Is Growth Slowing For Reliance Worldwide?

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This story features RELIANCE WORLDWIDE CORP. LIMITED.
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Reliance Worldwide's FY19 guidance has disappointed high expectations, despite increased synergies expected from the John Guest acquisition.

-Growing concerns regarding growth in the US business
-Moderation in margin expansion on the back of input cost pressures
-Increased synergies from John Guest expected, but some revenue is uncertain
 

By Eva Brocklehurst

Plumbing products manufacturer Reliance Worldwide ((RWC)) disappointed high expectations with its FY19 guidance, while the company's FY18 results were complicated by the re-classification of categories for products imported to the US and the acquisition of the John Guest business.

The company has highlighted its ability to offset US tariffs by alternative sourcing strategies as well as, potentially, in pricing. Reliance Worldwide does have the opportunity to manufacture more of its product in the US but the broader Australia-US manufacturing capability is unchanged.

FY18 adjusted underlying operating earnings rose 25% to reach the lower end of guidance and net debt has increased to $388m following the John Guest acquisition. The company's guidance for FY19 operating earnings (EBITDA) is $280-290m, with $10m in synergies from John Guest included.

Regardless of the synergy upside, Deutsche Bank remains concerned about growth in the underlying US business. Significant risk exists in achieving organic growth in the longer term, the broker suggests, because of management's focus on a multi-faceted growth strategy. Given the risks, and the fact the stock still trades at a 23x FY20 price/earnings estimate, Deutsche Bank downgrades to Sell from Hold.

Morgans was also disappointed with the Americas division, being -7% below its expectations. Still the broker considers the stock an attractive investment proposition because of a strong market position and earnings growth profile.

Management has indicated that Holdrite continues to perform to expectations and, together with EvoPex, this underscores its expansion strategy into the US residential and new construction markets. Earnings from this market segment remain small but Morgans expects contributions to increase progressively over time.

The main disappointment for Ord Minnett was the margins in the Americas, which fell short of projections. The broker incorporates more favourable currency assumptions in its outlook than those provided by the company. On Ord Minnett's estimates the base business should achieve a growth rate of 8% in FY19.

Revenue Growth Slowing?

While acknowledging the weaker-than-expected FY19 guidance should be taken in context, and the John Guest acquisition is strategically sensible, CLSA believes there are indications that revenue growth is slowing and this warrants some caution.

Seasonality could be a factor but, with the UK and EU taking up around 77% of John Guest sales, any deceleration in top-line growth may have further implications for FY19-21 estimates. The broker, not one of the eight stockbrokers monitored daily on the FNArena database, retains an Underperform recommendation with a target of $5.76.

Bell Potter notes the Americas division will be cycling a strong comparable in FY19 because of temporary factors that boosted revenue and earnings in the second half of FY18. As broader activity levels soften in both US and UK housing markets the higher synergies from the John Guest acquisition will be a tailwind although, the broker points out, this includes some assumptions on both the revenue and cost sides.

The broker lowers the Americas division forecasts as well as John Guest forecasts. Adjusting FY19 forecasts to include the full synergies of $30m, an implied price/earnings multiple of around 25.5x and an enterprise value/operating earnings multiple of around 16.5x suggests the valuation is full, in Bell Potter's view.

The broker also expects margin expansion will moderate because of input cost pressures. Bell Potter, also not one of the eight, downgrades to Hold from Buy with a target of $5.66.

John Guest Synergies

Macquarie liked the upgrade to synergies associated with John Guest. The company has moved forward the timing of realising the full $20m that was previously assessed, to the end of FY19. On top of this, Reliance Worldwide now expects $30m in synergies by FY20. Around half the increase of $10m relates to revenue.

Credit Suisse previously modelled $20m in realised synergies by FY20 and adds a further $5m for FY21, based on the increase to guidance. The $10m increase includes revenue synergies which, in the broker's opinion, are less certain.

Morgans suggests, while some of the increase will come from revenue, most of the extra revenue synergies are from cost savings such as procurement, operating efficiencies and business integration.

Over time, the broker expects even greater revenue synergies, as Reliance Worldwide introduces new products globally and leverages its network for new markets and channels. Morgans acknowledges execution risk remains key to the John Guest acquisition but the integration process appears to be off to a good start.

FNArena's database shows three Buy ratings, one Hold (Credit Suisse) and one Sell (Deutsche Bank). The consensus target is $5.91, suggesting 6.9% upside to the last share price. Targets range from $4.80 (Deutsche Bank) to $6.50 (Macquarie).

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