EBITDA would be 6.0x. We believe that EV/EBITDA is perhaps the best valuation criterion at present, and do not think that the shares look overly expensive on this basis on normalised earnings, as traditionally aggregates companies would trade on EV/EBITDA multiples of 8x and over. However, we believe some discount is required given both that it is early days in terms of Breedon management and also that it will take some time for the group to achieve normalised earnings organically. The corollary of this is that as the industry structure changes Breedon may end up being a much larger entity as existing industry players deconsolidate their UK exposure. We see this as a positive backdrop for the group and believe that the shares offer an excellent way to play the structural changes we expect. Risks Key risks are threefold: Macro risks remain the potential impact of public sector cutbacks and private sector weakness on construction demand. As we have outlined in this document, new orders in construction are still falling, which will lead to falling industry volumes over We outline in this document that we believe that Breedon can outperform on volumes relative to the industry. Raw materials prices continue to rise and the need to pass on fuel, bitumen and cement costs are important to be able to prevent margin slippage. Breedon s strategic aim to be a consolidator of primary aggregates in the UK is a major feature of the growth argument in Breedon, as on short-term valuation metrics it is hard to point to a strong buy case for Breedon. 5

6 Figure 1. The Primary Aggregates supply chain The market opportunity for growth Building & Property An important starting point in the case for Breedon is to understand the nature of the business and the recent history. We start with a simple overview of the supply chain in this area: Primary Aggregate Crushed Rock, Sand & Gravel + Cement + Bitumen Processing Readymix Concrete (Rmc) Mortar Concrete Products Asphalt Industrial Minerals Decorative Products Source: Numis Securities Research Department Primary aggregates (crushed rock, sand & gravel) are low value and heavy so there are two important aspects of the industry: Rmx and UK consolidation by international majors Value added. The ability to use primary aggregate into a manufactured product adds value added, with the key areas above being readymix concrete (rmx), concrete products (tiles/pavers/blocks/pipes etc.) and asphalt. Economic radius is extremely limited, as a 44 tonne lorry will carry only 240 of revenue of primary aggregate. On average, primary aggregates are transported less than 30 miles. The logistics for transporting cement are easier because of the higher price of the manufactured product ( 2,500 of revenue per 44 tonne lorry), while rmx has to be a local product because of the nature of the product (i.e. it sets after a period of time). Figures from the British Geological Survey point to over 50% of all cement being consumed through rmx, and we have seen two major developments in this regard since 2000: UK cement players have increased their exposure to rmx, while the UK s largest rmx player has also moved into cement (RMC Group acquisition of Rugby Cement). This has also involved acquisition of primary aggregates, as buying-in these materials reduces the economics. While generally regarded as vertical integration, it would be wrong to assume companies in this regard are inevitably self-providing moving cement from the South East of England for a Scottish rmx plant, for example, would severely limit the economics of this. Rather the national nature of owning rmx provides a strong ability to generate value added, but also enables rmx players to buy off each other at a transparent price. These are more vertical silo s than genuine vertical integration. The UK consolidation of the industry has taken place against this backdrop, which for the most part has been driven by cement chess. The table below outlines the major acquisitions over the period: 6

