Tag Archives: Building Material & Const

article 3 months old

Brickworks In A Sweet Spot

-Should industrial portfolio be sold?
-Improved pricing power
-Land & development profits to slow
 

By Eva Brocklehurst

Brickworks ((BKW)) is luxuriating in a strong residential construction environment on Australia's east coast as demand for bricks runs up against capacity, while management also forecasts an increase in earnings from investments in the second half.

The company's first half earnings were a fair reflection of the driving force in the property and equities markets in Australia, in Citi's view. With direct participation in industrial property development and an investment in coal miner/equity adviser WH Soul Pattinson ((SOL)), the broker considers the company is in a good position, while a 6.4% return on capital employed remains well short of the weighted average cost of capital (WACC) hurdle and below building material peers.

In terms of capital employed, Citi wonders about Brickworks' industrial property trust portfolio and whether, given the strong outlook for building products, the company should realise the value in its share of these properties. If that were to be the case, gearing would drop to 8.0% from 15%. Despite expecting an improved outlook over FY15, Citi believes the share price is fair and retains a Neutral rating.

Ongoing strength in housing is flowing through to improved pricing outcomes for the company, expected to play out strongly in the second half. In this respect, management expects second half building product earnings to be significantly higher than the prior corresponding half. Deutsche Bank highlighted this upbeat pricing outlook and the trend in demand for bricks. Brick prices are expected to increase 8-10% in FY15, with demand in Sydney observed as strong as it was before the 2000 Olympics. All available east coast production is now being brought online.

Deutsche Bank currently expects FY15 Australian housing starts of 203,200 units and FY16 starts of 205,600 units, 8.6% and 11.8% above consensus estimates respectively and retains a Buy rating on the stock. The broker does observe that the Bristile Roofing business has lost some market share because of heavy discounting in alternative products, such as BlueScope's ((BSL)) Colorbond range. Also, growth in building products may be at capacity in Western Australia while the company may have lost some share in Queensland. Nevertheless, renovation of 2-3 storey buildings in Sydney is underpinning brick demand, given historical building codes that demand brick inputs.

First half results were better than Macquarie expected and the broker notes Brickworks is looking to boost output to meet demand. The company is planning to bring plant 2 at Horsley Park back on line, with the re-commissioning expected to cost less than $1.0m. Brickworks expects the market to reach its constraints in terms of capacity by the second half of 2015 and Macquarie suspects the will lengthen the cycle somewhat, providing protection for building products profitability. Meanwhile, high capacity utilisation and a more consolidated market are supporting pricing power.

The main area where first half results beat Macquarie's estimates was land and development, driven by revaluation profits. While property sales remain in prospect, Macquarie suspects earnings will be under pressure from this source going into FY16. On a prospective basis the stock has de-rated vis-a-vis the ASX100 Industrials, to the bottom of historical levels, but Macquarie does not envisage much in the way of re-rating ahead, especially as land and development profits slow.

Brickworks has two Buy and one Hold rating on FNArena's database. The consensus target is $15.54, suggesting 10.3% upside to the last share price. This compares with $14.80 ahead of the results. Targets range from $14.55 to $16.82.
 

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article 3 months old

Weekly Broker Wrap: Oz Equities, Building, Telcos, Grocers, Aussie And Oil

-Headwinds stronger in some sectors
-Benefit of infra spend more so in FY16
-Focus on telco pay-outs, stable earnings
-Risk to Woolworths' guidance
-Another cut to cash rates likely?
-Negative wealth offsets to lower oil
 

By Eva Brocklehurst

Equity Strategy

As earnings season gets underway Citi notes expectations are being tempered and becoming more realistic. The broker expects large moves in global markets over the past three to six months will continue to impact earnings estimates, with downside risks to resources earnings from commodity prices and upside risk to offshore industrial earnings from the Australian dollar.

Domestically, the outlook is mixed. The improvement in the economy outside of resources is still concentrated in housing, which has been good for developers, construction materials and, less directly, retailers. It has not yet buoyed areas such as logistics or advertising. In Citi's view, some of the larger sectors now seem to be facing stronger headwinds. These include the banks, insurers and food retailers.

A reluctance to invest and a preference for distributing profits to shareholders does appear entrenched at this juncture and the broker considers it still too early for management to be talking much about FY16, so the main outcome from reporting season could be just the continued erosion of FY15 earnings, for which growth forecasts were already downgraded late last year. If so, the broker suspects this may stymie the recent gains in the market.

Building

JP Morgan believes the construction sector is emerging into a smoother period which should underpin reasonable growth over the next five years. Residential construction remains the bright spot, with an ongoing high level of approvals supporting the stronger-for-longer theme. The non-residential and engineering construction outlook looks bleaker. The broker finds some evidence to suggest road infrastructure will go a way to offsetting the headwinds from a declining spend in resources and energy, but the benefit of these projects is unlikely to be felt until well into FY16.

