James Hardie Poised For Better 2018

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This story features JAMES HARDIE INDUSTRIES PLC.
For more info SHARE ANALYSIS: JHX
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

Brokers have welcomed the substantial improvement in James Hardie's earnings in the December quarter, amid increased activity in the US and a continuation of the strong Australian residential cycle.

-Confidence in earnings growth lifts materially
-FY19 margins could be sustained above 25%
-Volumes growth still lags
 

By Eva Brocklehurst

Brokers were impressed by James Hardie's ((JHX)) ability to not only get back on track in North America but to substantially surprise on the upside in the December quarter.

This is the seasonally weakest quarter and suggests to Citi the start of an extended upgrade cycle. The broker's confidence is lifted materially regarding the company's ability to deliver double-digit underlying earnings growth in successive years and ultimately retire debt through strong free cash flow.

Macquarie observes a 10% beat to its expectations in the December quarter. Moreover, commentary regarding further improvements to operations, a strong housing market and potential for freight efficiencies provides more confidence that FY19 margins could remain above the target of 25%.

On the subject of freight, Macquarie suggests much would already have been expensed, resulting in gains in the next few quarters.

The company has guided to FY18 net profit of US$260-275m, up 11% on the prior year. Macquarie suggests this is conservative and expects FY18 net profit of $281.8m.

The strength of margins signals to CLSA, too, that FY18 guidance could be conservative. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, has an Outperform rating and $26.20 target.

Margins were the highlight for Morgan Stanley, with the improvement as a result of price improvement and additional manufacturing efficiencies. The broker notes inventory built up significantly and provided some support for unit costs.

Macquarie notes the growth in corporate costs but ascribes this to higher discretionary spending and increased stock compensation costs. This is expected to normalise going forward and does not make the broker uncomfortable, as the majority relates to the adjustment to stock compensation.

Management acknowledged that a lot went right in the December quarter and this does not lead it to a more bullish view, Credit Suisse points out. The broker scales back its rating to Neutral from Outperform, given the elevated valuation and limited potential upside to consensus estimates.

Primary Demand Growth

Volumes may have been slightly disappointing in the US, Macquarie acknowledges, but this is attributed to declines in the interior products, around 20% of the sales mix. A turnaround is expected. CLSA found the volumes slightly disappointing, but also acknowledges the drop off in interiors, which it suggests is a declining sector anyway.

Ord Minnett believes primary demand growth (PDG) must return to justify the relative valuation. The PDG is expected to return to 4% in FY19 before rising to 6% in FY20.

The broker acknowledges underlying net profit guidance appears conservative but, given the strong share price performance, downgrades to Lighten from Hold. The broker's terminal margin assumption of 25% is unchanged and at the top end of management's target range.

Volume growth is lagging and PDG is elusive, Morgan Stanley agrees, although, as the business is well positioned, considers the valuation fair. Deutsche Bank expects PDG to return in FY19, at 5%, and rise to 7% in FY20, noting start-ups are expected at Plant City 3 and Summerville 1 to ensure supply issues do not recur.

Credit Suisse still considers the stock well positioned for the acceleration in US housing activity, based on a forecast for 11% growth in single housing starts in 2018, 6% renovations growth and recent data that suggests activity will be strongest in the south/west regions.

Renovations are expected to be driven by an aging housing stock and above-average price appreciation, encouraging owners to refurbish rather than move. Management has signalled it does not expect quick wins to convert customers lost in early 2017 but is progressing on that front.

Australia

The company has announced an investment in phase 2 of the brownfield expansion at Carole Park at a cost of $28.5m, to be commissioned by the first quarter of FY21. Australia's performance was robust with Macquarie noting volume, price and margins all improved. The long-drawn out residential cycle has meant higher levels of activity have been maintained for this division.

Management expects Australia to continue performing strongly, yet Credit Suisse suggests a decline in activity over the medium term as the market exits the period of elevated activity.

The exact timing is uncertain but the broker models a -4% decrease in Australian volumes in FY19 and FY20, consistent with a -10% drop in new housing construction activity, offset by renovation expenditure growth. Growth in New Zealand and the Philippines, plus price rises, are expected to offset weakness in Australia and Europe.

The database shows four Buy ratings, two Hold and one Sell (Ord Minnett). The consensus target is $24.12, suggesting 3.6% upside to the last share price. This compares with $21.83 ahead of the quarterly update. Targets range from $21.25 (Ord Minnett) to $27.00 (Citi).

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