Robust Outlook For Oz Building Materials Sector

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-Apartments at all-time high
-Skew to house/land packages
-Morgan Stanley upgrades sector
 

By Eva Brocklehurst

The latest building approval data from the Australian Bureau of Statistics reveals an interesting trend. The proportion of approvals attributable to multi-dwellings – apartments – is near an all-time high. This is underscored by May's data which, seasonally adjusted, shows the 9.9% rise in approvals was driven by a 25.5% rise in apartments, with just a 0.6% rise in single family dwellings. Monthly data may be lumpy, but key to broker observations are the NSW numbers which surprised with a 7.9% decline in detached housing approvals but showed a rise of 18.7% overall. Queensland led the way with a 45.0% rise in approvals in the month. Victoria and South Australia gave up ground during the month, approvals falling 8.5% and 6.7% respectively, seasonally adjusted.

The latest data was ahead of JP Morgan's forecasts and the broker observes NSW drove a rise in approvals for 1-2 storey apartments while Queensland experienced a large boost to 4-plus storeys. The proportion attributable to apartments is at all-time highs – 44.1% of total approvals for the year to May. The broker tempers enthusiasm by citing assumptions made by building materials manufacturer CSR, that the revenue opportunity from two medium density approvals is equivalent to one single family approval, while 3-5 high density approvals equates to one single family home approval. Having said that, importantly for the sector, JP Morgan notes single family approvals have registered the 14th consecutive month of improvement. Still, normalising the shift to multi-unit residential construction, the improvement in housing starts, while still positive, is not as highly promising for the building materials sector as the headline numbers might suggest. 

Moreover, Credit Suisse thinks there is a disproportionate skew to house and land packages compared with the past. Previously the split versus knock-down-and-rebuilds was about 50/50. The impact of this skew to packages is evidenced by a widening lag between approvals and actual work. Developers are selling land parcels well before official land registration and this implies that while new home sales and building approvals are on the rise, the improvement is not reflected in actual work – housing starts and completions – for another 12-18 months. Credit Suisse observes other changes in the building cycle too. A preference for apartments results in lower household formation rates. Add this to lower-for-longer interest rates, increasing population and continued demand from offshore purchasers, and the cycle is likely to be longer and stronger.

Credit Suisse notes resilience in the Western Australian market continues to support the unwinding of excess brick inventory and this bodes well for industry returns, particularly for Boral ((BLD)). Morgan Stanley now finds building stocks more attractive, upgrading its industry view as concerns about the strength of the housing recovery ebb. Detached dwelling approvals are improving in each of the major states and, while there was some pull back in January and February, recent months are showing detached dwellings tracking around 14% ahead of 2013.

So what does the building outlook herald for specific stocks? James Hardie ((JHX)) is considered the best exposure to the US recovery with a strong first quarter expected. Headwinds are likely to resume on volume and price in the second quarter but Morgan Stanley believes the company is on track to improve US margins. Boral's US business could sustain further cost cutting with construction material margins at cyclical lows but Morgan Stanley expects strong earnings growth in FY15 and upgrades to Overweight. CSR's ((CSR)) risks are skewed to the upside for FY16 and the stock is exposed to a recovering Australian east coast property market. The Viridian turnaround is priced in, while the broker observes insulation continues to be a poor performer. CSR, too, is upgraded to Overweight.

Adelaide Brighton ((ABC)) is unlikely to pay a first half special dividend but foundations for growth in FY15 remain intact, although Morgan Stanley downgrades to Equal Weight ahead of the potential for a weak first half result. The biggest concern is flat cement volumes and exposure to the resources industry through lime sales. DuluxGroup ((DLX)) is downgraded to Underweight as Morgan Stanley finds there is limited upside at the current price. Market share gains in Australian paint are sustainable but the broker thinks the Alesco businesses, which have underperformed, need attention. Lastly, Fletcher Building ((FBU)) has a large exposure to the recovery in New Zealand housing and a solid balance sheet that could provide capital management options in FY16. Morgan Stanley thinks the company's Australian assets are less favourably positioned relative to listed peers.
 

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