Telcos

Macquarie finds two themes for the telecoms sector over 2015, including the impact of the digital dividend amid the shifting dynamics of fixed line competition. Digital spectrum is now online and the broker expects it will have the greatest positive impact on Optus as it covers a prior deficiency in the company's low-frequency spectrum holdings. Both Telstra ((TLS)) and Optus are placed to benefit from improved coverage and capacity in the spectrum.

Macquarie expects a positive impact on financial for mobile players form consumer data consumption and a more competitive fixed line segment, reflecting a more aggressive Optus and rising customer acquisition cost in NBN areas. M&A is expected to remain on the agenda. The focus on liquid, cash generating businesses with high pay-out ratios, franking credits and stable earnings will continue to attract investors to Telstra. Optus will also be an important driver of growth for SingTel ((SGT)), should it succeed in reinvigorating its brand and customer growth trends.

Supermarkets

Recent reports from Australian real estate investment trusts have highlighted slowing growth in supermarket sales. The landlords, SCA Property ((SCP)), Novion ((NVN)) and Federation Centres ((FDC)) collectively control of 10% of Woolworths ((WOW)) and Coles ((WES)), stores. Morgan Stanley believes the trends are relevant for these two and risk of a soft sales performance in supermarkets is growing.

Tobacco accounts for 7-8% of supermarket category sales, so given the timing of excise increases in December 2013 and September 2014, this should have contributed to a net acceleration in growth in the second quarter versus the first quarter of FY15. According to Australian Bureau of Statistics data however, supermarket category growth slowed in the second quarter to 5.9% from 6.3%, highlighting for the broker the underlying weakness and the risk to Woolworth's 4-7% profit growth guidance.

Australian Dollar

Australia's economy is struggling to gain traction and the central bank is easing official rates. High yield advantage is becoming negligible and volatility is rising. Thus, ANZ analysts expect further erosion of investor confidence in the Australian dollar. High net worth individuals are reportedly shying away from AUD instruments The downgrading of iron ore price forecasts by the ANZ commodity team only adds to this story. To the analysts, it means pressure remains not only on the AUD's risk premium but on the valuation level as well.

The analysts expect another downshift in the Australian currency is coming. The US dollar is starting to look more resilient while, technically, numerous tests in the AUD above US78c recently have all been rejected. Moreover, US dollar strength is broadening into emerging market currencies and its break-out against the yen has set a direction which will be important for the AUD. A weaker yen will reduce the appetite of Japanese investors to buy yielding assets in Australia, by keeping the AUD above 90 yen.

As Chinese New Year approaches the analysts also expect Australian bond issuance is likely to lighten, as major centres of demand close, and this will take away some of the marginal support for the currency. A final reason for the prospect of a mark down in the AUD is that it would be unusual for the Reserve Bank not to following up its February cash rate reduction with another cut in March. On this note, ANZ analysts expect a cut next month, while observing the market is only factoring in a 40% probability.

Oil In Australia

In the short term, falling oil prices are likely to mean lower inflation and lower interest rates in Australia, in the view of National Australia Bank analysts. The impact will also be contingent on the degree to which second round price effects are passed through to consumers and, ultimately, household spending. The analysts suspect that the windfall opportunity is limited, reflecting the offsets to higher disposable income from negative wealth effects in terms of lower equity prices (energy) and greater contraction in business investment, namely mining, that will weigh on the labour market.

Moreover, less inflationary pressures along with lower global interest suggest lower official domestic rates. The NAB analysts also expect the RBA to move again in coming months. Lower rates will be instrumental in the anticipated recovery in consumption and dwelling investment into 2016.

NAB analysts have revised the profile of their oil price forecasts lower through 2015-16, but expect a recovery to pick up pace later this year. The oil futures curve has moved into contango - where forward prices are higher than spot prices - since last October. This typically indicates excessive downward adjustments to prices in a short time frame alongside the lowering of longer-term expectations. Still, the analysts note contangos in commodity markets tend to be short-lived.
 

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article 3 months old

Weekly Broker Wrap: Oil Price, Property, Aust Dollar And Wagering

-Reduced demand for coal, gas?
-Authorities target property investors
-Aust dollar weakness likely preferred
-State, industry racing revenue broadens
 

By Eva Brocklehurst

What does a lower oil price mean for Australia? It is positive for household spending and Commonwealth Bank analysts calculate the fall of 20% since mid year equates to a lift of around 0.2% in household income. IMF calculations suggest that a 10% fall in the oil price equates to an increase in global GDP growth of around 0.2%. The current downtrend is not just about higher supply but also weaker demand. The supply-side shock is occurring as US output lifts from non-conventional sources. Supply has also surprised on the upside from countries such as Libya. On the demand side, there are indications growth from India and China will be lower than expected over the coming year.

