Tag Archives: Building Material & Const

article 3 months old

James Hardie Builds Hopes For Better FY18

Inefficiencies plagued James Hardie in the December quarter and FY17 guidance is downgraded. The key is whether the company continues to take US market share and secures price increases.

-Inefficiency associated with rising costs as capacity ramps up
-Top line growth supported by cycle while inefficiencies expected to recede
-Better plant performance in FY18 expected as expansions come on stream


By Eva Brocklehurst

Gross profit margins were weak at James Hardie ((JHX)) in the December quarter, amid supply challenges in the North American fibre cement business. Operational inefficiencies were in evidence, as the company deals with a ramp-up in capacity and the inefficiency associated with tight supply. Cost growth was ahead of broker expectations.

UBS reduces FY17 profit forecasts by -7%, to reflect poor plant performance and higher costs through the second half in the North American fibre cement business. This implies a margin of 21.5% in the March half, and overall group earnings growth of 2% for FY17. The broker continues to envisage a solid backdrop for earnings momentum in FY18, providing valuation support at current levels. Nevertheless, given the market's expectations, UBS believes there is little room for poor execution.

In the face of these headwinds, Macquarie believes securing price rises will be important going forward. The company is targeting an inflation-offsetting price increase of at least 3% going into FY18. While the broker acknowledges the frustration of another downgrade in guidance, it cautions about losing sight of the big picture. Brownfield expansion is coming to an end and this should support efficiency improvements. All of this is occurring within a growing market in which the company is taking share.

Downgrade To Guidance

FY17 guidance has been narrowed and downgraded, to a range of US$245-255m from US$250-270m. Macquarie believes top line growth is supported by cyclical factors and expects the operational inefficiencies will recede in FY18. Meanwhile, increased capital expenditure, while impinging on free cash flow, is in keeping with the company's longer-term strategy, and solid returns are expected on these investments over time.

Management is confident operations will improve as most of the expansions come on stream in early FY18. While management is pointing to a better performance in FY18, Macquarie is more interested in the step-up in FY19, driven by plant performance. Extra capacity should alleviate distribution inefficiencies but better plant performance will be the key to driving a sustaining performance.

The new plant being built in Tacoma is aimed at improving efficiencies in the north-west of the US, enabling growth in northern California, a strong market for the company.

The broker also believes that as the company moves to greenfield expansion, operational disruption associated with capacity growth should recede. The company's measure of market share is in the target range of 6-8% and this is a key positive, Macquarie's view, as it points to improved sales.

Overweight Texas

CLSA observes that, realising it was caught short as demand surged, the company accelerated its start-up capacity and now forecasts it will spend US$600m over the next three years to build this capacity. The broker points to the likelihood of an oil-induced slowdown in Texas where employment has finally turned lower and there is a slowing in single family housing production.

The company, the broker reminds, is overweight Texas earnings and, within that state, overweight Houston, where about 40% of Texan houses are built. CLSA, not one of the eight stockbrokers monitored daily on the FNArena database, retains a Sell rating and $17 target.

While trimming forecasts to reflect a deeper trough with regard to inefficiencies in manufacturing and a step-up in costs, Credit Suisse continues to believe FY18 will be better. With an unwinding of the issues in manufacturing, a return to price growth in fibre cement should pave the way for a sharp inflection in North American margins.

The broker believes there is value in the stock on a risk/reward basis but acknowledges it may be range-bound until visibility improves regarding the timing of a recovery in margins. North American volume growth of 10% pleased Credit Suisse. With primary demand growth within the 6-8% target range, and in the absence of supply constraints, the broker suspects volume growth improved in the quarter.

The broker notes the company is working through a backlog of orders and tight production capacity meant that sales orders were missed. This is now beginning to unwind. Credit Suisse has an Outperform rating. Deutsche Bank also believes that the -4.7% negative margin impact related to production costs will not be present in FY18.

As a result the broker expects FY18 US fibre cement EBIT margins of 27%. Deutsche Bank estimates primary demand growth of 5.7% in the December quarter, noting management believes this will reach mid to high single digits in FY17.

Volume Growth And Price Increases Needed

Morgan Stanley found the costs endured in the quarter surprising, given the point in the cycle, and suspects there are earnings risks still in train for FY18. Part of this risk appears to come from lower tax assumptions, where the market appears to be assuming a strong rebound in US earnings, without a commensurate increase in tax take. Having said this, the broker concedes the lower base provides easier comparables to achieve high teens growth in FY18.

While the broker considers the stock is challenged by further executive changes, solid volume growth in the core business is still expected. The broker notes, on the conference call, management acknowledged that not all costs embedded in FY17 would roll off in FY18. The 3-4% price increase indicated by management is in line with the broker's expectations.

Ord Minnett believes the December quarter results are indicative of the large task that lies ahead for the company and that price increases are needed to offset cost inflation. The reversal of manufacturing and freight inefficiencies will be pivotal if the company is to deliver margin expansion in FY18.

Citi also highlights the sub-optimal nature of manufacturing performance. The announcement of another senior management departure, Mark Fischer, who has been with the organisation since 1993, combines with many senior departures over the last few years and makes the broker questioned why a high performance organisation has been unable to retain some of its best performers.

The broker downwardly revises forecasts again for FY17 to reflect higher-than-expected plant commission costs and slightly more modest growth in the US new residential construction market. Citi suspects that while the favourable exposure to the US housing cycle remains, a materially higher-than-usual capital expenditure profile in FY18-19 poses a risk that James Hardie could miss out on leverage in, what will be, the critical growth years of the US housing cycle.

FNArena's database shows four Buy ratings and three Hold. The consensus target is $21.12, suggesting 5.9% upside to the last share price. Targets range from $18.65 (Ord Minnett) to $22.50 (UBS).

