CSR (ASX:CSR) shares have recovered in the last few weeks after suffering a beating by the market. Does this mean we have seen the low and is it time to buy?
Overview of CSR
CSR’s principal activities include the manufacture and supply of building products in Australia and NZ. This is the main operating division of the Company, accounting for over 60% of group earnings. Other divisions include:
i. An interest in aluminium smelting through its 70% interest in Gove Aluminium Finance. This owns 36.05% of the Tomago aluminium smelter,
ii. Property assets where CSR aims to generate returns from the sale of its surplus land and
iii. Viridian – a provider of a range of residential and commercial glass including double glazed windows, laminated, energy-efficient, safety, security and self-cleaning glass.
Challenges for the Building Products Division
Since reporting its results for the 12 months to 31 March 2018 (FY18), CSR shares have weakened significantly. The weakness was driven by expected earnings and margin pressure for the Building Products division over FY19 and FY20. Earnings have considered to have peaked in FY18.
Amongst its ASX-listed peers, CSR has the greatest exposure to the Australian housing cycle. Because of this, CSR’s earnings are at risk from a further decline in residential activity. This is notwithstanding that only ~12% of revenues for the Building Products division are generated from the high density/apartment market. This is where concerns are most significant.
After demonstrating operating leverage in FY17 (i.e. EBIT growth of 21% well in excess of sales growth of 8%), the rate of cost growth in the Building Products division matched the rate of sales growth in FY18. This was because not all of the product segments within the Building Products division have been able to offset higher energy costs. Improving operating leverage is likely to be challenging. We expect the rate of decline in EBIT to outstrip the rate of growth/decline in sales in FY19 and FY20. Also, the quantum of price increases in FY19 is expected to be lower than that achieved on FY18. This is because of ongoing competitive pressure in several key products.
Fundamental View of CSR
Whilst the shares have recently recovered off their lows, we remain cautious on the sustainability of an improvement in the share price. This is in light of continued negative sentiment towards the Australian housing cycle. Not only that but we believe that the performance of the other three divisions are offering little to offset the declining earnings trend for Building products. In particular, earnings for the Aluminium division are being impacted by higher energy costs. There are questions around the sustainability of any improvement in earnings for Viridian and earnings for the Property division are difficult to predict. The reason is that the Property division is highly reliant on the quantum and timing of property transactions.
CSR has maintained a conservative balance sheet. This provides scope for accretive acquisitions and/or capital management. However, this is not likely to take place until FY20, given that CAPEX is required in FY19 a number of initiatives, including the expansion of an operating facility.
Technical View of CSR
The share price has seen a nice recovery in the last few weeks. But you have to question how sustainable this is when you look it at alongside the huge beating that it sustained during May – June. The shares are nearing resistance in the $4.50 zone so at best we would like to see it come back and form a “higher low” before we can begin to feel a bit more comfortable about the chart.
Michael Gable is managing director of Fairmont Equities.
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