Recovery In The Building Industry A Difficult Proposition

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

By Eva Brocklehurst

In the building industry it all depends on whether you're looking out – towards recovery in a major US market – or looking in – to the bricks and mortar of local housing construction. It also depends on just when you see value emerging in a sector that has been plagued by economic downturn and, locally, a lack of investment incentive as mining construction boomed. This, in turn, depends on how much downside you factored into estimations during the slump.

Several brokers have tried to pin down the pace of recovery, looking at various facets of the industry, and they've come up with – a very mixed bag. Critically, given the exposure of the likes of Boral ((BLD)) and James Hardie ((JHX)) to the US industry, the trajectory of the Australian dollar can play havoc with projections.

Credit Suisse sees some positive signs emerging  in the US housing market and believes this should bolster Australian materials suppliers Hardie and Boral. It has placed these stocks in the queue for improved earnings based on increased housing starts in the US. Home prices over the past six months have improved there. Importantly, the strongest price momentum was in states like Arizona, California and Florida, where both companies have significant exposure. Higher sustained activity in conjunction with above-trend market penetration suggests upside risk to Hardie's volumes –  for Credit Suisse.

In contrast, RBS Australia has looked at Hardie and Boral and seen these stocks stretched, and downgraded them. The broker says they are expensive and, in regards to Hardie, much of the cyclical upside is priced in. Ratings for Hardie, according to the FNarena database, run the gamut from Buy (Deutsche) to Sell (RBS, UBS and JP Morgan) with four Holds in between.

RBS downgraded Boral to Sell following its strong recent share price performance and further downgrades to earnings. While accepting it carries cyclical leverage to improved US construction, the broker sees hurdles in the short term. Its estimates for FY13 and FY14 are at 8% and 13% below consensus. For Boral, back in August, Credit Suisse had an Outperform rating. Moreover, Deutsche Bank recently rated it a Hold, noting it will benefit from a higher Australian dollar given its US losses. The database currently shows two Buys, two Holds and four Sells for Boral.

As for NZ's Fletcher Building ((FBU)), around 50% of its North America earnings are leveraged to residential activity. Fletcher is actually RBS' favoured stock in the sector as it is a greater beneficiary of the improving New Zealand market. Fletcher is at a price earnings ratio of 13.8 times and 10.2 times FY13 and FY14 forecast earnings, which RBS says is attractive value given the longer-term potential earnings upside. Brokers generally agree, given Fletcher's 5/3/0 Buy/Hold/Sell ratio.

RBS has a positive outlook for a building recovery locally but is just a bit cautious on the stocks, believing valuations are rather stretched. The broker cast a wide geographical net with its survey of builders and found they are a little more optimistic. However, the respondents were at pains to point out that, while enquiries had improved commitments hadn't – as yet.  The broker rates CSR ((CSR)) a Buy on longer-term valuation upside [1/4/3] and has a Hold recommendation on Adelaide Brighton ((ABC)) [3/5/0]. RBS acknowledges that CSR's upside comes from several factors which are yet to be cemented – housing activity, aluminium prices and the Australian dollar.

However, Citibank downgraded CSR to Sell last month, noting difficulties in offsetting the residential downturn with obtaining engineering and non-residential work. RBS maintains a Hold recommendation on ABC, which it believes is trading around fair value and so offers less leverage to a cyclical rebound than its peers. A robust balance sheet, strong dividend yield and the potential for capital management should see ABC’s share price supported at current levels, it said. Meanwhile, Citi downgraded ABC to Sell last month for the same reasons as for CSR.

RBS is now more sober in its estimation of when a recovery should start. It expects housing starts to decline further in FY13 and the lowest point in the current cycle could be mid 2013. Beyond this, a gradual recovery should ensue. Indeed, the broker believes Australia's housing market will see another 12-18 months of difficult conditions, maintaining the pressure on Australia-focused businesses in the short to medium term. Mid-cycle leverage in the sector as construction markets in Australia, New Zealand and the US rebound is likely but, again, according to this broker, upside is really factored into share prices already.

Meanwhile, Goldman Sachs investigated whether any structural pressures were in play, as opposed to the cyclical ones referred to above. Goldman believes brick makers are the best-placed of the materials products to benefit from a recovery as intensity of usage does not appear to have declined over the last decade. The contrasts to the roof tile component which has suffered permanently from incursions into its market by the steel industry. Nevertheless, Goldman sees the entry of Buckeridge Group – brick maker, roofing supplier and builder –  into the WA market (around 30%-35% of national volumes) as negatively impacting profitability for Boral and, for that matter, Brickworks ((BKW)). However, the broker does view this as a one-off effect and not an indication of a systemic decline.

The masonry blocks segment sees ABC with the highest exposure in a fragmented market which, combined with significant excess capacity, is weighing on returns, according to Goldman. Looking at the relative exposures by state from a stock perspective, the broker estimates that Boral has the greatest exposure to WA and NSW in terms of the brick businesses with some 63% of its Australian brick volumes in these two states, while CSR has 55% in NSW and BKW has 53% of sales in WA/NSW. 
 

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