7 Table 4. UK Cement and primary aggregate consolidation, Year Acquirer Target Key reasons Acquisition price ( m) EV/EBITDA* (x) 2000 Anglo Tarmac UK Aggregates/Rmx/Concrete Products 1, Lafarge Blue Circle US/Asian/African/UK Cement 3, Cemex RMC Group UK/German/US Rmx plus UK/German cement 2, Holcim Aggregate Ind UK/US Aggregates/Rmx/Concrete products 1, Heidelberg Hanson UK/US Aggregates/Rmx/Concrete Products 7, Total 16, but UK presence was not the major reason * At time of purchase Source: Company reports We see the Lafarge acquisition of Blue Circle and Cemex acquisition of RMC Group as prompted by international cement motives much more than a UK presence. Moreover, Holcim and Heidelberger s acquisitions of Aggregate Industries and Hanson clearly did involve aspects of vertical integration moves, but these were driven by major US exposure as much as by UK footprint. Perhaps the key demonstration of this is the statistic that over this whole period of consolidation, these companies spent over 16bn (pre net debt) to basically take over the UK primary aggregate and cement market. In 2009 the British Geological Survey valued the whole of these markets at 3.3bn pa (Primary aggregates at 1.4bn, cement at 900m and rmx at 1.0bn), of which OFT suggests the major players have around 70% of total production (i.e. 2.3bn). This implies a price to sales of 7.1x, which is clearly hurting many of these companies (especially given that UK acquisitions took place at a time of very significant acquisitive growth worldwide). The resulting structure of the UK primary aggregates/cement/rmx/asphalt market is outlined below: Table 5. Primary aggregates and value added product market shares, 2009 Parent UK operator Cement (%) Aggregates (%) Rmx/mortar (%) Asphalt (%) Lafarge (France) Lafarge Cemex (Mexico) Cemex Heidelberger (Germany) Hanson Anglo American (UK) Tarmac Holcim (Switzerland) Aggregate Industries Breedon (UK) Breedon Marshalls (UK) Marshalls 1 Total Source: OFT, Numis Securities Research Department Generally, while the UK primary aggregates market is highly consolidated for the most part between major international cement producers, their interest in the UK is limited to where they can achieve vertical silos. It seems likely that over time areas outside this will be put up for sale. The Lafarge/Tarmac joint venture provides the best example of this, and potentially the greatest opportunity for Breedon to become a major consolidator within the primary aggregates industry. The Competition Commission has now published its findings on the joint venture, and we would summarise the key issues as the following: Unilateral horizontal effects effectively leading to loss of competition resulting from the JV which could lead to pricing, capacity, and quality issues. Coordinated effects which could lead to coordinated action by parts of the JV that limit existing rivalry to the detriment of competitors. 7

8 Vertical effects arising from unilateral market power involving vertical integration in local areas involving: Cement sold to rmx-producing customers Aggregates sold to rmx-producing customers Aggregates sold to asphalt-producing customers. Requirement for significant asset disposals from Tarmac/Lafarge Vertical effects arising from coordination effectively as a combination of the above impacts. The Competition Commission has concluded that to address these issues the JV would have to divest the following: Tarmac s stake in MQP (Midland Quarry Products Limited, Tarmac/Hanson 50:50 JV which is involved in quarrying from the Cliffe Hill quarry in Leicestershire, dry stone processing, asphalt, and rail ballast), six other quarries, an aggregates supply rail depot, two asphalt plants and seven rmx plants. Lafarge s Hope Cement works, Dowlow quarry in Derbyshire, three linked rail depots and a substantial portfolio of rmx sites. While clearly it is not possible to make detailed evaluations of the scope of disposal and appetite for these assets from Breedon, the table below illustrates the relative size of the combined Tarmac/Lafarge businesses relative to Breedon. The clear inference is the significant scope for Breedon to grow materially on the back of required disposals. We believe there are few companies with the scale, management ability or inclination to look to exploit this situation as readily as Breedon. To quote the CEO: Breedon has in the past indicated its interest in any assets which may become available through the divestiture programme, in line with its stated strategy of consolidating the heavyside end of the UK building materials industry. The company will assess any specific opportunities once further details on the proposed disposals have been made available. (Simon Vivian, press statement post Competition Commission report, 1 May 2012) Table 6. Tarmac, Lafarge and Breedon production statistics Tarmac Lafarge Total Market share (%) Aggregate (Mt) Rmx (M cu m) Asphalt Breedon Aggregate (Mt) Rmx (M cu m) Asphalt (Mt) Source: OFT, Breedon Independent observers have suggested that the most interested parties for disposals would be CRH and Breedon. CRH has recently stated that while it will clearly look at the assets, with little overlap with existing UK operations this is not a high priority for the group though the fact that cement assets may be up for sale could provoke greater interest. Other existing players in the UK industry are unlikely to be overly interested given their international interests and potential anti-trust implications, and we expect that Breedon would therefore be the most natural buyer of choice for aggregates and valueadded products. MQP could also be of interest (as it would give Breedon East Midlands exposure, and we expect that Breedon already trades with MQP), and while we would expect Breedon to look at the disposal package involving Lafarge s cement assets and associated rmx assets, we believe this will be lower priority than other assets in the joint venture and possibly generate more interest from other parties. 8