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article 3 months old

Boral And CSR Go Separate Ways On Bricks

Boral and CSR will disband their joint venture in bricks on Australia's east coast. Brokers declare the decision a win for both parties.

-Deal multiple considered supportive of CSR's building products expansion
-Well timed transaction for Boral, allowing easier transition to infrastructure activity
-Affords CSR greater control over property and plant


By Eva Brocklehurst

Boral ((BLD)) and CSR ((CSR)) will disband their joint venture in bricks on Australia's east coast, with CSR acquiring Boral's 40% stake for $133.9m including $7.5m in loan repayment. The JV was initiated in April 2014 and from Boral's standpoint the bricks business is now considered non-core.

Deutsche Bank believes the deal is 3% accretive for CSR and 2% dilutive for Boral in FY17. Boral continues to own the Midland brick business in Western Australia, which the broker expects to break even at best. After the JV divestment, Boral’s FY17 net debt is reduced to 0.9 times net debt/EBITDA (earnings before interest, tax, depreciation and amortisation).

The move to full ownership of the east coast bricks business is in line with CSR's strategy to grow its building products business and the broker finds the FY17 enterprise value/EBITDA multiple attractive, particularly given its view Australian housing activity will remain robust for the next 18-24 months.

The main downside risks Deutsche Bank envisages for Boral are declines in the Australian & US housing sectors and increased import competition in cement. For CSR the downside risks include softer aluminium prices, a slower recovery in Viridian Glass and a decline in the Australian housing sector.

Credit Suisse downgrades CSR's rating to Neutral from Outperform. The acquisition reduces the relative importance of the highly volatile aluminium business, while the broker also notes financial discipline was maintained and the acquisition multiple commensurate with near-peak cycle earnings.

The broker believes housing is approaching its cycle peak and, in conjunction with the emerging competitive threat in plasterboard, remains cautious on the medium-term outlook for CSR. Importantly, revised aluminium assumptions suggest that Tomago aluminium smelter, part owned by CSR, will be near break-even in 2019. The broker does not consider this development is appropriately reflected in the prevailing share price, despite the potential for a favourable outcome in terms of Tomago's electricity contract renewal.

For Boral, while the company has been criticised for a lack of capital discipline over the past decade, Credit Suisse believes this is a well-timed transaction, citing management's awareness of the cycle and the losses incurred in the bricks business in FY12-13 when housing last troughed.

Cash proceeds should improve an already under-geared balance sheet. The broker surmises that surplus balance sheet capacity could be used for acquisitions in the US, investment in a cement import terminal in Victoria or investment to enhance its quarry position, as well as capital management via a buy-back.

Post this transaction, Boral retains its WA brick business, which the broker suspects will eventually divested. Credit Suisse flags the precipitous decline in WA housing activity, which implies there will be some variable views around asset valuation, and estimates the value of this business at $25-75m.

Boral should continue to benefit from strong residential construction activity and the emerging road and infrastructure cycle, complemented by an improving US business and strong momentum in gypsum. While all this adds to the stock's appeal Credit Suisse looks for a cheaper entry point and retains a Neutral rating.

Macquarie considers the valuation outcome of the sale reasonable for Boral, with its medium-term outlook supported by an elongated residential cycle which is making the transition to infrastructure-driven activity easier to manage. At the upcoming AGM the broker suspects there could be some negative impact from an aggregate of 12 days of more than 10mm rainfall across key markets in Sydney and Melbourne, but expects positive commentary on residential activity and the outlook for infrastructure.

CSR, meanwhile, may be buying a cyclical asset near the high point in its earning potential, but Macquarie believes the transaction reflects a reasonable valuation. A key support for the acquisition is the exposure to a more resilient detached residential building market. It also affords CSR greater control over the property and plant, the broker asserts, as CSR's position in bricks is attractive in the context of the property angle it offers while the structural challenges in the industry are likely to remain.

Boral has a $6.76 consensus target on FNArena's database which signals 8.9% in upside to the last share price. Targets range from $6.07 to $7.10. There are two Buy ratings, three Hold and one Sell (Morgan Stanley). For CSR there are two Buy, one Hold and three Sell. The consensus target is $3.58, suggesting 1.4% downside to the last share price. The dividend yield on CSR's FY17 and FY18 forecasts is 6.8% and 6.0% respectively.

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article 3 months old

Slower Going Seen Beyond FY17 For Brickworks

Brickworks has raised expectations for its investment portfolio and expanded margins in building products but several brokers note that beyond FY17, the cycle is turning.

-Full order book currently and unprecedented activity in land and development
-Favourable east coast market but significant restructuring in Western Australian operations
-Despite investment portfolio, exposure to residential construction cycle is substantial


By Eva Brocklehurst

Brickworks ((BKW)) has laid a solid foundation in FY16, beating earnings and dividend expectations for its investment portfolio and expanding margins in building products. Management is positive regarding Australia's housing outlook but provided no formal guidance with the results.

Deutsche Bank notes the order book is full and there is an unprecedented level of activity in the property trust in terms of land and development. Given housing demand on the east coast is robust, the broker expects further FY17 EBIT (earnings before interest and tax) margin expansion of 290 basis points to 13%.

All states delivered an improvement except for Western Australia. Land and development was driven by revaluations and new developments in the trust are expected to contribute $16m in gross rental income per annum. The trust is also expected to generate sales from land of $90m in late 2017. The first section of Oakdale West is likely to be sold into the property trust in FY17 and Deutsche Bank believes further upside for the stock exists when the development application is approved.

Investment earnings beat Macquarie's estimates but the broker is preparing for the turn, expecting housing activity will slow over 2017 and weigh on demand going into FY18. The negative effect of a slowing cycle is likely to amplify the impact of rising energy costs on brick operations. Gas prices are an issue for 2018, the broker contends, with increases of around 30% expected. Gas contributes 20% to brick production costs and the volatility in the price represents a risk.

