James Hardie Misses Targets, Again

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

-Questions over 35/90 strategy
-Will it be margins or share that give?
-Lack of clarity on market penetration
-Yet US market growth remains solid
 

By Eva Brocklehurst

James Hardie ((JHX)) missed US market penetration targets in its first half, one of the levers for growth it outlined in previous presentations. The company has downgraded FY16 earnings guidance to a lower range of US$230-250m from US$240-270m and attributes this to soft volumes and a flat patch in growing market share.

This complicates its investment appeal, Credit Suisse observes. Growth in earnings is likely to be solid over FY16-18 but the lack of market share expansion raises a question over its 35/90 strategy. This so-called strategy involves an aspirational target of 35% fibre cement product share of the cladding market while growing James Hardie's share of that market to 90%.

Credit Suisse acknowledges there is no quick fix and the stock could be range-bound until confidence in the growth story is restored on that front. In the broker's opinion, the investment case is also impaired by the capital management story largely being played out and any premium ascribed to the stock in this regard may unwind.

A lack of growth in the second quarter suggests to Credit Suisse that the easy wins have been made in terms of market share for the company's fibre cement product, that competes with vinyl siding in the US. Further investment is probably required to accelerate growth. The broker acknowledges some concerns that weakness in housing activity is creeping into the renovations market but finds scant evidence as yet.

The broker does highlight that James Hardie appears to be adopting a more flexible pricing strategy, guiding for no price hike in March 2016 and flat net average prices over the next 18 months. A similar strategy was adopted in FY12, Credit Suisse observes, and was successful. The challenge is, therefore, how long short-term margins can be sacrificed for long-term gains.

UBS estimates the market is currently pricing in volume growth in new housing of roughly 20% in FY17-18, versus its expectations of a more sober 11-15%. This implies either an improvement in housing starts is needed, or that the company penetrates the market more strongly over that period. This broker also questions whether the 35/90 strategy is on track.

The broker's Sell rating is based on belief the market is too optimistic about this strategy. UBS believes it unlikely that 90% share can be achieved and high margins maintained. It's either one or the other. The path to the 35% fibre cement share of the cladding market is also not without obstacles. Substantial inroads into vinyl and wood are needed.

Back in Asia Pacific James Hardie's earnings rose 19%, underpinned by volumes as well as prices. This highlights the company's ability to drive margin growth despite production inefficiencies and procurement headwinds, in Credit Suisse's view. The broker expects that, if a favourable product mix continues, the drag on production at Carole Park diminishes and the US dollar stabilises, then margins could increase to over 25%.

While expectations have softened, Macquarie is not so worried, given the ongoing recovery in the US market. While the company has not worked its buy-back in the last quarter the broker notes it remains the preferred method of capital return and the second half typically provides more opportunity to execute on such activity.

In terms of the competitive dynamics, Macquarie notes rival Louisiana Pacific's siding volumes fell 14% in the last reported quarter so US volume growth of 7.0% for James Hardie compares well on this measure.

As for market penetration, it remains unclear to the broker as to which material is gaining share, whether it be vinyl, stucco or brick. Nevertheless, Macquarie acknowledges James Hardie's focus is on displacing vinyl siding and this has stalled over recent quarters.

Deutsche Bank is confident that the company's track record in turning around problem areas will stand it in good stead and it can again grow market share in fibre cement. It may take several quarters, nonetheless, to lift primary demand growth in both the US and Europe back to targeted levels.

The downgrade and lack of a price increase forthcoming in March surprised Morgan Stanley. The broker is also uncertain as to why unit costs increased in the second quarter, although this is a volatile item on a quarterly basis.

A weaker market rather than market share losses have driven the volume outcomes in the second quarter, Morgan Stanley believes, and any indication of a normalising of market demand would be taken positively.

Furthermore, the broker finds it difficult, on analysis of competitor business, to assess where market share in cladding has gone, suggesting this may simply be de-stocking rather than any large recovery in vinyl demand. Further details are sought from the next quarter's data, to obtain a read on whether any new trend is forming.

JP Morgan was disappointed in the results and, while the weaker margin performance can be explained away, the most pertinent issue is the stalling of primary demand growth. Acknowledging management's competence, the broker suspects this may be a deeper issue and have a longer time frame to resolution.

There is no expectation for primary demand to improve beyond being "flat", the broker observes, and downgrades its rating to Neutral from Overweight.

The downgrade to earnings forecasts has pushed Citi the other way. The broker upgrades to Buy from Neutral. Citi envisages there is much more to come from the US housing market cycle and remains confident in the company's intentions and ability to restore primary demand growth. The ensuing share price weakness after the forecast downgrade has delivered a buying opportunity, in the broker's opinion.

FNArena's database has four Buy ratings, two Hold and one Sell. The consensus target is $18.45, signalling 10.8% upside to the last share price, and compares with $19.62 ahead of the update. Targets range from $16.45 (UBS) to $20.50 (Macquarie).

See also, What Will Drive Growth For James Hardie? on September 14 2015.
 

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