9 Scope for bolt-ons remains significant in shorter term Breedon has firepower and inclination to benefit from market structure changes In addition to the larger end of the scale, however, the local and regional nature of the business does mean there are a significant number of small players. The scope to grow Breedon through bolt-ons is just as significant to the group based on two factors: Expansion of primary aggregate footprint enables greater economies of scale on centralised functions, including back office and purchasing economies. Expansion of value-added materials such as rmx and asphalt increases internal use of aggregate, which increases the margin mix. In this respect it is worth briefly outlining the structure of the key product areas in terms of Breedon s ability to consolidate through bolt-on acquisitions. As we have outlined in Table 5 above, we believe that some 24% of primary aggregates market share is in the hands of independent players. OFT research points to there being approximately 235 primary aggregates operators supplying from over 1,200 quarries and wharves in Available market share in rmx outside the major players is some 23%. According to OFT statistics, in 2009 there were 47 companies in the UK with capacity of 30,000+ cu m, plus 159 smaller companies with their own concrete plant. Asphalt available market share is some 12%. We discuss the implications of smaller deals in the following section with reference to recent acquisitions made by Breedon. In both potential large and small deals, a key consideration must be that Breedon is likely to be the purchaser of choice the group has the financial firepower now for small deals, an institutional foundation that would back larger deals, and in our view is the only company in primary aggregates with the firepower and inclination to expand in this area. We discuss in the valuation section of this note that we believe Marshalls is similarly well-placed in the related area of concrete products plus benefits from being a larger and more established player in its markets. 9

10 Current status and organic potential Having only acquired Breedon Holdings in September 2010 (having effectively previously been an investment shell as Marwyn Materials), Breedon Aggregates in its current form does not have a long financial history, but below we have outlined the two key parts of the business and our views on short and longer term trends. Scotland Historically the larger of the two businesses, Breedon Scotland operates in the North, West and East of Scotland above the Glasgow-Edinburgh corridor. Activities comprise: 17 quarries 15 crushed rock, 2 sand & gravel. 11 asphalt plants and associated contracting operations working out of four regions. These include an associate 37.5% holding in BEAR Scotland, an asphalt contracting operation (alongside Jacobs UK and Ringway Group). 22 rmx plants, 13 in quarries and 9 standalone. Figures in the chart below outline proforma sales and EBITDA margin for 2009 and 2010 as given by Breedon management, and Numis estimates for the current and next year. Figure 2. Breedon Scotland sales and EBITDA margin, E Sales ( m) A 2010A 2011A 2012E 2013E Sales EBITDA Margin 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% EBITDA margin Source: Company, Numis Securities Research Department The group experienced lower sales and margins in 2010 due to the wet weather impact but also due to the impact of lower asphalt volumes coupled with the lagged impact of passing on higher bitumen prices. In 2011, the weather bounce-back coupled with Local Authorities, Highways Agency and Transport Scotland expending budgets ahead of cutbacks led to a sharp increase in revenues, but the lagged impact of rising bitumen costs also impacted the EBITDA margin. Challenging backdrop, but company specifics should underpin profits Breedon Scotland is likely to face a challenging outlook in the current year and next, in our view, reflecting both the fact that the business is skewed more towards public expenditure than Breedon England, but also that as a well-established business the scope for major short-term gains in operating margins are limited. However, there are several major projects that the group will be bidding for and should be the favoured candidate on several on location alone (Peterhead new prison, Blar Mhor development (foodstore and non-food retail park), Forth Road Crossing for example). As a result, we expect that the Scottish group can show an element of progress in revenues and pass on higher raw materials prices enabling some growth in the current year and next. 10