For Australian households, secondary effects could occur as lower transport costs are passed on. Discretionary retail, where price elasticity is high, is usually a major beneficiary of a fall in petrol prices. The analysts point out a lower oil price has dampened inflation expectations and bond yields, and is already showing up in the inflation data. From a national perspective, lower oil prices will decrease demand for other substitute energy sources, namely coal and gas. This could result in a trade shock with some rough calculations suggesting a 20% fall in oil prices equates to a terms of trade reduction worth around 0.4% of nominal GDP.

There will be some offsets. Fuel makes up a considerable proportion of business costs and the industries with the highest consumption are transport, manufacturing and electricity. These will likely benefit. The choice of improving margins and profitability or passing on lower costs will come down to the competitive pressures, in the analysts' view.

***

Domestic housing-linked stocks have been affected by concerns about macro prudential policies being tightened and a resultant pullback in housing approvals. Morgan Stanley is not overly worried, as the relevant authorities, the Reserve Bank of Australia and Australian Prudential Regulation Authority, will likely be scrutinising investors in established property. The broker anticipates higher serviceability buffers and capital requirements such as risk weights or capital ratios are most likely.

The RBA has described the housing market as becoming unbalanced but its concerns lie specifically with investors in established housing in Sydney and Melbourne and inner city apartments in Melbourne. Morgan Stanley observes Australia is along way from an oversupply in housing while a sustained construction cycle is helpful in boosting supply. Hence, the broker envisages building stocks can still outperform, even as more difficult comparables are cycled.

AllianceBernstein still believes the fundamentals are supporting capital markets even as investors express concern that valuations are stretched. The analysts observe that markets have been expensive before, even for lengthy periods, without enduring a calamity. Ordinarily, the analysts note, the Australian dollar would act as a shock absorber and fall to offset some of the income squeeze coming from lower iron ore and coal prices. As yet, the falls have only been modest relative to the slide in commodity prices and this is proving to be a headache for the central bank.

AllianceBernstein notes momentary easing was initially intended to boost the housing sector through construction activity but also resulted in a surge in lending to investors and in doing so may have been too successful. This highlights the potential for some form of policy restraint on the sector.

CIBC observes, despite attempts by the RBA to maintain a stable bias in rates, markets are pricing in easier policy amid uncertainties in the real economy and commodity market weakness. This points to underperformance by the Australian dollar. The analysts suspect the RBA may well prove to be another central bank that encourages a bout of currency weakness to counteract less-than-encouraging trends. The RBA would prefer conditions ease via the currency than via interest rates, as household debt levels remain high. The analysts acknowledge the currency does look rich when compared with other similarly based valuations and expect the Australian dollar to fall to US82c in the coming year.

***

Investor updates from the likes of Tabcorp ((TAH)), Paddy Power and William Hill suggest to Credit Suisse that wagering industry growth is being stimulated by smartphone technology, led by the Europeans. Still, regulatory change could level the field and enable all three operators to grow revenue. The broker observes Paddy Power and William Hill are over-indexed to market growth drivers of mobile, fixed odds and sports betting and their high gross profit margins, unburdened by state taxes, allow them to spend more in terms of marketing their product.

Meanwhile, Australian racing industry regulators have shown a willingness to devise new fee arrangements that selectively tax corporate bookmaker products and favour incumbent tote operators. There are potential headwinds as the industry and governments seek to broaden revenue sources away from lower growth totes.
 

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article 3 months old

Fletcher Building’s Growth Skews To Second Half

-Overall demand needs to improve
-Oz businesses doing it tough
-Attractive entry point for Credit Suisse
 

By Eva Brocklehurst

Fletcher Building ((FBU))  has placed great emphasis on its second half earnings. At its AGM the company has guided to FY15 earnings of NZ$650-690m but expects all growth to be in the second half. This forecast suggests to JP Morgan that at both the mid point and top end of the range, the second half earnings could well present a record, well above the last top of NZ$371m in 2008.

At the top end of this guidance, the lift against FY14 would be over 18%. While always expecting a second half skew, JP Morgan notes there is even greater emphasis on this now, despite the drag emanating from asset sales as well as the roll-off of Stonefields an EQR. New Zealand's August building consents rose 15.7% and reveal activity remains strong in that quarter but in Australia, Iplex and Stramit are battling weak demand and competitive pressures.

JP Morgan believes the situation will need to improve in order to hit management's targets. Morgan Stanley agrees. The broker estimates Australian earnings may be down by 15% in the first half, so 15% growth is then required in the second half to hit forecasts. Iplex and Stramit are drivers of the weakness and the broker remains cautious regarding the ability to improve these businesses by the second half. Morgan Stanley is also concerned about NZ's housing market outlook beyond FY15.

The company's earnings are both late cycle and infrastructure related which to Deutsche Bank means an Australian recovery will likely be more pronounced from FY16. With the company expecting a flat first half Deutsche Bank's revised forecasts imply 13% second half earnings growth. This can be achieved by cost cutting and some recovery to Australian earnings, in the broker's calculations. Outside of Australasia the company remarked that US housing growth has slowed, with no significant signs of a commercial uptick, while Europe's outlook is mostly centred on a modest improvement in the UK. South East Asian markets continue to grow but China and Taiwan are expected to be flat.

