Building Blocks for Growth
Australian-listed shares of fibre-cement leader James Hardie Industries (ASX:JHX) have made modest gains to date in 2018, building on the sharp recovery from the lows of 2017 visited in October. The appreciation in the share price has been supported by sales growth, margin improvements and a relatively optimistic outlook. The company also announced the completion of its acquisition of Europe-based Fermacell in early April.
Strategically, we view the Fermacell as a good fit and agree with management that it will provide a platform for James Hardie to expand its business in the large and affluent European market.
Source: James Hardie (ASX:JHX)
The company will provide an update on Fermacell and the early stages of its integration at its fourth quarter results briefing on 22 May. A European Building Products segment will be reported from the first quarter of fiscal 2019.
Fermacell was acquired in an all-cash transaction at an enterprise value of €473 million. We view the price tag as reasonable, with James Hardie (ASX:JHX) anticipating the acquisition to be accretive from year 2 on an absolute basis, and accretive in year 1, excluding integration, transaction and one-off costs. The price represented an approximate 9 times CY17 EBITDA multiple.
The deal will push James Hardie’s gearing above its target range of 1-2 times net debt/EBITDA in the short-term though, so the company will have to work on reducing debt over the next few years.
James Hardie (ASX:JHX) entered into a €525 million 364-day term loan in December 2017 to provide the bridge funding for the deal and used a combination of cash-on-hand and a €400 million drawdown from that facility for the closing. The plan is to refinance the facility in the euro bond market sometime this year.
Fermacell is Europe’s leading fibre gypsum board manufacturer, with more than 70% market share of that category.
The company also produces cement-bonded boards. Discussing the deal rationale, James Hardie CEO Louis Gries stated, “Fermacell’s market position, go-to-market strategy and strong management team will enable us to scale and accelerate our European business, which has long been a strategic goal. Fermacell will diversify our geographic, product and end-market portfolio, complementing our strong positions in North America and Australasia, and will create significant growth opportunities and drive long-term value for customers, employees and shareholders.”
James Hardie (ASX:JHX) reached scale in Europe previously, as it basically sells US products exported from their US plants. Fermacell’s largest markets are Germany, Switzerland / Austria, France, Scandinavia and BeNeLux (Belgium, Netherlands and Luxemburg). This provides a complimentary market opportunity and provides a platform for growth, brand recognition, established sales / industry relationships and strong track record. Fermacell has been consistently profitable.
Like James Hardie, the company is a category leader, although in a slightly different siding category (i.e. fibre gypsum versus fibre cement). Headquartered in Germany, the company has approximately 800 employees, with a sales force in 12 countries. At the time the deal was announced, James Hardie (ASX:JHX) confirmed Fermacell’s top management team will remain in place.
Turning to the charts, on the daily, overhead resistance is indicated at the February intra-month high of $23.85 as shown by the horizontal solid-red line. However, it should be noted that the rapid increase in share price has resulted in the RSI to venture into overbought territory (exhaustion of short-term upward momentum). Hence, should the bears emerge over the near-term, a temporary pullback in price could follow. Positively, should this occur, we would view this short-term pause as corrective. Medium-term momentum is in favour of the bulls, as the share price has comfortably cleared both the 50 (red line) and 200 (green line) day moving averages.
Besides acquiring Fermacell to transform its European business, James Hardie has been addressing capacity constraints in North America over the past couple of years and has more expansion (Tacoma and Alabama) on the near-term horizon.
The following chart from the March 2018 Investor Roadshow highlights the capacity expansion since FY10.
Source: James Hardie (ASX:JHX) March 2018 Investor Roadshow presentation
Management believe that capacity constraints have hindered sales and in the last quarterly release stated, “We are on track to increase manufacturing capacity, improve the performance of our North America manufacturing network and drive improved primary demand growth.”
The company is seeking to grow the market share of fibre cement to 35% of the exterior cladding market against other wood-looking siding alternatives and maintain its category share at a high 90%. James Hardie cites fibre cement’s advantages as being “durable than wood and engineered wood, looks and performs better than vinyl, and is more cost effective and quicker to build with than brick.”
Source: James Hardie (ASX:JHX) March 2018 Investor Roadshow presentation
Positively North America delivered unit costs have improved over the course of FY18 to date, while the average net sales price of its fibre cement increased. That resulted in a margin recovery for the North American unit.
Source: James Hardie (ASX:JHX) March 2018 Investor Roadshow presentation
Input costs are currently a headwind for the North America business, but management remain relatively upbeat about the outlook, saying US housing conditions remain favourable.
In the third quarter earnings release the outlook statement was, “We expect to see steady growth in the US housing market in fiscal year 2018. The single family new construction market and repair and remodel market are expected to grow similarly to the year-on-year growth experienced in fiscal year 2017. The Company expects new construction starts between approximately 1.2 and 1.3 million.”
New construction starts grew more than expected in March, coming in at 1.319 million, up 1.9% on a seasonally adjusted annual bass according to the US Commerce Department. We expect housing starts to continue to edge upwards, underpinned by a strong job market. While interest rates are on the way back up, they remain low from a historic perspective and the increases should be gradual.
Regarding the monthly chart, dynamic support sighted at the $17.00 region (long-term uptrend line) has managed to do its part in stabilising the correction evident between May and September 2017. This is deemed positive price-action, which has led to a resumption of the broader uptrend. An initial target is expected at the 127.2% Fibonacci extension of $24.87, followed by the 161.8% Fibonacci extension of $27.01. Furthermore, long-term momentum is favoured to the upside, as evident from the series of higher lows and higher highs, which are characteristics of a dominant uptrend in play.
Year-to-date headline numbers (US$)
To briefly recap, for the nine months ended 31 December 2017, James Hardie (ASX:JHX) posted sales of $1,528.6 million, marking year-on-year growth of 7% respectively, with the increase supported by higher average net prices in North America and higher sales volumes in the international business. Gross profit increased 5% to $539.1 million for 9M18, as the gross margin decreased 0.7 percentage points to 35.3%. Adjusted EBIT for the 9M18 period increased 5% to $289.8 million as the adjusted EBIT margin contracted 0.7 percentage points to 19.0%. Adjusted net operating profit increased 6% to $205.5 million and adjusted diluted earnings per share increased 7% to 49 cents.
Summary
Australian-listed shares of fibre-cement leader James Hardie (ASX:JHX) Industries have made modest gains to date in 2018, building on the sharp recovery from the lows of 2017 visited in October. The appreciation in the share price has been supported by sales growth, margin improvements and a relatively optimistic outlook. The company also announced the completion of its acquisition of Europe-based Fermacell in early April.
The margins at the key North America business have recovered and management is addressing capacity constraints. The Fermacell acquisition will diversify the business and provide a growth platform in Europe, where previously James Hardie has had comparatively little traction.
We remain positive on James Hardie’s ability to grow earnings. Rising interest rates are likely to be only a modest headwind considering they will still be at low levels and meanwhile, the US economy is ticking over nicely and wage growth is beginning to flow through more meaningfully. US housing stock also will need to be replenished with a period of ‘underbuilding’ in the wake of the GFC.
We believe the US housing and repair and remodelling market will continue to be healthy for some time. Therefore, we view James Hardie (ASX:JHX) as well placed to capture some of the remaining opportunity, with capacity constraints being addressed.
The shares trade on approximately 28.3 times forecast FY18 earnings, set to drop to 22.9 times the following year.
James Hardie (ASX:JHX) will remain held in the Fat Prophets portfolio.
Disclosure: James Hardie (ASX:JHX) is held in the Fat Prophets Concentrated Australian Share and Australian Small & Mid Cap Models.
