Friday 5th May 2017
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by James Lennon
As evidenced by James Hardie’s share price performance since the dust settled on the GFC, the stock has been a consistent performer over this period despite operating in what have been patchy markets. However, taking into account the fact that the relative outperformance of James Hardie’s share price has been intact for around three years now, and given the cyclical nature of its end-markets, is it now time to take some profits?
To answer this question it is important to first consider what has been driving the outperformance of James Hardie’s share price. There are in our view two key points to note. First and foremost has been James Hardie’s focus on its core competency, which is fibre cement. While James Hardie has been developing complementary income streams, management’s main priority has been to drive market share gains in fibre cement in key geographic regions through product quality and service.
This of course has required ongoing and often large investments in James Hardie’s manufacturing capacity and research and development capabilities. The end result of which has been James Hardie’s internationally diverse operating base and market leading positions, with the company’s core market (i.e. North America) accounting for 78 percent of Group revenue and 79 percent of underlying EBIT in for the nine months to 31 December 2017.
This in our view has been the second key driver of James Hardie’s solid share price performance, based on the belief that North America is in the early stages of a cyclical upswing in construction activity. It is no coincidence that Boral recently announced a major acquisition in North America, the key rationale of which was management’s intent to increase the company’s exposure to what is a large and growing market with potentially favourable currency translations into Australian dollars.
Positively for shareholders, James Hardie is also currently reporting a solid performance from its international business. Despite being more geographically diverse than James Hardie’s North American segment, the company’s international segment has been able to generate a good return on its invested capital on the back of price increases and some modest, albeit more patchy, increases in sales volumes.
The benefits stemming from James Hardie’s current strong earning profile are also evident in the company’s capital management initiatives. While management is continuing to reinvest its strong cash generation (operating cash flow up 33 percent in the nine months to 31 December 2016) into growing its business (i.e. R&D and capital expenditures), other key features have been the buy-back and dividends. Access to capital is currently not an issue for James Hardie.
While James Hardie’s 3Q17 results remind us that the company is not without its risks, we attribute these recent operational hurdles to growing pains rather than mismanagement. With James Hardie’s capital position in good shape and management’s recent strategic investments expected to go a long way to addressing operating inefficiencies, we remain of the view that the company’s earnings will continue to trend higher over the next 12-18 months.
James Hardie’s shares are trading at 28.6 times FY17 earnings with a yield of 2.3 percent. While this appears expensive, we believe these metrics can be justified by the potential upside to earnings from North America. This fundamental view appears consistent with the stock’s technical set-up, with the share price having recently closed (on a monthly-basis) above the 78.6% Fibonacci retracement of $21.96, which is a bullish development that activates two additional upside targets.
We remain favourably disposed to an investment in James Hardie given our view that the outlook for the company’s core business (i.e. North America) will remain positive for the foreseeable future. This is based on our expectation that demand for US housing/construction will be underpinned by Donald Trump’s intent to lower the US corporate tax rate and invest around US$1 trillion in public infrastructure over the next decade.
James Lennon is a senior analyst at investment research and funds management house Fat Prophets. To receive a recent Fat Prophets Report, CLICK HERE
Disclosure: James Hardie is held within the Fat Prophets Concentrated Australian Share and Australian Small & Mid Cap Models.
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