The outlook for CSR is full of contrasting factors that leave us neutral on the stock. CSR has faced a very challenging period for building materials companies, accompanied by an inevitable downturn in housing construction. But a rational industry has helped CSR to navigate its way to achieving pricing offsets supported by its substantial property portfolio.
Proactive pricing. CSR mostly operates in consolidated and rational industries which has enabled it to recover some of the substantial cost winds facing manufacturers. Rising energy costs are threatening the margin performance of building products manufacturers, particularly those engaged in energy-intensive products such as bricks. There is an opportunity for product substitution into Hebel and Fiber Cement which are less energy intensive. CSR is facing higher energy costs as its contracts expire so the ability to obtain some proactive price increases ahead of this factor should give CSR a near term margin boost.
Recent ABS data confirms that producer price indices rose significantly in the year to June 2022. Plaster products increased 5.8%, bricks +11.8%, insulation +22.4% and Fiber Cement +7.1%. Competitors in each of these categories have announced price increases for 2H23f to varying degrees and there appears to be a willingness to follow suit. CSR’s Bradford Insulation, for example, has announced price increases of 7-10% effective in September 2022 while Fletcher Insulation (FBU.AX) raised its prices by 5-10% in October 2022.
Housing backlog remains. A period of intense homebuyer demand in 2021 was compounded by a shortage of key construction materials such as timber for framing. Detached housing completions are still running well below peak housing demand and although materials supply is now easing slightly, the backlog of work remains elevated for most of 2023. Labour shortages may not be easing, and excessive wet weather could persist through 2H23f. Government immigration policy might eventually add to the pot as net overseas migration figures head towards 200k in CY22.
Property buffer. CSR has an ‘as is’ valuation of $1.1 billion for its Western Sydney property portfolio. The company has taken a more strategic approach to realising value from the portfolio since 2017 with a steady flow of earnings. CSR will be holding an investor day on 10 November at which we expect further detail on how the portfolio can add value to the company will be unveiled.
Aluminium cost headwinds. The price of pitch and coke remains high, while coal itself is manageable in the near term. CSR had hedged 95% of its aluminium price exposure for FY23f but we think full year divisional earnings may not reach guidance as cost increases bite.
Investment view
The Building Products business is presently undervalued by the market, trading at 6x FY23f EBIT which in our view is close to trough levels. The approaching interim result needs to clarify where EBIT margins are heading for FY23f for the market to have confidence. The pricing response and long backlog of work provide a good basis for our Hold recommendation, but we remain wary of the cost headwinds that are hanging around.
CSR has completed approximately 24% of its $100 million buyback program.
Risks To Investment View
The timing and severity of the expected demand erosion is a key earnings risk. As interest rates rise, housing affordability may also dampen demand for CSR’s products.
Recommendation
We have retained our Hold recommendation.
