CSR Takes More Viridian Medicine

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-Two Viridian glass plants to close
-Profitability of glass still a concern
-Aluminium the swing factor for CSR
-Brokers reserve judgment
 

By Eva Brocklehurst

CSR ((CSR)) has been taking a lot of medicine with the Viridian business and finally coughed. The company will close the Ingleburn glass manufacturing site and consolidate the Wetherill Park site into the Erskine Park facility. All these plants are in NSW. The restructure of the Viridian business, created in 2007 with the acquisition of Pilkington and DMS Glass, will deliver a net benefit of $27 million from FY15. Brokers welcomed the decision, which will result in about 150 redundancies, but are sceptical about a return to profitability any time soon in the troubled business.

In JP Morgan's view, the restructure and closures reveal management's acceptance of the low profitability potential in domestic glass manufacturing. With the closure of Ingleburn, Viridian capacity will decline to below what it was when first created. The problem is glass manufacturing faces many headwinds and some of these the company has found hard to combat. The high Australian dollar has made imports so competitive that the company now expects import competition is here to stay. This has been compounded by weak residential and commercial construction in recent years. There has been an unfavourable shift in product mix from higher value glass to float glass, impacting revenue. Higher energy and manufacturing costs are doing the rest.

Citi expects greater throughput at the Dandenong, Victoria, plant with the closure of Ingleburn. This should make primary products more competitive. The broker still believes there's more restructuring to come as there remains significant overcapacity in the downstream processing industry. Moreover, rationalisation in building products, brick and tile, and insulation could help too. Citi underlines the need for the company to be focused on cost control and capacity reduction across the board, not just at Viridian.

As a corollary to this view, Citi believes the bigger problem at Viridian is the downstream processing business, GP&S. The broker estimates GP&S lost $23.8m last year and refers to ASIC accounts which show that other leading glass processors also lost money, just not as much as GP&S. Closing Ingleburn should help but there is industry overcapacity that underscores a bigger problem. The Australian glass processing market is fragmented. The top five control 50-55% of the market, according to Citi. The broker believes the market tends to exhibit boom and bust characteristics, with players adding capacity in good times to a point where it becomes unsustainable as the cycle takes it course. More processing capacity rationalisation, not just from CSR, is needed in Citi's view.

The latest restructure should go some way to reverse the substantial value destruction of the past but Credit Suisse is cautious, given past attempts. Maybe the new management team at Viridian can win over market confidence in time. The broker's greatest concern, financially, is that rationalisation may not progress as quickly as desired, given market deterioration. Perhaps CSR needs to form an alliance. That's Citi's view. Maybe with Saint Gobain, to which CSR sold its Malaysian concrete business in 2011, or a large Asian producer such as Xinyi. The broker estimates imports are 25-30% cheaper than Ingleburn can produce.

Based on JP Morgan's revised DCF valuation of the business ($188m) and funds employed as at September 2012 of $423m, impairment could be in the order of $200m. The broker expects break even won't be reached until FY16, when the full benefits of the restructure are realised. CIMB believes the path to profitability has been opened up but wants more details on the aluminium hedge at the FY13 results, which will be released in May. The broker suspects favourable hedging has been added for FY14 and this will allow the focus to return to the housing leverage.

The Viridian announcement was accompanied by a guidance downgrade, driven by weakness in domestic construction and negligible earnings from property. Profit is expected in the range of $30m-34m for FY13, against forecasts of $34m-54m provided at the first half results. Brokers have downgraded CSR earnings forecasts substantially as a result. CIMB has now downgraded CSR to a Hold rating, one of five on the FNArena database. The other four rating the stock as Hold include Macquarie, Deutsche Bank, UBS and JP Morgan. All appear to be predicating their recommendations on hopes of a resurgence in the building and housing industry and on this basis, rather than any great prognosis for Viridian, are prepared to put the Viridian debacle to one side.

The other three brokers rate the stock as a Sell. What the company really is reliant on now is a boost from aluminium prices. BA-Merrill Lynch, one of the Sell ratings, makes this case. For every 5% increase in aluminium prices the broker would add 12% to FY14 earnings estimates. Moreover, this is the variable Merrills has the least confidence in predicting. The broker's target price of $1.60 is based on the sum-of-parts discounted cash flow and is the lowest on the database, some 25% below the current share price.

On a mid-cycle assumption the stock is inexpensive, according to Credit Suisse, which has another of the Sell ratings. This is based on the potential for exogenous factors such has the housing industry, the high dollar and aluminium prices to reverse current form. On current valuations the broker finds it expensive so patience is the virtue here. The other rating the stock a Sell on the database is Citi. The broker notes, given the share price rose 3% on the news, investors must be looking further ahead. Citi is just not convinced the downgrade cycle, five years old now, has ended. The consensus target of $1.92 on the database shows 7.9% downside to the last traded price. The range of targets is $1.60 (Merrills) to $2.30 (CIMB). CIMB has chosen a blended valuation and reserves further judgment until there is clarity with the FY13 results.
 

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