Is James Hardie Overvalued?

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

-Is market overpaying?
-Softness sector wide
-Growth story intact
 

By Eva Brocklehurst

After another soft first quarter analysts are running the ruler over James Hardie ((JHX)). Last year started in a similar vein but the results ended up beating expectations so most brokers are not unduly concerned.

UBS is an exception, downgrading the stock to Sell from Neutral. The broker believes the market is overpaying for the company's attributes. Undoubtedly James Hardie has strong exposure to growth in US family homes, given pricing power and low fixed costs. Still, these features are all priced in and UBS maintains cost performance can only achieve so much. Pushing up prices eventually means volume growth becomes critical and UBS warns investors not to be too dismissive of this fact.

The company has proven to be one of the most defensive building materials companies exposed to US housing, enjoying a dominant share of fibre cement. Still, UBS cannot avoid the impression the market is pricing in super-normal profits as well as a high market share over the long term and profits could ultimately be competed away, with either margins or market share maintained at the expense of the other.

While acknowledging one quarter does not make a case, UBS believes, as long as James Hardie demonstrates ongoing growth in primary demand and margins are in line with its strategy, then investors are unlikely to discount longer-term valuation issues. Still, whenever it becomes apparent that management is having difficulty achieving on targets then investors are likely to become more cautious.

The US and Europe were operationally strong in the quarter, Macquarie contends. The broker believes more than half of the margin improvement came from plant efficiencies and this should provide a base for leverage as the cycle recovers and utilisation improves. For that reason lower primary demand growth, while disappointing, should not be permanent. Meanwhile, the US housing cycle continues to accelerate.

The first quarter may have been light but Morgan Stanley considers growth was good enough when compared with peers. That said, the broker considers the stock is fairly valued. Goldman Sachs, not one of the eight brokers monitored daily on the FNArena database, observes competitor Louisiana Pacific also reported weak volumes in the January quarter. Hence, Goldman attributes much of the volume weakness to broader market issues such as weather, not to company-specific problems.

The cost predicament that faced the company in the prior first quarter (FY15) was dealt with swiftly. This time around revenue is the culprit, JP Morgan observes, and the failure of market initiatives to gain traction has exacerbated the softness. Still, the broker does not believe there has been a sharp change in fundamental demand growth, so the headwinds should abate.

The growth story remains intact. That is the most important aspect for Deutsche Bank. The first quarter fell short because of lower US sales relating to a pulling forward of demand to the fourth quarter of FY15. The broker also believes the FY16 profit guidance of US$240-70m, which implies a reduction of 5.0% to consensus estimates, is largely related to a higher effective tax rate.

Deutsche Bank's analysis reveals that a higher US fibre cement margin is more important than primary demand growth although, obviously, both moving in the right direction would be preferable.

Citi does not believe management is shying away from the fact that primary demand is lacklustre, given expectations have been lowered for FY16. However, the floods in Texas and the FY15 price rise have likely been key factors. Texas represents an estimated 22% of North American volumes while the March 1 price rise would have pulled demand forward. Hence, the broker is not unduly worried but, given the stock is fair value, retains a Neutral rating.

FNArena's database has three Buy ratings, three Hold and one Sell. The consensus target is $18.65, suggesting 2.3% upside to the last share price. Targets range from $17.28 (Morgan Stanley) to $20.50 (Macquarie).
 

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