Australia | May 22 2012
– Low tax rate boosted 4Q result for James Hardie
– Margins under pressure as company builds market share
– US housing recovery key
By Chris Shaw
While building materials producer James Hardie ((JHX)) enjoyed a favourable tax outcome in the final quarter of FY12 the company's adjusted profit for the period of US$32 million still fell short of some market expectations given ongoing margin contraction. Full year earnings of US$140 million were broadly in line with market consensus.
According to RBS Australia the margin pressure experienced by James Hardie was a reflection of persistent input cost pressures and the moves by management to boost growth in the fibre cement business in particular.
With average prices in this division also declining modestly, RBS now sees a risk profitability falls short of targeted levels over the medium-term. Earnings estimates for RBS have been trimmed by 6% in FY13 to reflect this view, a move followed by the likes of JP Morgan and UBS.
On the plus side, RBS suggests longer-term the current spending to position the business should result in better leverage to an improvement in US housing market conditions. Deutsche Bank agrees, noting while margins are likely to be under pressure through the coming year or so, James Hardie is now better placed to achieve future market share gains.
The impact of boosting market share could be significant, as Deutsche estimates if 35% fibre cement share of the siding market is factored in, valuation for James Hardie would increase by 50% to $12.30. As well, Deutsche suggests recent market share gains should support further potential upgrades to earnings and valuation in the future.
The other significant point to come out of James Hardie's result in BA Merrill Lynch's view was the inefficient state of the group's balance sheet. At present the company has around $240 million in net cash and no immediate cash requirements.
This suggests significant scope for capital management, though in BA-ML's view the current high trading multiple for the stock and a lack of franking credits means no obvious option that would be a significant game changer.
The move to lift dividends was something of a positive in UBS's view, as this is expected to provide some share price support while market conditions remain difficult. The other positive for UBS is the net cash position of James Hardie means both growth and income can be achieved simultaneously.
Post the full year result, the FNArena database shows James Hardie is rated as a Buy three times, Hold four times and Sell once. The consensus share price target according to the database is $7.53, which is broadly unchanged from prior to the result. Targets range from JP Morgan at $6.80 to Deutsche Bank at $8.20.
Not surprisingly given their respective share price targets, JP Morgan and Deutsche have ratings for James Hardie at the opposite ends of the spectrum. JP Morgan rates James Hardie as Underweight in the sector, while Deutsche Bank has upgraded to a Buy rating within the index post the result.
For JP Morgan the issue is valuation relative to others in the building materials sector. On JP Morgan's numbers James Hardie is trading at a 2% premium to valuation yet the remainder of the sector is trading at a discount and this suggests limited value in the stock.
On RBS' numbers James Hardie is closer to fair value, as much of the potential for a US housing recovery is priced into the stock at current levels and this supports a Hold rating. The rating was matched by Citi, who was at least positive on the increase in dividends accompanying the result.
The Buy argument put forward by both BA-ML and Deutsche is if US housing starts return to mid-cycle levels of around 1.5 million per annum, there is significant valuation upside in the stock. This is enough for BA-ML to rate James Hardie its preferred exposure on the building materials sector, while the potential for future upgrades to earnings expectations and valuation supports Deutsche's upgrade to a Buy rating.
Shares in James Hardie today are higher in a stronger overall market and as at 1.00pm the stock was up 29c or more than 4% at $7.24. Over the past year the stock has traded in a range of $4.66 to $7.99, the current share price implying upside of around 4% relative to the consensus target in the FNArena database.
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