In Australia, Macquarie notes CSG-related earnings for Iplex last year were material and a second half FY14 pause in work from this area has probably influenced the company's guidance. The outlook for Rocla is also likely influenced by relatively weak rail and road work over FY15. In the case of Stramit, the brand is facing weak non-residential and engineering volumes.

The company's chairman remarked that Australia, which makes up 40% of the asset base, has been a valuable contributor to growth but is now experiencing what New Zealand did in 2008 and doing it tough. Macquarie makes the point on the back of these remarks that Fletcher Building has been a reasonably reliable forecaster of earnings over the past two years. The broker suspects the market will be somewhat worried about the split in guidance and commentary on Australia. Meanwhile, New Zealand may be the stand-out performer but is starting to face capacity constraints. Macquarie retains a NZ$8.16 target and Underperform rating.

The guidance was softer than CIMB expected, reflecting the challenges in Australia mainly stemming from declining mining investment and relatively low levels of budgeted government expenditure on road and rail. The broker still believes the company offers multiple years of growth on relatively attractive metrics, highlighting the NZ businesses which appear to be benefiting from broad based cyclical improvement as well as the rebuilding of Christchurch. CIMB has downgraded its target to NZ$9.72 from NZ$10.51 but retains an Add rating.

Management has indicated it is adopting an active portfolio strategy for its businesses, signalling to Credit Suisse further divestment of non-core assets may be on the table. Credit Suisse finds that the recent rotation by investors out of cyclical stocks into "defensive" companies, and the weakness since the results in August, presents an attractive entry point for Fletcher Building. The risk reward is envisaged positively, with the company providing a diversified exposure to the ongoing recovery in the NZ building market and a pick up in detached home building in Australia, as well as projected recovery in the US non-residential sector in 2015. The broker, in a similar vein to CIMB, expects further earnings recovery for Fletcher Building in the next three years and this reflects in the Outperform rating with a NZ$10.80 target.

FNArena's database contains four Buy, one Hold and three Sell ratings. Dividend yield on FY15 and FY16 earnings forecasts is 4.5% and 5.0% respectively.
 

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article 3 months old

Brickworks Underpinned By Dwelling Activity

-Back seat for investments, property
-Decision on CSR/BLD JV key catalyst
-Difficult comparables being cycled
 

By Eva Brocklehurst

One of the best residential construction scenarios in many years underpins the Brickworks ((BKW)) building products business. This segment of the company is benefiting from the upturn in dwelling activity, with improved volume and profitability in bricks, roof tiles, masonry and pre-cast concrete. Investment and property earnings, while remaining relatively stable over the longer term, are likely to take a back seat in FY15. 

The company's FY14 investment performance was weaker than Deutsche Bank expected, made up for by stronger-than-expected land sales. Management expects activity in Australia's housing market will be the strongest for a decade during the first half of FY15, with robust orders in the pipeline. Brickworks' final distribution of 28c was in line with expectations but it was the first time the final payment has increased since FY10. Management provided no quantitative guidance for FY15 but does expect property earnings to be lower, with a reduced contribution from land sales.

Brick pricing is strong in some markets while competitive in others. Moreover, Deutsche Bank expects pricing outcomes may improve if the joint venture between Boral ((BLD)) and CSR ((CSR)) in bricks is approved. A decision on this JV is considered likely by the end of the year and may usher in more disciplined pricing in the industry. The broker reiterates a Buy rating on the stock, given the leverage to the residential sector and the evidence of strong pricing momentum, with a target of $15.19. The business has developed a pre-cast concrete and masonry division over the last 3-5 years, increasing exposure to the higher density dwelling sector. While pre-cast is currently running to expectations and masonry has been restructured this is where, if Brickworks does not achieve continued category and price growth, it may negatively impact on Deutsche Bank's forecasts.

Citi observes progress in improving margins but also a lack of leverage in building products, largely because of patchy pricing outcomes and higher input costs. The challenge is evident in Western Australia, in particular, where competition is placing market share ahead of profits. The broker is also awaiting the decision on the CSR/BLD JV, believing that Brickworks' decision to add capacity in the east coast will boil down to a choice between market share or pricing-based returns. Better to just let demand build at this stage, in Citi's opinion. The broker believes the stock does not offer much upside and retains a Neutral rating and $14.50 target.

Bell Potter believes the first half is likely to offer the best operating conditions in over a decade for residential building products but this is now reflected in the earnings base and, as lead indicators for dwellings appear to be peaking, Brickworks will start to cycle difficult comparables. The broker has reduced profit forecasts for both FY15 and FY16 to reflect a lower Australian dollar coal price forecast for New Hope Coal (((NHC)) - hence Brickworks' investment earnings - and a modest reduction in the contribution from building products.

Having outperformed the sector recently, Brickworks' discount applied to the building products business has closed to 5% from 15%. Bell Potter downgrades the rating to Hold from Buy with a target of $14.55, reflecting lower earnings, unfavourable marking-to-market of investments and a higher net debt balance by year end. 
 

