Australia | May 09 2019
Brokers laud CSR for being on the front foot in mitigating the volume losses from the housing downturn, yet expect FY20 will be a challenging year.
-Initiatives and flexibility in cost base should counter reduced building activity
-Less exposed to multi-residential dwellings but downturn will still hurt
-Conditions could change quickly with supportive fundamentals
By Eva Brocklehurst
A soft outlook prevails for building products supplier CSR ((CSR)) as the housing downturn gathers pace. Lower prices and higher costs are also affecting the company's aluminium business, making FY20 a challenging year. Management is well aware of this and intends to mitigate volume losses by improving the cost base. The Darra site in Queensland and one kiln at Cecil Park in NSW will be temporarily closed.
CSR expects the downturn will be short lived, noting some signs of market stabilisation, but has not provided specific guidance for FY20. The company also pointed out that only 11% of revenue is exposed to multi-residential buildings, which have experienced the greatest weakness so far.
Citi asserts the major impediment in the housing market is the availability of credit rather than the price of credit and population growth should stabilise the Australian housing market over time.
The company reported underlying net profit of $186m in FY19, at the higher end of guidance. The weak point in the result was operating cash flow, Ord Minnett observes, as working capital and cash restructuring charges affected conversion. That said, the company has a solid position in terms of cash which provides ample room for investment or buybacks. Citi agrees the balance sheet provides support for buybacks or opportunistic acquisitions.
Ord Minnett expects the volume declines of -3-4% that were experienced in April will deepen across the rest of the year. Earnings (EBIT) for the building products division are forecast to ease by -11.7% in FY20. Aluminium sales and earnings are expected to decline -3.0% and -26.2%, respectively, in FY20.
The company has outlined a number of initiatives, amid flexibility in its cost base, to counter reduced market activity. Macquarie cites these as being more flexibility in brick capacity, overhead consolidation and the displacement of/reduction in low-margin exports.
Credit Suisse agrees there is perhaps greater leverage for CSR than the market realises, yet downgrades to Underperform from Neutral, assessing the downturn in housing activity is only just beginning. Building products earnings were in line with expectations, albeit net of $11m in unexpected restructuring costs taken below the line. A second-half increase in coal costs implies an FY20 impost that is $10m higher, in addition to other costs incurred in the second half.
Morgan Stanley agrees there are too many headwinds. The broker accepts the business is primarily exposed to the less-volatile detached dwelling segment but revenue and margins are likely to still be under pressure.
The aluminium business has endured higher prices for electricity and the pass-through of higher coke and pitch prices, and these pressures are expected to continue into FY20, along with higher alumina prices. Yet, energy cost increases appear to have run their course and management has indicated there is potential for power costs to pull back.
Citi also points out the new Hebel (blocks) manufacturing facility should help reduce import costs and improve margins, while recent data from the Australian Bureau of Statistics shows price increases for building products, which should benefit CSR. Plaster prices rose 4.4% and clay bricks 5% in the March quarter. Prices for fibre cement also increased for the eight straight quarter. Insulation products have continued to fall.
CSR confirmed that half of its new alumina contract will be at an 18-18.5% linkage to the London Metal Exchange, up from 15%. Citi estimates each 1% increase reduces net profit by -3%. CSR maintains a view that the alumina market will normalise once Alunorte is back in full production so is only taking up short-term contracts.
The property division, which re-zones and refurbishes residential and industrial sites, continues to experience strong demand. There is strong demand for industrial property, particularly in western Sydney. The company will take advantage of this with two major projects, in Horsley Park and Badgery's Creek.
While the quantum of earnings may fluctuate because of the timing of transactions, Credit Suisse believes the ongoing development of a number of major projects will support property earnings over the next 10 years.
Morgan Stanley suspects the CSR share price will over-correct to the downside and provide an opportunity for patient investors, but this remains some way off and caution is required at present.
Macquarie comes to a similar conclusion, given the company's readiness to cope with the downturn. The balance sheet is strong and there are cost and efficiency-enhancing products in the wings. All up, this should provide an emerging opportunity.
Management has noted that conditions could change quickly in the context of supportive fundamentals such as interest rates, employment and population growth. A new CEO is expected to be announced before the AGM in June.
FNArena's database shows four Hold and three Sell ratings. The consensus target is $3.22, signalling -3.6% downside to the last share price. The dividend yield on FY20 and FY21 forecasts is 6.9% and 6.6% respectively.
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