While the company's cash flow improvement is positive, it includes a substantial increase in the receipt of dividends and distributions and when this is excluded, Macquarie calculates receipts from customers net of payments to suppliers actually declined 15%. Meanwhile, the pipeline of property realisations and low volatility profits from investments should support the business in the medium term.

While favourable conditions prevail on the east coast, Brickworks has engaged in significant restructuring of its operations in the west, following a rapid downturn in market conditions. The less efficient Malaga plant will close and the Cardup plant will be re-commissioned.

Macquarie finds the specialised building systems business, which Brickworks has now established, is an interesting development which, although in its infancy, should bring more diversity to the portfolio. Brickworks is employing a distributor business model for a range of lightweight panels, sheets and facades.

While building products will continue to benefit from both volume growth and price rises in the short term, Morgans is conscious of the fact that a peak is near and, henceforth, there will eventually be a PE multiple de-rating across building product companies.

The broker acknowledges the company's cross-holding in WH Soul Pattinson ((SOL)) makes it more than just a building products business but, nevertheless, it has considerable exposure to residential construction and obtained good leverage to the cycle over the past few years. The broker believes, with the stock now trading at a 3.5% yield and at a FY17 price/earnings ratio of 14x, the top of the cycle is nigh and the positive outlook is factored into the share price.

Bell Potter, not one of the eight stockbrokers monitored daily on the FNArena database, envisages continued growth over the medium term as Oakdale Central and Rochedale are completed, upgrading FY17 forecasts by 4.5% to reflect the near-term momentum in building products and contributions from the Oakdale estates. However, the broker downgrades its FY18 expectations to reflect softening building activity and increasing gas costs.

The broker's forecast contribution from the investments division for FY17 and FY18 is also lowered, largely on the back of lower expected contributions from TPG Telecom ((TPM)), offset a little by increases to New Hope Coal ((NHC)) forecasts. The broker has a Hold rating and $14.03 target.

Citi suspects there is increased risk of the share price underperforming in FY17, although the well documented spread between dwelling starts and completions means earnings should remain robust, supported by property development, especially in a low interest rate environment. Catalysts may come from the AGM in November, or a pick up in underlying new residential construction, as well as an improvement in the market value of WH Soul Pattinson, of which Brickworks owns 42.7%.

As an aside, Deutsche Bank observes the cross-claim brought by Perpetual ((PPT)) against Brickworks and WH Soul Pattinson continues. The discovery process has commenced and will take some time to be completed. Brickworks incurred $2m in costs in FY16 related to the Perpetual litigation.

The FNArena database shows one Buy (Deutsche Bank) and three Hold ratings. The consensus target is $15.09, suggesting 14.2% upside to the last share price. This compares with $16.45 ahead of the results. Targets range from $14.00 (Citi) to $17.53 (Deutsche Bank).

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article 3 months old

Is James Hardie Biting Off More Than It Can Chew?

Brokers are positive about James Hardie's strategy in the US but remain wary of the amount of time and financial investment required.

-FY17 profit outlook within reach, underpinned by US housing market growth
-Expanding capacity amid plans to identify further opportunities outside fibre cement
-Are consensus capital expenditure assumptions too light?


By Eva Brocklehurst

James Hardie ((JHX)) has provided detailed presentations as part of its US investor tour, highlighting the company's market potential and plans to expand. FY17 underlying profit guidance in the range of US$260-290m is maintained, unsurprising for most brokers given the recovery going on in the US housing market.

The company is rolling out capacity expansion and assessing greenfield projects for construction over 2-3 years at an estimated cost of US$70-120m.

Ord Minnett remains of the view that the company will deliver strong volume and earnings growth in coming years but not without significant investment, from both a financial perspective and in terms of management time.

James Hardie is expanding its management roles and seeking to improve retention in the ranks and, with the changes, the broker suspects there is increased risk of distraction and disruption within senior management.

There is a temptation to get bogged down in the detail of the company's plans and forget about the big picture, Credit Suisse suggests. The housing cycle is still experiencing a strong tailwind and new capacity is expected provide a robust platform for further growth. Near term, the broker identifies risks around this new capacity coming on line and the potential for increased inefficiencies.

The commissioning of four new brownfield facilities will be followed by greenfield capacity and the balancing act required has the potential to create margin volatility, the broker asserts. FY17 capital expenditure is expected to be around US$100m which should increase in FY18-19 as costs ramp up, although the specific timing and magnitude is unclear.

Credit Suisse believes the company's FY17 profit outlook is within reach, underpinned by margins at the top end of the 20-25% range and broader US housing market growth. The fundamentals also support a rating agency review, in the broker's view, with the potential for an upgrade to investment grade in the next 12 months.

James Hardie re-stated its 35/90 strategy, which is an aspirational target to grow fibre cement's share of the US cladding market to 35% and its share of that market to 90%. Deutsche Bank notes, for fibre cement to achieve the 35% target management has now stated an 8% primary demand growth (PDG) target per annum. The broker calculates, on this basis, James Hardie would achieve the 35% target by FY25. Deutsche Bank currently forecasts PDG of 6% in FY17 and 8% in FY18.

Deutsche Bank notes the company is currently trying to identify another three opportunities outside of fibre cement to drive growth beyond FY25. In addition, an increased focus in selling fibre cement to geographies where James Hardie currently has no presence is intended to drive longer term profitability.

Citi also notes the focus on people, tactics and markets with little change in strategy. The broker believes the company is unique in that it offers market growth, enviable margins, robust cash flow and a transparent management team.

The business may be large but management is demonstrating and acknowledging the challenges of being high growth, the broker observes, and the clarity that management has shown with regard to the issues suggests that any necessary change will be via modification and adjustment rather than major dislocation.

Citi believes the company has the capabilities and capacity to gain further market share in the US while the biggest risk in the short term is a faster-than-expected recovery in the US housing market, as this may upset the trajectory of the company's plans if it becomes short on capacity. Citi expects US housing starts to grow a double digit rates over the next three years as the market recovers.