11 England Breedon England has seen a significant restructuring under new management comprising two key factors strategic growth through acquisition and management initiatives: 1. Acquisitive growth 2. Management initiatives Breedon has acquired C&G Concrete and Nottingham Readymix, of which C&G is by far the most significant. The table below outlines the impact of acquisitions on Breedon s England operation. Table 7. Breedon England activities, England Quarries Crushed Rock 4 4 Sand & Gravel 1 4 Value added products Asphalt 7 7 Concrete 5 18 Contracting 2 2 Other products 3 3 Source: Company C&G brought three sand and gravel quarries to the operation, while this acquisition plus Nottingham Readymix has taken the number of Rmx depots up from 5 to 18. Acquired from the administrator for 10.8m in July 2011, at the time C&G was making marginal EBITDA losses on 12m of revenue. Resulting from management actions, in its five months in the group to year-end 2011 the acquisition produced EBITDA of 0.46m on revenues of 7.2m, and in the current year we are projecting that C&G s contribution looks set to rise to some 1.5m. Based on adjusted EV of 9m (adjusting for asset disposals less required initial capex), this implies an EV/EBITDA multiple of 6x and EBITDA multiple of around 12%, which clearly looks good value. Strategically, C&G has three key attributes: Critical mass in Rmx by more than doubling existing Rmx plants by adding 13 Rmx, screed and mortar plants. Links up existing East Anglian and East Midlands activities to enable scale economies. 24 million tonnes of reserves at the three quarries enables internally-sourced sand & gravel for own use, whereas previously Breedon had to buy aggregate in the open market. It is not possible to quantify Breedon s potential in terms of ability to purchase businesses, but C&G provides an excellent case study in this respect. Moreover, we believe there are two factors that investors should take comfort from in this regard. The management team comprises Chairman Peter Tom (ex-ceo Aggregate Industries), CEO Simon Vivian (ex-main board director, Hanson Building Materials Europe), CFO Ian Peters (ex-finance Director, Hanson Building Materials Europe), Breedon Scotland CEO Alan Mackenzie (ex-wimpey, Tarmac) and Breedon England CEO Tim Hall (ex-tarmac). This, in our view, is one of the most experienced teams in the industry, which we believe is key both to knowing potential targets and ability to integrate these. Given consolidation of the industry plus difficult macro conditions that are likely to prevail for some time, the group has suggested that it sees a number of opportunities at the small to mid-end of the market. This fits in with the recent 15m placing to be used to acquire in this area, as we discuss in this document. We have argued above that Breedon Scotland has been more well-established than the English operation, and the clear implication is that England required more remedial work. 11

12 Below we list the key aspects of this action as undertaken by the Breedon management: Radical overhaul of health & safety, which has been manifest in better plant reliability and increased productivity. Restructured commercial organisation involving streamlined back office and more regional responsibility. Elimination of contracting losses from asphalt, which have moved from a 1.1m loss to a small profit as the business has been significantly downsized to the point where it handles base-load tonnage. Procurement increases have involved better cement and operating costs, full recovery of bitumen costs and over 1m of excess asset disposals. Vehicles have also been reduced from 66 to 40 and new owner-driver's introduced, thereby increasing the variable cost element of the business. Introduction of smaller volume sizes to niche markets and boosting the profile of Special Aggregates (a small, but very high margin aspect of the business). The results of the two factors together are illustrated below for Breedon England. Figure 3. Breedon England sales and EBITDA margin, E Sales ( m) A 2010A 2011A 2012E 2013E Sales EBITDA Margin 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% EBITDA margin Further progress expected in 2012, 2013 Source: Company, Numis Securities Research Department In 2010 the impact of higher costs hit the EBITDA margin as in the Scottish operation. With management actions in place and the initial impact of C&G, in 2011 England showed a good level of progress in terms of sales and EBITDA margin. However, with the EBITDA margin at 10.6%, it still underperformed relative to Scotland at 12.4%. With the benefit of C&G expected to continue to feed through in the current year and further gains expected from management actions, the gaps should close more. Macro conditions are likely to remain tough, but a higher focus on the private sector than in Scotland and signs of new housing activity improving should enable England to be the major driver of the growth over this year and next, in our view. Group The details for Scotland and England above demonstrate that Breedon has already seen some benefits of both organic and acquisitive growth, as illustrated by volume figures outlined below; Table 8. Breedon Group annual output, Volumes Aggregates (Mt) Asphalt (Mt) Rmc (M cu m) Total tonnage (Aggregates + Asphalt) Source: Company 12

