The good thing about cyclical industries such as housing construction, is that lessons learned can be applied in the future. James Hardie Industries is faced with a peaking housing market but mitigated by a backlog of completions.
After a decade of steady growth in US housing activity, we have reached the top of the current cycle. Inflation is now biting, and rising interest rates are applying the brakes to economic activity. The market is now anticipating US interest rates to peak near 3.3% by the end of the year to combat rampant inflation. But in order to avoid an economic recession, the market is also now anticipating a decline in interest rates (~50bp) in CY23f.
In the current cycle, completions have failed to keep up with starts creating a backlog that may continue to swell. The detached housing backlog has typically ranged between 50-60% of single-family completions over the last 30 years but has climbed dramatically since mid-last year. This means future demand for building materials will remain heightened until balance is restored (see Figure 2).
The backlog is probably large enough to support elevated materials demand for the next 15-18 months even with housing starts declining. Cancellation rates are typically around 2% and homebuilders are already easing back on sales to try and alleviate the situation. The building cycle is also lengthening (see Figure 1) as homebuilders are tending to sell houses closer to the end of the build cycle.
The Repair and Remodel (R&R) sector is also important for JHX. At the FY22 result, management confirmed its leverage to the R&R market in the US was 65-70% of total NAFC volumes. R&R has proven to be a very resilient part of the market during housing downturns even though there is still some inherent cyclicality. Unsurprisingly, rising house prices are closely correlated to increasing R&R spending. US institution Fannie Mae is expecting house prices grow 11% in 2022 and a further 3% in 2023.
Investment view
The backlog of work in US housing construction should support demand for building materials for possibly up to 18 months, despite a softening in US housing starts. The possibility of a recession in the US has increased but we think the impact on JHX’s earnings may not be felt until FY24f due to the backlog of work supporting volume growth. Input costs are still elevated and price discounting among competitors is becoming more prevalent. We think consensus earnings forecasts for FY24f are too optimistic. Despite that, the share price has been unfairly punished in the short term and does not reflect the strong position in which JHX finds itself.
The current share price is implying group/NAFC volumes will decline by 15-25% which does not reconcile with the significant backlog of housing construction underway.
JHX has had time to prepare for changes in demand and should avoid any drastic fall in EBIT margin. Volumes should not fall precipitously given the backlog of construction and we think price competition should be less intense than previous cycles. A few of JHX’s senior management have been with the business since the last housing downturn and should be able to apply the lessons learned.
Risks to investment view
Demand for JHX’s products may not achieve the growth or margin anticipated. Rising interest rates may dampen demand and lower consumer spending on housing products.
Recommendation
We have retained our Buy recommendation.
Figure 1: US housing starts
Source: Refinitiv Datastream
Figure 2: US housing backlog
Source: US Census, Sandstone Insights