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article 3 months old

James Hardie Disappoints, But Outlook Solid

-US growth modest but on track
-Issues are not unsurmountable
-Underpinned by dividend yield
 

By Eva Brocklehurst

James Hardie Industries ((JHX)) produced a soft first quarter, with growth in US housing activity disappointing both the company and the market. Deutsche Bank believes the weakness should not be taken out of context, nor extrapolated longer term. Market share growth is robust and US pricing remains strong. Earnings margin upside can be obtained if some of the costs are taken out.

Morgan Stanley is of a similar opinion. The broker retains an Overweight rating, envisaging the US target earnings margin of 25% is still achievable and US housing activity, both new and renovation, will continue to drive value. Tough comparisons in the second quarter may make growth harder but improvement should come in the second half. Assuming growth can be sustained, the broker considers the upper end of the earnings guidance range of US$205-235m is achievable.

The first quarter was a reality check, in CIMB's opinion. Margins were disappointing, contracting 20 basis points relative to the prior corresponding quarter and despite an 8% increase in volume and 7% increase in prices. Clearly anticipated leverage to volume and price was not forthcoming. The broker accepts production inefficiencies that weighed on profitability will be addressed but suspects increased organisational costs are likely to remain. They are probably an inherent feature of a growing market. The broker considers James Hardie a quality stock, but the focus is heavily on the US housing market, where growth is likely to remain modest, and this may disappoint those hoping for more stellar gains. The dividend yield is the key supportive feature of the stock, in the broker's view. CIMB lowers FY15 forecasts by 13% and retains a Reduce rating.

The fact that volumes were soft relative to the available opportunity - new US housing was up 13% in the quarter - raises questions for UBS. The broker suspects volumes may have been affected by price increases over the past year as this market is hard to penetrate. Manufacturing problems are likely to be sorted out by the end of the year and one of the company's strengths, which UBS highlights, is that it can manipulate costs as required. UBS plumbs for a FY14 forecast at the lower end of guidance and retains a Sell rating.

Credit Suisse is content that reasons behind the weak result are one-off factors. The broker upgrades its recommendation to Outperform from Neutral, expecting the market will focus on emerging opportunities. Demand growth is on track and margins should improve as operational inefficiencies unwind. The US market is tough so overall revenue growth of 16% was pleasing for Credit Suisse. Moreover, renovation activity lifted and this underpins James Hardie's earnings.

JP Morgan was not surprised by the market reaction to the results but does not believe any of the issues are intractable. Earnings were affected by manufacturing inefficiencies, higher-than-expected corporate costs and FX losses. In contrast, the top line performance was better than the broker expected and longer-term growth prospects are intact. The broker believes it is important to disaggregate volume growth and look at the exterior products. Doing so reveals first quarter growth in exterior products was around 12%, with an estimated 3% fall in interior volumes. While accepting that repeating past errors is no excuse, the broker does note a recurrence of cost related issues, which resulted from investing ahead of volume growth. This highlights the uncertain nature of the recovery path in US housing construction.

US demand simply missed more optimistic management estimates and corrective action should be in place, in Citi's view. The broker maintains disappointment really centres on the lost earnings associated with the commissioning of the Fontana plant, and a poor manufacturing performance. The adverse impact of overestimating market demand may not be completely clawed back in the second quarter, as the company intends to restrict production in order to run down inventory. Accordingly, Citi believes issues should be better managed in future months. Higher pulp prices are expected to persist and this will continue to place pressure on margins. Having said that, the broker does not expect any major obstacles to James Hardie achieving its FY15 guidance.

On the FNArena database there are four Buy, two Hold and two Sell ratings. The consensus target is $14.28, signalling 6.5% upside to the last share price, and compares with $14.74 ahead of the quarterly result. A dividend yield of 5.4% is forecast for FY15, with 5.3% for FY16.
 

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article 3 months old

Robust Outlook For Oz Building Materials Sector

-Apartments at all-time high
-Skew to house/land packages
-Morgan Stanley upgrades sector
 

By Eva Brocklehurst

The latest building approval data from the Australian Bureau of Statistics reveals an interesting trend. The proportion of approvals attributable to multi-dwellings - apartments - is near an all-time high. This is underscored by May's data which, seasonally adjusted, shows the 9.9% rise in approvals was driven by a 25.5% rise in apartments, with just a 0.6% rise in single family dwellings. Monthly data may be lumpy, but key to broker observations are the NSW numbers which surprised with a 7.9% decline in detached housing approvals but showed a rise of 18.7% overall. Queensland led the way with a 45.0% rise in approvals in the month. Victoria and South Australia gave up ground during the month, approvals falling 8.5% and 6.7% respectively, seasonally adjusted.

