Construction suppliers built to weather the corona storm
Housing is in the virus doldrums, but Grant Slade sees balance sheet strength among building suppliers.
Mentioned: GWA Group Ltd (GWA), James Hardie Industries PLC (JHX), Reliance Worldwide Corp Ltd (RWC)
The balance sheet strength of Australian building suppliers should insulate them against the long-term effects of coronavirus, says Morningstar.
The pandemic has strangled economic activity and prompted dire predictions among economists and the construction industry’s peak bodies that housing starts here and in the US could plumb levels not seen since the 1960s.
Housing construction had dipped by 15 per cent annually before the coronavirus. It is now tipped to sink further, according to UBS economists.
Housing starts are forecast to fall from about 174,000 in 2019, to about 120,000 in the 2020 calendar year, UBS says. And they could fall below 100,000 in coming quarters, which would be the lowest level since at least 1960.
It’s grim on the jobs front too. In the past six weeks, the number of building and construction industry jobs has fallen 5.3 per cent, according to the ABS.
This is bad news in the short term for Australian building supplier James Hardie (ASX: JHX), plumbing supplier Reliance Worldwide (ASX: RWC) and bathroom fittings company GWA Group (ASX: GWA).
But there is room to be upbeat.
Morningstar analyst Grant Slade says that while the near-term impact of COVID-19 on residential construction will be substantial, it does not represent a “structural disturbance” to the Australian economy or its housing market.
“We expect the dip in housing investment to be relatively short-lived,” Slade says, “with a recovery in housing construction—commencing in 2022—toward a midcycle activity level of 150,000 starts.”
Similarly in the US, Morningstar analyst Brian Bernard says his longer-term forecast of housing starts reaching more than 1.4 million units by the mid-2020s remains unchanged.
Building up a strong balance sheet
Source: Morningstar
Slade has trimmed his fair value estimate for James Hardie Industries and GWA Group. His fair value estimate for Reliance Worldwide is intact.
Slade argues some building names have been unfairly sold off are now trading at attractive discounts of between 19 and 45 per cent.
James Hardie and GWA Group each have a narrow moat rating—or ten-year competitive advantage, and a medium uncertainty rating, according to Slade.
GWA has a high uncertainty rating but Slade says “it screens attractively with both the near-term economic impact of COVID-19 and competitive threats to its operating margins priced in.”
Following is a snapshot of his thoughts on the above names.
James Hardie Industries
James Hardie's sell-off amid the COVID-19 market rout is overdone, with the pandemic's impact on the valuation of the narrow-moat name modest. We expect a sizable contraction in US residential construction in 2020 amid unprecedented efforts to contain the spread of the virus. With containment measures taking effect in mid-March, we make no change to our fiscal 2020 net income forecast of US$370 million. Nonetheless, Hardie's fiscal 2021 earnings will be impacted by the contraction in construction activity and we lower our estimate for the coming fiscal year accordingly. However, with a swift recovery in housing starts anticipated in 2021 and with our long-term expectations for the US housing market unimpacted, we trim our fair value estimate by a modest 2 per cent to $22.40. Importantly, we believe Hardie's balance sheet is well positioned to navigate the uncertain near-term environment. All told, Hardie shares screen attractively amid the equity market sell-off, trading at a 13 per cent discount to our revised fair value estimate.
Certainly, the near-term impact on residential construction in the US will be substantial. However, the dip in housing investment is expected to be relatively short-lived and we expect a strong rebound in activity in calendar year 2021. Furthermore, our long-term expectations for US housing investment remain unchanged with the COVID-19 pandemic not a structural disturbance to the US economy or its housing market.
Reliance Worldwide
The looming economic fallout from the COVID-19 pandemic is likely to provide a cyclical headwind to no-moat Reliance’s top line over the fiscal 2021–fiscal 2022 period. However, our $4.20 per share fair value estimate remains intact with the outbreak of the virus not altering the substantial secular growth opportunity that exists for Reliance’s push-to-connect, or PTC, plumbing fittings franchise. We expect falling construction and repair and remodel, or R&R, activity in Reliance’s key geographies in calendar year 2020 and 2021 to soften earnings over the fiscal 2021–fiscal 2022 period. Nonetheless, we still anticipate earnings growth over the period, with the combination of secular growth of the PTC plumbing fittings category and Reliance’s substantial exposure to the highly stable repair and maintenance plumbing fittings segment to shield the top-line from falling housing starts. Importantly, we believe Reliance’s balance sheet has sufficient strength to navigate the ominous COVID-19-related economic fallout that lies in store. All told, Reliance’s shares screen attractively, trading at a sizable 35 per cent discount to our unchanged fair value estimate.
GWA Group
Cyclical headwinds posed by the COVID-19 pandemic lead us to lower our fair value estimate for narrow-moat GWA Group by 3.5 per cent to $2.80 per share. We expect falling construction and repair and remodel, or R&R, activity in Australia and New Zealand in calendar year 2020 and 2021 to materially soften GWA’s earnings over the fiscal 2021-fiscal 2022 period. But the COVID-19 outbreak and the unprecedented global containment measures which have accompanied it are a cyclical shock to Australia’s housing market. Therefore, we anticipate the impact to be short-lived and a recovery in GWA’s earnings is expected to gather steam from fiscal 2023. GWA shares screened as significantly overvalued prior to the pandemic’s outbreak. In our view, the market had failed to appropriately incorporate the risk that recent entrants to the Australian sanitary-ware and bathroom fitting market pose to GWA’s long-term profitability. However, with the stock last trading at a 17 per cent discount to our revised fair value estimate, GWA now screens attractively with both the near-term economic impact of COVID-19 and competitive threats to GWA’s operating margins priced in.
