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Is James Hardie Biting Off More Than It Can Chew?

Australia | Sep 21 2016


Brokers are positive about James Hardie's strategy in the US but remain wary of the amount of time and financial investment required.

-FY17 profit outlook within reach, underpinned by US housing market growth
-Expanding capacity amid plans to identify further opportunities outside fibre cement
-Are consensus capital expenditure assumptions too light?


By Eva Brocklehurst

James Hardie ((JHX)) has provided detailed presentations as part of its US investor tour, highlighting the company's market potential and plans to expand. FY17 underlying profit guidance in the range of US$260-290m is maintained, unsurprising for most brokers given the recovery going on in the US housing market.

The company is rolling out capacity expansion and assessing greenfield projects for construction over 2-3 years at an estimated cost of US$70-120m.

Ord Minnett remains of the view that the company will deliver strong volume and earnings growth in coming years but not without significant investment, from both a financial perspective and in terms of management time.

James Hardie is expanding its management roles and seeking to improve retention in the ranks and, with the changes, the broker suspects there is increased risk of distraction and disruption within senior management.

There is a temptation to get bogged down in the detail of the company's plans and forget about the big picture, Credit Suisse suggests. The housing cycle is still experiencing a strong tailwind and new capacity is expected provide a robust platform for further growth. Near term, the broker identifies risks around this new capacity coming on line and the potential for increased inefficiencies.

The commissioning of four new brownfield facilities will be followed by greenfield capacity and the balancing act required has the potential to create margin volatility, the broker asserts. FY17 capital expenditure is expected to be around US$100m which should increase in FY18-19 as costs ramp up, although the specific timing and magnitude is unclear.

Credit Suisse believes the company's FY17 profit outlook is within reach, underpinned by margins at the top end of the 20-25% range and broader US housing market growth. The fundamentals also support a rating agency review, in the broker's view, with the potential for an upgrade to investment grade in the next 12 months.

James Hardie re-stated its 35/90 strategy, which is an aspirational target to grow fibre cement's share of the US cladding market to 35% and its share of that market to 90%. Deutsche Bank notes, for fibre cement to achieve the 35% target management has now stated an 8% primary demand growth (PDG) target per annum. The broker calculates, on this basis, James Hardie would achieve the 35% target by FY25. Deutsche Bank currently forecasts PDG of 6% in FY17 and 8% in FY18.

Deutsche Bank notes the company is currently trying to identify another three opportunities outside of fibre cement to drive growth beyond FY25. In addition, an increased focus in selling fibre cement to geographies where James Hardie currently has no presence is intended to drive longer term profitability.

Citi also notes the focus on people, tactics and markets with little change in strategy. The broker believes the company is unique in that it offers market growth, enviable margins, robust cash flow and a transparent management team.

The business may be large but management is demonstrating and acknowledging the challenges of being high growth, the broker observes, and the clarity that management has shown with regard to the issues suggests that any necessary change will be via modification and adjustment rather than major dislocation.

Citi believes the company has the capabilities and capacity to gain further market share in the US while the biggest risk in the short term is a faster-than-expected recovery in the US housing market, as this may upset the trajectory of the company's plans if it becomes short on capacity. Citi expects US housing starts to grow a double digit rates over the next three years as the market recovers.

Morgan Stanley recently downgraded the stock to Equal-weight and the investor briefing underlined its view that consensus capital expenditure assumptions for US$80m per annum over the next three years are too light. The broker expects expenditure of US$130m in FY18 and US$210m in FY19.

Morgan Stanley believes margins need to improve by 50 basis points from the first quarter North American fibre cement margin to obtain FY17 net profit of US$275m – the mid point of guidance – and suspects this may be too high.

This broker also cites the potential for inefficiencies to creep in from the ramping up of new production lines. While higher utilisation of the plant through FY17 may mean lower than average seasonality, Morgan Stanley still expects a decline in margins over FY17.

On a positive note, the broker likes the strategy to increase the share of the interior market to 50% from 40% over the medium term, with product additions and greater revenue targeted across the portfolio.

There are four Buy ratings, two Hold and one Sell (Ord Minnett) on FNArena's database and not all brokers updated after the US investor tour. The consensus target is $21.84, suggesting 6.3% upside to the last share price. Targets range from $18.60 (Ord Minnett) to $25.00 (UBS).

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