We recently researched Reliance Worldwide Corporation (ASX:RWC) in The Dynamic Investor. Market concerns about weakening demand across all operating segments had weighed on the shares. We took the view that the de-rating in RWC presented an opportunity. This was because the shares were trading on a multiple that was well below historical levels and at the bottom end of the prior trading range. With the shares having recovered strongly since our recent report, do current levels still present an attractive entry point?
About Reliance Worldwide Corporation
Reliance Worldwide Corporation is a global designer, manufacturer and supplier of premium-branded water flow and control products that are typically used by end-users such as plumbers/contractors. These end customers purchase RWC’s products through a number of distributors.
The Company holds the leading market position in a number of product categories. It was the first to introduce a full range of Push-To-Connect (PTC) fittings to the US plumbing industry, through its premium SharkBite brand in 2004. PTC fittings allow lengths of pipe to be connected through a rapid push-on connection mechanism, without the need for soldering, clamps/rings, glue or tools.
Key Fundamental Drivers
Is The EMEA segment set for a recovery?
The EMEA segment was the weakest performing segment in the 1st half of the 2024 financial year (1H24). Across the region, sales fell 12% in local currency terms, which means volume likely fell by a 15-20%. The core UK plumbing and heating market saw sales down 6%, with volumes likely down around low-double digits.
The EMEA segment underwent a restructure at the end 1H24 to cater for further volume declines and a soft outlook. The restructure (which included management changes), combined with further cost reductions, are expected to provide margin support. Importantly, the earnings are well leveraged to improving volumes, noting that at present, volumes are ~10-20% below normal levels. RWC has previously noted that a ±5% movement in volume results in a ±100-150 basis point movement in the EBITDA margin.
Operating Leverage to Resume from FY25
At the group level, RWC expect a low- to mid-single-digit revenue decline and stable margin in FY24. This implies a weakened revenue trend, mainly driven by the EMEA segment. Company guidance is for FY24 EBITDA margin for the Americas segment to be consistent with 1H24 (19.9%).
We expect operating leverage to return in FY25, reflecting a full-year contribution from Holman Industries (acquired in February 2024), as well as the rollout of new products SharkBite Max and PEX-a. Both products are higher margin. In addition, the Company is becoming increasingly focussed on generating efficiencies, especially given that volumes are currently at depressed levels.
One risk to the YF25 margin profile is higher copper prices. Copper prices recently reached a near 2-year high on 21 May to US$5.18/lb, which is +60% higher on a year-on-year basis. While copper prices have since retreated (to US$4.18/lb at the time of writing), higher copper prices are likely to have an impact in FY25. This is because there is typically a 6-month lag. In addition, zinc prices have recovery from recent lows.
Higher copper prices can be largely recovered through price increases passed through to channel partners (e.g. Home Depot, Lowe’s). However, there may be pushback from channel partners on price increases should copper prices continue to retrace. Further, the earnings sensitivity from copper price movements is slightly more pronounced given that volumes are currently at depressed levels.
Balance Sheet Remains Conservatively Geared Despite Debt-Funded Acquisition
Gearing (on a net debt to EBITDA basis) as at 31 December 2023 was 1.6x, having declined in recent periods. The acquisition of Holman Industries has increased net debt to US$481m from US$360m in FY24, with a gearing of 1.8x. However, this level is still within the target gearing range of 1.5-2.5x.
We expect a gradual de-leveraging of the balance sheet, underpinned by healthy free cash generation as well as a prudent approach to capital management. In terms of potential Merger & Acquisition potential, RWC sees commercial construction as a key growth opportunity besides its core residential Repair & Remodelling segment. To this end, the expansion into commercial construction is likely to be facilitated through a combination of new product development and bolt-on acquisitions.
Fundamental View
In our recent report, we highlighted several factors underpinning a potential recovery in the shares:
i. Investor focus following the release of full-year results in August is likely to turn to the resumption of operating leverage in FY25. Notably, the revenue and margin upside from recent product launches and ongoing operational efficiencies over the medium-to-longer term remain in place.
ii. Volume growth is likely to be supported by the rollout of new products.
iii. The stabilisation in interest rates (with potential for rate cuts in the US) should have a positive impact on demand going forward.
We consider that these factors can still support further upside in the shares.
Charting View
We last looked at the RWC chart on 20 February in The Dynamic Investor when we noted: “The past two years has seen RWC form a large inverse head and shoulders with resistance at $4.50. We now have an upside break … This means that RWC should trend higher from here with an ultimate target near $6.” After trading as high as $5.90 in March, RWC then spent the next several weeks pulling back. At the end of June it retested the old $4.50 resistance level before bouncing again. We should see a recovery in the share price from here.
Michael Gable is managing director of Fairmont Equities.
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