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James Hardie Set To Perform Strongly

Australia | Nov 13 2019

This story features JAMES HARDIE INDUSTRIES PLC. For more info SHARE ANALYSIS: JHX

James Hardie delivered a very robust first half, lifting forecast profit for the full year and raising expectations for a re-rating.

-Key external variables such as pulp and freight moving in the company's favour
-Increased investment may offset further benefits from lower pulp costs
-Stock expected to re-rate back towards an historical premium

 

By Eva Brocklehurst

James Hardie ((JHX)) has emerged from a period in which the US business was being hurt by higher raw material costs and capacity constraints, posting a strong first half result and upgrading guidance. The company now expects a profit of US$340-370m in FY20.

Problems with sales execution, cost pressures and inefficiencies prevailed just a year ago and, brokers observe, the company has now turned around, delivering ahead of plan amid benefits from lower cyclical input costs.

North America stood out as volumes grew by 4.9%, with 6% growth in exteriors and flat volumes in interiors. Ord Minnett notes sentiment is very positive on the stock but this lifts the hurdle for results to surprise on the upside, and also raises the risk of a correction if the performance falters.

Nevertheless, the broker does not believe the stock is expensive as it is trading on a forward PE (price/earnings ratio) of 19x, excluding asbestos, at a discount to historical levels. Key external variables are moving favourably, including US housing starts, pulp and freight costs.

Margins

Notably, margins improved the US, supported by a 190 basis points gain from “LEAN” manufacturing efficiencies and this sets up a margin range of 25-27% for the year. Ord Minnett estimates US$5-10m in LEAN benefits were achieved in the half.

Yet an enhanced margin performance in the second quarter (27.1%) has led to questions as to why management is not raising its long-term earnings margin target of 20-25% for North America.

The answer is management is intent on generating growth, and increased investment is expected from the second half onwards. The company plans to invest its efficiency gains in an enlarged sales and marketing effort to drive market penetration. Further benefits from lower pulp costs are also expected as FY20 unfolds further, although Citi suspects increased investment may offset this.

Credit Suisse models elevated margins for 18 months before investment catches up, and increases forecasts to reflect the primary demand growth (PDG) target of 5.5%. UBS also points to increased expenditure as evidence of why the long-term margin guidance has been retained.

To support long-term PDG the company will invest in analytics and innovation but is unsure at this stage just how much expenditure is required to underpin its target of 6% over the long term.

UBS remains of the view that 6% is unsustainable and assumes a long-term PDG of 3.5%. Ord Minnett assesses, while current levels of PDG are likely to persist through to FY22, a reversion to something more like 3% is realistic.

Re-rating Potential?

James Hardie continues to trade at a discount to the ASX Industrials and Morgan Stanley believes this discount disregards the quality and growth attributes of the business. A delivery on key PDG and margin milestones in the US, amid further growth in Europe, will mean the gap closes and the stock is expected to move to a premium.

Citi agrees the stock is more attractively valued than its domestic rivals and US peers and expects it will re-rate back towards its historical 5-20% premium to the ASX Industrials.

Investors value the stock for its PDG or the ability to take market share, UBS ascertains. As the US housing market improves, amid low mortgage rates, the macro backdrop should remain strong and drive a PE re-rating. Moreover, the broker believes the company has the right strategy and a cost reduction program to help fund this growth over the longer term.

A number of new products are being launched, with Macquarie noting the EasyTex application could open up a front against the stucco market in the US. Stucco has a 25% wall share in the US. The company has a 20% share of the new US siding market which, while impressive, means taking more share over the longer term will become expensive and challenging, UBS points out.

James Hardie continues to expect modest growth in the US, supported by the renovations market and offset by a slight contraction in new construction. Citi anticipates the recent recovery in US new housing starts should flow through to the third quarter, noting the company expects system growth of 1% for FY20.

Volumes in Asia-Pacific were still solid, Ord Minnett notes, given the moderating end markets. The company estimates the addressable market in Australia contracted -8-10% in the first half.

On the negative side, Europe missed many forecasts. In defence, UBS points out James Hardie has provided a new target for the European business which includes no real growth within the first three years. The company expects the European housing market to be slightly weaker in FY20 and aims to introduce new fibre cement products specifically targeted to the region.

FNArena's database has six Buy ratings. The consensus target is $29.89, signalling 5.0% upside to the last share price. Targets range from $28.50 (Ord Minnett) to $32.40 (Macquarie).

See also, James Hardie Discount Difficult To Justify on August 12, 2019.

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