13 Based on the activities above, we outline the breakdown of the business as below: Figure 4. Breedon sales breakdown, 2011 Figure 5. Breedon EBITDA breakdown, % 20% 9% 8% 27% 8% 9% 10% 35% 48% Aggregates Asphalt Rmc Specials Contracting Aggregates Asphalt Rmc Specials Contracting Source: Numis Securities Research Department Source: Numis Securities Research Department We have outlined both revenue and EBITDA because of the different margins we expect each of the activities to make most notably on contracting, though Rmx will also make a lower margin structurally than primary aggregates. Using this breakdown together with our view of end-user market breakdowns, we derive the following EBITDA breakdown by end-user for Breedon Aggregates. Figure 6. Group EBITDA exposure by end user market, 2011 % of EBITDA 40% 35% 30% 25% 20% 15% 10% 5% 0% 2% 2% 2% 2% 2% 2% 7% 2% 10% 2% 26% 5% 12% 6% 8% 1% New housing New private New public Public+ private RM&I Aggregates Asphalt Rmc Specials Contracting Macro outlook points to tough times ahead Source: Numis Securities Research Department In our view, the New Public and RM&I (which for the most part road maintenance through asphalt exposure) combine to approximately 55% of EBITDA exposure are the largest markets for the group. New private (commercial + industrial) accounts for just over 20% of exposure, and there is also an element of private sector RM&I in this area also due to asphalt products feeding into the retail/commercial/leisure markets. The new housing market is some 15% of total EBITDA exposure on Numis estimates. With most independent commentators predicting overall activity to decline in 2012 on the back of falling new orders as illustrated in the following table, industry volumes can be expected to decline. 13

14 Table 9. UK Construction new orders, (%) Public housing Private All housing Infra Pub nonresid Industrial Commercial All nonresid All work Public (incl. Infra) 2007/ (3) (1) (8) /2007 (17) (43) (38) (26) (27) (11) (18) 16 (32) 2009/ (31) (23) 40 0 (39) (45) (18) (19) 12 (41) 2010/ (11) (9) (20) 5 (6) 3 (7) /2010 (24) 8 0 (15) (32) 3 (3) (16) (12) (25) 2 Private % of total Ability to normalise to 15% EBITDA margins Source: NAO Breedon is not immune to this outlook, but we would also point out that its relatively small scale, while the fact that with no client accounting for more than 5% of total sales we believe the group can at least offset the volume decline we would expect for the industry over the next two years. Thereafter, we believe there are two key drivers of the business in keeping with progress to date in Breedon England which are important: Scope for acquisitions. We have outlined in the section on England above that we see scope for significant growth through acquisitions, but clearly at this stage it is not possible to quantify this fully. We would point out, however, that on the recent placing to raise 15m was, in our view, to be used to acquire further small bolt-on acquisitions. On the basis of the success and metric of the C&G deal, bolt-on acquisitions could contribute over 20m to sales (+11% relative to 2012 estimates) and 2.5m to EBITDA (+13% relative to 2012 estimates), which would underpin growth. Perhaps more definite is the management strategy to increase the profitability of the group to be the best in the industry. We believe that this equates to an EBITDA margin of c.15% in the business. While we believe this will only take place incrementally and require some aspect of macro recovery, we believe that through self-help and best practice the EBITDA margin could get to over 13% indicating that this normalised profile points to material profit growth potential relative to 2011 actual results. 14

15 Table 10. Breedon targeted returns vs 2011 actuals ( m) 2011A Normalised Sales England Scotland Total Sales EBITDA England Scotland Central costs (2.3) (2.5) Total EBITDA Sales (% chge) England Scotland Total Sales EBITDA Margin (%) England Scotland Total EBITDA margin Depreciation & Amort England (5.0) (5.4) Scotland (6.4) (6.2) Total DA (11.4) (11.6) EBIT (pre central costs) England Scotland Total EBIT EBIT Margin (%) England Scotland Total EBIT margin Source: Company, Numis Securities Research Department We assume that revenues would need to be around 25% above 2011 levels to attain normalised profitability, implying a return to 2007 type levels of activity. With this recovery plus management initiatives in place, we estimate that the group can move up to an EBITDA margin of 15% across the Scottish and English operations, implying a 9.5% EBIT margin for the group as a whole. We discuss the implications for valuation in this document. 15