The latest data was ahead of JP Morgan's forecasts and the broker observes NSW drove a rise in approvals for 1-2 storey apartments while Queensland experienced a large boost to 4-plus storeys. The proportion attributable to apartments is at all-time highs - 44.1% of total approvals for the year to May. The broker tempers enthusiasm by citing assumptions made by building materials manufacturer CSR, that the revenue opportunity from two medium density approvals is equivalent to one single family approval, while 3-5 high density approvals equates to one single family home approval. Having said that, importantly for the sector, JP Morgan notes single family approvals have registered the 14th consecutive month of improvement. Still, normalising the shift to multi-unit residential construction, the improvement in housing starts, while still positive, is not as highly promising for the building materials sector as the headline numbers might suggest. 

Moreover, Credit Suisse thinks there is a disproportionate skew to house and land packages compared with the past. Previously the split versus knock-down-and-rebuilds was about 50/50. The impact of this skew to packages is evidenced by a widening lag between approvals and actual work. Developers are selling land parcels well before official land registration and this implies that while new home sales and building approvals are on the rise, the improvement is not reflected in actual work - housing starts and completions - for another 12-18 months. Credit Suisse observes other changes in the building cycle too. A preference for apartments results in lower household formation rates. Add this to lower-for-longer interest rates, increasing population and continued demand from offshore purchasers, and the cycle is likely to be longer and stronger.

Credit Suisse notes resilience in the Western Australian market continues to support the unwinding of excess brick inventory and this bodes well for industry returns, particularly for Boral ((BLD)). Morgan Stanley now finds building stocks more attractive, upgrading its industry view as concerns about the strength of the housing recovery ebb. Detached dwelling approvals are improving in each of the major states and, while there was some pull back in January and February, recent months are showing detached dwellings tracking around 14% ahead of 2013.

So what does the building outlook herald for specific stocks? James Hardie ((JHX)) is considered the best exposure to the US recovery with a strong first quarter expected. Headwinds are likely to resume on volume and price in the second quarter but Morgan Stanley believes the company is on track to improve US margins. Boral's US business could sustain further cost cutting with construction material margins at cyclical lows but Morgan Stanley expects strong earnings growth in FY15 and upgrades to Overweight. CSR's ((CSR)) risks are skewed to the upside for FY16 and the stock is exposed to a recovering Australian east coast property market. The Viridian turnaround is priced in, while the broker observes insulation continues to be a poor performer. CSR, too, is upgraded to Overweight.

Adelaide Brighton ((ABC)) is unlikely to pay a first half special dividend but foundations for growth in FY15 remain intact, although Morgan Stanley downgrades to Equal Weight ahead of the potential for a weak first half result. The biggest concern is flat cement volumes and exposure to the resources industry through lime sales. DuluxGroup ((DLX)) is downgraded to Underweight as Morgan Stanley finds there is limited upside at the current price. Market share gains in Australian paint are sustainable but the broker thinks the Alesco businesses, which have underperformed, need attention. Lastly, Fletcher Building ((FBU)) has a large exposure to the recovery in New Zealand housing and a solid balance sheet that could provide capital management options in FY16. Morgan Stanley thinks the company's Australian assets are less favourably positioned relative to listed peers.
 

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article 3 months old

Weekly Broker Wrap: Broadband, IT, Retail, Mining, Electricity And Building Products

-Value in small players in broadband
-More downside risk likely in IT
-Two-year budget drag on retail spending?
-Warnings on mining services stocks
-NSW power play heats up
-Will ACCC clear Boral/CSR brick JV?
-Aluminium positive for CSR
 

By Eva Brocklehurst

Broadband penetration is reaching maturity in Australia and changes to market share are becoming key to value creation. Morgan Stanley believes prices are the reason why consumers change providers and, having reviewed broadband prices for June, thinks this supports Overweight calls on TPG Telecom ((TPM)) and iiNet ((IIN)). Looking at broadband plans, TPG has the best value product in Morgan Stanley's opinion. Delivering slightly more expensive plans but better customer service is iiNet's strategy. Telstra ((TLS)) offers the least value in its plans compared with peers, but continues to gain broadband share from success in bundling, underpinned by the company's broader market reach. NBN pricing plans are in their infancy but Morgan Stanley believes they support the view that iiNet and TPG will win share as the NBN is rolled out, particularly in regional areas.

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Trading updates across the IT services sector have indicated downside risk to earnings. Morgans was hoping for a flat second half in FY14 with recovery in FY15 but suspects disappointment is in the wings. Data #3 ((DTL)), SMS Management & Technology ((SMX)) and PS&C ((PSZ)) have all downgraded expectations and the broker thinks Oakton ((OKN)) and UXC ((UXC)) are at risk of similar downgrades. Having said this, Morgans is convinced overall IT spending is not discretionary and businesses will be forced to upgrade hardware, systems and processes to improve productivity. Still, the delays and deferrals keep happening and, meanwhile, the broker waits.