Morgan Stanley recently downgraded the stock to Equal-weight and the investor briefing underlined its view that consensus capital expenditure assumptions for US$80m per annum over the next three years are too light. The broker expects expenditure of US$130m in FY18 and US$210m in FY19.

Morgan Stanley believes margins need to improve by 50 basis points from the first quarter North American fibre cement margin to obtain FY17 net profit of US$275m - the mid point of guidance - and suspects this may be too high.

This broker also cites the potential for inefficiencies to creep in from the ramping up of new production lines. While higher utilisation of the plant through FY17 may mean lower than average seasonality, Morgan Stanley still expects a decline in margins over FY17.

On a positive note, the broker likes the strategy to increase the share of the interior market to 50% from 40% over the medium term, with product additions and greater revenue targeted across the portfolio.

There are four Buy ratings, two Hold and one Sell (Ord Minnett) on FNArena's database and not all brokers updated after the US investor tour. The consensus target is $21.84, suggesting 6.3% upside to the last share price. Targets range from $18.60 (Ord Minnett) to $25.00 (UBS).

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article 3 months old

Weekly Broker Wrap: Aldi, Oz Equity, Builders And Aged Care

-Coles best at countering Aldi
-Oz market driven by PE re-rating
-Difficult investment case in building
-Confidence in aged care continues
-Maiden FY17 profit expected from NAN
-HUO benefits from major supplier problems


By Eva Brocklehurst


Is Aldi unstoppable? This is the question UBS asks in assessing the opportunities in Australia for the disruptive supermarket chain. Based on its analysis, Aldi appears to be obtaining new customers at an accelerating rate. Driving the lift in penetration is increasing volumes of wealthier shoppers.

Despite this feature, the chain's share of basket has fallen, as shoppers express a view that Aldi is good for some things but not a main shop. The fresh category appears to be the main impediment to Aldi lifting its share of main shopping trips.

UBS expects Aldi will reach $10.6bn in sales by 2019, equivalent to a 15% compound growth rate and a doubling of sales since 2013. This will be supported by like-for-like sales growth of 3.0% per annum, further roll-out in the east coast and new regions in South Australia and Western Australia.

UBS forecasts, as a base case, Aldi's market share reaching 10% by 2019. The broker believes Aldi is winning sales from all retailers, but its like-for-like growth has slowed over the past 12 months driven by the “Every Day Value” strategy from Coles ((WES)).

Coles is judged to have grown both trips and share of main shop among Aldi shoppers over this period. In contrast, Woolworths ((WOW)) has seen both measures deteriorate. This suggests to UBS that Coles has been successful in minimising its share loss to Aldi. The broker also notes that even the independent grocers appear to have benefitted from the issues at Woolworths.

Australian Equity

Australia has outperformed global peers in the past six months and the market is up more than 10% from its February lows, Deutsche Bank observes, and this is largely driven by a price/earnings (PE) ratio re-rating rather than earnings. The stocks are now seen becoming a little expensive.

Resources appear to have driven a lot of the rise, with improved momentum in China. While high PE stocks have been key contributors, Deutsche Bank notes the PE re-rating has been largely in stocks which were not expensive relative to others in 2015 but broke away in 2016 to be 15% more expensive relative to history.

In screening defensive stocks and ranking them in terms of PE ratio relative to a six-year average, earnings revision momentum and dividend yield the broker highlights AGL Energy ((AGL)), Suncorp ((SUN)), Healthscope ((HSO)) and Stockland ((SGP)). Others that screen attractively are Coca-Cola Amatil ((CCL)), Estia Health ((EHE)), Mirvac Group ((MGR)) and Duet ((DUE)).


A more normal housing market is developing, Macquarie contends, compared with the conditions in 2015 when the fear of missing out featured in consumer behaviour. Underlying demand still is firm, despite some evidence of a pre-election lull emerging. The broker notes affordability remains an issue but positive fundamentals are underpinning growth.

In canvassing builder viewpoints the broker notes a peak in construction activity is still in the future with all citing good visibility for the next 12-18 months. Consulting engineers were starting to see a slowing in the early stages of the supply chain. Supply constraints are also broadening. While bricklaying capacity was under pressure a year ago this seems to have been alleviated.

Trades in short supply now include painters, formwork and joinery. In terms of the location, momentum in NSW is on par with 2015 while there remains some strength in pockets of the regional markets, the broker observes. One participant reported increasingly buoyant conditions in Queensland and expressed confidence in the Victorian detached market.

Materials pricing appears to be growing 4-6%. The overall investment case remains difficult, Macquarie maintains, as cyclical risks continue to grow. The broker continues to prefer offshore exposure with James Hardie ((JHX)), and maintains an Underperform rating on CSR ((CSR)) and Brickworks ((BKW)).

Aged Care

UBS is encouraged by the long-term prospects for the aged care sector despite the short-term earnings pressure. The broker calculates that a bed shortage over the next two years will drive occupancy rates up 200 basis points and occupancy is not expected to fall below 93% before 2020.

The broker expects financial pressure from the 2016 federal budget will stymie bed growth, with the larger operators continuing to invest but the smaller end likely to reduce planned investment as a means to conserve capital.

Industry operators are likely to react to the government's cuts to funding by increasing the co-payment for residents, via accommodation payments and additional services charges. UBS expects the tight supply will mean residential accommodation deposits (RADs) will continue to show strong value appreciation and suspects estimates of 5% annual growth are looking increasingly conservative.

Morgan Stanley expects low organic growth, noting the listed operators are confident that additional services revenue, scale benefits and cost management will partly offset the lower government funding and enable margins to be maintained. Still, the broker incorporates a small amount of negative leverage into its base case.

