Ugly housing outlook won’t last

-- | 19/05/2020

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Glenn Freeman: In this edition of "Ask the Expert" I'm speaking with our equity analyst Grant Slade.

Now, first up, can you just explain for us what your view is on housing construction activity given the effect that we've seen on house prices across Australia?

Grant Slade: Yeah, absolutely. Look, I guess, the key message is that the near-term will look ugly for building and construction materials names against a housing outlook which is materially weakening. We expect housing stocks will contract materially in calendar year 2020 and 2021. And that's despite the construction that has obviously been deemed as a life essential activity and has continued under the present social distancing settings. But the bigger issue really is just how quickly I guess the pipeline of construction projects for the sector will begin to dry up, and we expect that construction of new dwellings and repair and remodel activity will respond vigorously to rising unemployment, already flagging consumer confidence and house prices which are likely to also correct sharply. So, consequently, when we kind of look across the building materials space, we're expecting earnings to contract significantly in fiscal 2021.

Freeman: Sure. So, in a nutshell, you basically see that it's going to be a fairly short sharp hit to housing rather than a protracted drawn out?

Slade: That's right. So, while the near term, as I mentioned, is ugly, the long-term does – so, the long-term outlook for the sector does remain bright and population growth really is what sets the stage for growth in our housing stock and therefore, long-term the demand for the building materials that are going to be needed to construct those new dwellings.

Freeman: And Grant, the first company you wanted to discuss here was Adelaide Brighton. How do these factors you've just discussed affect that stock?

Slade: Yeah. So, look, Adelaide Brighton is attractive at current price levels. It trades at around a 35% discount to our fair value estimate of $4 a share. So, we're obviously expecting, as I had previously mentioned, that earnings will contract significantly in 2020. But that eventual recovery that we see in residential construction in tandem with an unprecedented infrastructure pipeline nationally will help to drive a recovery in earnings from 2021 onwards. So, certainly, the long-term opportunity for Adelaide Brighton is there and in the near term we think that Adelaide Brighton's balance sheet is strong enough to see it through a fairly challenging 12 to 18 months ahead.

Freeman: Sure. So, the debt levels are good. And I believe – so, another company that you wanted to discuss is in plastic packaging which is also exposed to housing and consumer demand. What do you like so much about Amcor? It's a stock that has been on our best ideas list a number of times in recent months, hasn't it?

Slade: That's correct. So, Amcor remains on our best ideas list. We think it continues to look attractive, trades at around an approximate 8% discount to our $15.30 per share fair value estimate. And Amcor really is at the opposite, I guess, kind of end at the spectrum from building and construction materials names which are highly cyclical. Amcor, as I said, is – as I mentioned, is on the other side of that. It's highly defensive and it's a very acyclical exposure that will perform well really in any – against any kind of macroeconomic backdrop really. Plastic packaging is intimately tied to the consumption of household staples and around 95% of Amcor's plastic packaging volumes are tied to that household staple consumption.

Freeman: And Grant just lastly, yet another play on households which is quite a different one that has – it's actually been added to our coverage here at Morningstar quite recently is waste management company Bingo.

Slade: Yeah. So, Bingo Industries is another compelling idea. It currently trades around a 25% discount to our fair $2.75 per share value estimate. And while it is a waste management business, it's a building and demolition waste management business. So, it's really the same thing here as the building materials names. So, the tide is really rising for waste management industry generally. So, from fiscal 2022, so that's sort of beyond the headwind from COVID, we're expecting a resumption of strong earnings growth for the company. It's really benefiting from capacity additions which – the company has made some investment into the materials recovery capacity that they have in New South Wales. They've also entered the Melbourne B&D waste market. Finally, there's also some favorable pricing outcomes that have benefited Bingo quite substantially actually in fiscal 2020 and some of the tailwind from those pricing outcomes will continue into the next couple of fiscal years.

This report appeared on 2020 Morningstar Australasia Pty Limited

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