GWA Imports A Cleaner, Leaner Strategy

This story features GWA GROUP LIMITED. For more info SHARE ANALYSIS: GWA

-FY15 dividend reduction, or absence
-Capital return probable from sales
-Eventually, a cleaner business
 

By Eva Brocklehurst

GWA ((GWA)) is setting the stage to primarily be an importer of home renovation products. Shareholders may have become used to the company's restructuring over recent years – Citi observes eight out of the past 10 have recorded restructuring expenses – but another nail in Australian manufacturing's coffin has been hammered home.

Among the initiatives the company has announced are the closures of both production facilities in Sydney and Adelaide. The Sydney vitreous china facility at Wetherill Park will close by the end of the year, to be sold and leased back, while the Norwood plastics facility in Adelaide will be phased out over three years, as the company manages the transition to sourcing material externally. Being an importer makes strategic sense to Macquarie but that does not mean execution risk is eliminated. The reduced reliance on Australian-based manufacturing capacity is another operational issue for the company to manage. Macquarie is cautious, and believes there are risks restructure may limit GWA's ability to capitalise on improving market conditions. The company will reduce its head count by 10% and further rely on offshore supply for its bathroom ware range.

Importantly, an impairment charge of $29m will affect the company's ability to pay franked dividends in FY15. Citi suspects dividends will be scaled back at the very least, or perhaps cancelled altogether. That said, upon divesting its Wetherill Park facility as well as the Dux and Brivis brands, the company could still return funds to shareholders as special dividends or via some other distribution mechanism. The broker believes GWA is well placed for the housing recovery and will turn out to be a leaner, cleaner business over time. GWA's profits come from housing completions and these are derived as the housing upswing matures, meaning the current improvement in housing is yet to show up in terms of volumes.

The changes to production mainly affect the bathrooms & kitchens division, which represented 89% of earnings in FY14. This figure includes Dux, which is underperforming and which the company intends to sell. The other businesses, Brivis, Gainsborough, Gliderol. collectively represent just 11% of earnings.

A strategic review in mid 2014 identified both Dux (hot water) and Brivis (heating & cooling) as non-core and UBS believes the sale of these would be positive, freeing up capital to deploy in divisions with stronger returns and more robust market positions. Without these two, the residual business should provide a cleaner play on the domestic renovations market, in UBS' view. Still, the broker agrees, until they are disposed of, there is a messy period ahead with closures, redundancies, sourcing offshore product and selling down inventory. UBS concurs that momentum in the residential market is yet to be fully reflected in GWA's turnover but it is the uncertainty regarding the execution of restructuring initiatives that will likely constrain the share price in the near term.

To Deutsche Bank, the move to source offshore was inevitable. The company expects to achieve $4m in annualised savings and, excluding the 3-year sale and lease back at Wetherill Park, annualised savings rise to around $8m. The broker believes the respective sales of Dux and Brivis are on track for FY15 and should be valued up to $100m. The broker expects a capital return is probable because of the lack of franking credits by the FY15 result. Deutsche Bank has upgraded to Hold from Sell, given 7% upside to the current share price.

Goldman Sachs considers a capital return is the mostly likely method of returning proceeds, although an on-market buy-back is also a possibility. The broker forecasts no dividends for FY15 but adds an 11c capital return from the sale of the Wetherill Park site. There is the prospect of greater returns if the Brivis and Dux businesses are sold. Goldman calculates that capital return and earnings-per-share dilution from the potential divestments, assuming the price/earnings ratio is unchanged, yield an uplift of 1.6%. Hence, these divestments are not a material source of value. However, add a potential 6.6% uplift in value from the retention of FY15 earnings and this results in a total potential net return to shareholders of 8.3% for FY15, despite no dividend being paid.

On FNArena's database there is one Buy rating – Citi. There are four Hold ratings and one Sell. The consensus target is $2.95, which suggests 12.2% upside to the last share price and compares with $3.01 ahead of the announcement. The dividend yield on FY15 forecasts is 3.8% and on FY16 it rises to 5.8%.
 

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