|Summary: The housing markets in Australia, New Zealand and the US are recovering, albeit slowly. For the companies leveraged to housing, especially those exposed to all three growth markets, there’s light at the end of the construction zone.|
|Key take-out: As the resources boom begins to taper, the Reserve Bank will be keen for housing to pick up at least part of the slack.|
Key beneficiaries: General investors. Category: Growth.
After years of being a drag on economic growth, housing finally is in recovery mode.
Although still very patchy on a state by state level, modest growth in Australia has been evident since late last year. New Zealand also is registering growth, while America has finally begun the long road back to recovery after its housing bubble burst in 2006.
For residential developers and building materials companies, some of which operate in all three markets, the recovery couldn’t have come sooner.
Equity investors jumped aboard the housing recovery early, pushing building materials stocks sky high during the past year. We’ve found the best buying to be among the developers and REITs, with Lend Lease the clear winner.
The Australian housing sector remains sluggish, beset by the almost complete absence of first home buyers and tepid credit growth, apart from investment property buyers.
But after 18 months and 175 basis points of interest rate cuts, investor demand is returning, residential home prices are on the rise in the country’s biggest market, Sydney, while more importantly, new housing starts once again are climbing.
In New Zealand, authorities have responded to the devastating Christchurch earthquakes with a building recovery program that is likely to continue for at least the next three years.
Meanwhile, in the US, leading indicators have turned positive as prices have stabilised at 2003-04 levels and new starts have begun to increase.
For the major building materials companies, however, valuations remain stretched and opinion is divided on the right vehicle.
But with all three housing markets showing nascent signs of strength, opportunities will arise for building materials and selected real estate investment trusts.
Housing construction is a key driver of broader economic growth. As the resources boom begins to taper, the Reserve Bank will be keen to see this sector pick up at least part of the slack. And gradually improving real estate values are vital to maintaining and lifting consumer confidence.
Australian population growth during the past year has exceeded forecasts, both from strong immigration and record birth rates, which has shifted the balance to one where underlying demand now far exceeds the supply of new housing.
There has been a marked shift in construction towards medium and high-density construction, which has implications for material supply companies as increased levels of common walls reduce the quantities of materials required.
As an indication of just how weak Australian construction has been, and the low base from which it is bouncing, consider these factors:
Nominal new dwelling investment last year slumped to its lowest level since 2001, alteration and additions activity has been at multi-decade lows, and turnover of housing has fallen to just 4% of the stock which generally is considered recessionary levels.
Housing activity in the earthquake affected regions of the South Island is now nearing peak capacity of 4,000 starts per annum.
The Canterbury Earthquake Recovery Authority estimates that 15,000 new houses will be required, suggesting capacity will be stretched for at least the next three years.
Even modest lifts in building requirements outside of the earthquake affected regions will result in solid flow throughs for companies with New Zealand exposure, with Fletcher Building most exposed.
Housing starts in the US have shown clear evidence of a rebound. Figures released for March show detached housing starts up by 28.7% on the previous corresponding period, while multi-dwelling activity rose 85.3%. That delivered an overall rise of 46.7%.
In America, there is a much higher level of speculative activity in housing construction. More than 60% of new housing is started before a buyer is found.
After more than five years of declines, sales of existing and new homes both have begun to rise. While construction now is recovering, the inventory of new and existing homes for sale has plunged, indicating that demand for building materials is set for solid growth.
Building materials companies
Almost every building materials group is valued at heroic levels after some adrenaline fuelled share price performances in the past 12 months. While spectacular earnings growth is forecast by many analysts, this will mostly serve to underpin already lofty pricing levels.
Of the major players, Boral is considered by some to have the brightest prospects given its strong exposure to housing starts in Australia and the US.
UBS rates it a buy, with a 35% exposure to housing starts in Australia and 11% exposure in the US in terms of sales. Citigroup, on the other hand, rates it a sell.
However you view it, Boral has one of the more sane valuations with a price earnings multiple of 14.2 times next year’s forecast earnings. The housing slump of recent years has forced the group to slash costs, taking out around $100 million, and to restructure its internal organisational structure.
The cheapest stocks available are Adelaide Brighton Cement and Fletcher Building, which are both trading at around13.7 times next year’s earnings.
Source: Bank of America Merrill Lynch
Adelaide Brighton is the most defensive, and while both UBS and Citigroup have a buy rating on the company, citing its potential for further share price rises on reasonably undemanding forecasts, earnings growth may be constrained in the medium term.
Not every analyst shares that optimism. Bank of America Merrill Lynch downgraded the company to underperform earlier this year, and this week indicated that margins were under pressure from a challenging cement pricing environment as a strong Australian dollar made imported clinker increasingly competitive.
Fletcher Building has a 38% exposure by sales to housing starts, evenly split between Australia and New Zealand, with a tiny portion to the US.
The company is a conglomerate, with a large number of almost independently operating businesses, offering management the capacity for back-office cost rationalisation, a process it recently began with a restructure of its Crane Group business.
Like Adelaide Brighton, it is offering an attractive dividend, only slightly less than Adelaide Brighton, where both yields reflect the more sedate pricing multiples.
Like Boral, James Hardie has had a stellar share price performance in the past 12 months, easily outpacing the ASX 200.
Hardie has the greatest exposure to new housing starts. On a revenue base, 53% of its earnings are exposed to new housing, with the bulk of that (34%) in the rapidly recovering US market. On an earnings before interest and tax basis, that exposure jumps to 66%, where its leverage to US housing starts stands at a whopping 46%.
Apart from its ongoing asbestos exposure, James Hardie’s main problem relates to its stratospheric pricing multiples. At almost 27 times next year’s earnings, it is priced to perfection and beyond.
CSR’s strong exposure to Australian housing starts largely has been factored into its share price, and it now is trading on 19.6 times next year’s earnings.
Dulux and GWA are the two to look at in the small cap arena. Dulux’s takeover of Alesco has helped lift its exposure to new housing starts from 10 to 20%. It too is priced at more than 17 times next year’s earnings.
GWA, a leading supplier of building fittings and fixtures, has suffered a dramatic fall in revenue in recent years as housing has slumped, prompting management to significantly lower the cost base. It too is expensive, trading on 19 times next year’s forecast earnings.
Developers and REITs
The shift towards medium and higher density housing will favour developers who have foreseen the trend.
UBS points to Lend Lease as its preferred candidate in this department, with Stockland most at risk given its focus on land and first home buyers. They are not alone. Almost every major broking house rates the stock a buy, with several upgrading in the past few months.
Lend Lease is far and away the most attractively priced stock, paying a reasonably strong dividend.
Developers and REITS
Source: Broker consensus
Mirvac, while it has an attractive pipeline of medium density projects, is still labouring under the weight of projects undertaken before 2009.
“Currently, around 35% of Mirvac’s inventory and 20% of Stockland’s is impaired,’ the broker notes.
“As this inventory needs to be cleared, the early stages of a residential recovery will not translate into an improvement in earnings.”
Australand stands out as another attractive proposition. Recent corporate activity is focussing on a potential break-up of the business. But it also has an attractive exposure to the recovering Sydney residential market. The pipeline is skewed to Victoria, but UBS notes this is held in a capital efficient manner.