Australia | May 20 2014
-Fully priced and defensive
-Opportunity in any pull back
-FY14 guidance a low hurdle
By Eva Brocklehurst
DuluxGroup ((DLX)) delivered a strong first half result, underscored by the paints business. The company also benefitted from its earlier acquisition of Alesco, which makes garage doors and construction products, for the full half year, as that company's strongest months are November and December. Brokers are quite positive about the outlook for company's markets but remain cautious about the amount of exposure to new home construction. Sales from heritage businesses were up 3.9% on the prior corresponding half. The company increased the first half dividend to 10c, reflecting a 67% pay-out ratio.
Moelis is attracted to the core operations, as Dulux has an entrenched leadership position in the renovations and trade distribution channels. The broker believes this is fully reflected in the share price, which has risen 25% over the past year. A Hold rating and $6.00 target remain in place. Morgan Stanley retains an Equal Weight rating, cautious about the outlook in the medium term. The broker expects some upside from lower interest costs in the short term. The company's market share in paint is flat in Australia and the broker estimates retail channels outside of Bunnings may have declined by as much as 4.3% in the half.
BA-Merrill Lynch is more upbeat, expecting the stock will outperform over the next 12 months. The company may be a late player in the housing cycle, primarily exposed to home improvement, but the broker thinks this will still provide a tail wind over the next year given the strong relationship between house prices and spending on home improvements. The broker also thinks the company will gain through the performance of retail channel partners such as Bunnings and Mitre 10. In addition, the company's marketing, sales and brand management expertise should drive revenue synergies and market share gains for the Alesco business. The price of the stock compares well with domestic building material peers, in Merrills' view.
To Citi it was a very solid result, as Dulux grew revenue by 17% and core net profit by 34%. The broker acknowledges the flat market share in Australia and the fact the company is under-represented in the new homes market, given its premium products are less exposed to lower value, new residential building. Dulux expects FY14 earnings to be higher than the $94.1m in FY13, subject to economic conditions. Australia and New Zealand should remain strong, while China is expected to be flat and PNG weaker.
Macquarie believes guidance to simply "exceeding the FY13 result" is conservative and retains an Outperform rating. This broker also considers the stock is fully priced but, in the context of the broader building materials sector, Dulux is a defensive name and earnings support should justify its current valuation premium. The company noted the outlook for engineering and infrastructure projects remains weak but in this area Macquarie thinks there may be some medium-term growth potential from recent federal budget initiatives.
What worries Deutsche Bank is the 22% reduction in net operating cash flow in the half, and the cautious outlook for the commercial and infrastructure markets, as well as input costs. Furthermore, the broker thinks the market may be over-estimating leverage to improved new housing activity. As the stock is trading at 19 times FY15 earnings estimates a Sell rating is maintained. Key divisions such as paints and Selleys Yates performed ahead of the broker's forecasts. Hence, earnings estimates for FY14 and FY15 are raised 4-5%. Earnings from Alesco were slightly below the broker's estimates, providing a partial offset to forecasts. CIMB also makes compositional changes to earnings forecasts, leading to immaterial changes overall. CIMB is maintaining a Hold rating with a view to re-visiting the stock on any pull back in the share price.
JP Morgan attributes weak cash flow to timing, driven by higher integration costs for Alesco, tax payments and payment of a tax penalty in New Zealand. The share price factors in the company's execution capability, positive momentum and market share gains in Australian and New Zealand paint, in the broker's opinion, as well as a recovery in Alesco. JP Morgan believes the company will continue to trade at a premium to global comparatives as well as valuation, given there are limited, high quality, defensive exposures in the small caps space. On that basis the Neutral rating is retained. The broker also thinks the FY14 guidance is a low hurdle to jump and estimates have been revised up by 2.5% for FY14 and by 0.3% for FY15.
On FNArena's database there are two Buy ratings, four Hold and one Sell (Deutsche Bank). The consensus target price is $5.57, suggesting 3.1% downside to the last share price. This compares with $4.79 ahead of the results. Targets range from $4.10 (Deutsche Bank) to $6.15 (BA-Merrill Lynch).
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