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Treasure Chest: Sun Shines For James Hardie

Treasure Chest | Apr 28 2020

James Hardie's share price implies very conservative long-term estimates and Ord Minnett suggests this is an opportunity in the making.

-Share price implying minimal primary demand growth
-Has already corrected enough to reflect weak US demand
-Long and proven record of market share gains and returns

 

By Eva Brocklehurst

Ord Minnett singles out James Hardie ((JHX)) as presenting an opportunity. The share price is implying very conservative long-term estimates, having underperformed the ASX 200 by -10 percentage points since the index hit its recent low on March 23.

In order to lower the valuation to the current share price, the broker would need to factor in very conservative assumptions such as minimal primary demand growth (PDG) and a terminal earnings (EBIT) margin of just 20.5% in North America.

During previous shocks to demand, the share price relative to the ASX 200 reached lows well before housing data began to improve, such as mid 2008 and in early 2019.

The broker asserts temporary market issues and mis-steps emerge from time to time and, as the stock is rarely considered "cheap", it is often in hindsight that its opportunity value is realised.

Despite the weak environment, over the near term the company still leads its category which should ensure pricing power. Furthermore, margins are protected by a highly variable cost base and favourable input trends.

Morgan Stanley, too, likes the structural growth opportunities, competitive advantage and the track record of exceptional margins.

Ord Minnett acknowledges, in the US, weak demand will undoubtedly affect James Hardie but the share price has already corrected enough to reflect this. UBS agrees current pricing assumes very bearish assumptions even compared to its soft estimates.

Risk

One risk the broker believes needs to be considered is the "relatively full" balance sheet. Hence, it could be prudent to skip the final FY20 dividend and this should not be construed as a significant negative.

Based on Ord Minnett's forecasts, leverage is assumed to reach 2.2x by March 2021. Morgan Stanley also envisages some balance sheet risk and the possibility of a capital raising down the track, while gearing remains uncomfortably high for Credit Suisse.

Earlier in April, Credit Suisse downgraded to Neutral, anticipating a high risk of a sharp decrease in activity, given the company's exposure to the repair & remodelling segments, which is around 60% of US sales.

The business has a long and proven record of gains in market share amid industry-leading returns. In addition, Ord Minnett points out the company's strategy can persist during difficult times, citing PDG and EBIT margins in the US in FY09 at three percentage points and 22% respectively.

Morgan Stanley has noted that James Hardie controls around 90% of the US fibre cement market, a category which in turn has around 20% of new exterior siding and the company's position is protected by barriers to entry in the form of scale, technology and innovation.

FNArena's database has five Buy ratings and one Hold. The consensus target is $29.83, suggesting 62.3% upside to the last share price. Targets range from $21.50 (Credit Suisse) to $36.00 (Citi).

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