What Will Drive Growth For James Hardie?

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

-More conservative outlook in US
-Volume growth difficult
-Margin vs share, or both?
 

By Eva Brocklehurst

James Hardie Industries ((JHX)) was at pains to define the US market to investors at its recent briefings. At the time of the first quarter results, the absence of primary demand growth was a concern for brokers and the question was whether this reflected a weaker state of play ahead in FY16.

Management's recent presentations suggest to brokers that while primary demand is likely to be below the 8.0% recorded in FY15, there are other levers which will drive growth such as margins, market penetration and pricing.

UBS suspects the company is finding it more and more difficult to achieve volume growth. That said, FY16 profit guidance is unchanged at $240-270m and the company presented a conservative outlook for US housing starts. This conservative view means market penetration could be the key, in the broker's view. 

James Hardie has framed its conservative outlook in terms of the increasing numbers of 18-34 year-olds staying at home with their parents, as saving for a down-payment on a home becomes more difficult than previously was the case. While the softness in primary demand growth may be temporary, it needs to be watched, UBS maintains, because it is the main driver of shareholder value.

In this environment, UBS still finds it difficult to ascribe value to the company's FY17 price/earnings ratio of 25x. Profits are expected to ultimately be competed away and will remain a toss-up between market share or margins.

On the other hand, Deutsche Bank does not find growth paths for the two impossible to conceive. There is potential upside to assumptions in FY16 and FY17 from higher margins, derived from lower costs and higher prices. The company has programs in place to capture market share and Deutsche Bank expects this will be supportive in FY17, despite the likelihood of lower primary demand growth.

Given US housing starts have been slower than previously expected, the broker suspects James Hardie will not bring idled capacity back on line until FY18, with new capacity decisions unlikely before FY22. This should have a positive impact on US margins in FY16 and FY17.

In the end, the company is in a comfortable position vis-a-vis FY16, Citi maintains. The company has a normalised dividend pay-out ratio of 50-70% and balance sheet capacity for around US$100m to be returned to shareholders. There is also leverage to a recovering US housing market, albeit more gradual, as well as the less volatile renovations market.

Credit Suisse also debates the earnings and valuation drivers. The broker suspects achieving market share growth is proving much harder, but believes a step-change in margins should provide the necessary offset. Moreover, the valuation should be cushioned by the falling Australian dollar.

The broker describes the company's strategy as a rainbow – there is a pot of gold at the end but it may never end up being found. This is not a criticism, Credit Suisse is keen to assert, but simply  a view that growing market share is harder than previously thought.

Continuing to launch products that differentiate James Hardie's offering is a means to not only defend a market but to grow, in the broker's opinion. While the way forward will not be smooth, increasing opportunity is expected to come via a declining wood and vinyl market. The company is also at the forefront of educating contractors to make its product as a preferred choice.

JP Morgan believes inefficiencies in the manufacturing operations, now largely resolved, meant the company took its attention away from demand in order to resolve the problems. Now, the broker expects a redoubling of efforts towards growth and targets. James Hardie is targeting fibre cement to become 35% of the siding market (currently 18%), of which it aims to have a 90% share.

FNArena's database has three Buy ratings, three Hold and one Sell (UBS). The consensus target is $18.70, suggesting 0.2% upside to the last share price. Targets range from $17.28 to $20.50.

See also, Is James Hardie Overvalued? on August 17 2015.
 

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