Housing construction will recover early next year and help dig Australia out of the covid-induced recession, says Morningstar.

For Australian investors seeking opportunities in the building arena, waste management company Bingo (ASX: BIN) and building materials supplier Adbri (ASX: ABC) are the names to watch, according to Morningstar analyst Grant Slade.

Other undervalued names include Boral (ASX: BLD) and plumbing supplies giant Reliance Worldwide (ASX: RWC), although Reliance has climbed by more than 8 per cent since Morningstar last wrote about it on 25 August.

Fletcher Building (ASX: FBU) is another undervalued name, although it does carry a high uncertainty rating and a poor stewardship rating, which Slade hopes he will be proved wrong on.

“We expect residential construction activity will stage a recovery from early 2021, marking the dawn of the next housing cycle in Australia,” Slade says in a new survey of the Australian housing industry.

“Dwelling investment typically leads the business cycle. As such, the recovery in housing commencements we anticipate in 2021 is a welcome development that will contribute substantially to the recovery of the Australian economy from the economic shock dealt by the coronavirus pandemic.”

The near-term outlook is, however, brittle, particularly as Australia this week entered recession territory for the first time in almost three decades. Rising unemployment and falling household income will put a bite on dwelling investment.

Cyclical trough in dwelling investment expected to form in mid-2021

Source: Morningstar

But Slade does see green shoots emerging. Ultra-loose monetary policy will pump some oxygen into housing starts early next year, getting a jump on other forms of housing investment such as alterations and additions.

Overall, long-term housing investment should remain untouched by the pandemic, Slade says.

“We expect dwelling investment to stage strong, catch-up growth from late 2021.

“The long-term impact of the covid-19 shock will be largely immaterial. We forecast dwelling investment a mere 2.5 per cent below pre-pandemic expectations in 2025.”

An early recovery in housing commencements anticipated

Source: Morningstar

Bingo and Adbri: strong earnings ahead

Among individual stocks, waste management company Bingo Industries and building supplies firm Adbri are the most compelling names within Morningstar’s sector coverage, Slade says.

“With the forecast low-point in residential construction activity anticipated in late calendar year 2020, earnings growth is likely to elude Bingo in fiscal 2021. Nonetheless, we expect a return to strong earnings growth for the narrow-moat name from fiscal 2022 as a cyclical recovery in Australian construction activity forms from calendar mid-2021.

“Equally, narrow-moat Adbri stands to benefit from a cyclical earnings recovery in 2021 and the construction materials player is compelling at current share price levels, trading at a 17 per cent discount to our $3.00 per share fair value estimate.”

Another name worth mentioning is narrow-moat building supplies powerhouse James Hardie (ASX: JBH). It is, however, the most overvalued among Morningstar’s Australian building materials coverage, trading at a steep 40 per cent premium to Slade’s $22.40 per share fair value estimate.

“Hardie’s performance in the early stages of the pandemic has been impressive but has re-ignited exuberant long-term expectations for the business by investors,” Slade says.

“The strong momentum in US market share gains enjoyed by James Hardie in late fiscal 2020 has continued into early fiscal 2021. While we continue to forecast strong growth for Hardie’s fibre cement business in North America, we do not see value in Hardie at its current share price of circa $31 per share.”

Undervalued names in Australian construction and housing

Source: Morningstar Direct; data as at 10:45am, 4 September 2020

Let’s examine in more detail some of the undervalued names in Slade’s report.

Bingo Industries

Bingo Industries began life in 2005 as a four-truck waste collection services business in western Sydney. Fourteen years later, it is Australia's leading construction and demolition waste management company, with more than 340 garbage trucks, a market cap of $1.9 billion and is poised to boost its earnings via shrewd acquisitions.

It has a narrow moat rating, which implies a competitive edge of at least ten years. This rating is partly attributable to an earnings mix that skews in favour of post-collection, which is one of the more lucrative aspects of the waste management value chain.

The company floated in 2017 with a launch price of $1.85. Since then, the share price has risen about 40 per cent. Morningstar began coverage of Bingo Industries in December last year, setting a fair value estimate of $2.75, which has since been slightly raised to $2.80 a share. It is trading at a 17 per cent discount.

Adbri

Narrow-moat-rated Adbri manufactures cement, concrete, lime and aggregates for Australian construction markets, with leading positions in three of Australia’s seven regional cement markets, those being: resource-rich WA, as well as South Australia, and the Northern Territory. As such, it is the second-largest supplier of cement and clinker products in Australia, producing roughly 30 per cent of Australia’s cement requirements.

Following rationalisation of its domestic clinker manufacturing capacity, Adbri is the largest clinker and blast furnace slag importer, importing more than two million metric tons of cementitious material annually.

Boral

Boral is Australia’s largest construction materials supplier. It is an integrated aggregate, cement and concrete player with $3.1 billion construction materials sales in fiscal 2020.

It acquired US building supplies company Headwaters, in May 2017, making it the largest fly ash marketer in the US with an about 50 per cent market share and sales of US$540 million in fiscal 2020. Critics claim Boral, under former chief executive Mike Kane, paid too much for Headwaters.

Boral’s strategy is presently in flux, following the arrival of new chief executive Zlatko Todorcevski. A review of company’s portfolio of businesses is under way. Slade expects greater detail next month.

“Boral’s balance sheet is the most leveraged and gives us the greatest concern among our coverage of the Australian building and construction materials industry. Nevertheless, we don't see an equity raise on the cards under our base case at this juncture.”

Reliance Worldwide

Reliance, the company behind the SharkBite pipe connector, staged a 17 per cent rise in its share price following strong full-year results last month, which reflected growth in its Americas division. It is now trading in line with Slade's fair value estimate of $4.20.

Slade says Reliance’s success rests on the ability of its R&D spending to consistently provide it with a lead in bringing new products to market.

Reliance Worldwide designs and manufactures branded, plumbing products, including its labour-saving SharkBite-branded brass PTC plumbing fittings, which has about a 90 per cent share of the brass PTC fittings category.

Slade assigns a medium uncertainty rating to Reliance. “While Reliance is exposed to residential construction cycles, the business is most exposed to the less cyclical residential and repair and remodel market. However, structural factors—specifically, the extent to which Reliance’s PTC technology can make further inroads in plumbing fittings category share—pose the largest risk to valuation.”

Fletcher Building

Fletcher Building’s diversified building materials business has many strong brands and dominates key product categories in New Zealand, where it generates healthy returns on investment. It is trading at 20 per cent discount to Slade’s fair value estimate of $4.20.

At the group level, however, returns are below the cost of capital, as the company has made what Slade sees as poor acquisitions in adjacent segments and new geographies and suffered execution issues in the construction division. This has overwhelmed the positive impact of an unprecedented building cycle in Australia and New Zealand which peaked in 2018.

Slade is hopeful chief executive Ross Taylor, who began in late 2018, can refocus the business and improve its capital allocation.

“We think the key priority is to set out a new vision for Fletcher,” Slade says. “Figuring out where Fletcher has its strongest competitive advantages—and, just as importantly, where it doesn't—would help make Fletcher worth more than just the sum of its parts.”

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