Strong through the cycle
Shares of James Hardie Industries (ASX:JHX) have fallen materially over the past couple of months, along with the US homebuilding sector, as James Hardie generates most of its sales in the US market. Although there are some headwinds buffeting the stock, we continue to believe in the quality of the business and the long-term market opportunity for fibre-cement.
James Hardie’s Australian-listed shares have fallen approximately 20% from their 52-week high. Several factors seem to have driven the decline, including the recent rout in global equities, the rise in US interest rates, patchy US housing data, an announced CEO succession and slowdown in momentum.
Touching on several of these factors and in September, James Hardie announced Jack Truong will succeed CEO Louis Gries as the chief executive toward the end of the 2019 fiscal year, marking an approximate six-month handover. Dr Truong has been President of International Operations at James Hardie since April 2017. Before that, Dr Truong was President and CEO of Electrolux North America, a $5 billion plus revenue business with more than 14,000 employees at the time he was in the role.
CEO Louis Gries has been steering the ship at James Hardie for 13 years now and is widely respected as having been a strong CEO, so some trepidation about a new CEO is understandable, but Dr Truong certainly has the right skillset and leadership experience and will step into the role at a time when the company is in good shape.
The recent volatility in global equities is a relatively natural occurrence given the length of the bull market in US equities post-GFC. If the correction is not too deep so as to have a flow on impact on the underlying economies, we view it as a healthy pause for the broader and not a major detrimental factor for James Hardie at this junction.
US Housing sector data has been mixed in 2018 and hit a weak patch lately, with housing starts falling 5.3% from August to a seasonally adjusted annual 1.201 million rate in September. Though that was still 3.7% above the September 2017 rate, after a long upward stretch, housing indicators have started turning down somewhat. The US is the key market for James Hardie.
Source: US Census Bureau
Rising interest are likely or at least partly responsible, but they could not be expected to remain at ultra-low levels in a healthy economy such as the current one. The return to a tightening of the interest rate cycle is sign of a healthy economy and buyers will get used to higher ‘normal’ rates. A strong jobs market, with wage growth likely to increasingly flow through should mitigate much of the impact. Unlike homebuilders, James Hardie also benefits from demand from the repair and remodelling market as well, further cushioning the company’s business.
James Hardie (ASX:JHX) has long outpaced the broader market in its segment by gaining market share, and 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.” Positively, with its dominance in the niche, it has strong pricing power (leading to relatively high margins within the industry) and has exhibited this through the cycle.
To address its recent relative slowdown, the company has fixed capacity shortfalls across all product lines in the US. James Hardie is also enhancing the value proposition of its products and a reallocation of field sales resources to previously underserved markets “has started to show early returns.”
We are positive on the company’s push into Europe, with the Fermacell acquisition providing a strong platform.
At the recent Analyst and Investor presentation held in September, management outlined at goal of building this to a €1 billion business within 10 years, with James Hardie “like” returns, meaning relatively high margins for the building products industry.
Source: James Hardie (ASX:JHX)
Management highlighted especially large opportunities in the UK, German and French markets. The company will seek to grow market share, as it has successfully done in the United States, due to superior durability and other characteristics of its products.
Source: James Hardie (ASX:JHX)
A growing European business would be welcomed by investors, both as source of growth and diversification.
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 as the share price has dipped below the 50-day (red line) and the 200 day (green line) moving averages. Support at $22.82, the January 2018 high, and that at $21.01, has also given way. The November low of $18.59 now needs to hold to avert a steeper decline.
Regarding the monthly chart, the dominant long term upward trend (green line) remains largely in play. Prices have however closed (on a monthly-basis) below the 78.6% Fibonacci retracement at $21.88. Also giving way has been the 61.8%, 50%, and 38.2% Fibs at $20.84. $20.11, and $19.38 respectively. These remain a target (near term), but will need to be watched closely. The next later of meaningful support below here is at $17.03.
Summary
The correction in James Hardie (ASX:JHX) shares looks to have already ‘priced in’ recent negative sentiment. The company’s fiscal first quarter results were strong overall and 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 as the US economy is ticking over nicely, and wage growth is beginning to flow through more meaningfully. US housing stocks are being replenished after a period of ‘underbuilding’ in the wake of the GFC.
While we do expect to see housing price growth in the US market moderate, we expect the housing and the repair and remodelling market will continue to remain healthy for some time. James Hardie’s fibre-cement product should continue to win market share, outpacing the broader market. Therefore, we view James Hardie as well placed to capture some of the remaining opportunity, with capacity constraints addressed and other initiatives ongoing.
The Fermacell acquisition will diversify the business and provide a growth platform in Europe, where previously James Hardie has had comparatively little traction. The ‘resetting’ of expectations downward over the past couple of months provides a lower bar for outperformance going forward.
The shares trade on approximately 18.2 times forecast earnings for the fiscal year ending March 2020, with a projected dividend yield for that year of 3.4%.
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 managed account portfolios.
