We recently analysed James Hardie Industries (ASX:JHX) after the Company reported quarterly results for the 2nd quarter of financial year 2022 (2Q22).
Strong pricing growth, margin expansion, low balance sheet gearing, a clearly articulated long-term growth strategy and investment appeal as a strong cyclical exposure are all factors that have supported the investment case for JHX. With the share price now trading at all-time highs, is there scope for a further rerating? Or is it time for a breather?
About James Hardie Industries
James Hardie Industries (JHX) manufactures and sells fibre cement, fibre gypsum and cement-bonded building products for interior and exterior building construction applications, primarily in North America, Australia, Europe, NZ, the Philippines and Canada. The key value driver for the group are the North America Fibre Cement (NAFC) operations, which account for ~75% of group earnings and 2/3rd of group volume.
Key Fundamental Drivers
Shift to Higher-Value Products Underpin Pricing Growth
The Company has implemented a strategy to shift demand from lower-value products (e.g. Cemplank) to higher value (e.g. HardiePlank, ColorPlus and new panels) products. It is worth noting that 63% of JHX’s portfolio is currently high-value products.
JHX’s market position is enabling the Company to enjoy strong pricing power at present. In 2Q22, the North America segment reported growth in Average Selling Price (ASP) of 9%, which was at the top end of the guided range).
ASP growth in North America is expected to continue as JHX transitions from selling Cemplank to HardiePlank (almost 2x ASP) over the next few quarters. A large proportion (~40%) of price/mix growth is being driven by a continued shift of Cemplank customers to higher-priced product. The transition to ColorPlus (at 3x Cemplank ASPs) also a factor in driving the 8-9% expected ASP growth.
JHX has indicated a headline price increase of ~5% across its North American portfolio from 1 January 2022, with the strong ASP expected to result in pricing growth of +5% in FY23. Over the medium-term, ASP growth to be supported by Textured Panel making an impact into FY23/24 as penetration grows.
Margin Outlook for North America Fibre Cement
The EBIT margin in the North America Fibre Cement (NAFC) business is a key indicator of performance for the Company and likewise, a key area of focus for investors. JHX previously had a medium-term EBIT margin target of 20-25% and given that the quarterly EBIT margin has generally been above the upper end of this target range over the last five years, the Company has increased the target range to 25-30% for NAFC.
Also, the margin target range has increased from 20-25% to 25-30% for APAC and from 10% to 11-16% in Europe. The increase in targets for medium-term EBIT margin is a strong sign that the group is confident in its ability to manage cyclical variability (via higher ASPs as new products typically attract a higher margin), especially in the context of additional cost pressures expected in FY22.
Significantly, the Company strategy to shift towards higher-priced products means that pricing is now the main driver of EBIT margin expansion, as opposed to reliance on lower input costs.
Opportunity to Grow Market Share
With a high category share of 90% share of the US fibre cement market, and fibre cement at an estimated 22% of new housing siding, there is plenty of growth runway for JHX to reach the company’s traditional 35/90 target (fibre cement to be 35% of new housing siding in the US; and for JHX to hold 90% share of fibre cement).
JHX’s 90% share is expected to be held, given that: i) The Company has strong brand integration with the contractor, ii) Its scale of production drives a lower unit cost and iii) Competition within fibre cement is also low and, over the last 12-18 months, some competing brands have been impacted by quality issues.
Solid Progress on Internal Initiatives
In May 2021, the Company commenced a direct marketing campaign, whereby JHX is focused on building demand with large homebuilders and contractors with a view that these parties will push product to homeowners, with a view to building consumer awareness in order to develop James Hardie as a consumer brand.
The next phase of the push-pull strategy is direct-to-consumer marketing. JHX aims to grow further into the Repair & Remodel (R&R) segment, which currently represents ~55% of JHX’s sales. The Company sees an opportunity in the 44 million homes in the US that are more than 40 years old and aims to reach this market via direct consumer channels.
A key benefit of increasing exposure to the R&R market is that while supply chain constraints have been evident in US new building activity, it seems JHX have seen less constraints in the R&R space. Less critical path dependencies means that the key constraint is labour availability, which in itself could be better off given builders could be drawn to working in less constrained contexts.
In addition, new capacity initiatives are being pursued across all three geographic regions. This strategy indicates the Company’s confidence in longer term growth.
JHX shares are currently trading on a 1-year forward P/E multiple of ~32x, which we contend is undemanding in the context of EPS compound annual growth rate (CAGR) of 21% over FY21-24 and the premium rating to market (~10%) that JHX shares have historically traded. Importantly, there is scope for further EPS upgrades from:
i. Benefits from the structural change arising from an increased exposure to the repair and remodel (R&R) market,
ii. The higher-value/margin product pricing strategy in North America and
iii. Potential for further market share gains in North America.
After forming a triple top in August – September, JHX shares fell back and found support at the uptrend line in October. After that, they rallied strongly, hitting an all time high and then consolidating again. This consolidation was a bullish sign as it meant that the shares were able to take a breather, testing dual support lines near $52 and $55. Now that it has worked through all the sellers, it has broken to a new high. This means that JHX is likely to rally higher from here and resume its longer-term uptrend.
Michael Gable is managing director of Fairmont Equities.
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