Is James Hardie Still Overpriced?

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This story features JAMES HARDIE INDUSTRIES PLC.
For more info SHARE ANALYSIS: JHX
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Doug Grant, Minc Stockbroking

I have been looking at James Hardie Industries ((JHX)) as a potential short. This has been based on both a technical view and a fundamental view formed on recent data out of the US and associated articles out of the Wall Street Journal and London Financial Times. I am the first person to acknowledge that my fundamental grasp of JHX is basic at best, so I’ll leave that for the experts. However in a few of the latest research articles out on JHX in the past few weeks, I note that most analysts, even though they have a Buy or Hold recommendation, temper that by saying things such as,

“While we believe JHX is a business with a good track record and strong competitive advantage, concerns about the likely pace of recovery in the US housing sector and the fact that the current share price (in our view) is already discounting a substantial earnings recovery, cause us to maintain our neutral view on the stock for the time being” (Goldman Sachs JB Were, Hold, target $8.74)

Or this

“In addition management notes there are only signs of stabilisation in the US housing market, not an increase. We are concerned following an end to the US stimulus, housing may take some time to recover” (Deutsche Bank, Hold, target $8.50)

So in the brokers' views it all hinges on a sustainable recovery in US housing starts and the share price is already factoring in a substantial earnings recovery. So when I see articles like “New Home Sales Plunge to Record Lows” (WSJ 25/2/2010), which highlights that sales dropped 11.20% in January, the lowest since the government started tracking numbers in 1963 which, or “Beware the Fabulous Federal Money Machine” (FT 26/2/2010) that highlight possible scenarios of what might happen when the Fed withdraws its support for the mortgage market (Freddie and Fannie do practically all the lending) at the end of this month, which the FT surmises could lead to a fresh house price crash, I start to question whether JHX is overpriced even at these levels if further falls are thus possible.

Finally the Australian Financial Review posted an article called “Conflicting US Data Muddies Water” (02/03/10). It talks of both Boral ((BLD)) and JHX and effectively highlights analyst concerns about US housing and speed of the US recovery.

Thus I want to look at JHX on a technical basis and pick a point where, if it breaks, I should look to short as that is my bias given the above commentary.

Pretty much from the chart below you can see that JHX has been stuck in a band between $7.40 and $8.00 for the past month. In my mind a confirmed break of the $7.40 level will lead to a pullback to $6.80 initially (height of congestion zone is 60c), and then a target of approx $6.20. I get this from the first move down from $8.80 to $7.60 – hence a $1.20 move should not be unexpected. Also there is a gap in the chart at $6.20 and in my experience they always seem to close at some stage. I would suggest using exchange-traded options as a method of shorting, as we all know how quickly this name can move, and if I am wrong I want some form of ETO cover.

I notice that implied volatility is offered at approx 39% in the April $7.25 put options, so it would cost something like 32c to get a few on board (short) I would suspect. Conversely if you are looking to hedge an existing position that you have, either selling call options outright (April $7.75 calls are bid at 33% implied volatility and you would receive approx 34c for those), or possibly even a collar might be in order.

To conclude I have also attached a chart that my old friends from Southern Cross Equities have been using. It compares the share price of US housing starts to the share prices of BLD and JHX. The correlation has been pretty spot on until recently. Pretty scary stuff.

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