***

On another subdued note, Citi thinks the impact from the latest federal budget cuts will hit consumers' wallets in FY15 and FY16. While the immediate rush of negative sentiment may fade quickly, the drag on retail spending might continue for two years. The broker expects a 2% drag on spending in FY15. Retailers will need to rely on wages growth or lower savings and higher house prices to boost sales.

***

Still more gloom appears. Naos believes it is time to be careful with mining services. Downgrades are still catching unwary investors trying to pick a bottom to the earnings cycle, hoping that current prices are providing long-term value entry levels. The asset manager finds evidence for this in Ausdrill's ((ASL)) recent downgrade. To make the right choices in the sector investors need to focus on the client base of the service provider, the miner. More specifically, the focus should be on that miner's commodity exposure, strength of its mines and nature of expenditure.

Listed investment company NAOS ((NCC)) offers the following warnings: avoid capex related business models, as they may look cheaper but the cliff in capex spending is approaching, and avoid exploration-related models, with commodity prices weak and falling. The focus needs to be on models that target maintenance, repair and replacement. NAOS believes this sort of spending is about as non-discretionary as you can get in mining services. Moreover, a preference should be shown for those servicing the major miners with the best assets and most robust operating margins.

***

The potential privatisation of the NSW electricity wires and poles has been given a further push, with the government announcing plans to lease 49% of the electricity networks. The NSW government ultimately plans to sell stakes in state-owned network services such as Ausgrid, Transgrid and Endeavour, excluding rural network Essential. How this ends up being priced with be key to how enthusiastic investors become, in JP Morgan's opinion. The listed providers such as DUET ((DUE)), Spark Infrastructure ((SKI)) and SP AusNet ((SPN)), and to a lesser extent APA ((APA)), are expected to vie for the assets. The broker is not getting too excited just yet. The government will only undertake the sale of the poles and wires with an election mandate and, because privatisations have been unpopular in the past, the timing and final structure is difficult to predict.

The government has also flagged the money will be spent on infrastructure for roads, rail, schools, hospitals and water. UBS thinks this is good news for the construction materials sector. The broker expects electricity prices will fall in NSW by 5% in FY15 and regulated prices will grow at around the rate of inflation. Nevertheless, UBS notes the traditional utility model remains under long-term structural threat from solar and storage and this should be priced in to expectations.

***

 CIMB has found a number of parallels between the proposed brick JV between Boral ((BLD)) and CSR ((CSR)) and the merger proposition between Boral and Adelaide Brighton ((ABC)) that was blocked by the competition regulator in 2004. This suggests that the current JV transaction may encounter regulatory headwinds. This has negative implications for the two businesses. Profitability is expected to remain under pressure in the absence of the JV being approved, as excess capacity remains in the system and competition is robust. The case is similar to the 2004 situation in terms of competitive threats.

CIMB expects the Australian Competition and Consumer Commission's definition of the market for clay bricks will rule at the end of the day. The companies will likely argue for a broader market definition but a narrower one is quite appropriate, in the broker's view. On this basis the JV would produce two players with a peak share of around 60% of a product that has a 65% share in wall finish. CIMB expects the ACCC's refusal to accept this proposition will prompt a fall-out. As neither party can deliver an acceptable return in bricks, it may force an exit by one of them. This would mostly likely be Boral, in CIMB's opinion.

Strengthening aluminium premiums are a positive development for companies such as CSR which have smelters. They can capture all additional upside at the earnings level. The strengthening premium remains a negative for end users of aluminium, such as Capral ((CAA)), which is unable to pass through the premium increases to customers. With scope for premiums to rise further by the end of the year, this signals to Bell Potter there is upside earnings risk for CSR and downside risk for Capral.
 

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article 3 months old

DuluxGroup: Muted Upside From Housing Recovery

-Fully priced and defensive
-Opportunity in any pull back
-FY14 guidance a low hurdle
 

By Eva Brocklehurst

DuluxGroup ((DLX)) delivered a strong first half result, underscored by the paints business. The company also benefitted from its earlier acquisition of Alesco, which makes garage doors and construction products, for the full half year, as that company's strongest months are November and December. Brokers are quite positive about the outlook for company's markets but remain cautious about the amount of exposure to new home construction. Sales from heritage businesses were up 3.9% on the prior corresponding half. The company increased the first half dividend to 10c, reflecting a 67% pay-out ratio.

Moelis is attracted to the core operations, as Dulux has an entrenched leadership position in the renovations and trade distribution channels. The broker believes this is fully reflected in the share price, which has risen 25% over the past year. A Hold rating and $6.00 target remain in place. Morgan Stanley retains an Equal Weight rating, cautious about the outlook in the medium term. The broker expects some upside from lower interest costs in the short term. The company's market share in paint is flat in Australia and the broker estimates retail channels outside of Bunnings may have declined by as much as 4.3% in the half.

BA-Merrill Lynch is more upbeat, expecting the stock will outperform over the next 12 months. The company may be a late player in the housing cycle, primarily exposed to home improvement, but the broker thinks this will still provide a tail wind over the next year given the strong relationship between house prices and spending on home improvements. The broker also thinks the company will gain through the performance of retail channel partners such as Bunnings and Mitre 10. In addition, the company's marketing, sales and brand management expertise should drive revenue synergies and market share gains for the Alesco business. The price of the stock compares well with domestic building material peers, in Merrills' view.

