Wattyl Waiting On Housing Recovery

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

By Chris Shaw

Paint group Wattyl ((WYL)) delivered an operational earnings result below its recent guidance, earnings before interest and tax of $6.6 million being less than the slightly more than $7 million the market had been expecting. Lower volumes contributed to the shortfall, while broker Credit Suisse notes there was also a fall off in margins and some market share losses during the year.

But the profit news was not all bad as the broker notes the company did at least improve its financial position through the year, with debt falling to $38 million at a pace ahead of the company’s target and its financial covenants with banks, while a restructuring of the group and some property sales have now been completed.

Post these moves, the broker now expects earnings to start to recover. Credit Suisse does make the point any improvement will come off what is a very low base. As well, CS points out while cost savings and other measures have and will continue to help generate a recovery in profits, an increase in revenues is needed to drive earnings sustainably higher. Here the broker doesn’t expect a material recovery in the Australian housing market until FY11/12.

While the broker has lifted its earnings per share (EPS) forecast by 67% in FY10, it still only means 5.2c in earnings, while an 8% increase in FY11 has the broker forecasting 9.2c in that year. Others in the market have made similar increases. RBS Australia is more aggressive with its numbers, forecasting EPS of 8.6c and 14.6c respectively. Bank of America Merrill Lynch is at 5.7c and 10.9c with its estimates, while consensus EPS numbers according to the FNArena database stand at 6.6c and 11.9c.

The key, according to RBS Australia, lies in the group’s fixed cost leverage, meaning if housing approvals continue to improve there is upside risk to its forecasts. An example of the sort of leverage in the stock is shown in the broker’s estimate that an increase in sales growth from 1.5% to 4.0% would lift earnings before interest and tax by around 28%.

But Bank of America Merrill Lynch takes the view trading conditions for the company will remain subdued over the next year as while first home buyer interest has sparked the housing market, it is likely to have added only around 10,000 additional housing starts by the end of this year. This doesn’t offset the full extent of the downturn in starts the broker anticipates.

As well, the broker suggests the announcement by Woolworths ((WOW)) of its entry into the Australian hardware market is another potential pricing pressure point, so it sees little scope for any significant improvement in earnings. While its forecasts suggest a near doubling in earnings from FY10 to FY11, BA-ML makes the same point as Credit Suisse in that the improvement comes off a very low base.

Similarly Macquarie has lifted its forecasts and the changes see the broker increase its price target to $0.81 from $0.46. There is no change to the broker’s Neutral rating on valuation grounds, even though it sees signs of a pick up in housing sector activity.

This matches Credit Suisse’s recommendation and is better than Bank of America Merrill Lynch’s Underperform rating, but falls short of RBS Australia, who post the profit result upgraded the stock to a Buy from Hold previously. RBS lifted its target to $0.89 from $0.80, while the average target according to the FNArena database has increased to $0.76 from $0.59.

Shares in Wattyle today are stronger and as at 1.40pm the stock was up 4c or 5.6% at $0.76. Over the past year the shares have traded between $0.37 and $1.395.

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