Australia | Jul 09 2013
-Goldman notes improved market share
-Key to rating upgrade is US building
-Focus is on long-term US housing trends
-Aust dollar fall helps but not material
By Eva Brocklehurst
James Hardie ((JHX)) has received a boost to its outlook. Goldman Sachs has decided to give the stock a Buy rating, upgrading the recommendation because the cycle is expected to turn more favourable in the US for the building materials supplier. There has been a substantial improvement in US housing starts over the last two years but James Hardie's US business has not impressed. Fibre cement operations have been flat, both in terms of volume growth and margin performance. The reason the company did not get a better share of this growth has been the tendency for much of the initial rebound in construction to be skewed towards lower value and less fibre cement-intensive multi-resident segments. This may be about to change.
Alterations and additions, which account for around 60% of the company's US volumes declined in FY13, partially offsetting the pick up in new building. Nevertheless, Goldman Sachs has found US siding products gained meaningful category share in FY13 and James Hardie is therefore poised to benefit when this construction segment improves. The increased market share gives the broker increased confidence that the long-term market penetration for James Hardie's products is intact. In FY14 alteration and addition activity is expected to improve and the housing recovery broaden. Goldman's forecasts are robust enough to inspire a reduction in the discounted cash flow to 15% from 20% and so the target price has risen to $10.88 from 10.06. As an aside, James Hardie will be cycling its toughest year-on-year comparative in the first quarter report, due in August.
The US may be improving but the housing industry remains problematic in Australia. Last month Credit Suisse monitored a 5% price hike across the company's products which may mitigate some cost increases but the broker expects growth in FY14 will be flat, at best. BA-Merrill Lynch also also noted there was increased building in fibre cement but did not feel that warranted any change to a Neutral call.
Goldman, nevertheless, believes fibre cement's gains in US market share are material enough. Quoting from the US Census Bureau's 2012 characteristics of new single family homes, fibre cement's share of the primary wall market was up 1.3% to 15.8%. Goldman observes the largest gains in price terms were over the median house price bracket of US$200-299,000, a segment dominated by large home builders. The usage in this level was also up 5.6% to 20.8%. Jame Hardie is expected to retain a market share of around 90% in the fibre cement market, given significant competitive advantages over other producers. Again, citing the US Census Bureau survey, after a period of weaker apparent growth driven by a return to cheaper products such as vinyl, James Hardie's US siding business is undergoing primary demand growth. Vinyl and wood siding appear to be the losers.
On the FNArena database there are no Buy recommendations. James Hardie has five Hold and three Sell. CIMB reviewed the stock last month in the wake of the updated actuarial report on the asbestos legacy. CIMB has revised the liability valuation to $1.51 a share from $1.56 a share and this delivered a slight decline in the discounted cash flow valuation for James Hardie and an Underperform rating was retained. Goldman admits James Hardie looks expensive on a short-term multiple relative to domestic industrials but considers the fixed nature of the asbestos liability means the earnings multiple will contract quicker than earnings growth. So, with the stock trading at a 2% discount to the FY16 market multiple on the broker's share price, adjusted for potential asbestos liability, the company is seen representing good value relative to peers.
Key to Goldman's upgrade, and the opportunity in the stock, is the long term. Some features of the outlook, such as competitive pressures and margins, may continue to negatively affect earnings growth in the short term but long-term growth prospects are intact. R&D expensed in FY13 totalled US$37.2m and this would have reduced the company's US fibre cement earnings margin. Margins have also historically shown a strong relationship with pulp prices. As the majority of pulp needs in the US are sourced from Canada a softer Canadian dollar, forecast in the longer term, should assist margins. The other improving aspect is a temporary increase in the proportion of low-value products in James Hardie's sales mix, and the effect this had on average selling prices and margins.
Deutsche Bank and UBS recently reviewed the stock, in the wake of the slump in the Australian dollar. James Hardie reports in US dollars but derives sales in the Australian currency from the Asia Pacific businesses. As such, Deutsche Bank's forecasts have been lowered for the Australian dollar by 6-7% for FY14-15 and there was corresponding reductions for James Hardie's earnings forecast of 2%. The lower Australian dollar increased the broker's valuation and the target price was raised to $9.56 from $9.32. Deutsche Bank expects US housing starts will increase by in excess of 20% over 2013/14 and retains a Hold rating on that basis.
For UBS, the Australian dollar moves provoked a re-rating to Neutral from Sell. The broker finds the stock is expensive on a price/earnings basis but the exposure to the US housing sector recovery will help support valuation. UBS has a target of $9.56. On the FNArena database the target price range is $7.30 to $10.60.
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