The broker observes there is a fair amount of time to deal with the budget changes but remains cautious and desires more confidence that the strategies to manage the difficulties in the sector are working.

Morgan Stanley prefers Aveo Group ((AOG)) in the sector, as the company is most advanced with its strategy in Australia, having had success previously in New Zealand. The broker also expects higher returns over the long term if the Aveo Way contract with Stockland becomes the norm, although does not incorporate this into its base case.


Nanosonics ((NAN)) has now established Trophon as the standard of care for high level disinfection of ultrasound probes in Australia and Bell Potter observes it is quickly reaching a similar status in the US. The installed base of Trophon in the US is approaching 25% of the market.

The company is expected to generate a maiden full-year profit in FY17. Beyond the US and Australia a start has been made on key markets in Europe and the broker anticipates revenues will accelerate as the regulatory environment changes to embrace the broad adoption of Trophon.

The company is not expected to require further cash from shareholders, given Bell Potter expects it to be positive on cash flow in FY17, but the broker cautions that the investment does warrant a higher risk rating than more established industrial stocks. Bell Potter initiates with a Buy rating and $2.25 target.

Huon Aquaculture

A contraction of salmon biomass at sea in Norway and Chile, where major suppliers are confronted by algal blooms, sea lice and lower stocking rates, has resulted in a material contraction in global supply. Production is forecast to be down by 5-8% in 2016.

Huon Aquaculture ((HUO)) generated 90% of its revenue in export and domestic wholesale markets in FY15 which Bell Potter notes is where pricing has had a reasonable correlation to global import parity levels. Hence, the broker envisages Huon Aquaculture providing leverage to the continued improvement in global salmon prices.

Bell Potter retains a Buy rating, which it believes is supported by the completion of a significant investment in the asset base to deliver growth towards 25,000 tonnes of fish and a reduction in operating costs from the benefits of the recent capex program, as well as a more favourable pricing environment. The broker's target is $4.05.

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article 3 months old

Good As It Gets For CSR?

-Plasterboard competition heightened
-Power costs for Tomago likely to rise
-Scope for more capital returns


By Eva Brocklehurst

In delivering its FY16 results CSR ((CSR)) emphasised building work piling up for at least another 12-18 months, despite concerns of a peak in the housing market. On an underlying basis building product earnings were up 28% while Viridian glass more than doubled earnings, albeit off a low base. Aluminium earnings were flat.

The company also expects to achieve price increases in excess of cost inflation in FY17. Hence, Deutsche Bank, forecasts building product earnings margins to expand to 13% from 11.5% in FY16. The broker takes an optimistic view on FY17 profits on the back of this margin expansion and agrees the Australian housing market should remain robust.

Moreover, volume increases in aluminium at around 2.0% per annum combined with costs reductions should mean the company outperforms, despite weak aluminium prices. The broker expects aluminium prices to fall 4.0% in FY17 and rise 7.0% in FY18.

At the other end of the spectrum, Morgan Stanley believes the current situation is as good as it gets and downgrades to Underweight from Equal-weight. The current share price implies earnings from building products which are just too high, in the broker's opinion.

The main reasons for this view are that the market will looking through higher building product earnings in FY17 towards a weakening housing market, despite any measures from the Reserve Bank in terms of further cuts to the cash rate. Knauf Plasterboard is also envisaged raising the competitive threat level in 2017.

The broker also notes a high positive correlation to the Australian dollar limits support for the stock in a rate cutting environment. The broker expects similar risks in the wake of the FY16 results to what occurred after the first half result when the stock underperformed.

Macquarie also is concerned about the market outlook and continues to envisage limited valuation support for the stock, retaining an Underperform rating. The broker finds it difficult to envisage a win-win compromise on the step-up in electricity costs at Tomago aluminium smelter and, longer term, aluminium market fundamentals are weak and this will be felt in the price of the metal.

On the positive side, the company's brick joint venture has performed particularly well and Macquarie notes it is on track to realise $10m in synergies in FY17, at the top end of prior guidance.

Credit Suisse is also recommending caution when it comes to capitalising peak cycle earnings. While the momentum for building products should continue in FY17 the broker expects earnings to be weighed down by aluminium. In FY18 and beyond the pressure should be aggravated by the easing housing cycle.

At present the strong balance sheet and share price support from an on-market buy-back prevents the broker from taking a more negative stance and a Neutral rating is retained.

Brokers concede the company's commentary that the volume of dwellings approved but not yet started is large, with supply constraints appearing from a lack of labour in the building trade. This suggests activity will remain elevated for another 12 months before easing back.

Credit Suisse also acknowledges the aluminium price was better than expected in FY16 and strong volumes and cost cutting meant the company delivered a credible result. Yet, this is not expected to be easy to replicate going forward. Furthermore, there is the competitive threat in plasterboard, previously mentioned, as well as the step up in electricity costs at Tomago.

The balance sheet is in a cash position and the asbestos liability continues to fall, so Ord Minnett believes there is scope to increase capital management initiatives. On the broker's assumptions CSR has the ability to return a further $150m in cash following the current buy-back.

Citi also suspects capital returns and/or high-growth expansion or M&A could be on the slate, and believes the consensus outlook needs to be reviewed given the beat in the FY16 results. Buy-back support should leave the balance sheet under-geared by the end of FY17. The broker also highlights the quality in the dividend yield and retains a Buy rating.

There are three Buy ratings, two Hold and two Sell on FNArena's database. The consensus target is $3.58, suggesting 0.6% upside to the last share price. The dividend yield on FY17 and FY18 forecasts is 6.3% and 6.4% respectively.

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article 3 months old

Weekly Broker Wrap: Oz Health, Gaming, Pacific Smiles And US Housing

-Lower health claims flagged by nib
-Yet hospital growth seen solid
-Positive signals for gaming
-Material expansion likely for PSQ
-Brokers optimistic on US housing


By Eva Brocklehurst

Australian Health Care

The improved claims experience cited by nib Holdings ((NHF)) is difficult to extrapolate across the sector, Goldman Sachs maintains, given the company has less than 10% market share in private hospital operators and its policy holders are predominantly in NSW.

