Fletcher Building Limited is Australasia’s largest building materials supplier and one of the largest listed companies in New Zealand. The company traces its history back to 1909 when James Fletcher and his brothers began building houses in the country's southern-most city of Dunedin.
A large source of its growth came through acquisitions made in the last two decades of the 20th century, which, while great for scale, left the company saddled with debt and struggling to manage its sprawling empire. Recent years have seen the company divest assets and restructure, declare losses and writedowns from unprofitable projects, all while dealing with substantial legal challenges.
The company’s share price is a quarter of its 2007 peak. In August 2024, it reported a net loss highlighted by legacy provisions and writedowns, as it named a new CEO, who pledged a strategic review. Some brokers talked about mismanagement of capital after the company announced an emergency fund raise the following month.
It’s a remarkable fall from grace for an organization that up until 2016 ranked in the top 15% of companies globally for accounting quality and transparency, as measured by Transparently.AI’s Manipulation Risk Analyser (MRA). Unfortunately, as of 2024, Fletcher Building now registers in the bottom third of companies globally, and now demonstrates significant accounting issues on our system.
We will detail those issues identified by the MRA in this article. First, some background.
Table of contents
History of Fletcher Building
James Fletcher and his brothers opened their first retail outlet for materials in 1910. Five years later, they established Fletcher Bros. Ltd, which would evolve into Fletcher Building.
In the heady boom-bust years from 1980 to 2000, the company experienced several transformations. In 1981, it merged with Challenge Corporation and Tasman Pulp and Paper to establish Fletcher Challenge, New Zealand’s first true multinational. The merged entity focussed on construction, forestry, building materials, and energy. It subsequently grew through acquisition to be the largest company in New Zealand.
Fletcher Bros. yard, Dunedin (c.1913). Image source
The acquisition spree incurred considerable debt, and profitability fell as the sprawling entity proved difficult to manage. In 1993, Fletcher Challenge split into two separate market listings: Ordinary Division (pulp and paper, energy, building) and Forests Division (wood plantation assets).
In March 1996, the Ordinary Division was further split into Fletcher Challenge Paper, Fletcher Challenge Building, and Fletcher Challenge Energy. In December 1999, the Board decided to dismantle Fletcher Challenge entirely due to financial pressures exacerbated by high debt.
This decision resulted in a program of divestment and a final split in 2001, which saw the emergence of Fletcher Building. The new company had low gearing and credit risk and engaged in several strategic acquisitions through the 2000s that allowed the company to expand its operations both domestically and internationally. The company operated six divisions: building products, distribution, concrete, residential and development, construction and Australia.
The company successfully navigated the global financial crisis of 2008-2009 and benefitted from the subsequent recovery in housing and infrastructure spending into the mid-2010s. However, it faced operational difficulties, especially in its construction division, and profitability lagged. The share price never regained the highs seen in 2007. In 2016 and 2017, Fletcher Building suffered major losses due to unprofitable construction projects.
In November 2017, the company appointed Ross Taylor as the Group CEO amid ongoing restructuring efforts. Taylor had a background in engineering and construction, key areas where Fletcher was experiencing operational difficulties. Taylor was previously the COO at Lend Lease (1985-2009), CEO at Tenix Group Pty Ltd (2009-14) and CEO at UGL (2014-2017).
In 2023, just before Taylor joined, the Australian law firm Mayweathers brought a class action against Fletcher Building for misleading investors over its guidance for FY2017 and FY2018.
Problems at Fletcher Building
Taylor inherited about 80 loss-making projects, the biggest of which being the New Zealand International Convention Centre (NZICC). This project was awarded in 2015 and was scheduled for completion in 2019. It remains unfinished, partly due to a fire in 2019. That year, the company estimated that delays and cost overruns in this project might cost the company NZ$660 million.
To date, the company has recorded more than NZ$400 million in write-downs on a project initially estimated to cost NZ$500 million. The full-year loss it reported in August included NZ$180 million in provisions for its legacy construction projects including the NZICC.
The COVID-19 pandemic led to significant layoffs and financial losses at the company. In addition, the pandemic led to a nationwide plasterboard shortage that affected construction timelines across New Zealand.
At the present time, the company is fighting fires across multiple fronts, mostly linked to depressed market conditions and legal challenges. In addition to the class action suit, Fletcher Building is facing a legal challenge in relation to defective pipelines and legal proceedings from the NZ Commerce Commission regarding rebate structures associated with its Winstone Wallboard division.
The pipeline scandal stems from Iplex, an Australian subsidiary of Fletcher Building. It is alleged that Iplex supplied defective pipes to around 30,000 dwellings leading to widespread damage. Fletcher Building continues to refute those claims.
