Consecutive earnings guidance downgrades for FY23 (year end 31 March) is now being overlooked in favour of a positive change in US housing market index data. Peers of James Hardie are reporting subtle but improving trends in activity.
The NAHB Housing Market Index is beginning to exhibit evidence that new housing is near a trough, if not already there. A combination of house price corrections, mortgage rates down from the peak and wage inflation is improving affordability in the US housing market that is generating demand. JHX’s biggest regional exposure in the south has returned to neutral on the HMI.
More recently, two of the largest homebuilders in the US, DR Horton and PulteGroup, have made positive commentary on the homebuilding industry such as increasing orders. In context, this is after housing starts have been in the doldrums for the last year as the backlog of construction from the pandemic has almost normalised.
For JHX, the priorities have shifted to defending and targeting market share growth to build a bigger business. This involves offering price competitive products to volume customers, for example, Cemplank to select large homebuilders. At the same time, it is demonstrating its value proposition for the rest of its customer base.
The immediate outlook is very difficult making the earnings trajectory negative. JHX has lowered its FY23 earnings guidance three times to the current range of US$600-620m with consensus sitting just below at US$599m. For FY24f, earnings continue to fall before a recovery.
JHX’s strategy in the last few years has been to drive price/mix and higher margins by spending more on marketing. In the face of weak demand, the focus has changed to defending market share as the leading provider of sidings in North America. Market share growth is the key priority.
The company has worked hard to remain ‘match fit’ by avoiding any idling of its plant. Flexibility in shifts and production has put JHX in a position to respond quickly as demand changes. The company has also tried hard to maintain EBIT margins at 25%+ for the NAFC and APFC divisions by lowering unit production costs and reallocating volume to lower cost facilities.
The APFC and European businesses have been particularly hard hit with ugly numbers reported at the 3Q23 result.
Investment View
The building industry is cyclical, so JHX must be ready for when the signals appear. In North America at least, this is now the case as the economic parameters turn in favour of home builders and their suppliers, such as JHX.
With FY23 almost completed, the outlook for FY24f is in discussion. We will learn more of what JHX management expects when it reports its FY23 result on 16 May, but we broadly know their thinking. JHX is expecting single-family construction starts in North America to decline 17% in CY23, with repair & remodelling down 6-7%. The company expects to keep EBIT margin above 25% through cost containment and some price increases.
It may seem contradictory to be raising our recommendation to Buy while the earnings trajectory is so clearly negative for the coming financial year. But with the economic indicators in North America beginning to turn positive for the building industry, we believe JHX’s PE ratio at 16x is at or near the bottom of the cycle. The long term PE multiple for JHX is around 19x.
Risks to Investment View
The recovery in NAFC may be slower than expected while the APFC and European BP divisions could also take longer to recover. If higher interest rates persist, this may impact on demand for building products in JHX’s markets. Competitive responses may challenge JHX’s market share position, forcing a response. EBIT margins may fall below the target 25% for NAFC and APFC which could affect earnings.
Recommendation
We have lifted our recommendation to Buy from Hold.
Figure 1: NATIONAL ASSOCIATION OF HOME BUILDERS – HOUSING MARKET INDEX
Figure 2: LONG TERM PE IS ~19X
Figure 3: PE RELATIVE TO MARKET
