After a massive share price boost post-election, is there further upside in the CSR Limited (ASX:CSR) share price? We have a look at both the fundamentals and technicals.
Around two weeks ago, we revisited CSR in our client research report The Dynamic Investor (since then CSR has rallied over 18%. Click here to get an 8-week trial to this report) This was following the release of the Company results for the 12 months to 31 March 2019 (FY19). The stock was trading well but from a fundamental point of view we were cautious on the outlook for the stock. Since our report, a number of new developments have emerged that have potentially positive implications. This is from both an operational and macro viewpoint. As a result, there has been a significant re-rating in the share price.
A more favourable domestic macro environment has emerged in the form of the surprise Federal Election win by the incumbent Liberal government. There is also the prospect of RBA rate cuts and APRA’s decision to re-assess mortgage serviceability assessments. Positive developments in the alumina market globally have improved the outlook for the Aluminium division over the short term. Finally, the appointment of a new CEO remains an unclear catalyst.
Why were we cautious?
Australian housing approvals in March 2019 declined 27% (on a year-on-year basis) to an annualised 173,000. This was the 9th consecutive month of declines. In FY20 single-family starts are forecasted to be down 5% and multi-residential down 15%. However, the Company has limited revenue exposure to the multi-residential segment, which has seen the greatest weakness. These factors underpin an outlook for declining volumes in the Building Products division.
Coupled with the expectations for the Aluminium division to be impacted by lower prices and higher costs, the group earnings outlook for FY20 and FY21 appears weak and at risk to the downside. This is given that around 55% of CSR’s revenues are exposed to housing activity.
In addition, while there is strong balance sheet capacity for further acquisitions, there was uncertainty as to how/when the Company will use this capacity. This was especially in light of the upcoming change in leadership.
Positive News for Aluminium Division
The Company’s Aluminium division has suffered from declining earnings. This was a result of higher electricity-related costs (in particular coal price pass-throughs, which impacted Aluminium margins significantly) and higher raw material costs (including coke and pitch due to supply constraints).
A key input cost is alumina. A recent decision by a Brazilian Federal Court to lift the remaining production restrictions at Norsk Hydro’s Alunorte facility has improved the outlook for more balanced pricing in the Alumina market.
The Alunorte refinery transforms bauxite from mines in Brazil into alumina used to make aluminium. The Alunorte plant, an important supplier to the aluminium industry, has been forced to operate at half capacity. This was due to a spill in February 2018 which prompted regulators and courts to restrict output.
CSR management recently signed a new supply contract for 50% of alumina volumes. Pricing in relation to the remaining 50% of volumes is expected to be announced sometime during 1H20. The prospect of lower spot alumina prices aids CSR’s position as it completes the negotiation of its remaining 50% alumina supply, thus improving the outlook for divisional earnings.
Appointment of New CEO
In mid-May, the Company announced the appointment of Julie Coates as CEO and Managing Director (MD), effective 2 September 2019. Ms Coates is an external appointment and will replace Managing Director and CEO, Mr Rob Sindel, who assumed the role in January 2011.
In our recent review of CSR, we commented that the key question in relation to the new MD is whether there is likely to be a change in strategy regarding capital allocation. This is especially given that under the current leadership, the Company has maintained a conservative balance sheet over the last five years. In other words, would the new Managing Director pursue acquisitions more aggressively?
On this score, the jury is still out, as Ms Coates does not have a work background commensurate with the industries in which CSR operates. Ms Coates, who is currently the MD Australia & New Zealand at Goodman Fielder (a major food products manufacturer and distributor) has a “strong track record in manufacturing operations as well as large-scale complex supply chain and logistics expertise”. She also has “a deep understanding of product, brand and marketing, as well as digital transformation and global sourcing”.
Fundamental View of CSR
Since our review on CSR, the shares have re-rated from 1-year forward P/E multiple of ~11x to ~14x. This is above its historical average of ~12x. At current levels, we contend that the above-mentioned positive developments are well factored into the share price. From a fundamental perspective, we would prefer to see evidence of an underlying improvement in construction activity before taking a more favourable view. In particular:
i. While the improved macro environment has improved sentiment towards the sector, the key consideration is if and when this is likely to filter through to the detached residential market. This is especially given that CSR’s earnings are well leveraged to an eventual improvement in housing volumes.
ii. In the event that it does filter through, the earnings benefit is likely to come in FY21. This is given that the outlook for FY20 is for declining volumes in the Building Products division and the cost headwind in FY20 from alumina prices remains in place – notwithstanding the developments at the Alunorte plant.
Charting View of CSR
We recently looked at the CSR chart in mind February and noted that it a low was probably in place and that the shares should drift up towards resistance near $4. The election result has seen CSR jump higher and push through the $4 mark. It is now close the 50% retracement of the 2018 decline which means it is now encountering some resistance. As long as it can consolidate in the higher part of last week’s candle, it should be able to make the next move to the next resistance zone which is just above $4.60.
Michael Gable is managing director of Fairmont Equities.
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