James Hardie Excels But Is More Upside Possible?

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

-Margins could exceed target
-Decline in pulp costs helps
-Outpacing competitors
 

By Eva Brocklehurst

After a soft first quarter James Hardie ((JHX)) excelled for the rest of FY15, exceeding expectations and raising the level of confidence amongst brokers. US margins increased significantly, driven by improved performance and higher volumes, and the company expects these to remain within its target range of 20-25%. A special dividend of US22c was declared and a new share buy-back program announced, with the intention to acquire up to 5.0% of issued capital to May 2016.

Management did indicate a special dividend was not a preference, given a lack of franking credits, and the focus will be on buying back shares going forward. Small acquisitions may still feature, Deutsche Bank contends, prior to utilising capital for the share buy-back. The broker considers there is potential for the company to buy back between 3-11% of its shares on issue in FY16. In the US, management expects growth rates in line with FY15 which, in Deutsche Bank's calculations, translates to an increase to US fibre cement earnings margins to at least 25%. In Asia Pacific fibre cement growth in line with the market is expected.

Goldman Sachs already has a significant increase in margins factored into FY16 and FY17 forecasts for the US and Europe so the better-than-expected FY15 result is largely implied in forward estimates. The broker expects strong earnings growth from a combination of higher prices and increasing market penetration in the US and maintains James Hardie offers investors the best mix of earnings growth, dividends and capital management opportunities within its building materials coverage. Goldman Sachs has a Buy rating and $17.36 target.

The highlight was the strong US operations and given positive momentum in housing starts and robust renovations growth, the environment remains supportive, in Macquarie's view. The stock has reacted strongly on the back of the FY15 results but the broker expects additional support from the ongoing US recovery and a weaker Australian dollar. The one question for Macquarie is the competitive impact of Louisiana Pacific and James Hardie's investments in order to address this challenge. The company appears confident it has the upper hand, and while a strategic issue longer term, the broker accepts this does not have a significant bearing on the current investment case. Macquarie retains an Outperform rating.

James Hardie has enjoyed a stellar rebound from a subdued first quarter and still offers an attractive and predictable growth profile, in JP Morgan's view. Now that the rebound is largely priced in the broker downgrades to Neutral from Overweight. The company has confirmed demand is growing around 7-8% and expects growth of 10% in FY16. Orders are running slightly behind target, JP Morgan observes, and may temper first quarter earnings but any impact is expected to be offset by lower unit manufacturing costs. Margins are expected to increase to the top end of the target range and the broker would not be surprised if they exceeded 25% in the first two quarters of FY16.

Credit Suisse found the results a strong positive signal on the outlook and suspects margin forecasts could be exceeded. Margins are most sensitive to the cost of pulp and, with benchmark prices in decline, the broker wonders just where FY16 margins could end up. The growth story and market penetration are intact and the proactive buy-back is underpinning the share price. Still, Credit Suisse awaits a more attractive entry point and retains a Neutral rating.

The cost of pulp did not impress UBS as much as the efficiencies achieved in the company's US factories. The broker calculates earnings per square metre are near the 2010 peak, on volumes that are still 20% lower than in 2006. Management has advised not to expect too much volume growth in the short term but UBS believes the outstanding cost performance will be sustained until new capacity starts up in 2017.

Further ahead the rating of the stock does depend on volume growth, the broker acknowledges, but the operational excellence demonstrated in the past decade should be supportive. Again, UBS believes it is hard for an increasingly mature business to justify the current earnings multiple and retains a Neutral rating.

Morgan Stanley does not consider the stock expensive on a relative basis and suspects this could drive near-term upside, although admittedly it appears fully priced at current levels. The broker notes, on a relative basis, James Hardie has averaged a 30% premium to the S&P ASX200 industrials ex financials over the past five years. Calculations suggest that after the latest move and update to estimates, the stock will trade at a 20% premium which implies further 10% upside in order to re-rate back to the five-year average.

In Citi's view the best is yet to come in the US. While not discounting competitive responses, sustainable alternative products to those of James Hardie appear limited by the lack of additional capacity installed at the bottom of a historically low US housing cycle. Hence, competition has an uphill battle to gain traction against the company. The market has also efficiently priced in the implied earnings upgrade so Citi, too, retains a Neutral rating.

FNArena's database has two Buy (Macquarie, Deutsche Bank) and five Hold ratings. The consensus target is $17.20, which suggests 2.5% upside to the last share price and compares with $15.16 ahead of the results. Targets range from $15.46 (UBS) to $20.11 (Deutsche Bank).
 

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