Is The Building Recovery Priced In?

This story features BORAL LIMITED, and other companies. For more info SHARE ANALYSIS: BLD

-Boral a major beneficiary but is it expensive?
-Adelaide Brighton's yield provides support
-Fletcher Building CIMB's key pick
-James Hardie well placed in US market
 

By Eva Brocklehurst

Surveys of home building in the US, Australia and New Zealand have prompted several brokers to review the outlook for the building materials sector. Overall, the backdrop is buoyant and there's a strong recovery in train. Nevertheless, when it comes to individual stocks the general consensus is that much of this highly-anticipated recovery is priced in. In some cases the stocks are considered downright expensive.

CIMB's survey of home builders in Australia and New Zealand reveals the most positive and broad-based feedback since the survey's inception. Domestic residential activity is gaining momentum and NSW stood out in that regard. Both current sales and prospective buyer traffic have improved and these metrics are the leading indicators for building approvals, starts and ultimately materials demand. The positive trends are expected to continue for some time. New Zealand is the strongest market and, coupled with the US recovery that's underway, that suggests the materials sector has benefits mounting across key geographies. 

The broker expects a sustained recovery in Australian housing over the medium term, with a rise of 9% and 6% in FY14 and FY15 respectively. Despite the prospect of a concerted improvement across key markets for building materials, CIMB thinks attention should be paid to earnings leverage. On this basis, the broker thinks the sector is fully valued and much of the upside is factored in. CIMB sees no indication that the skew towards multi-unit construction will slow and this means that, on an adjusted basis, any given level of housing starts will be less valuable than in previous cycles. This could create a gap between market expectations and reality. This is why the broker urges caution regarding those stocks where significant improvement has been factored in.

CIMB thinks Boral ((BLD)) will be a beneficiary of an improving Australian and US residential market but remains concerned about the pace of recovery. Earnings should improve but at a slower rate than many anticipate. CIMB believes Boral is expensive on a multiples basis, trading at 16 times FY16 earnings forecasts. This is expensive when based on conditions that are in line with, or above, mid cycle activity levels. CIMB has a Reduce rating.

As demand for concrete picks up in the key states of NSW and Queensland, JP Morgan observes an opportunity to improve prices. Frequently, profitability in concrete has been undermined by the protagonists raiding market share. The tightening of the supply/demand balance provides the opportunity for that to change and Boral is Australia's largest producer of concrete. Concrete may be low margin but it's a critical element in both building and infrastructure. The prospect of major government-led infrastructure investment in the eastern states stands out as a critical growth catalyst, in the broker's opinion. The three largest concrete suppliers in NSW and Queensland are Boral, Hanson and Holcim, dominating 65% of the market. Hence, Boral is JP Morgan's preferred exposure in the sector and the broker retains an Overweight recommendation.

Credit Suisse has also surveyed home building, in the US, and observed increased value for the building materials sector with exposure to rising house prices. Credit Suisse notes, regionally, there's relative strength in those markets that favour James Hardie ((JHX)). The survey reveals competition for a limited inventory, suggesting a lift in house prices and implying that more construction projects will become economically viable for home builders. There has been some soft patches in US new home construction but a strengthening renovations market should provide some offset, according to Credit Suisse. The broker notes Boral has guided to a US divisional break-even run rate in the second half but thinks this is ambitious in the absence of strong volume growth, as cost cutting and restructuring has run its course. Credit Suisse has Neutral ratings for both Boral and James Hardie.

Either way, rising house prices underpin the renovations market, of which James Hardie is a key proponent. For James Hardie, around 65% of volume is exposed to the renovations sector and Credit Suisse believes the better price environment also allows the capacity to push through higher fibre cement prices. The company's primary exposure may be in the US, but CIMB still thinks James Hardie will be also be a beneficiary of the improving Australian residential market. The company's focus on capital management should provide significant yield support for shareholders although CIMB struggles to justify the current share price on a fundamental basis and maintains a Reduce rating.

Despite being cautious, CIMB has an Add recommendation on Fletcher Building ((FBU)), because New Zealand is still the strongest of the housing markets and Fletcher is a key beneficiary. Adelaide Brighton's ((ABC)) exposure to heavy construction and a skew towards Western Australia has provided a more favourable macro position for some time but, with the improvement in activity in both Australia and the US, the broker thinks Adelaide Brighton offers less leverage to improved conditions than its peers. The broker rates the stock Hold, acknowledging there is still an attractive dividend yield, supplemented by special dividends, which will provide some support at current levels.

CSR's ((CSR)) building product business is supported by the upturn, but CIMB notes a large portion is leveraged to the aluminium price and the exchange rate and this dilutes the stock's leverage to the improving Australian construction market. CIMB retains a Reduce rating, believing this stock is also expensive.
 

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