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Will Softer Housing Take The Gloss Off Dulux?

Australia | Mar 09 2016

-Main advantage is in home renovations
-Little stock price upside likely near term
-Strong market share and balance sheet


By Eva Brocklehurst

Morgans has taken up coverage of DuluxGroup ((DLX)), highlighting the company's quality portfolio of well known brands, including its eponymous paint, Selleys sealants and adhesives, Yates garden products, Cabot’s wood stains and B&D garage doors & openers.

These brands are some of the most recognised and trusted in the housing and renovations industry and hold market leading positions in their respective categories. Yet the main advantage, from the broker's perspective, is that the business is skewed to the maintenance and home improvement segment, this being 65% of its revenue.

The renovations segment does not have the peaks and troughs that are evident in the housing construction category. The company's strategy is centred on home improvement, and while forgoing some of the potential upside from the recent strength in building activity, earnings are expected to be shielded in any pull-back.

Building activity in Australia has risen to record highs in FY16 but recent data suggests activity is weakening. Nevertheless, any slowing in housing over the next few years is not expected to have a major impact on the company's earnings growth. Morgans expects 7.2% earnings growth in FY16 and 6.3% in FY17.

The balance sheet is strong, despite the planned outlay of $130m on a new paint factory in Melbourne. This plant will be completed by the end of 2017 and will produce nearly all the company’s water-based decorative paints. The existing Rocklea factory will focus mainly on production of solvent-based paint products.

In addition, the company will construct a new distribution centre in Sydney to replace two existing centres. The facility will be built, owned and operated by Linfox to Dulux specifications and should open in late 2016. To Morgans, this merging of the two distribution sites makes sense given lower operating costs and increased efficiencies and is expected to be positive to net present value.

The broker kicks off its coverage with a Hold rating, as the qualities of the company appear reflected in the current share price, but would reconsider its view on any share price weakness. Target is $6.18.

Morgans suspects there is relatively little potential share price upside in the short term but there should be an opportunity in the future for investors to pick up the stock at more favourable price points. The broker believes a small premium in valuation is justified given the dominant market share, strong brand and solid financials.

Dulux holds the number one market position in the Australian paints market with a current market share around 40%. The business has proven to be stable over time, with relatively defensive earnings. Morgans believes it has the ability to pay down debt quickly if necessary. The broker also likes the fact the company is continually innovating, making a number of improvements and adding new products to the market each year.

Paints, coatings and adhesives are distributed through retail and trade channels. Product is stocked in over 800 retail outlets across Australasia and sold via 240 ore more trade centres and depots. Garage doors & openers are marketed via dealers and the cabinet & architectural hardware sells mainly to the trade.

In December, Deutsche Bank observed the company's commentary contained a softer outlook for 2016, in relation to new housing as well as the commercial & infrastructure markets. The broker maintains a Sell rating. Morgan Stanley shares the same concerns, with an Underweight rating, believing the potential for earnings upside is factored in and growth is expected to be trending flat by FY18.

Citi, on the other hand, does not share the fears about a downturn in the housing cycle, given the company has a healthy balance sheet and a dominant market share in paints. Morgans, too, acknowledges the company is exposed to a subdued macro economic environment, but points to its record of growing earnings despite very tough conditions during the GFC.

The FNArena database shows one Buy rating (Citi), with four Hold and two Sell. The consensus target is $5.86, suggesting 6.2% downside to the last share price. Targets range from $4.25 (Deutsche Bank) to $6.88 (Citi).

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