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James Hardie Discount Difficult To Justify

Australia | Aug 12 2019

Brokers note James Hardie is trading at a discount to industrials peers, which appears increasingly difficult to justify in the wake of a robust first quarter.

-Primary demand growth is now at the top end of target
-Risks to margins considered to the upside
-Slowing Australian housing likely to drag on the business

 

By Eva Brocklehurst

James Hardie ((JHX)) strode ahead of its competition in delivering solid growth in North America in the first quarter. Brokers observe management is starting to enjoy success as it rolls out the transformation program (LEAN) across its 10 North American plants. This provided momentum at what is arguably a bottoming of the US housing market, Citi contends, calculating that if the company delivers on targets, three-year compound growth could reach 20%.

Earnings (EBIT) in North America constituted US$113m out of the total US$124.4m on margins of 25.1%, ahead of the company's target range of 20-25%. Moreover, primary demand growth (PDG) of 5% was at the top end of the FY20 target of 3-5%.

Credit Suisse points out management claimed there was nothing unusual in this report, yet did not raise guidance. The broker acknowledges there is always variability in quarterly results, and receivables did increase versus the prior comparable quarter, implying some normalisation. Credit Suisse increases its estimate for PDG marginally to 4.0%.

The stock's PE multiple de-rated over the past year as concerns grew regarding the sustainability of PDG and market share in the US, along with weak housing activity. On the back of this result, UBS notes confidence has improved. Nevertheless, growing at above-market rates is likely to be more difficult and costly in time.

Morgan Stanley believes the result will satisfy any concerns around the PDG target. Despite the strong response in the share price, Morgan Stanley still assesses James Hardie is trading at a discount to its industrials peers, which is difficult to justify. The company has now delivered on the key pillars of its investment thesis – PDG and margins – and, hence, the broker suspects the discount will continue to close.

Exterior volumes grew 5% while interiors were down -3% over the quarter. Macquarie believes the strength in exteriors, which surprised some investors, was partially explained by the company's sub-regional exposure to markets that were comparatively solid. There was also a strong performance for renovations in the north-east of the US.

Macquarie also notes James Hardie is making headway in commercial initiatives and although it is shedding some base business, this is occurring at a diminishing rate. The broker believes a realigned engagement with the retail channel is having a moderating impact on the weakness experienced in interiors in the quarter.

Volume growth has been partly the result of better control of distribution channels and management highlighted its success, having noted there was some PDG loss from negative perceptions previously. The company also emphasised that the improvement was not a result of channel stuffing or a pulling forward of sales.

Margins

The company has now upgraded earnings margins for FY20 to the top of its target. Citi lifts margin estimates to 25.5% for FY21 and 25.8% for FY22, stemming from the cost savings expected. The company has confirmed that it is on track to deliver US$100m in cost savings over FY20-21. Morgan Stanley believes margin should at least be maintained, with the risk to the upside.

Australasia/Europe

In Australia local currency earnings eased -5%. Approvals for detached houses for the June quarter were down -17% and the alterations and additions market volume was down by -1%. NZ earnings also fell in the first quarter, primarily because of unfavourable plant performance and higher input costs.

Volumes rose 11% in the Philippines as a result of further market penetration. In Europe, building product sales were up 7% and earnings margins were 10.7%. Europe was disappointing, in Macquarie's view, as price and volume outcomes were weaker than expected. Nevertheless, the integration of Fermacell is progressing and costs are within budget.

The company plans to introduce its LEAN to the five European plants, beginning in the third quarter of FY20. James Hardie has provided a 10-year target for the European business which UBS notes includes no real growth within the next three years. However, the broker envisages some upside in the short term.

Ord Minnett assesses the stock has had a good performance for the year to date and FY20 guidance is likely to be conservative. Investor briefings over the next month in Europe and the US should improve sentiment further.

Macquarie points out, while still a headwind in the June quarter, if spot prices prevail in this should mean solid reductions in pulp pricing benefit the company. However, gains in terms of freight costs will moderate as the year progresses if spot prices prevail.

The stock is trading on a PE multiple of 18x 1-year forward earnings (excluding asbestos), at a discount to historical averages, Ord Minnett notes. As pulp prices are now moving more favourably and there is benefits from the transformation program, the broker believes there is plenty of room for savings to drop to earnings and/or be reinvested to accelerate PDG.

UBS agrees this is the case and upgrades to Buy from Neutral, noting the company is back near a market multiple but there is still room for re-rating higher and James Hardie has both the financial capacity and the right strategy.

FNArena's database shows six Buy ratings for James Hardie. The consensus target is $24.39, suggesting 8.2% upside to the last share price. This compares with $21.28 ahead of the results. Targets range from $23.50 (Ord Minnett) to $25.35 (Macquarie).

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