CSR’s Outlook Dulled By Glass And Aluminium

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-Improved building product margins
-Viridian still lacklustre
-Aluminium under a cloud
-Dividend increase seen likely
 

By Eva Brocklehurst

CSR Ltd ((CSR)) beat expectations in its first half results but brokers remain divided as to just how long the housing cycle can underpin robust earnings growth. Strength in the building products division was generally unsurprising, as Australia is in the midst of a housing boom and CSR's products are mainly directed to housing.

Deutsche Bank is optimistic that a significant improvement in building product margins will mean upgrades to FY17 as well. The broker currently factors in 13.5% for FY17 building product margins, which compares with the 12.2% witnessed in the first half results. Upside to these assumptions is also considered possible, given product price increases of a similar magnitude are expected next year.

JP Morgan was also encouraged by the company's focus on operating efficiencies, with expectations of price increases and operating improvements driving its forecasts for margin expansion.

The first half may have beaten expectations in terms of building products but Viridian earnings (glass) were below Macquarie's estimates. While aluminium performed well, the outlook is challenged in the broker's opinion, and caution prevails as the company is still working on a deal for electricity pricing at the Tomago smelter.

Macquarie suspects price growth is lacklustre in building products, while still slightly ahead of cost growth. Outside of the bricks market, pricing power seems limited, with builders suggesting higher utilisation of plasterboard may bring price growth but the broker considers, for the rest of CSR's products, the outlook is mixed.

Estimates for FY16 and FY17 are revised higher, by 9.0% and 7.0% respectively and Macquarie believes FY16 will represent the peak in earnings. Moreover, housing approvals will increasingly become a headwind next year. A rapid decline in approvals and commencements is expected, starting in 2016. The broker has an Underperform rating and would use price strength as an opportunity to reduce its exposure to the stock.

The company may be generating cash and capital management is not out of the question, likely in the form of dividends. Nonetheless, Macquarie suspects a growth acquisition will be hard to come by and organic options are limited.

Citi is much more upbeat on this aspect, suspecting several options will be presented to the company amid an extended earnings cycle and cash flow that goes beyond dividends, such as mergers, acquisitions and capital management.

UBS is also positive, observing the company has made efforts to differentiate its business via small acquisitions that have had higher-than-average growth. Cost cutting has helped in aluminium and glass and a lower Australian dollar will be supportive. While all those aspects are pleasing the broker acknowledges the potential for a downturn in housing and aluminium prices.

UBS observes that in building materials, high multiple stocks which have growth are often preferred to those considered cheap but ex growth. Lead indicators are indeed what the market outlook relies on and the broker suspects CSR may continue investing to attempt to outperform the cycle. Also, the downside may already be priced in and there is the prospect of capital management, given a growing cash balance.

The most disappointing aspect for UBS was still Viridian. The broker suspects that an eventual housing downturn could make profits in this division sub optimal.

Morgan Stanley weighs in on the downside in terms of risks to the stock over the medium term. For now, the dividend yield is protecting the downside but the stock is not considered overly cheap.

At the current share price the broker estimates the market is valuing the building products division at around 12.6 times FY17 earnings forecasts. As this is expected to be the peak earnings year, this is considered a fair multiple. In the absence of a rally in the aluminium price Morgan Stanley expects FY16 is likely to be the peak for earnings in that division.

For Credit Suisse, the clouds hang over aluminium. Lower costs appear sustainable but the Tomago electricity contract remains a key area of uncertainty and one where the broker questions whether a better contractual outcome is achievable.

In terms of capital management, CSR is restricted by the asbestos liability on its balance sheet and, against this backdrop, Credit Suisse doubts it can explore special dividends and/or share buy-backs. The broker does highlight that the dividend pay-out in the first half of 63% was below trend and increasing it to the top of the company's pay-out target, at 80%, would represent a material increase from current levels.

FNArena's database has four Buy ratings, two Hold and one Sell. The consensus target is $3.57, suggesting 16.3% upside to the last share price. Targets range from $2.74 (Macquarie) to $4.25 (UBS). The consensus dividend yield on both FY16 and FY17 forecasts is 7.6%.
 

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