Australia | Mar 20 2007
By Greg Peel
Shares in building products manufacturer James Hardie Industries (JHX) had a torrid 2006 as asbestos obligations cut into company earnings. It seemed like the bad news had all passed when the stock retraced to around the $10.00 mark in February, but now it appears Hardie has come good at the wrong time.
Macquarie analysts have just cut their US housing market forecasts from 1.67m residential housing starts in 2007 to 1.45m. The analysts have forecast a recovery in 2008, but this has now been trimmed to only 5%. This brings Macquarie into line with large US forecasting bodies, the analysts note.
Is it sub-prime mortgages? Certainly there are fears that the US housing market – already weak – will be kicked once more by a raft of foreclosure sales, but that has more to do with housing values. Tighter mortgage requirements will no doubt have an affect on the number of residential starts, but Macquarie targets the major problem as inventory.
“The real issue is the creation of inventory in the market place”, said the analysts. “A strong economy, cheap borrowing and rising house prices helped to push investor speculation to a high during 2006. It is very difficult to calculate the exact inventory level in the market place, but it could be as high as 400,000 units. This will take at least another 12 months to unwind, in our view.”
Cheap money has thrown a spanner in the works of forecasting based on historical trends. Macquarie points out that US housing down cycles usually last three years from peak to trough, implying this cycle has two years to go before recovery. But up cycles usually last five years (at least they have averaged so over the last fifty), and this one has lasted fifteen years. Who knows how long recovery might take.
Earnings for US housing stocks will come under pressure. Macquarie notes builders’ earnings usually bottom 3-6 months after the housing market bottoms, so there’s not much to look forward to in the short term.
James Hardie is effectively a US building stock, deriving a large percentage of its earnings across the Pacific. It is a strong company, but the model is not as robust as the analysts first thought. Hardie will derive a benefit from its superior market share, but this only suggests outperformance in an otherwise falling sector.
Macquarie has left FY07 profit forecasts alone, but slashed FY08 by 16.7%. The analysts have moved from Outperform to Neutral.
This takes Hardie’s B/H/S ratio in the FNArena database to 5/4/1. The Buy recommendations are supported by a belief in strong margins, but also in anticipation of share buybacks. Merrill Lynch (Sell) supports the Macquarie view of further weakness in US housing.
The average target price currently stands at $10.05. The stock is down over 2% today to trade around $8.42 in mid-afternoon.