16 Pre-tax and cash flow forecasts Based on our divisional analysis outlined above, the table below gives a detailed breakdown of our 2012 and 2013 estimates: Table 11. Breedon Aggregates Profit & loss, E Year end December ( m) 2010A 2011A 2012E 2013E Revenue England Scotland Group total revenue % Change EBITDA England Scotland Central Costs (2.0) (2.2) (2.2) (2.2) Total EBITDA % Change (17.0) Depreciation & Amortisation (12.3) (11.4) (11.7) (11.6) Operating profit Return on sales (%) % Change (50.2) Associate Total net finance (6.5) (4.8) (4.4) (4.4) Exceptionals (9.9) Reported Pre-tax profit (14.4) Adjusted Pre-tax profit (4.5) Tax charge (%) Reported 0.0 (20.0) (24.0) (24.0) Adjusted 0.0 (20.0) (24.0) (24.0) Net income: Reported (14.4) Adjusted (4.5) Avge. No shares - Fully Diulted England the major driver of growth EPS reported (p) (5.3) EPS - Adjusted (p) (1.6) Source: Company, Numis Securities Research Department As we have outlined above, our estimates are mostly predicated on England being the major growth driver over 2012 and 2013, in part due to the C&G acquisition but also reflecting the ongoing benefit of management initiatives. Scotland is likely to face a flatter profile, but against a difficult market backdrop we believe that current workloads plus lower cost pressures should enable incremental growth in EBITDA over this year and next. 16

17 The following table outlines the cash flow profile over the same period. Table 12. Breedon Aggregates cash flow, E Year end December ( m) 2010A 2011A 2012E 2013E Operating profit (8.5) Depreciation Work. capital (7) (2.5) (1) (0.5) Net profit fixed asset sales (0.5) (1.5) 0 0 Pension charge 0 (0.4) 0 0 Net cash from operating (3.4) Interest paid (6.5) (4.6) (4.8) (4.4) JV dividends Dividends Finance servicing (6.5) (3.7) (4) (4) Taxation (0.5) 0 (1) (1) Capex + intangibles (3.5) (6.7) (6) (8) Acquisitions 0.0 (9.8) 0 0 Disposals Other Investing activities 7.0 (13.3) (6) (8) Net cash movement pre financing (3.4) (4.5) Gearing high, but backed by very robust balance sheet Closing net debt SHF Gearing (%) Source: Company, Numis Securities Research Department The table above illustrates that in the current year we expect net debt to decline, though for the most part this reflects the 15m placing in April 2012 of 83.3 million shares that the group is looking to use to fund small acquisitions. This aside, there are no major movements in the cash flow of note. Net debt at year-end 2011 was 96m, of which net bank debt was 74.8m and finance leases were 21.4m (of which leases less than one year were 5.1m and over 1 year were 16.3m). We anticipate that finance leases will be paid down through operational cash flow so are unlikely to impact on net debt. While the gearing level is high compared to other companies in the sector, an important point, in our view, is the robust nature of the balance sheet in this regard. The table below outlines the key aspects of this. One aspect we would draw attention to is that mineral reserves of 72m in the balance sheet effectively equate to 36p/tonne based on total reserves of 200 million tonnes. Clearly as these are held at cost/lowest realisable value we do not expect these to increase, but believe that this demonstrates the conservative nature of the balance sheet. 17

18 Table 13. Breedon Aggregates Balance Sheet, Year end December ( m) Intangibles Tangible fixed assets Reserves Land Plant Total Deferred tax asset Associate investments Stocks Debtors Creditors (27.6) (33.4) Working capital Net operating assets Bank loans/overdrafts (95.6) (97.1) Cash/investments Net (debt)/cash (91.9) (96.2) Deferred creditors and income Pension liability (0.3) (1.1) Provisions (6.3) (7.2) Other 0 0 Total capital and reserves Balance sheet ratios W/capital % of turnover Gearing (%) ROCE (pre-tax) (%) ROE (post tax) (%) (7.9) 2.1 Reserves (Mt) Reserves Balance sheet value ( /t) Source: Company 18

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Distribution of Ratings US Requirement 01/04/11-31/03/12 All Securities Corporate Clients UK Requirement 01/01/12-31/03/12 All Securities Corporate Clients Buy 42.2% 70.8% 49.1% 75.5% Add 23.6% 19.8% 20.9% 16.3% Hold 28.0% 9.4% 25.9% 8.2% Reduce 2.9% 0.0% 2.6% 0.0% Sell 3.2% 0.0% 1.4% 0.0% 100% 100% The above table shows the split of recommendations based on the last recommendation for each research stock during the last four calendar quarters. The above table shows the split of recommendations based on all recommendations during the last calendar quarter for all securities and within each category the proportion of issuers to which Numis supplied material banking services. For the split of recommendations by sector for the period from 1 Jan 2011 to 31 Dec 2011, please contact the Research Department of Numis Securities Ltd. The following graphs display the three year recommendation, target price and share price history for the subject corporation(s) of this research report. 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