Australia | May 11 2017
CSR has acknowledged that building approvals for residential developments are well past their peak although building product earnings are expected to be supported in FY18. Brokers trim the outlook further out.
-Non-residential building may mitigate some challenges as high-density residential growth eases
-Strong balance sheet and dividend yield provide support for the stock for now
-Yet interest in the stock is based on building products exposure and a fall in housing indicators may weigh
By Eva Brocklehurst
CSR ((CSR)) has suggested residential building approvals are well past peak levels and energy costs will present a headwind in FY18. Building product revenue in FY17 was supported by construction activity in the east coast markets but failed to meet the company's targets.
CSR's commentary regarding demand has moderated somewhat and while a recovery in non-residential building could ease some of the challenges in high-density multi-residential building, Macquarie believes the earning cycle will still peak through FY18.
The addition of more earnings visibility around property helps the growth picture for FY18, but the broker is inclined to discount this source of growth, being sceptical that property earnings much in excess of $20m per annum are sustainable.
A sum-of-the-parts approach is the most appropriate in the context of varying earnings streams and, while the earnings outlook for FY18 holds up, Macquarie does not envisage the valuation impacts are as positive.
Credit Suisse expects earnings momentum to continue into FY18, underpinned by building product volumes and prices and a hedged aluminium book. In the near term the main risk is the shape of the cycle, in the broker's opinion, and the multiple that investors are willing to ascribe to building products as earnings fade. The broker suspects sentiment towards the sector may create volatility in the share price although, for now, the strong balance sheet and dividend yield should provide support.
Citi is not as confident and downgrades to Sell from Neutral. The broker suspects the backdrop of rising energy prices and lower building product margins in FY17 may counter some of the benefits from price rises expected in FY18, which is likely to be the peak earnings year for the company.
Despite the hedging of its metal exposure out to FY20 and a formidable start to FY18 in property earnings, Citi asserts investor interest in the stock is primary on the back of its building products exposure. The broker suspects investors may turn increasingly to companies with offshore earnings, as leading indicators of housing signal a fall in volumes, margins and earnings in the FY18-20 forecast horizon.
Viridian
Viridian was a notable weak spot, in Macquarie's view. The challenges for this business in New Zealand also loom large. Following the buying out of minorities the company is battling to improve plant efficiencies and is unable to meet demand and customer service requirements. The broker believes a drive into less import-oriented commercial markets remains key to the business, although acknowledges this has a higher risk profile.
Deutsche Bank no longer factors in margin expansion for building products in FY18. Prior to the result, the Viridian business appeared to be recovering but now further investment in restructuring appears necessary. Deutsche Bank suggests glass industry issues may be structural and, as a result, there is a risk that the current $247m in invested capital is too high. The broker believes a write-down is probable in the next 12 months if earnings do not recover.
The results were below Ord Minnett's forecasts in building products, Viridian and and property, while aluminium was ahead. The residential cycle may be set to weigh on earnings from FY18 and a step up in electricity costs affect profitability at Tomago but the broker believes the earnings outlook is benign. That said, while management has guided to improved earnings in FY18, Ord Minnett remains cautious about the business and lowers its estimates substantially.
Aluminium
The company has presented a significant increase in its aluminium hedge position. While the increase provides improved visibility on earnings, the average hedge prices are below prevailing forward curves, Credit Suisse notes. Modest volume gains and reduced fixed costs are expected to feature at Tomago. From December, the smelter will be required to pay an additional $250/t in electricity costs which negatively affects operating earnings (EBIT) for four months.
Credit Suisse was surprised by the magnitude of the hedging in the aluminium book, noting this has not occurred for some time. While bears may argue the company has given away potential upside as positive price developments emerge in China, the broker believes a forward hedged position should be accompanied by a higher stock multiple as this reduces earnings volatility.
Deutsche Bank also believes FY19 operating earnings will be negatively affected by a softer housing market, lower property income and higher aluminium costs. The broker also notes a risk the new plasterboard plant in Queensland will affect pricing.
Buy-back
Both Macquarie and Deutsche Bank consider it unlikely the company's buy-back will be active in FY18 and remove it from future earnings expectations. Credit Suisse notes the balance sheet is in great shape and, despite the sharp step-up in growth capital expenditure, strong cash flow is expected to mean the metrics are relatively unchanged. This should leave ample room for accretive mergers & acquisitions and/or capital management, in the broker's opinion.
Citi agrees that with an inactive share buy-back and the possibility of industry valuation multiples falling as the residential cycle rolls over, the company may be on the look-out for emerging M&A opportunities but this could take some time.
FNArena's database shows a consensus target of $4.26, suggesting -2.3% downside to the last share price. This compares with $4.48 ahead of the results. Targets range from $3.40 (Morgan Stanley, yet to update on the results) to $4.90 (Credit Suisse). There are four Hold ratings and two Sell. The dividend yield on FY18 and FY19 forecasts is 6.0% and 5.1% respectively.
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