As a consequence of a succession of losses and earnings downgrades, the current share price is only a quarter of the peak attained in 2007. The company has faced criticism for its corporate culture, particularly in terms of leadership accountability, communication breakdowns, and a perceived sense of entitlement among its executives.
Taylor has resigned and the Chairman Bruce Hassall is due to step down after the AGM in October. The recent capital raising will alleviate financial pressure but there may yet be a risk of further write-downs.
Fletcher Building's accounting quality
Figure 1 provides our MRA’s overview of accounting quality at Fletcher Building. Through machine learning, the MRA has been trained to recognise risk signals across 14 accounting clusters, and flagged potential problems in 9 of them.
The most serious issues highlighted were in the clusters for income quality and gearing. The risk signals for cash quality, credit, asset quality, business manipulation and working capital were also highlighted.
Figure 1: Overview of accounting issues at Fletcher Building
Source: Transparently.AI
The main concern with respect to income quality relates to the abnormally high percentage of Fletcher Building's income derived from affiliates, non-operating sources and non-core business. When a high percentage of a company's income derives from non-consolidated entities, one-time events or abnormals, its accountants typically have wide discretion over how to record such income or losses.
Fletcher Building has such high levels of these three sources of net income that management has considerable scope in its income declarations. This is merely an observation. We are not suggesting that Fletcher Building is manipulating income, only to say that where our system has seen these conditions before, the opportunity for manipulation is high.
The MRA has highlighted gearing as an issue because the overall debt level is very high. In FY2024, the ratio of total borrowing to EBIT was 23.2x. This compares with a regional median of 2.65x. Where we’ve seen this type of gearing ratio before is in situations consistent with significant financial stress.
In addition, Fletcher Building has a very high level of lease obligations in relation to equity, according to our system. Lease obligations represent 35.88% of total equity versus the regional median of 0.97% and the regional sector median of 1.64%. Our software has identified a significant relationship between the extent to which a firm engages in leases and manipulation risk. That risk is magnified when a company has high gearing.
Fletcher Building’s high gearing goes hand-in-hand with weak credit quality. For example, in 2024 the company’s interest coverage (the ratio of EBITDA to interest expense) was just 2.72 versus a regional sector median of 13.76, according to our MRA.
Our system has also highlighted asset quality. Fletcher Building has a very high ratio of intangibles and investments in associates in relation to total assets. Intangible assets are non-physical assets that are not easily measurable or quantifiable, such as patents, trademarks, copyrights, goodwill, brand recognition, and customer relationships. Unlike physical assets such as buildings or equipment, intangible assets are often subjective in their valuation.
The primary risk with intangibles arises when companies fail to recognize losses in the value of such assets. Figure 2 shows that intangibles represent 12.07% of total assets at Fletcher Building. This compares with a regional sector median of 1.25%, according to our system.
Figure 2: High intangibles at Fletcher Building
Our system has highlighted cash quality as a concern. Fletcher Building has abnormally high non-cash items relative to cash flow. Non-cash items refer to expenses or gains that do not involve the exchange of cash and can include items such as depreciation, amortization and equity-settled share option expense.
In 2024, non-cash items in funds from operations excluding net income, depreciation, amortization and deferred taxes represented 119% of net cash flow from operating activities. The regional median was 6.9%.
Having such a high percentage of non-cash items makes it difficult to interpret a company’s financial statements because the relationship between reported income and cash flow is weak and may indeed be negative. The weaker the link between cash flow and income, the greater the risk that a company is using aggressive accounting methods. At a minimum, Fletcher Building’s accounts lack transparency.
There are other concerns, but the bottom line is that the quality of Fletcher Building’s accounts today is significantly worse than it was prior to 2017. In part, this deterioration reflects financial strain. Nevertheless, the level of transparency in Fletcher Building's accounts is worth questioning.
Disclaimer: Views presented in this blog are the author’s own opinion and do not constitute financial research or advice. Both the author and Transparently Pte Ltd do not have trading positions in the companies it expresses a view of. In no event should the author or Transparently Pte Ltd be liable for any direct or indirect trading losses caused by any information contained in these views. All expressions of opinion are subject to change without notice, and we do not undertake to update or supplement this report or any of the information contained herein.
About the author: Mark Jolley has been an investment strategist for almost 40 years and has advised some of the world’s biggest investment funds, public companies and notable investors. In the mid-1990s, as a global investment strategist with Deutsche Bank, Mark produced a daily note read by more than 16,000 investment professionals including voting members of the Federal Reserve and the European Central Bank. In the 2000s, Mark worked as Deutsche Bank’s Asian strategist and then as strategist for China Construction Bank. He is now an independent analyst.
