James Hardie Disappoints, But Outlook Solid

This story features JAMES HARDIE INDUSTRIES PLC. For more info SHARE ANALYSIS: JHX

-US growth modest but on track
-Issues are not unsurmountable
-Underpinned by dividend yield
 

By Eva Brocklehurst

James Hardie Industries ((JHX)) produced a soft first quarter, with growth in US housing activity disappointing both the company and the market. Deutsche Bank believes the weakness should not be taken out of context, nor extrapolated longer term. Market share growth is robust and US pricing remains strong. Earnings margin upside can be obtained if some of the costs are taken out.

Morgan Stanley is of a similar opinion. The broker retains an Overweight rating, envisaging the US target earnings margin of 25% is still achievable and US housing activity, both new and renovation, will continue to drive value. Tough comparisons in the second quarter may make growth harder but improvement should come in the second half. Assuming growth can be sustained, the broker considers the upper end of the earnings guidance range of US$205-235m is achievable.

The first quarter was a reality check, in CIMB's opinion. Margins were disappointing, contracting 20 basis points relative to the prior corresponding quarter and despite an 8% increase in volume and 7% increase in prices. Clearly anticipated leverage to volume and price was not forthcoming. The broker accepts production inefficiencies that weighed on profitability will be addressed but suspects increased organisational costs are likely to remain. They are probably an inherent feature of a growing market. The broker considers James Hardie a quality stock, but the focus is heavily on the US housing market, where growth is likely to remain modest, and this may disappoint those hoping for more stellar gains. The dividend yield is the key supportive feature of the stock, in the broker's view. CIMB lowers FY15 forecasts by 13% and retains a Reduce rating.

The fact that volumes were soft relative to the available opportunity – new US housing was up 13% in the quarter – raises questions for UBS. The broker suspects volumes may have been affected by price increases over the past year as this market is hard to penetrate. Manufacturing problems are likely to be sorted out by the end of the year and one of the company's strengths, which UBS highlights, is that it can manipulate costs as required. UBS plumbs for a FY14 forecast at the lower end of guidance and retains a Sell rating.

Credit Suisse is content that reasons behind the weak result are one-off factors. The broker upgrades its recommendation to Outperform from Neutral, expecting the market will focus on emerging opportunities. Demand growth is on track and margins should improve as operational inefficiencies unwind. The US market is tough so overall revenue growth of 16% was pleasing for Credit Suisse. Moreover, renovation activity lifted and this underpins James Hardie's earnings.

JP Morgan was not surprised by the market reaction to the results but does not believe any of the issues are intractable. Earnings were affected by manufacturing inefficiencies, higher-than-expected corporate costs and FX losses. In contrast, the top line performance was better than the broker expected and longer-term growth prospects are intact. The broker believes it is important to disaggregate volume growth and look at the exterior products. Doing so reveals first quarter growth in exterior products was around 12%, with an estimated 3% fall in interior volumes. While accepting that repeating past errors is no excuse, the broker does note a recurrence of cost related issues, which resulted from investing ahead of volume growth. This highlights the uncertain nature of the recovery path in US housing construction.

US demand simply missed more optimistic management estimates and corrective action should be in place, in Citi's view. The broker maintains disappointment really centres on the lost earnings associated with the commissioning of the Fontana plant, and a poor manufacturing performance. The adverse impact of overestimating market demand may not be completely clawed back in the second quarter, as the company intends to restrict production in order to run down inventory. Accordingly, Citi believes issues should be better managed in future months. Higher pulp prices are expected to persist and this will continue to place pressure on margins. Having said that, the broker does not expect any major obstacles to James Hardie achieving its FY15 guidance.

On the FNArena database there are four Buy, two Hold and two Sell ratings. The consensus target is $14.28, signalling 6.5% upside to the last share price, and compares with $14.74 ahead of the quarterly result. A dividend yield of 5.4% is forecast for FY15, with 5.3% for FY16.
 

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