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Building Materials Sector To Withstand Higher Rates

Australia | Feb 09 2022

This story features CSR LIMITED, and other companies. For more info SHARE ANALYSIS: CSR

Pent-up demand and the typical rate-rise-to-impact lag mean Australia's Building Materials sector should continue to outperform in the face of rising global interest rates, say analysts, who advise getting with the strength for selected favourites.

-Higher interest rates and supply-chain problems pose risks to building materials companies
-Companies with pricing power best placed for gains
-Brokers generally favour James Hardie and CSR
-Some analysts see margin compression for Boral and Adbri

By Nicki Bourlioufas

With US and Australian official interest rates set to jump in 2022, the higher cost of credit is a key risk for the housing and construction sectors. Yet pent-up demand should support building activity, and companies with pricing power are best positioned.

The Macro View

The macroeconomic environment will be more challenging for the sector in 2022 due to rising inflation and interest rates. Supply-chain constraints remain a risk, and the construction industry faces rising commodity prices and higher labour costs.

Yet economists do not fear a hard landing for housing and construction. Economic indicators such as building approvals and housing finance are holding up better than expected amid zero migration. 

In December, the total number of dwellings approved rose 8.2% in seasonally adjusted terms, after a 2.6% rise in November, according to the Australian Bureau of Statistics (ABS) thanks to a jump in approvals for private-sector dwellings (excluding houses) which surged 27.5%.

Companies With Pricing Power Best Placed to Gain

Jarden's chief Australian economist Carlos Cacho expects Australian housing construction activity to remain solid due to strong dwelling approvals (particularly for detached housing) in 2021 which will flow into 2022.

A resumption in immigration is also expected to add to demand. Jarden forecasts dwelling starts at 196,000 in 2022 (after 228,000 in 2021), before moderating to 180,000 in 2023.

“We expect the pipeline of work remaining to contribute to the value of work done in 2022, with still-above-historical starts to add to activity, suggesting near-term performance can be sustained despite a medium-term slow down,” opines Jarden.

“We believe companies with pricing power and greater exposure to residential construction activity should still do well from an earnings perspective in the coming 12 to 24 months.”

Nor are higher interest rates expected to dent housing construction this year given the one-to-two-year lag between the central bank raising rates and the impact on residential building activity.

Brokers Pick Their Winners

Jarden’s preferred stock is CSR ((CSR)), earning it a 12-month target price of $6.70 and an Overweight rating. Jarden also likes James Hardie Industries ((JHX)), and pegs a target price of $53. It is Neutral on Adbri ((ABC)), holding a target price of $3.00.

According to Credit Suisse, the easing of Covid-19 restrictions will help maintain demand for housing. Infrastructure and commercial activity is also expected to strengthen in the second half as projects which were delayed due to Covid-19 get under way.

“We expect modest building products EBIT (earnings) margin growth in FY23F despite a high-cost environment, with prices to offset costs, and operating leverage from volume growth," reports Credit Suisse.

JP Morgan is also upbeat on CSR and James Hardie and is Overweight Adbri ((ABC)).

“We see companies with a strong track record of execution, relative pricing power and local manufacturing best placed to navigate this environment,” notes JP Morgan.

The broker has a $54 target price for James Hardie and expects the company will also benefit from a strong US housing market as it too recovers from the covid-19 pandemic, and pent-up demand buoys sales.

James Hardie, CSR and Fletcher Building ((FBU)) are well placed to handle supply-chain risks, the prospects for raising prices being better for lightweight building products than for construction materials.

JP Morgan’s least preferred building-related stock is Reece ((REH)). As a retailer of finished goods sourced from offshore, the company faces elevated supply-chain risks.

According to FNArena’s database, the consensus target price for James Hardie is $56.95, suggesting 17.2% upside to the last share price.

The consensus for CSR is $6.69, offering 17.1% upside. For Adbri, the consensus target price is $3.41, suggesting 12.9% upside.

For Reece, the consensus target price is $18.51, suggesting -9.3% downside to the last share price

Margins Could Contract For Boral, Adbri

Some companies won’t do as well as others as costs rise. Credit Suisse notes that industry margins narrowed in 2021 for Adbri and Boral ((BLD)), compressed by flat pricing and increased costs such as shipping, diesel, energy, and labour costs.

“While some price rises have been put through in January, we expect further margin compression due to costs and high competition,” says Credit Suisse.

The broker prefers CSR and Fletcher Building due to their greater pricing power, which should help them overcome rising costs.

“Our preference is for CSR and FBU, with better pricing outcomes/power, domestic supply chains, and for CSR, a great record of managing costs/margins.”

Valuations too are “cheap” for building materials companies versus the S&P/ASX200. 

Credit Suisse says. “FBU is cheapest of the sector on a P/E relative, is trading in a strong Australian/NZ demand environment, with largely domestic production and good pricing power.” 

Credit Suisse has an Outperform rating on Fletcher, with a target price of $8.60. Credit Suisse also holds an outperform rating on construction materials business Wagners Holding ((WGN)).

According to FNArena’s database, the consensus target price for Wagners is $2.17, suggesting 49.4% upside to the last share price. Shareholders in Wagners have experienced a volatile ride since the company listed in late 2017, and that's putting it mildly.

Macquarie also likes infrastructure-exposed names, where the prospect of a resurgence in construction activity is supporting stock performance.

The broker is of the view the recent share market correction has opened up buying opportunities in companies that can grow despite higher rates and prices.

Its stock preference, in order, is Adbri, Boral, James Hardie, CSR and Reliance Worldwide ((RWC)).

Macquarie’s key short pick is Reece, given its high valuation against a potentially slowing growth backdrop.

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CHARTS

ABC BLD CSR FBU JHX REH RWC WGN

For more info SHARE ANALYSIS: ABC - ADBRI LIMITED

For more info SHARE ANALYSIS: BLD - BORAL LIMITED

For more info SHARE ANALYSIS: CSR - CSR LIMITED

For more info SHARE ANALYSIS: FBU - FLETCHER BUILDING LIMITED

For more info SHARE ANALYSIS: JHX - JAMES HARDIE INDUSTRIES PLC

For more info SHARE ANALYSIS: REH - REECE LIMITED

For more info SHARE ANALYSIS: RWC - RELIANCE WORLDWIDE CORP. LIMITED

For more info SHARE ANALYSIS: WGN - WAGNERS HOLDING CO. LIMITED