James Hardie shares (ASX: JHX) have lost around a quarter of their value after the company announced a cash and scrip deal to buy its building materials peer Azek (NYS: AZEK).

While our analyst Esther Holloway is rather lukewarm on the deal, she thinks the market sell-off is overdone.

What’s the big deal?

The mooted deal would include JHI handing over one newly issued share in the company and USD 26.45 for each Azek share. Esther estimates the total consideration would be around USD 7.4 billion at today’s lower share price levels, down from over USD 8 billion before Hardie’s shares crashed.

All in all, James Hardie is set to issue around a third of the existing share capital in new shares, and Azek shareholders owning roughly a quarter of the combined company.

I’ll let you decide how much of a “bet the company” deal that is for James Hardie, which generated USD 3.8 billion in revenues over 2024 and had a market cap of around AUD 20 billion before this announcement caused its shares to plunge. But why are they doing it? First, let’s look at what both companies do.

James Hardie sells fibre-cement panels that clad the outside and inside of houses. In the key North American market, fibre-cement has been taking market share from other ‘siding’ materials for decades. Mostly because of its lower ongoing maintenance costs and longer lifespan.

Azek, on the other hand, is a smaller materials business focused on a different niche. It generated US 1.4 billion in its latest twelve-month reporting period – around half of the USD 2.9 billion generated by JHI’s US business – and gets most of its revenue from outdoor products like decking and railing.

This, according to JHI, is where the opportunity lies. It does not currently compete in this space yet says that 55% of people re-siding their homes renovate their outdoor areas at the same time. In short, JHI sees a big cross-selling opportunity, to the tune of $500 million in extra revenue each year by 2030.

Why do markets hate it?

Our analyst Esther Holloway thinks the cross-selling makes sense and that the deal fits JHI’s long-term strategy, which includes moves to increase its wallet share with contractors and form partnerships in new channels.

Esther’s lukewarm reaction to the deal comes from the price-tag. She thinks the price bakes in a lot of this opportunity before it is even realised, meaning that JHI will have to execute very well to avoid destroying value for shareholders.

Markets may also dislike the potential for Azek’s business to be more cyclical than James Hardie’s core siding business. In hard times, customers could be more likely to delay renovating or building new outdoor areas than carrying out essential structural work to their house.

On the bright side, Esther thinks the deal brings an opportunity to introduce Azek products to new markets in Europe and Asia-Pacific where JHI has a large presence. She also thinks that achieving big cost-savings at the corporate level will be made easier by both companies being based in Chicago.

Overall, Esther sees the purchase as being slightly value destructive but not to the extent that it affects her long-term Fair Value estimate for the shares. As a result, she thinks the 25% share price fall is an overreaction and that JHI now looks materially undervalued.

Long term demand drivers look solid

A big factor in Esther’s optimistic view on JHI is the outlook for its vital US siding business, where around 80% of revenue comes from renovation work as opposed to new builds.

Esther admits that higher interest rates could stimmy renovation activity this year, but there is no getting away from the fact that most houses need to be re-sided every 20-40 years. As over half of US houses are over 40 years old, there should be plenty of work for decades to come.

As for Hardie’s position in the fibre-cement market, it couldn’t be much stronger. Having literally invented the product and investing continually to improve its range and quality, James Hardie remains the US market’s most trusted supplier of fibre-cement and enjoys around 90% market share.

This brand power and huge scale versus many competitors underpin Esther’s view that Hardie has a Wide Moat around its siding business. At a recent price of $38, the company’s ASX listed shares traded considerably below Esther’s unchanged Fair Value estimate of $55.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

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Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn more about how to identify companies with an economic moat, read this article by Mark LaMonica.

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