Fermacell is in the Fold
Australian-listed shares of fibre-cement leader James Hardie Industries (ASX:JHX) have performed relatively well over the past year, 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, which will provide a platform for James Hardie to expand its business in the large and affluent European market.
Strategically, we view Fermacell as a good fit and expect to hear more details on the integration progress in the first quarter results due in August.
Capacity constraints have largely been addressed in the US market and dovetailing with a robust US housing market, we believe, the company is well placed for fiscal 2019.
4Q18 and FY18 headline numbers
(in US$ unless otherwise stated)
For the quarter and financial year ended 31 March 2018 James Hardie posted sales of $525.9 and $2,054.5 million, marking year-on-year growth of 6% and 7% respectively. For both periods sales benefited from higher average net prices in North America and higher sales volumes in both the US and international businesses.
James Hardie has faced some headwinds, including sluggish volumes in the US business, as it ran up against capacity constraints and cost input pressures. Being unable to keep up with demand is a relatively ‘nice’ problem to have and management has been working to address the issue.
At the time of the results release in May, the company said it will add an additional 600 million square feet of capacity to its greenfield expansion project in Prattville, Alabama. That is some ways off yet before it is expected to come on line, but in the meantime, James Hardie completed work on some projects in FY18 and has started work on and nearly completed construction of a greenfield expansion project on land next to its existing Tacoma facility. This is expected to be commissioned in the first half of fiscal 2019. Accordingly, James Hardie CEO Louis Gries said, “We enter fiscal year 2019 with no constraints on capacity and are focused on driving improved primary demand growth.”
Gross profit of $191.1 million for the quarter and $730.2 million for FY18 increased 19% and 8% year-on-year respectively. The gross margin of 36.3% in 4Q18 increased 3.8 percentage points from 4Q17, while the gross margin of 35.5% for FY18 edged up 0.4 percentage points.
James Hardie’s cost of goods sold of $334.8 million in 4Q18 was only a marginal increase from a year earlier. For the full year, the cost of goods sold was up roughly 6% to $1,324.3 million.
Selling, general and administrative (SG&A) expenses for 4Q18 and FY18 increased 12% and 7% respectively to $85.1 million and $311.3 million. The substantial year-on-year increase in the quarterly expense was skewed by Fermacell acquisition costs and stock compensation expense. For the year, the increase was driven by acquisition costs and higher labour expense. The company also increased R&D (research and development) spending by 10% in FY18 to $33.3 million.
Reported EBIT (earnings before interest and taxes) moved to a loss of $95.8 million in the quarter, primarily due to the unfavourable movement in asbestos adjustments, partially offset by the favourable underlying performance of the operating businesses. The asbestos adjustment swung from positive $1.4 million a year earlier to negative $192.9 million in 4Q18. For the full year, EBIT came in at $229.2 million, down over 41% from $393.2 million in FY17. Again, the primary negative factor was an unfavourable movement in the asbestos adjustment. The asbestos adjustment was based on the actuarial report provided to the company.
For the quarter, the reported result was softened somewhat by an income tax benefit, but still the company reported a net operating loss of $57.6 million compared to a $44.5 million profit a year earlier. For FY18 the net operating profit of $146.1 million marked a 47% decline. The full year result was also impacted by a loss on the early extinguishment of some debt,
as it redeemed senior notes due in 2023.
Source: James Hardie (ASX:JHX)
Diluted earnings per share came in at -13 cents in 4Q18 and 33 cents for the fiscal year, compared to 10 cents and 62 cents respectively a year earlier.
Adjusted figures tell a different story and in this case better represent the underlying picture. Adjusted net operating profit for the quarter surged 49% year-on-year to $81.1 million, while increasing 17% for the year to $291.3 million. This equated to adjusted diluted earnings per share of 18 cents in 4Q18, up 50% and full year adjusted EPS of 66 cents, up 18%. There was a 4.0 percentage point improvement year-on-year in the adjusted EBIT margin to 19.6% and a 0.9 percentage point improvement in the full year adjusted EBIT margin to 19.3%.
Source: James Hardie (ASX:JHX)
Net operating cash flow of $295 million showed a slight (~1%) improvement year-on-year.
Looking at segment performance briefly, and the key North America segment posted net sales of $410.1 million in the fourth quarter, up 6% year-on-year with volumes and prices both higher.
Volumes ticked up 1%, while pricing was strong, rising 5% year-on-year. The segment’s EBIT margin impressed, increasing 5.6 percentage points year-on-year to 25.2%.
The International segment posted sales of $112.5 million in 4Q18, marking a strong 9% increase from 4Q17. Volumes increased 2% along with a 2% increase in prices.
The EBIT margin was effectively flat, increasing just 0.1 percentage point year-on-year to 23.1%.
Turning to the daily chart, overhead resistance at the February intra-month high of $23.85 was backed away from. Medium-term momentum has waned slightly as the share price has dipped below the 50-day moving average (red line), although remains above the 200 day (green line). A move back above the 50-day moving average would be positive as would a breach of resistance at $22.82, the January 2018 high.
Regarding the monthly chart, the dominant long term upward trend (green line) remains in play. Prices have also closed (on a monthly-basis) above the 78.6% Fibonacci retracement at $21.88. This is a bullish development and now activates two additional upside targets. The 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.
Outlook
Looking ahead, and the company was relatively upbeat about the outlook saying they expect steady growth in the US housing market to continue into FY19. New construction starts are expected to be in the range of 1.2 million to 1.3 million. This outlook seems reasonable based on the data points we have seen on US housing lately.
The North America segment margin is projected to be towards the top of its 20% to 25% target range. That assumes stable exchange rates, strong operating performance from plants and moderate growth in input costs.
Summary
We remain positive on James Hardie’s ability to grow earnings at a robust pace. 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 stocks will also need to be replenished after a period of ‘underbuilding’ in the wake of the GFC.
We believe US housing and the repair and remodelling market will continue to remain healthy for some time. Therefore, we view James Hardie as well placed to capture some of the remaining opportunity, with capacity constraints largely addressed. The Fermacell acquisition will diversify the business and provide a growth platform in Europe, where previously James Hardie has had comparatively little traction.
The shares trade on approximately 22 times forecast FY20 (March 2020 year-end) earnings, with a projected dividend yield that year of 2.9%.
James Hardie (ASX:JHX) will remain held in the Fat Prophets portfolio. For Members without exposure, and taking a long-term view, we remain comfortable continuing to recommend the stock as a buy around current levels.
Disclosure: James Hardie (ASX:JHX) is held in the Fat Prophets Concentrated Australian Share and Australian Small & Mid Cap Models.