In theory, the broker notes, lower claims growth for health funds should mean lower revenue growth for the private hospital industry. Yet the December half revealed this is not necessarily the case in terms of lower revenue growth and/or margins for listed operators Healthscope ((HSO)) and Ramsay Health Care ((RHC)).

Although private hospital payments make up the bulk of health insurance claims, doctor fees and payments to ancillary services are also large segments. Goldman Sachs observes public hospitals also account for 10% of insurance payments to hospitals.

The broker observes anecdotal evidence suggests hospital volumes grew solidly for a number of operators in the March quarter. Hence, Goldman Sachs makes no changes to its Healthscope or Ramsay Health Care forecasts.


Victorian gaming machine expenditure rose by 2.3% in March, slightly below Deutsche Bank's expectations. The broker notes Crown Resort's ((CWN)) Melbourne casino expenditure is growing in excess of this rate.

After a strong FY15 the broker notes domestic gaming machine expenditure remains firm, with NSW, Queensland and Victoria all showing growth. Deutsche Bank believes this is a positive signal for the casino operators and equipment manufacturers.

Pacific Smiles

The dental centres in the Pacific Smiles Group ((PSQ)) portfolio offer a superior consumer experience, in Morgan Stanley's opinion, and there is scope for five times the number of centres, supported by demand and low government funding risk.

There is flexibility for dentists and value for insurers as well, the broker maintains. The industry is considered to be large, fragmented and relatively defensive with corporatised models comprising a very small percentage. This presents scope for consolidation.

Morgan Stanley initiates coverage on Pacific Smiles with an Overweight rating and target of $2.50, expecting material expansion in the long-term margin and returns on investment.

US Housing

US new home sales missed expectations in March. Morgan Stanley observes growth has been decelerating for the past four months. The broker notes around 75% of single family starts in the past year have been built for the “for sale” market. On that basis the March data signals a significant increase in sales is required to support the current level of building.

The broker remains positive on the US housing outlook, with mortgage purchase applications rising solidly to a six-year high monthly average in March. Despite expectations that James Hardie's ((JHX)) fourth quarter will show weaker volume growth, Morgan Stanley expects a solid profit outcome.

Deutsche Bank reduces housing starts forecasts by 2.0% for 2016 with forecasts for 2017 relatively little changed. This broker, too, remains optimistic on US housing despite the minor downward adjustments. Growth of 11% is expected in FY16 and FY17.

The broker makes minor changes to earnings estimates for Australian stocks on the back of the US data, with a 1.0% decline in its James Hardie target a result of Australian dollar translation. The broker believes the downside risks for Boral ((BLD)) include pricing weakness in cement and concrete in Australia as well as a slower-than-expected recovery in the Australian and US housing market.

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article 3 months old

Weekly Broker Wrap: Stock Picking, Food, Cement, Household Income, Adacel And Automotive

-Imminent catalysts for APN Outdoor, IPH
-Benefits ebb from China's "grey" market
-Could Adelaide Brighton acquire CA stake?
-Income growth likely to stay modest
-Less volatility for Adacel
-Favourable drivers for novated leasing


By Eva Brocklehurst

High Conviction Stocks

The $19bn in dividends being paid out in March and April should provide strong support for the equity market ahead of the May confession session, Morgans contends. The broker still urges investors not to be complacent, particularly those with heavy blue chip weightings, as the pace of earnings growth across the market is uneven. (Note: The "confession session" sees companies downgrading guidance ahead of end of FY to get the bad news out of the way before results season in August).

The broker makes no changes to its high conviction list this month but believes APN Outdoor ((APO)) and IPH Ltd ((IPH)) stand out, with imminent catalysts which signal potential re-rating.

Strong growth rates for the industry in the first two months of the year are expected to result in upgrades to APN Outdoor's guidance. IPH continues to reduce costs and has signalled a number of potential acquisitions in Australia and secondary markets which may materialise.


The Chinese government has announced a new tax policy on cross-border e-commerce sales where import duty and VAT for importers using bonded warehouses will be applied to replace postal tax. The duty-free price threshold will be RMB2,000 per transaction. VAT will be charged at an effective 12%. The tariff for infant formula imports has been temporarily reduced to 5.0%.

UBS believes the regulatory changes will negate a significant amount of the benefits from “grey” market imports. For food companies which rely heavily on such sales, like A2 Milk ((A2M)) and Bellamy's Australia ((BAL)), this would require a shift to alternative sales channels, either directly online or via physical stores. As a minimum, it will result in sales disruption but may also reduce markets or limit future growth through higher prices.

Building Materials

Morgan Stanley envisages that a partial sale of Cement Australia, as speculated in the press, could make the Holcim assets in Australia accessible to Adelaide Brighton ((ABC)). For Adelaide Brighton a debt and equity funded acquisition could realise significant accretion.

Holcim is reportedly considering selling its 50% stake in Cement Australia. Morgan Stanley has been of the view that Adelaide Brighton would find it hard to participate in industry consolidation because of the integrated nature of Holcim's Australian assets. If the stake in Cement Australia is sold separately the competition issue could lessen.

Nevertheless, the splitting up of Cement Australia and Holcim Australia may result in a 30% loss of Cement Australia's volume and could impact earnings by up to 50% the broker calculates. It is unclear if the other owner Heidelberg has pre-emptive rights over the remaining stake.

The broker's negative view on Adelaide Brighton has centred on the structural challenges in cement. An acquisition would overcome this and, whilst such is unclear as yet, the broker includes the potential within a bull case scenario, granting 37c-$1.56 per share of value for the potential.

