Australia | Feb 06 2019
The new CEO of James Hardie has outlined significant cost reduction plans and committed to previous market share ratios and earnings margin targets.
-Main pillars of broker investment views are maintained
-Still, targets are above trend results in most instances
-Primary demand growth to be driven by increased flexibility from cost reductions
By Eva Brocklehurst
Brokers had keenly awaited the strategic outlook from the new CEO of James Hardie ((JHX)), Jack Truong, and were not disappointed. Key growth and market share targets have been reiterated and there is a new cost reduction target for manufacturing.
A slightly softer result in the third quarter was overshadowed by the positive update on strategy and the ambitious targets, in Morgan Stanley's view. While primary demand growth (PDG) was somewhat disappointing the broker wonders whether there may have been more impact from the weather than the company has allowed for.
Importantly, the main constructs of the investment thesis are maintained, with a commitment to the 35/90 market/category share ratios and the 20-25% earnings margin target. The goal of maintaining 6% US PDG was also reiterated, although the timeline has been extended to FY21.
Credit Suisse welcomes the change in the sales approach, to an emphasis on retaining and growing existing customers. The broker believes some caution is warranted, nevertheless, as the company's targets are above trend results in most instances. Still the stock appears cheap relative to historical levels, amid expectations of market share momentum and internal efficiency measures.
A driver of the de-rating over the past year has been the underwhelming market share gains in North America, Ord Minnett points out. The company has attributed this to erosion of its business with existing customers.
Hence, James Hardie will restructure the sales force with incentives to limit the impact. Deutsche Bank believes management is correct to focus on base customer share but believes this is unlikely to be accomplished in time to achieve the upper end of its PDG target.
Amid concerns about US housing weakness, Deutsche Bank was pleased to observe strength in the forward book, which allowed management to tighten its guidance range. Net profit guidance for FY19 has been narrowed to US$295-315m, which represents a 2% upgrade to prior forecasts at the mid point.
While the US housing market trajectory is uncertain and there are supply-side and affordability challenges, cost pressures have moderated, although pulp remains relatively elevated. Citi flags a noticeable pick-up in North American operations in recent months as raw material headwinds have subsided.
Management has indicated that the main driver of lower earnings in the third quarter were input costs. Yet, pulp prices have started to plateau. If pulp prices continue to ease Citi suggests an earnings tailwind may emerge in the first half of FY20. Separately, the company has confirmed a 2% price hike to take effect from April.
While the potential for internal initiatives to unlock value appears achievable, the cost to serve is likely to lift as the company's position in the US becomes more akin to a mature business, UBS asserts. This makes the 6% PDG target something that the market is unlikely to price in.
Primary Demand Growth
Estimating PDG is somewhat of an "art", UBS adds and, while believing the share price can rally further, remains cautious about the challenges that still exist in the US housing market as well as increasing costs to serve new customers and lost traction in PDG.
Still, increased flexibility in the business from cost reductions, which will allow reinvestment in marketing and new product, should drive PDG and, as the goalposts are now set, the broker's focus shifts to execution in FY20.
PDG in North America is expected to be 3-5% in FY20 and 6% thereafter. In Asia-Pacific the focus is on 3-5% PDG while James Hardie intends to build a EUR1bn revenue base over 10 years in Europe.
Morgan Stanley found little extra detail on the strategy for Europe although the targets of 14% revenue growth out to 2022 and an exit EBIT margin of 14%, if achieved, would present meaningful upside to forecasts.
Cost Reduction Targets
The cost reduction plans are significant, Macquarie suggests, being a systemically important intervention that enables 35% market penetration in the long-term and underpins confidence in the profit profile. Management has announced US$100m in cost reductions over three years in North America.
Macquarie suggests the key messages from a strategic point of view should be well received and the relative and absolute valuation remain attractive. The broker was less enthusiastic about North American volumes and price growth.
The strategy also triggers a more proactive stance on the interiors business with the launch of a new waterproof back board, which may return this segment to growth, Morgan Stanley adds.
FNArena's database is replete with seven Buy ratings. The consensus target is $20.95, suggesting 26.4% upside to the last share price.
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