Investors should be careful but not overly cautious about the building sector, writes Barry O'Halloran

HOUSE BUILDER McInerney Holdings' share price was down by more than 6 per cent by lunchtime yesterday, despite the fact that the 2007 figures it released in the morning were broadly in line with expectations.

Shortly after the results came out, Davy analyst Flor O'Donoghue said the stockbroking firm was "cautious" on McInerney's prospects for the year ahead.

"Cautious" means "go carefully", and while it definitely does not mean you should stock up on McInerney shares, neither does it mean "sell the company" at such a rate that it loses 6.25 per cent of its value in the space of a few hours.

The market's reaction tells you more about investors' jittery approach to the building business than it does about McInerney's actual worth as a company.

For the last few months there has been plenty of bad news on the building and housing front. The latest came this week when Britain's Royal Institute of Chartered Surveyors named the Republic's property market as the worst performer in Europe last year, with a decline of 7 per cent in prices.

The institute added that the fall was too much for a soft landing, and added that there was a marginally increased risk of a collapse, although it stressed that this is still a very small risk.

Housing registration agency, Homebond, followed this up with a monthly report showing that proposed new housing starts in the first two months of 2008 were 64 per cent behind the same period in 2007 and just one- quarter of the 2006 level. Sliding house prices are bad news for a company like McInerney that builds and sells new homes and, in its case, is focused on the Irish and British markets, both of which look weak for different reasons at the moment.

Its results came towards the end of a week where a few other notable names in the building game reported. They ranged from global giant CRH to Readymix, whose focus is strictly local (even though its biggest shareholder is Mexican multinational Cemex).

CRH, by far the biggest player in the sector, announced a 36 per cent increase in operating profits to €2 billion for 2007. The most significant feature was that virtually all the growth came in Europe, with some of its US divisions showing a decline in profit increases. This is a reverse of previous form, where the US drove most of the expansion.

As it had already flagged, Readymix saw its operating profits fall by 64 per cent in 2007. It blamed the slowdown in Irish building activity and a reorganisation for its bad fortunes.

Kingspan, which produces insulation and flooring products, put in a stellar performance last year. Operating profit rose by 22 per cent to top €236 million, while earnings per share grew at the same rate.

However, those results lost their sheen when the company warned that this year would be "appreciably behind the 2007 outcome", meaning that its profits would be down in 2008. The market did what it always does in this situation, and the stock dropped almost 5 per cent.

Kingspan's prediction gets to the heart of the matter for companies in this business. Readymix aside, last year's results were not bad. But past performance does not guarantee what will happen in the future. And it is what the next year or two holds that has investors worried. The key issue is credit, which is more expensive and harder to come by than last year, a situation that is going to last indefinitely.

Building is largely financed by debt. It follows that any increase in the cost of borrowing money does the same to construction costs. At the same time, demand for new houses and, it is feared, for commercial buildings, is waning.

If you are a builder like McInerney, or like CRH and Kingspan, you supply builders, this has obvious implications for your business. Readymix has already stated that it is going to focus on supplying Government-funded projects such as roads, rail and other infrastructure.

In a similar vein, CRH also said this week that it believes that US federal spending on highways will continue. It also hopes that the commercial building sector will hold up, compensating for the stagnant residential construction market. But at the same time, finance director Myles Lee said that it had "contingency plans" should things get worse in the US, and the group was not ruling out that eventuality. CRH chief executive Liam O'Mahony, who spent a long time in the US, stressed on Tuesday that it will come back. He was unwilling to put a date on when, but, based on previous experience, he said the slowdown was more likely to be short-lived.

Merrion Stockbrokers analysts John Mattimoe and Killian Jones recently recommended buying CRH shares and set a target price for the stock of €33. Yesterday afternoon, it was trading at around €25. Whether the company hits that target is another matter.

CRH is a huge company, one of the biggest in its sector in the world. It is a solid bet that it will be with us for some time. Both O'Mahony and Lee stressed this week that its operations are spread across multiple markets, products and services, which gives it greater resilience.

The other players do not have the same spread, but their story is not all bad either. Earlier this week, Flor O'Donoghue of Davy acknowledged that Kingspan could be in for an immediately bumpy ride. However, he pointed out that the long-term picture is good. Similarly, French institution Paribas recently published a research note on the company, recommending it as a long-term buy.

This is because Kingspan is catching what will ultimately be a rising wave. Developed nations are changing their regulations to make new buildings more energy efficient. Insulation products of the type in which the Cavan-based company specialises will form a key part of this.

In Britain, McInerney is negotiating sales of new homes to housing associations, which form a central plank of a government initiative to combat the country's housing shortage. Chief executive Barry O'Connor said yesterday that these deals would involve the sale of groups of houses rather than individual homes.

While the picture with Readymix is a bit cloudier, the company pointed out this week that it has a strong asset base and good cash balances, totalling €37 million.

The building industry is nowhere near out of the woods, and in some ways it may only be entering them.

Approaching it with caution is a good idea, but there's no reason yet to flee it in panic.