Doubts over James Hardie's bullish outlook
The building materials supplier's long-term North American market share forecast is too ambitious, says Grant Slade
Mentioned: James Hardie Industries PLC (JHX)
Glenn Freeman: In this edition of "Ask the Expert" I'm discussing the recent result of James Hardie which delivered its third quarter results. So, why is James Hardie screening as so expensive at the moment at a premium of around 40 per cent to your fair value estimate?
Grant Slade: Sure. Look, James Hardie screens extensively in spite of our continued optimism for their North American fiber cement business, really on the basis that the recent performance from the business in the last 12 months after their new CEO Jack Truong took the top job has been outstanding. While we remain incredibly optimistic about those growth prospects for their fiber cement franchise in North America, the markets' expectations now eclipse ours. The stock is now as a result priced to perfection.
Freeman: So, fibre cement is the one game, the big game for these guys and particularly within North America. Why are investors so bullish about this and overly so, in your view?
Slade: Fiber cement is an exterior wall cladding product that continues to chip away at the share of vinyl cladding in the U.S. and as it does so, is providing earnings growth for James Hardie that is outpacing the market generally. That story had been called into question at the start of last year as the transition to a new CEO took place. However, Truong has come into the job with a new sales strategy and has reinvigorated that above-market index growth that had been lacking for the 18 months to two years prior to his appointment in the role. That's reignited the markets expectations for just how big the fiber cement category and Hardie's terminal market share within that category can be.
Freeman: So, the new CEO is really having a positive impact. And that's part of this this investor reaction you believe?
Slade: That's right. So, that's the major reaction. So, to perhaps provide some context, the siding market was flat in the first half of James Hardie's fiscal 2020 year. Nonetheless, Hardie was able to grow its volumes by growing effectively above the market. By growing above the market, it is grabbing market share from vinyl and other cladding substrates. Q3 was even better. So, while the market itself returned to growth of about 2.5 per cent, Hardie's volumes up a very strong 11 per cent. So, it's growing a full 8.5 per cent approximately above the market. And with the December quarter housing figures having come out, Hardie's fourth quarter looks as though it will be just as strong if not stronger.
Freeman: And if we cast our mind back, in January, it was a best ideas stock on Morningstar's list. What would it take for it to become a 5-Star stock once again?
Slade: It would just be a reversion simply of investors' expectations around the ability of Hardie to continue to garner market share.
So, we remain incredibly optimistic about those long-term prospects for this business. It's a narrow moat business on the basis of its substantial brand equity that provides pricing power for the business.
And we think that that brand equity will allow Hardie to continue to grow its market share from a current 17 per cent all the way up to 25 per cent. So, that's another sort of 8 per cent of market share over the coming decade.
However, the way the stock currently trades, there's the implied market share gains that are that are effectively discounted into that price are north of 30 per cent. Now, Hardie's own long held target for market share in the North American market is around 32 per cent.
The current share price implies that they will not only get there, but go even a little bit further, perhaps towards the 35 per cent market share kind of level.
Freeman: Which you don't really necessarily think is going to happen?
Slade: So, what we're talking about is, investors have now baked in expectations that Hardie will execute perfectly on their plans and some more. And on that basis, it's a sell when we rate it as a 1-Star stock.