DuluxGroup: Interim result 2018

DuluxGroup never seems to put a foot wrong – let alone a paw. And, on the face of it, shareholders might be pleased that first-half headline sales and net profit rose 4% and 9% respectively.

The company rarely shoots the lights out, but nor does it disappoint. Over the past four years, interim operating profit has risen a middling 6% a year on average. So the 8% growth in operating profit in the first half of 2018 might suggest things are picking up.

The growth wasn't quite as good as it looked, however. And that's not the only issue – soon DuluxGroup might find it difficult to eke out much growth at all.

The company's Dulux ANZ business – paints and coatings in Australia and New Zealand – remains its best division. It accounts for 68% of earnings and has impressive operating margins – 18.6% in the first half. Divisional earnings rose 5%, a result that would have been stronger but for weakness in New Zealand.

Australian paint sales benefited from above-average market growth of 4% in the half, mainly because the previous period was depressed by the liquidation of Masters' paint stock. The cost of raw materials such as titanium dioxide has been rising too but so far DuluxGroup has lifted prices to maintain margins.

Long tail

You can see the divisional performance of DuluxGroup's remaining businesses in Table 1 but they're really the ‘rats and mice' divisions. Adhesives and sealants division Selleys and Parchem ANZ are the best of the rest, with earnings rising 5% in the half. Earnings from the ‘other businesses' segment grew slightly but only because the company sold its coatings business in China for a $2.5m profit.

Management's keen to grow its international businesses – despite selling China coatings – but it's taking a measured approach. We're not expecting any major moves from this management team although it has flagged potential acquisitions. Management has earned enough respect that we're prepared to give it some leeway.

It's the ‘Corporate' line in Table 1 that's perhaps most surprising. It's rare for corporate costs to fall much at any company – presumably because this is the cost line that contains management and director salaries.

But the 12% fall in corporate costs reflects a non-recurring profit on the sale of the company's former manufacturing site at Glen Waverley. With the recent opening of DuluxGroup's new facility at Merrifield, the Glen Waverley site was surplus to requirements.

The sale of the site generated a $6.1m profit, but management appears to be busy finding costs it can load into the 2018 financial year to offset the profit. By the end of 2018 it will be fully offset. At least management has disclosed this slightly murky cost-shifting, we suppose; not all companies would.

Tax headwind

First-half profit was also padded by a $2.8m writeback of a tax provision, which we've removed to derive our underlying net profit (there was a similar writeback in the first half of 2017, which we've also removed). Underlying net profit was therefore up 10% but the low tax rate won't persist, making it harder to grow profit in future periods.

All these accounting shenanigans could be nothing – or they could be something. It's hard to know how they will affect future periods, but we'll know more next financial year.

But with the tax rate normalising, raw material costs increasing, the positive effect of Masters' liquidation over, and higher depreciation from the Merrifield plant about to hit, 2019 could be tough. If the housing market weakens then that will be a headwind too.

If so, we might even get our long-awaited opportunity to buy DuluxGroup. We've been too conservative with the stock in the past and, to reflect that, we're lifting our price guide. We'd be happy buying the stock at $6.00 and we're also lifting the Sell price to $10.00, but that means the stock remains as a HOLD.

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