Building Materials Set For Growth Recovery

Array
(
    [0] => Array
        (
            [0] => ((DLX))
            [1] => ((CSR))
            [2] => ((BLD))
            [3] => ((JHX))
            [4] => ((FBU))
            [5] => ((ABC))
        )

    [1] => Array
        (
            [0] => DLX
            [1] => CSR
            [2] => BLD
            [3] => JHX
            [4] => FBU
            [5] => ABC
        )

)

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

-Growth outlook improves but mixed
-US contrasts for Boral, James Hardie
-AUD trend favours CSR, Boral, Hardie
-Benefit of carbon tax removal?
 

By Eva Brocklehurst

Building approvals look to be finally on the rise in Australia and Australian building materials stocks have seen price/earnings re-ratings in anticipation of growth recovery. Morgan Stanley thinks FY14 will provide some growth but is inclined to suspect consensus expectations are still too high.

The broker likes paint producer DuluxGroup ((DLX)) the best but does query whether market share growth can be maintained. Dulux has achieved 15 percentage points of gain in market share in the last 10 years. This has continued in the last five years, despite local players – Wattyl, Taubmans – being bought by larger offshore operators. The Alesco acquisition has also boosted the company's market position in a number of sub-sectors. The broker sees Dulux achieving 8% compound earnings growth to FY15. It may not be the strongest, but it is defensive.

CSR ((CSR)) is on the bottom of the list for Morgan Stanley as as the aluminium assets continue to weigh on valuation. Boral ((BLD)) is a preferred stock, although the US turnaround is taking longer than anticipated, while for James Hardie ((JHX)) the margin targets appear achievable. US margins recovered to 21.4% in the first quarter of FY14. Morgan Stanley notes, although US earnings margins are typically 280 basis points higher in the first quarter against the full year, an improved pricing trend through FY14 should mean the company's 20% can be met. JP Morgan thinks meeting the margin target will be a challenge.

JP Morgan has looked in depth at the US operations of both Boral and Hardie. The two are a contrast in terms of  their current performance, outlook and pricing. Boral has had to meet the downturn in the construction industry with deep cuts and restructuring and its US business is dependent on a recovery the intensity of building in brick. James Hardie, on the other hand, has weathered the downturn well and is one of the few building companies that remains comfortably profitable, in the broker's view. James Hardie has a differentiated product and retains high market share while Boral is in a more fragmented industry.

On the flip side, Boral's brick and tile pricing has held up better than James Hardie's cladding. Nevertheless, JP Morgan expects that future increases in prices will need to be considerable in order to restore returns. James Hardie has been trying to sort and stabilise its pricing for some years. JP Morgan contrasts Hardie's earnings over FY08-13 at US$1.1 billion with Boral's loss of US$449 million over that period. Ahead, both are expected to improve profitability.

In terms of a weaker Australian dollar and the impact on local building material company earnings, UBS finds CSR, James Hardie and Boral are most leveraged to the US dollar relationship. Exposures relate to imports, via import parity pricing and competition as well as US dollar denominated revenue/earnings, with US-based divisions or products priced in US dollars. CSR will likely have less import competition and higher prices and aluminum will obtain stronger Australian dollar earnings if the US dollar price of the metal holds up. As CSR's sales are hedged 32% in FY14 this will produce some lag for aluminium's impact. In Morgan Stanley's opinion, CSR offers the best exposure to an improving east coast property market in Australia but outweighing this is the aluminium issue and uncertainty over whether the Viridian business can be turned around.

James Hardie's Australian division earning will be weaker under US dollar reporting but favourable in the translation back into the local currency. Boral's US operations are not breaking even yet and there is also import related competition in timber and plasterboard that will weigh. UBS notes Fletcher Building ((FBU)) has limited direct US exposure and US dollar related import competition in steel and insulation. The Australian dollar weakness against the NZ dollar is neutral for Australian investors and negative for NZ investors in the stock. For Morgan Stanley, Fletcher may have leverage in the Australian assets to the domestic building recovery but may not benefit as much as listed Australian peers. Revenue growth across the company's divisions also looks light and it is one of the broker's least preferred in the sector.

Adelaide Brighton's ((ABC)) cost of importing clinker is expected to rise with the weaker Australian dollar, affecting cement margins should there some attempt by competitor Boral to pressure pricing. Adelaide Brighton's exposure to the lower Australian dollar is the most negative in the sector by UBS calculations. Morgan Stanley concurs it's all about the cement price and the Australian dollar. It may be a high-quality business, benefitting from a recovering Australian housing market, but the broker sees regional and resources related risks. Morgan Stanley prefers Boral over Adelaide Brighton.

The other aspect on UBS' radar for building materials companies is the carbon tax, or the removal of the carbon tax predicated on the incoming federal government getting the legislation through the parliament. UBS notes removal of the carbon tax should take out up to $5-15m in carbon costs per annum across what is a highly energy intensive sector. Boral and CSR earnings will benefit most. The impost of the tax has not been passed on to the customer given the level of import competition. Energy costs for the industry should decline as electricity prices fall if the carbon tax is removed. CSR's aluminium operations should be a key beneficiary of lower electricity costs, with electricity around 30% of the Tomago cost base and energy costs to fall around 15%. Offsetting part of the win is rising east coast gas prices, with Adelaide Brighton the most affected in that regard.

What's happening with import competition? In the insulation market where CSR and Fletcher supply around 90% imports are not significant, despite the cheap supply from Asia. This is an area where the production specifications in Australia defend the local pair. CSR's glass business is the sole manufacturer of flat glass in Australia. Globally there has been a glut and while imports represent a small share as yet of the local market, UBS notes they are on the rise. In timber, the weaker Australian dollar has provided some respite to timber imports while imports of cement and clinker have risen steadily, largely from Adelaide Brighton's adoption of an "import and grind" model.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms