James Hardie Cautious But Sell-Off Unjustified

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Investors were disappointed with James Hardie's first quarter because of cautious management commentary but brokers suggest the sell off in the stock is not justified.

-Business outlook remains sound
-Reduced tax rate pulls net profit guidance in line with forecasts
-Asia-Pacific exceeds expectations
 

By Eva Brocklehurst

James Hardie ((JHX)) underwhelmed brokers with its first quarter results, as cost inflation guidance has been revised upwards and a lower tax rate was the main contributor pushing net profit guidance close to expectations.

UBS suspects the disappointment stems from a lacklustre description of the state of the business currently, in the face of favourable expectations going into the quarter. Despite management stating the order book is not where it should be for hitting FY19 targets, and requires increased traction, the broker has no reason to believe the underlying result is not sound.

North American operating earnings (EBIT) of US$107m for the quarter compare with the broker's estimates of US$130m, while volume growth of 5% compares with expectations of 8%. As background, commentary from US home builders and building materials suppliers is positive and, therefore, UBS considers James Hardie's business is sound, even with cost pressures. Should these pressures moderate, margin expansion could follow.

Two new mega-plants are expected to reduce transport costs and provide access to lower-cost inputs. Details are expected with the US tour in September.

The quarter was a little bruising in Morgan Stanley's view, but primary demand showed some modest growth and, with concerns regarding the housing market prevalent, and an upcoming change of managing director, a range-bound period is the most likely scenario

The result included an effective tax rate of 17.1% and was well below forecasts. Morgan Stanley's forecasts, therefore, increase solely because of adopting the guided tax rate. The broker believes the business is well-positioned to benefit from further growth to a mid-cycle level of US housing and grow share at the expense of an inferior vinyl siding product.

Macquarie accepts the first quarter results were broadly in line because of a sustainable reduction in tax rates but believes the market overreacted to the news. The broker suggests US market support and tax changes are more permanent than perceived.

Management's expectations for growth and activity is central to optimism and the broker suggests fast-growing US construction employment should help with this. While volume improvement in North America has been some slower than expected unit costs have stabilised and prices have overcome the cost imposition.

Maiden net profit guidance for FY19 of US$300-340m is in line with Credit Suisse forecasts yet a lower tax rate necessitates a downgrade to the broker's FY19 operating earnings estimates of -3%.

The company has failed to provide meaningful share growth for five quarters in a row, and management has showed a lack of understanding as to why. Credit Suisse acknowledges there was little encouragement in the results but believes good momentum in manufacturing and strong and market demand will manifest in an improvement through FY19.

Costs for pulp from freight continue to rise, although the company managed to hold margins at the upper end of guidance, Citi notes. Management has conceded that second quarter orders have lagged expectations.

Ord Minnett upgrades to Hold from Lighten. The broker believes James Hardie should trade at a premium, particularly given the EPS growth outlook, which suggests a compound annual growth rate of 18%. Management has signalled continued momentum will be required to reach full year targets and the broker factors in primary demand growth of 3% for FY19 and 6% for FY20.

Asia-Pacific

Asia-Pacific stood out and several brokers, including UBS, believe this region has been overlooked. Volumes were up 15% year-on-year. Despite the subdued nature of the result, CLSA suggests James Hardie has a pedigree product offering and a strong market strategy and Asia-Pacific continues to exceed expectations.

Fermacell

This was the first full quarter that James Hardie owned Fermacell and the merger appears to be working smoothly. CLSA also notes there are US$31m in costs related to the acquisition of the European business, which will not be repeated in FY20. The broker, not one of the eight stockbrokers monitored on the FNArena database, upgrades to Buy from Outperform and raises the target to $27.20.

The challenges ahead include the integration of Fermacell and developing a European fibre cement strategy. Hence, Morgan Stanley would prefer to wait for announcement on the future managing director, and any likely changes to strategy, before adopting a more positive stance, maintaining a Equal-weight rating. Citi, meanwhile, is pleased that margins for the European business have grown to 11.9% from a starting point of around 10% on acquisitions.

FNArena's database shows five Buy ratings and two Hold. The consensus target is $24.46, suggesting 12.6% upside to the last share price. This compares with $25.08 ahead of the result.

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