Easy monetary and fiscal policies are driving a sharp recovery in economies and markets. And one of the key winners globally is the housing market. Stimulatory conditions, increased consumer savings and record low interest rates have created perfect conditions for a global housing boom.
At Firetrail, we believe this global boom in housing and related industries has a way to play out. And we have positioned our portfolios to gain exposure to the housing thematic through our best stock ideas. In this article, we do a deep dive into an Australian company that is a global leader in wall and floor building products for new and used homes, James Hardie.
James Hardie – A global leader in wall and floor building products
James Hardie is one of few successful Australian overseas stories. It sells building materials products centred mainly on exterior fibre cement siding and generates 70% of group sales in the US housing market.
Today, James Hardie is one of our best stock ideas exposed to the global housing cycle based on our thesis of:
1) Prolonged US housing recovery; and
2) Structural growth opportunities for James Hardie’s product portfolio.
The US market really is the key driver or ‘what matters’ to James Hardie given it generates >70% of earnings from the US market. 60% of products sold in the US (by volume) are sold into the repair and remodel (“R&R”) segment and 40% into new single-family housing.
At Firetrail, we are positive on the outlook for both segments and explore this in further detail below.
R&R – The housing cycle could be longer than anticipated
The R&R story is relatively straightforward. Firstly, there are around 140m existing housing units as part of the US housing stock. The chart below shows that over 50% of these homes were built before 1979, i.e. are over 40years old. This underpins a long-term structural tailwind for R&R spend in our view as homeowners spend to maintain and improve these older houses.
Source: US Census bureau
Source: US Census bureau
Secondly, over the past year we have seen a significant uplift in Do It Yourself (“DIY”) spending. The COVID pandemic has resulted in more people at home, with more time to spend on small repair jobs (such as plumbing). What has suffered is the Do It For Me (“DIFM”) segment.
James Hardie’s products are DIFM, requiring specialist installers on site to complete re-siding works. As vaccines continue to rollout in the US, we believe DIFM will benefit from significant pent-up demand, resulting in higher activity. Both these factors support our expectations for solid growth in R&R driven earnings.
New Housing – New housing starts are on the rise
New housing construction is a relatively smaller but more volatile driver of volumes and earnings for James Hardie. Housing starts have recovered only very slowly since the financial crisis of the late-2000s (see chart below).
Source: US Census bureau
Total housing starts are finally inching back to the 1.5m 30-yr average. Expectations embedded within Consensus James Hardie’s forecasts simplistically assume starts revert to the long term average and then grow by around 1-2%p.a. Roughly in-line with US population growth.
However, digging deeper into US housing demand suggests a significant underbuild of new housing post financial crisis could result in a higher and potentially more sustained peak in starts over the coming years. On our estimates the US needs around 1.5m starts annually to stand still. This factors in average population growth of c.1%p.a. (average since 2000) and the obsolescence rate of the existing stock as provided by the National Association of Home Builders (“NAHB”), see table below.
Source: NAHB
Looking back since 2000 highlights a period of overbuild from the early to mid 2000s, followed by a period of significant deficit from around 2006 through 2017. On our estimates it appears there has been a cumulative underbuild of >5m units since 2000. Simply reverting back to a mid-cycle starts appears simplistic in this regard. Consensus is not positioned for what may be a period of significant catch-up due to pent up demand.
Source: US Census bureau, Firetrail estimates
Further underpinning our expectation for a more sustained US housing cycle is the level of current inventory of existing and new homes, which are sitting at 30yr lows, see chart below. Should housing starts test previous peaks (up to 1.8m starts for single family) we could see significant earnings momentum continuing for James Hardie over the next several years.
Source: US Census bureau
Additional share opportunities are expanding the total addressable market (TAM)
Housing cycle aside, we believe James Hardie is also a market penetration story. Since entering the US market in the 1990s James Hardie’s focus has been to take share in the Wood Look siding category with its Fibre Cement suite of products. James Hardie has a >90% share of the Fibre Cement category in the US. We estimate Fibre Cement siding has grown to around 20% of annual siding installations. Its share of annual installations has increased by around 1%p.a. James Hardie has traditionally targeted a 35% share of annual US siding installations, with no firm time period to achieve this goal. This additional share should come at the expense of Vinyl, a cheaper albeit inferior quality product compared to Fibre Cement. Vinyl’s share is not insignificant at around 25% of annual installations. On the current trajectory James Hardie has substantial runway to continue to deliver above market growth as it battles to take share from inferior wood look products such as Vinyl.
Source: US Census bureau
Source: US Census bureau
While James Hardie has clearly been successful at growing share this is likely to become harder as maturity approaches across target wood look markets. As a result, James Hardie management are proposing to expand the Fibre Cement product offering further across the siding category. The most obvious markets to target are Stucco and Brick, which combined still account for 47% of annual siding installs and are not yet targeted by James Hardie products. Expanding into these categories will effectively double the US Total Addressable Market (TAM) for James Hardie and push out the growth runway well beyond the next 10yrs.
James Hardie will launch new products in FY22 to initially target Stucco. Stucco is a traditional exterior wall covering using cement plaster. The concept behind Stucco dates back centuries. Its installation is labour intensive, and its prone to cracking and water damage. James Hardie products due to be launched in the US will consist of panel like Stucco look products made of Fibre Cement. So the core focus and technical knowhow remains relevant with the portfolio expanded through R&D to expand its potential application. These products are expected to significantly improve ease of installation and could be 10-25% cheaper on the wall than traditional Stucco siding in the US. While success is not a given, the new products have seen encouraging results in Australia where they were first rolled out.
We believe the market is not ascribing any additional value to James Hardie expanding its TAM beyond the wood look category. We have estimated what this additional share could mean for valuation. Our base case is that JHX hits its 35% share of annual exterior siding installations by 2030. Each additional share taken from Stucco/Brick adds around $0.80/share or 2% to our current valuation in today’s dollars.
Source: Firetrail estimates
Conclusion
At Firetrail, we believe James Hardie is well positioned to benefit from an ongoing cyclical upswing in US housing activity alongside structural drivers that are likely to elongate the current cycle further. In addition, a new product strategy adds to the longer term growth profile of James Hardie which we don’t believe is currently being reflected in the valuation of the business today.
James Hardie is a key position in Firetrail’s high conviction portfolios.
