We recently researched Reece (ASX:REH) in The Dynamic Investor following a trading update issued to the ASX on 27 June. We took the view that the elevated trading multiple and several short-term factors would lead to a de-rating. Since our report, the shares have fallen by ~10% and are down by ~22% overall since the 27 June trading update.
Accordingly, we consider whether the shares now present any value.
About Reece
Reece is a specialist wholesaler of plumbing, waterworks, heating, ventilation, air-conditioning and refrigeration products. Reece’s products are used in residential, commercial and infrastructure applications. In 2018, Reece acquired Morsco, the US distributor of plumbing, waterworks and HVAC-R products, to expand its presence internationally.
The Company reports its results across two segments: Australia & NZ (ANZ) and the US. The ANZ segment accounts for ~45% of group sales, but around 2/3rd of group EBIT. REH currently has 675 branches across Australia & NZ (Aust: 634; NZ: 41) and 262 branches in the US (predominantly in the southern states).
Key Fundamental Drivers
ANZ Segment – Volume Weakness Cyclical Not Structural
With the benefit from the record pull-forward COVID spending now complete and backlog worked through, demand in the current calendar year was expected to trend sideways. So far, this has not tracked to plan. Underlying volumes in 1H25 were impacted by a soft housing market. Sales (flat on the prior corresponding period) were supported by bolt-on Merger & Acquisition (M&A) activity.
In context, although 14 new stores were opened in the six months to 31 December 2024 (1H25), the ANZ business remains a mature business. It has the largest share, at ~50% vs ~20% for its closest competitor. As such, any growth is predominately driven by market volumes.
Volume remains soft and recent interest rate cuts have not yet translated to improved housing activity. Notably, home loan repayments as a share of income remain extremely high, at 42% of gross household income). This will take time to flow through; noting that REH is a late-cycle beneficiary of improved housing activity.
However, housing supply appears likely to remain relatively weak, given the retracement in residential building approvals in recent months. Affordability remains a key issue, with the ratio of house price to income currently sits at near record highs for Australia at 7.1x median gross income.
Aside from volume pressure, the ANZ segment is facing margin pressure. The cost base in 1H25 was elevated due to investment in the business and ongoing inflation (net of cost initiatives). This resulted in EBIT declining by 17% and EBIT margin falling 211 basis points to 9.7%. Further, margin pressure is expected from the dilution to profitability from >20 new stores opened/acquired in the past 12-18 months.
US Segment Challenged by Volume Weakness & Competitive Pressure
REH’s high exposure to the residential new construction (RNC) sector continues to impact performance for the US segment. Housing units under construction remain down year on year, particularly in the sunbelt region where the Company operates.
Mortgage rates remain high and housing affordability continues to weigh on the US residential market. Notably, REH’s exposure to the residential sector is geared to the mid-to-smaller end of the market, share loss appears to be occurring.
Further, REH’s store footprint in the US is heavily concentrated in the South. This region has historically produced the majority of US’ new home construction and acted as a structural tailwind in recent years. However, this geographic skew is now becoming a relative headwind. Housing markets in the South have under performed the broader US market as housing prices across the region decline.
The Company also noted increased competition across all segments of its US business from new market entrants. The increased competition is impacting gross profit margin.
Moderate Gearing & Adequate Liquidity
The Company reported high debt levels in its last financial statements, Notwithstanding, gearing (on a net debt to EBITDA basis) remains moderate, at 0.8x (FY24: 0.6x).
The Company has adequate liquidity ($1.18b) available for growth opportunities, including Merger & Acquisition (M&A) activity. Having said that, we expect further M&A activity to be placed on hold given:
i. Current volume-related challenges across both segments and
ii. Recent tech businesses acquisitions have resulted in limited revenue accretion. Margin pressure is expected from the dilution to profitability from >20 new stores opened/acquired in the past 12-18 months.
Fundamental View
The Company is responding to external challenges via several avenues. It is making progress on re-branding and expanding the network, investing in digital capabilities, and increasing the exposure to the more stable R&R segment. However, continued market softness across both segments, heightened competition in the US as well as a lack of clarity around the potential impact from tariffs have driven a de-rating in the stock’s currently-elevated trading multiple.
While the shares are trading on a seemingly more attractive multiple – 26x compared to its long-term average of ~29x – we consider the investment risk profile to be too high.
Charting View
From late 2024 until early 2025, REH was falling away dramatically. It bounced well in early April but it has since given up those gains. It is now trading under support near $14, but there are no signs yet that it wants to bounce from here and head higher. At best, we can see this drifting sideways for a while.
Michael Gable is managing director of Fairmont Equities.
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