Household Income

The trend in household spending grew over the past year despite relatively weak income growth, Commonwealth Bank analysts observe. Growth is attributed to higher housing wealth. The analysts expect that this wealth effect could run into headwinds if house price growth stalls over 2016. Slower net migration may also dampen future household income growth.

The analysts also suspect the more populous states of NSW, Victoria and Queensland will enjoy better economic outcomes over the next few years compared with the smaller states because of firmer jobs growth, population and housing prices.

Australia's household savings ratio averaged around 10% from 2007 to 2012 before slipping to just under 8.0% recently. A large portion of the savings is held in mandatory superannuation and there is also a wealth effect from the rising pool of super funds. The analysts believe this causes households to adjust their savings ratio to lower levels.

If the share market, the main repository of super investment, remains in the doldrums over the next few years then a higher savings ratio may return and real consumer spending would have to shift down a gear.

The analysts also observe that lower housing debt servicing, via lower interest rates, could be another factor making households inclined to save less. Anecdotal evidence points to strong growth in mortgage offset accounts, which may be seen as more tax effective means of income management.

Income growth is expected to remain modest in 2016. Wages, the main component of household incomes, still appear to be easing in annual growth terms. If employment is included then the outlook for wages and salaries growth becomes more positive, the analysts contend. Leading indicators suggest a slight downward pressure on the national unemployment rate, although wide divergence is expected across the states.

Adacel Technologies

Adacel ((ADA)), a provider of air traffic control simulation systems and air traffic management automation, has undergone a significant transformation over recent years, Bell Potter maintains. The company is now more diversified, with less volatile earnings. Adacel generates revenue from new systems, extended support, system upgrades and field support.

Bell Potter observes new markets are emerging and there is a significant level of system upgrades scheduled for the next 10 years. The split between recurring and non-recurring revenue is around 60:40. The broker initiates coverage with a Buy rating and $2.50 target.

Automotive Stocks

Morgan Stanley recently initiated coverage on four new stocks linked to the automotive market. The broker believes the group offers exposure to favourable drivers that support strong growth over the medium term including dealership consolidation, fleet management outsourcing and salary packaging growth.

Morgan Stanley believe risks from changes the Fringe Benefits Tax legislation are being overplayed. Short term uncertainty for automotive dealers, the broker acknowledges, does stem from the Australian Securities and Investments Commission review on finance and insurance.

Eclipx ((ECX)) has the greatest relative valuation upside, given it has the lowest regulatory risk. The broker initiates coverage with an Overweight rating and $3.42 target.

The broker also initiates with an Overweight rating on novated leasing exposures McMillan Shakespeare ((MMS)) and Smartgroup ((SIQ)) with price targets of $14.79 and $5.34 respectively. Given the favourable growth drivers in this group the broker retains an Overweight rating on SG Fleet ((SGF)) with a target of $13.00.

In the automotive dealership segment, with increased uncertainty from the ASIC review the broker initiates on AP Eagers ((APE)) with an Equal-weight rating and downgrades Automotive Holdings ((AHG)) to Equal-weight from Overweight. The price targets are $11.91 and $4.35 respectively.

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article 3 months old

Weekly Broker Wrap: Global Outlook, Resources, Building Materials, Gaming And Electronics

-Global economy vulnerable to shocks 
-Central banks likely to ease further
-Resource equities lag general market
-Morgan Stanley more optimistic on Boral
-Gaming stocks below Deutsche's valuation
-Strong outlook for JBH and HVN

By Eva Brocklehurst

Global Outlook

Morgan Stanley is no longer looking for an acceleration in global growth in 2016. The risk of a global recession has increased and the broker attaches a 30% probability to the event. Solid spending, subdued oil prices and expansionary monetary policy counter the likelihood of recession, but the global economy in a low-growth environment remains vulnerable to shocks as well as a broad range of geopolitical risks, in the broker's opinion.

A stable growth rate of 3.0% on downwardly revised forecasts reflects a slowing in developed markets, led by the US, and a stabilisation in emerging markets, led by Russia and to a lesser extent India. The broker does not expect a recession but the declining impact of lower oil prices and easier monetary policy is becoming a concern.

The broker now only expects one rate hike from the US Federal Reserve in late 2016, an additional 10 basis points cut from the European Central Bank (ECB) and a 20 basis points cut from the Bank of Japan before the July elections. Both the Chinese and Indian central banks are expected to ease later than previously envisaged.

AllianceBernstein is of the view that the global economy is still growing modestly. Developed economies are expected to expand slightly faster this year at 2.2% compared with 1.6% last year. Developing economies are expected to grow 3.8% in 2016 versus 3.4% in 2015.

Nevertheless, the lacklustre environment and low inflation is likely to force central banks to ease further, with the analysts highlighting the experiment in several cases with unconventional policy and negative interest rates. Both the ECB and Bank of Japan are expected to push rates deeper into negative territory.

The wild card is China. The analysts note strong capital flows point to more currency weakness, while increases in credit use and the rebound in spot commodity prices for industrial materials suggest that the economy might be in the process of bottoming. AllianceBernstein expects that China will overcome this soft patch in its economy and post growth of over 6.0% this year.

Global Resources

Pengana Capital asks whether the recent rally in resources is sustainable. First glance suggests commodity prices have run too hard, too fast. Prices could fall back but the analysts are mindful that prices are now equivalent to levels seen in 2004, some 12 years ago. This generates the observation that the Chinese economic boom, which drove prices higher, could be construed as never taking place.

However, resource equities have lagged in the run-up in commodities. Industrials, financials and technology sectors have outperformed resources by nearly 100% over the last few years, the analysts contend. Hence, much of the pessimism appears to be priced into resource stocks and much of the optimism priced into general equities.

The analysts suggest it may be time for the relationship to normalise. Moreover, structural shifts in the US economy, with market expectations going from a potential for four US rate hikes in 2016 to just one, suggest that the undervalued resources sector could be a beneficiary.

