Australia | Aug 12 2020
Strength in new US housing starts drove another forecast-beating performance from James Hardie in the first quarter and new product releases later in 2020 are expected to provide even more gains.
-Better volumes in the US on a reduced cost base
-North American margins for fibre cement at 10-year highs
-Improved engagement with customers helping supply response
By Eva Brocklehurst
The US remains a purple patch for James Hardie ((JHX)) with strength in new housing starts reflected in healthy volume growth in the first quarter, despite the pandemic. This provided some offset to low renovations activity while favourable pulp/freight costs offset higher per-unit production costs.
Goldman Sachs sums up the sturdy performance as a combination of margin expansion, gains in market share in fibre cement across North America & Australia and a supportive construction backdrop in North America.
The area which surprised brokers was North American margins that have continued to grow ahead of most estimates. Goldman Sachs suspects there is some benefit from "abnormalities", including better volumes on a reduced cost base that has been skewed towards a severe downturn.
North American margins for fibre cement are at a 10-year highs, Morgan Stanley notes. The broker had previously expected pandemic shutdowns would adversely affect activity in the second quarter more than the first but the outlook is better than feared. With potential to outperform and an improving post-pandemic market, James Hardie remains Morgan Stanley's preferred pick across the Australian industrials coverage.
The company is guiding to second quarter US exteriors volume growth of 7-11% and earnings margins are expected to be 27-29%. FY21 net profit guidance is US$330-390m and the stay on the dividend payment will continue. UBS pencils in a $0.42 final dividend, suspecting James Hardie could reverse this policy if conditions improve.
Macquarie believes the upper end of the guidance range is "very attainable" given current trends but was surprised it was provided so early in the year, interpreting this as confidence in internal execution amid better visibility emanating from close relationships with customers.
The broker observes a lot is going right for the company at present as input costs remain benign and the environment in North America is surprisingly buoyant. Guidance assumes a "low bar" for the first half, Macquarie suspects, especially given the strong anecdotal evidence that suggests demand remains robust for single family homes.
When weighing up the strong July revenue growth and higher margins against flat net profit guidance at the mid point, Credit Suisse believes management has allowed for a cooling off in demand.
The broker's discussions with the industry imply products are struggling to keep pace with the sharp rebound in demand and James Hardie is doing better than most. Credit Suisse agrees improved engagement with customers is providing “real-time demand signals”.
Six consecutive quarters of margin decline in Europe means traction could be hard to re-establish, UBS asserts. Disruptions in France and the UK drove weakness in the quarter, although the company is confident disruptions are unwinding. Credit Suisse notes improving trends in the second quarter, and while forecasting revenue growth of 17% for fibre cement lowers the margin to 8.3% because of lower production efficiencies.
Meanwhile, despite closures due to the Covid-19 outbreak in the Philippines and New Zealand, Asia-Pacific earnings margins expanded and Australia reported a 28% margin, similar to North America.
Primary demand growth (PDG) featured as usual, albeit the company did not explicitly state a figure. UBS calculates it averaged more than 6% while the market appears to be pricing in less than 4%. However, the broker points out a difference in timing and pace of housing construction could cause PDG to be misleading on a quarterly basis as the pandemic may have delayed or pulled forward construction projects.
In turn, this may explain why the company did not state a figure. The broker suspects the market will continue to price in conservative long-term expectations for US PDG as well as earnings margins and then be forced to revise these up.
While concentrating on the core fibre cement offering, new products will be an increasing area of focus in the year ahead. The company intends to announce details later in 2020, with Goldman Sachs suspecting it will target the structural growth drivers that exist in the US market, including a lack of skilled labour and affordability in both new construction and renovations markets.
UBS expects products could include EasyTex, a substitute for stucco, and HardieDeck a substitute for timber decking. This should provide an opportunity to lift market expectations further in terms of PDG over the longer term.
UBS believes investors are buying the stock for its ability to grow even when the market is contracting and also suspects James Hardie has benefited from bushfires in California that has accelerated the adoption of fibre cement in these areas. Macquarie suspects the expectations for incremental investment of 200-300 basis points in new product will largely be countered by volume growth.
Citi assesses the stock is priced for perfection as revenue momentum continues to accelerate and downgrades to Neutral from Buy. Positive earnings margin outcomes in FY21 in the US are now fully factored into the stock, in the broker's view.
Goldman Sachs, not one of the seven stockbrokers monitored daily on the FNArena database has a Buy rating and $37.23 target. The database has five Buy ratings and one Hold (Citi). The consensus target is $34.88, suggesting 9.9% upside to the last share price. Targets range from $33.10 (Citi) to $36.00 (Macquarie).
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