Has Reliance Worldwide’s Upswing Peaked?

This story features RELIANCE WORLDWIDE CORP. LIMITED. For more info SHARE ANALYSIS: RWC

-Synchronised uptrend across all 3 geographiess continues into early-August
-Macquarie revisions underpinned by forex changes
-Global plumber shortage blurred by supply chain disruptions
-Uncertainty over future growth rates

By Mark Story

While covid has added to staffing and supply chain challenges for Reliance Worldwide Corporation’s ((RWC)) 15 manufacturing plants, 24 distribution hubs, and five R&D centres around the world, the delta wave has perpetuated unprecedented demand for the plumbing supplies manufacturer’s products which emerged early in 2020.

A global uptick in repair and remodel (R&R) – due to more people working, resting, and playing at home — plus new housing construction markets have arguably helped Reliance deliver a 63% increase in underlying profit to $211.9 million for the 12 months ended June 30, with sales up 15% to $1.3bn.

By segment, earnings increased 52% in the Americas – due in part to a ‘winter freeze’ event in Texas — 50% in Asia Pacific, and 45% in Europe, Middle East, and Africa (EMEA), and the uptrend has continued into early-August.

Slight detractors from an otherwise quality result were the accounting for a $10.9m profit on stock and the exclusion of a $8.5m restructuring cost associated with reconfiguration of warehousing capacity in the US ($6.3m) and UK ($2.2m) from underlying results.

While the rate of growth has slowed, underlying demand remains robust, with the company achieving positive sales growth in July in all three geographies, with net sales up 9%, and up 6% on a constant currency basis.

Following a stronger than expected result in FY21 and strong underlying conditions in the company’s key markets, Ord Minnett, which has a Buy on the stock (target price $7.00) has increased FY22/23 earnings forecasts by 11.7% and 12.3% respectively. With the company’s three key geographies in synchronised upswing, the broker is forecasting further earnings improvements in the period.

However, while Macquarie admits the underpinnings of the market context remain solid, the broker believes growth has now peaked. While Macquarie believes the company is executing well in this context, the broker concludes that the stock is fairly valued and reiterates a Neutral rating (target $5.70).

Macquarie notes while FY22, FY23, and FY24 earnings per share (EPS) forecasts are up 5.9%, 3.6%, and 1.1% respectively, revisions are largely driven by the broker’s forex changes. While Macquarie admits in the current time-pressured supply chain, Reliance could well drive conversion faster than normal, the broker still regards the broader growth headwind as hard to overcome.

The broker reminds investors that while Reliance did not provide specific FY22 guidance, the group expects growth rates to slow significantly.

Despite the strong FY21 result, Morgan Stanley, which has a Hold rating on the stock, (target $6.00) also expects modest growth over the next two years.

Growth outlook

While underlying indicators remain positive, UBS believes that slowing DIY, supply chain pressures, and a non-recurring FY21 one-off US$42m in freeze event benefit, means  Reliance unlikely to see above-normal volume growth going forward.

Following a period of strong share performance, and a softer outlook, UBS downgrades the company to Neutral from Buy and has lowered its target price to $5.80 from $6.16.

While management expects price increases (6%) to limit margin dilution to less than 100bps despite significant cost pressure, UBS is factoring in a -150bps decline in earnings margins year-on-year.

The discrepancy, explains UBS, is based on the broker’s expectation that Reliance is likely to see an uptick in selling, general and administrative expense (SG&A) in the Americas, as discretionary costs return and non-recurrence of the freeze benefit to margins in second half FY21. While UBS’s long-run Americas earnings margin of 17.5% remains unchanged, the broker notes some upside risk with the spot copper price declining to US8,900/t.

Overall, UBS’s FY22 net profit forecast declines -4% on lower top-line growth given non-recurrence of the freeze benefit and moderating R&R growth rates, with margins broadly unchanged at a group level.

Based on strong underlying demand, Morgans which has an Add rating on the company (target price $6.50), forecasts FY22 group net sales (in USD) to be up 4%. Morgans move earnings forecasts to USD from AUD, in line with Reliance’s reporting currency from FY22 onwards, and on a like-for-like basis, the broker’s FY22-24 underlying earnings estimates rise by 6%, while underlying net profit increases by 7-10%.

While not strictly visible in consensus forecasts for FY22 revenue growth, Credit Suisse observes the potential for a large FY22 reversion to have been a key investor concern.

But given the good operating performance and above-market growth, which Credit Suisse contends will see Reliance re-rate to a sustainably higher multiple – as concerns over retaining FY20 growth unwind – the broker retains an Outperform (target price $6.40) and increases its FY22 and FY23 net profit forecasts by 8%.

The broker expects a key driver of revenue growth over all three geographies to be an increase in FY22 pricing growth assumptions from 5% to 6%.

Threats and weaknesses

While Morgans sees Reliance as a high-quality business with a well-regarded management team, strong balance sheet, and solid long-term growth, the broker reminds investors the company is exposed to adverse forex movements given it operates in multiple countries.

Other vulnerabilities highlighted by Morgans include relatively high customer concentration, with the top two customers representing around 30% of group revenue, while movements in raw material prices can also impact earnings.

Macquarie notes that while trading could continue to surprise on the upside as covid dwells and drives consumer spending on homes, there’s downside risk if spend is diverted faster to pre-covid endeavours.

Morgan Stanley expects any continuation of strong demand in FY22 to be partly being offset by supply constraints in the building industry. Management has noted that while there are plumber shortages in all major markets, they are currently being masked by supply chain disruptions and notably port shutdowns in China.

Management also noted that while Sydney’s lockdown hadn’t caused a slowdown yet, it was likely coming.

Capex/M&A

While an aggressive capex plan to boost production capacity reflects buoyant housing markets and management’s confidence to meet such demand, Ord Minnett believes potential acquisitions and/or capital management could add to growth prospects.

FY22 capex increased to $81.5m versus $38.9m prior, which management indicates is ‘catch-up’ in an attempt to build capacity and improve efficiency to drive growth.

While management is actively looking for M&A opportunities, it noted that valuations remain high, and hence will continue to be patient and disciplined. In the absence of investment opportunities, management also suggested it will consider share buybacks, although this is not considered to be a priority.

FNArena's database has four Buy ratings, and two Holds. The consensus target is $6.29, suggesting 13.8% upside to the last share price. The dividend yield on FY22 and FY23 forecasts is 2.5% and 2.7%, respectively.

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