|Summary: The share prices of building materials and property development companies have gained ground, buoyed by expectations of a housing sector recovery. Factors adding to this include low interest rates, low rental vacancies, low housing supply, and a switch from mining-related stocks.|
|Key take-out: HSBC Bank believes the Australian economy will enjoy a housing sector led re-balancing as the mining story fades.|
|Key beneficiaries: General investors. Category: Growth.|
It’s been a long time coming, and some analysts say it’s still some way off, but the evidence is gathering to support a strong revival in residential investment that will boost the earnings of property developers and building materials suppliers.
Three of the best-known names in the building materials business – Boral, CSR and James Hardie – have hit 12-month share price highs in the past three weeks. But both Boral and CSR have further to go before returning to their multi-year highs.
James Hardie is different. It is already trading close to a 10-year share price high at $9.74, thanks to its heavy exposure to the rapidly recovering US housing sector. It actually did reach a 10-year price high of $10.50 on March 7, despite being dogged by its legacy as a one-time producer of asbestos products.
It would be unwise to assume that what’s happened to James Hardie will be quickly replicated in building materials suppliers more focussed on the Australian market, where there are different economic forces at work. The US housing sector fell much further than in Australia, and US interest rates are now much lower than here, meaning the rebound there is stronger and has arrived earlier.
But there are signs that Australia’s residential market is recovering thanks to a combination of factors, including low interest rates, low rental vacancy rates, limited housing supply, and a rotation of funds out of mining-related stocks as the resources boom ends.
One of the more interesting pieces of recent research on the potential for the sustained (and substantial) rebound in the residential property sector was published last week by HSBC Bank Australia, which argued that the Australian economy would enjoy a “housing sector led re-balancing” as the mining story fades.
To support its thesis, HSBC is tipping a 6.7% increase in dwelling investment this year, and an 8.2% increase next year (see graph).
To put those forecasts into perspective, both years will see the strongest flow of funds into dwelling investment in a decade, passing the 6% increase seen in 2003 and 2004.
But the rebound HSBC is predicting for this year and next is best shown in the poor dwelling investment data for the past eight years, when the mining boom was drowning out other forms of investment.
Last year, for example, the rate of dwelling investment declined by 4.7%, while the 2011 rate of growth was an anaemic 0.7%.
Not everyone agrees with the HSBC forecast. Goldman Sachs in a report two weeks ago argued that “housing finance data is yet to support a meaningful domestic housing recovery”, a view which caused it to maintain a “neutral” rating on the shares of the five building materials stocks it tracks: Boral, CSR, Adelaide Brighton, Fletcher Building and James Hardie.
But leaning towards two of the materials sector leaders that it follows was a rival research paper produced on Friday by Commonwealth Bank. The bank upgraded its recommendations on Boral and James Hardies, putting an “overweight” tag on both and upgrading the target price on James Hardie to $10.90 (it closed at $9.74 on Friday), while its target price on Boral was kept at $5.50.
Earnings Per Share
Dividend Yield %
Source: Google Finance
Whether or not any of the stockbrokers are correct with their price tipping, the key point for investors is that conditions have changed in the building materials sector. And they are changing for residential property developers as the once-dominant mining boom gives way to more conventional growth drivers.
Other examples of building materials companies with exposure to the residential property sector include Fletcher Building, which has rebounded from a cyclical low. Its share price slipped to $4.34 last July before rebounding to around $7.68 on February 1, with a recent price of $6.74. Brickworks fell to $9.70 on August 31 before rising to a recent price of $12.88.
Property developers are also on the move as demand for residential land picks up. Stockland has risen from a low last year of $2.90 to around $3.75. Australand is up from $2.19 to $3.41 (although its price gains also reflects recent takeover discussions), and one of the smaller participants in the sector, Peet, has almost doubled from its low of 62.5c to $1.15 (and did double when trading at a 12-month high of $1.27 on January 30).
The HSBC theory, built on a comparison of declining mining investment and a fresh focus on conventional economic drivers (“the great rebalancing”) starts by pointing out that more than 50% of Australia’s economic growth (gross domestic product) last year came from mining investment despite mining accounting for 10% of the economy.
“In stark contrast, housing construction has been very weak,” the bank said in the latest edition of its Downunder Digest. “Dwelling investment fell by 4.5% in 2012, after a barely growing 0.7% in 2011.”
This year could be different, according to HSBC. Housing construction is one area that is ripe for recovery.
“Last year’s interest rate cuts have already substantially improved affordability, which is lifting housing market activity. Mortgage rates are now around their lowest levels since the 1960s (aside from a short period after the global financial crisis began in 2009).
“While there remain some structural impediments to housing construction, including planning, land release and zoning, rising prices are typically a good lubricant for cutting through these issues.
“In our view, the fall in house prices that occurred in the 18 months to last May (down 8%) was a key reason why housing construction has been weak in recent years.”
Central to the HSBC proposition is that the construction cycle has turned, and while much of the latest activity has been in medium-density housing and apartments the improving trend is flowing through to detached dwellings.
“The construction outlook is supported by an expected pick-up in population growth and limited new supply,” HSBC argues. “At around 2% nationally, rental vacancy rates are at a very low level relative to history, due to limited housing supply, and rental yields have also been rising in recent years.
The trend for housing demand and supply, says HSBC, is up, and that should drive the share prices of developers and suppliers of raw materials.