To Citi it was a very solid result, as Dulux grew revenue by 17% and core net profit by 34%. The broker acknowledges the flat market share in Australia and the fact the company is under-represented in the new homes market, given its premium products are less exposed to lower value, new residential building. Dulux expects FY14 earnings to be higher than the $94.1m in FY13, subject to economic conditions. Australia and New Zealand should remain strong, while China is expected to be flat and PNG weaker.

Macquarie believes guidance to simply "exceeding the FY13 result" is conservative and retains an Outperform rating. This broker also considers the stock is fully priced but, in the context of the broader building materials sector, Dulux is a defensive name and earnings support should justify its current valuation premium. The company noted the outlook for engineering and infrastructure projects remains weak but in this area Macquarie thinks there may be some medium-term growth potential from recent federal budget initiatives.

What worries Deutsche Bank is the 22% reduction in net operating cash flow in the half, and the cautious outlook for the commercial and infrastructure markets, as well as input costs. Furthermore, the broker thinks the market may be over-estimating leverage to improved new housing activity. As the stock is trading at 19 times FY15 earnings estimates a Sell rating is maintained. Key divisions such as paints and Selleys Yates performed ahead of the broker's forecasts. Hence, earnings estimates for FY14 and FY15 are raised 4-5%. Earnings from Alesco were slightly below the broker's estimates, providing a partial offset to forecasts. CIMB also makes compositional changes to earnings forecasts, leading to immaterial changes overall. CIMB is maintaining a Hold rating with a view to re-visiting the stock on any pull back in the share price.

JP Morgan attributes weak cash flow to timing, driven by higher integration costs for Alesco, tax payments and payment of a tax penalty in New Zealand. The share price factors in the company's execution capability, positive momentum and market share gains in Australian and New Zealand paint, in the broker's opinion, as well as a recovery in Alesco. JP Morgan believes the company will continue to trade at a premium to global comparatives as well as valuation, given there are limited, high quality, defensive exposures in the small caps space. On that basis the Neutral rating is retained. The broker also thinks the FY14 guidance is a low hurdle to jump and estimates have been revised up by 2.5% for FY14 and by 0.3% for FY15.

On FNArena's database there are two Buy ratings, four Hold and one Sell (Deutsche Bank). The consensus target price is $5.57, suggesting 3.1% downside to the last share price. This compares with $4.79 ahead of the results. Targets range from $4.10 (Deutsche Bank) to $6.15 (BA-Merrill Lynch).
 

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article 3 months old

Treasure Chest: CSR Is Not Overvalued

By Greg Peel

When it comes to the current share price of building products manufacturer CSR ((CSR)), FNArena database brokers are split. Three Buy or equivalent ratings match three Sells along with two Holds, suggesting consensus has CSR now ahead of valuation. All brokers are supportive of the proposed merger between the east coast brick operations of CSR and sector peer Boral ((BLD)), but given potential ACCC interference analysts are not yet counting any chickens.

CSR’s share price has run up 40% in less than a year in line with an improving outlook for the Australian housing market. But despite this gain, and a rather “full” looking 18x PE multiple on FY15 forecasts, stock broker Moelis believes the rally has only just begun. The company’s FY14 result, due on May 14, will provide evidence, Moelis suggests.

CSR’s FY14 profit forecast of $70m, representing a 100% improvement on FY13, is no more than company guidance suggests. But the broker sees the result as likely to highlight the operating leverage within the building products division, which provides around 85% of revenue. Revenue growth will be seen to have accelerated into the second half, Moelis believes, given 20% year on year growth in domestic housing activity and the “early stage” relationship between building products and housing construction. Revenue growth in the first half of FY14 was a mere 3%, with 19% earnings growth achieved through cost reductions.

The albatross around CSR’s building products divisions’ neck has long been the Viridian glass business, and turning the business around is management’s number one priority. Major restructuring has commenced, and while Viridian will continue to show a loss in FY14, FY15 should see benefits begin to flow with breakeven to follow in around 18 months from now, Moelis predicts.

CSR has also struggled in its aluminium division from a weak aluminium price and a strong Aussie dollar, but the broker sees both, and Viridian’s fortunes, all trending in the right direction over the next few years.

Moelis joins the FNArena brokers in lauding the proposed brick merger with Boral, but agrees with ACCC uncertainty and thus considers success a “wildcard” in terms of CSR’s valuation. The process could take quite some time, the broker admits.

FNArena’s Stock Analysis currently shows a consensus target price of $3.13 for CSR, which is around 15% below the current trading price, but individual broker targets range from $1.90 (BA-Merrill Lynch) to $4.15 (Credit Suisse). Moelis has set its 12-month target at $4.50, with a Buy rating.


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