The CSR share price has room to improve

We recently revisited CSR Ltd (ASX:CSR) after the Company reported its results for the six months to 30 September 2020 (1H21).

Since our report was published in mid-November in The Dynamic Investor and sent to subscribers, the shares have gained around 7%, as the market continues to favour stocks better leveraged to an economic recovery. In this note, we outline the factors supporting our favourable view on the fundamentals and assess the potential for further upside.

About CSR

CSR is a leading building products company in Australia and NZ. The majority of group revenue and earnings are generated from the Building Products division. This comprises three business units: Interior Systems (e.g. gyprock), Masonry & Insulation, and Construction Systems (e.g. external cladding). EBIT for the Building Products division is expected to account for ~70% of total EBIT in FY21.

The Company also generates additional earnings from its Property division. This focuses on maximising financial returns by developing surplus former manufacturing sites and industrial land.

CSR’s third division is Aluminium, which comprises the Company’s 25% interest in in the Tomago aluminium smelter, which is located near Newcastle, NSW.

Key Fundamental Drivers

Building Products Division Showing Resilience

The Building Products performed well in the face of cyclical and COVID-19-related headwinds. There is potential for EBIT margin to be supported, so long as market activity does not weaken significantly from current levels.

EBIT margin for the Building Products division reiterate the Company’s leverage to detached housing activity, despite significant declines in multi-residential approvals. While CSR is exposed to the later stages of construction, Australian detached housing (50% of BP revenues) is surging. Approvals for private sector housing increasing by 20.7% in September and also increased in October.

The Building Products portfolio has a growing exposure to non-residential markets (now 20% from 17%), with CSR reporting strong momentum in both the commercial and social infrastructure sector (healthcare, etc). The changing mix is a positive from the viewpoint that it reduces exposure to multi-residential exposure (now 21% from 23% across medium and high-density), which is likely to remain weak.

Contribution from Property Business Reduce Earnings Volatility

The Company has 457ha of existing land holdings that are leveraged to key Western Sydney locations that are set to benefit from structural tailwinds, including a new Western Sydney Airport, surging e-commerce activity and strong demand for distribution centres. The residential property market that CSR is exposed to (which is mainly residential infill) has also not seen a decline despite the impact of COVID-19, hence there is a high degree of resilience in earnings from the Property business.

Further, whilst the quantum of earnings may fluctuate due to the timing of transactions, the ongoing development of a number of major projects will underpin Property earnings over the long-term.

CSR’s Property business did not generate any significant EBIT in 1H21 due to the timing of transactions. However, the 50ha Horsley Park development in Western Sydney has secured $226m in sale proceeds over next four years. Over the next three years, CSR has committed EBIT from Horsley Park of $141m with a further 9ha currently being marketed.

Proceeds from the sale of property, coupled with a net cash balance sheet could allow for further special dividends to be paid between after FY21.

Sale of Aluminium Business Likely to Improve Earnings Quality

CSR is looking to exit its aluminium business. While the EBIT contribution from Aluminium is minimal, we consider that a sale of the Aluminium division would be well received, given: i) The typically volatile nature of earnings due to ongoing cost pressure and a higher linkage rate to the alumina price, ii) The more concentrated business portfolio and iii) The resultant re-allocation of capital to the Building Products and Property division, which generate a more attractive return on investment.

The market is also presently ascribing little value to the Aluminium business.

Fundamental View

While cyclical headwinds remain within the Building Products division, CSR is well positioned to endure these via the improvement in the business mix and potential for further cost savings to support EBIT growth within the Building Products division.

In addition, the potential sale of the Aluminium division and capital management as a result of a strong net cash balance are key catalysts for the shares.

CSR is currently trading on a 1-year forward P/E multiple of ~16.5x, which we do not consider to be demanding in the context of forecast EPS growth of +9% in FY21 and likely conservative market estimates of flat EPS growth in FY22, especially as higher than expected cost savings could present an upside risk to earnings.

Charting View

The strong rally from the last few months fell short of the February peak in early November. The stock then consolidated in the form of an ascending triangle and now it is trying to break out again. Once it can break above the February peak, then the next target would naturally be the old high close to $6.

CSR Limited (ASX:CSR) daily chart
CSR Limited (ASX:CSR) daily chart


Michael Gable is managing director of Fairmont Equities.


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