Building Materials

Current conditions in south east Queensland appear robust to Morgan Stanley. Price growth in the Brisbane apartment market is slowing and interstate investors remain dominant, given the attractive entry point and strong yields.

Underlying demand, nonetheless, is weak, and the job market relatively poor, so this comes with risks on a 24-month view. The Gold Coast is strong ahead of the Commonwealth Games construction program.

Morgan Stanley expects concrete volumes to remain at high levels and while apartment activity may slow nationwide, some major projects such as the Kingsford Smith Drive upgrade and northern NSW Pacific Highway are expected to sustain activity for the next 2-3 years.

Morgan Stanley is incrementally more positive on the outlook for Boral ((BLD)), given the likely sustainability of the strengthen in south east Queensland. Queensland account for 22% of the company's revenue from construction materials and cement. Morgan Stanley forecasts a 10 basis point improvement in margins across FY16-18.


Deutsche Bank is positive on the gambling sector, given its robust earnings forecasts and sound balance sheets. The broker expects expenditure on gaming domestically will continue to benefit from low interest rates, high property prices and stable employment. Casino operators are also benefitting from Chinese tourism.

All gaming stocks are below the broker's valuations although Aristocrat Leisure ((ALL)) and Star Entertainment ((SGR)) remain preferred exposures. Value is also seen emerging at Tabcorp ((TAH)) and Tatts Group ((TTS)).

CrownResorts ((CWN)) is boosted by the prospect of a corporate restructuring which could involve a bid for the remainder of the company by James Packer. Deutsche Bank retains a Hold rating on the stock.

Consumer Electronics

Harvey Norman ((HVN)) and JB Hi-Fi ((JBH)) are both enjoying sales momentum in Australia. Deutsche Bank expects this to persist, with housing volumes and the wealth effects a tailwind. Relative to the population, housing starts are not seen at record levels and the broker believes the recent surge in construction is merely a catching up after decades of limited growth.

The exit of both Dick Smith and Masters should deliver meaningful benefits as well. The broker estimates Masters will vacate $120m in appliance market share as a complete shutdown is the most likely scenario. Apportioning the sales by existing market share suggests Harvey Norman is the largest beneficiary, with a boost of 0.7% expected to Australian sales.

In terms of Dick Smith's closure, JB Hi-Fi is expected to benefit with a 10% sales uplift, Harvey Norman 6.0% and Officeworks ((WES)), 3.6%.

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article 3 months old

Will Softer Housing Take The Gloss Off Dulux?

-Main advantage is in home renovations
-Little stock price upside likely near term
-Strong market share and balance sheet


By Eva Brocklehurst

Morgans has taken up coverage of DuluxGroup ((DLX)), highlighting the company's quality portfolio of well known brands, including its eponymous paint, Selleys sealants and adhesives, Yates garden products, Cabot’s wood stains and B&D garage doors & openers.

These brands are some of the most recognised and trusted in the housing and renovations industry and hold market leading positions in their respective categories. Yet the main advantage, from the broker's perspective, is that the business is skewed to the maintenance and home improvement segment, this being 65% of its revenue.

The renovations segment does not have the peaks and troughs that are evident in the housing construction category. The company's strategy is centred on home improvement, and while forgoing some of the potential upside from the recent strength in building activity, earnings are expected to be shielded in any pull-back.

Building activity in Australia has risen to record highs in FY16 but recent data suggests activity is weakening. Nevertheless, any slowing in housing over the next few years is not expected to have a major impact on the company's earnings growth. Morgans expects 7.2% earnings growth in FY16 and 6.3% in FY17.

The balance sheet is strong, despite the planned outlay of $130m on a new paint factory in Melbourne. This plant will be completed by the end of 2017 and will produce nearly all the company’s water-based decorative paints. The existing Rocklea factory will focus mainly on production of solvent-based paint products.

In addition, the company will construct a new distribution centre in Sydney to replace two existing centres. The facility will be built, owned and operated by Linfox to Dulux specifications and should open in late 2016. To Morgans, this merging of the two distribution sites makes sense given lower operating costs and increased efficiencies and is expected to be positive to net present value.

The broker kicks off its coverage with a Hold rating, as the qualities of the company appear reflected in the current share price, but would reconsider its view on any share price weakness. Target is $6.18.

Morgans suspects there is relatively little potential share price upside in the short term but there should be an opportunity in the future for investors to pick up the stock at more favourable price points. The broker believes a small premium in valuation is justified given the dominant market share, strong brand and solid financials.

Dulux holds the number one market position in the Australian paints market with a current market share around 40%. The business has proven to be stable over time, with relatively defensive earnings. Morgans believes it has the ability to pay down debt quickly if necessary. The broker also likes the fact the company is continually innovating, making a number of improvements and adding new products to the market each year.

Paints, coatings and adhesives are distributed through retail and trade channels. Product is stocked in over 800 retail outlets across Australasia and sold via 240 ore more trade centres and depots. Garage doors & openers are marketed via dealers and the cabinet & architectural hardware sells mainly to the trade.

In December, Deutsche Bank observed the company's commentary contained a softer outlook for 2016, in relation to new housing as well as the commercial & infrastructure markets. The broker maintains a Sell rating. Morgan Stanley shares the same concerns, with an Underweight rating, believing the potential for earnings upside is factored in and growth is expected to be trending flat by FY18.

Citi, on the other hand, does not share the fears about a downturn in the housing cycle, given the company has a healthy balance sheet and a dominant market share in paints. Morgans, too, acknowledges the company is exposed to a subdued macro economic environment, but points to its record of growing earnings despite very tough conditions during the GFC.

The FNArena database shows one Buy rating (Citi), with four Hold and two Sell. The consensus target is $5.86, suggesting 6.2% downside to the last share price. Targets range from $4.25 (Deutsche Bank) to $6.88 (Citi).

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