James Hardie Q1 Earnings: Growth Story Remains Intact (NYSE: JHX)
All things considered, major fiber cement supplier James Hardie’s (NYSE: JHX) The revised FY2023 forecast range was better than expected, slightly reduced while implied growth remained in the double digits. Even more impressively, JHX is making progress in its high added value mix strategy, with ColorPlus volume growth accelerating in Q1 23. And with the latest round of price increases implemented alongside some easing of cost pressures, I see a clear path to margin expansion over the next quarters. Still, the James Hardie story comes with risks, including a drop in real estate activity as long-term bonds and mortgage rates rise. Yet equities offer a large margin of safety against these risks at the current discount to historical levels, although the company retains strong opportunities for growth and FCF generation through the cycle. The upcoming September Investor Day and the impending appointment of the new CEO will be the main revaluation catalysts to watch.
Summary of a resilient neighborhood
James Hardie posted strong Q1 23 numbers, with adjusted NPAT (“net profit after tax”) of $154.3 million (+15% year-on-year). On the revenue front, the main contributor was broad-based price/mix growth across all three regions: North America led the way at +17%, followed by Europe at +14% and the Asia-Pacific at +12%. Encouragingly, the quality of growth shows that the higher value-added product strategy is paying off, as the +5% price increase over the period implies a +12% benefit from an improved product mix. ColorPlus remains the benchmark, with its continued market penetration driving accelerated volume growth of +31% (vs. +27% in FY22). All of this culminated in impressive overall revenue growth of +28% for North America for the quarter (previous guidance called for revenue growth of +18-22% for FY2023 ).
Europe, on the other hand, was a source of weakness – revenues were down c. 5%, with fiber cement sales down sharply c. 10% year-on-year (+1% in euros). Production and distribution costs were also c. Gross margin headwind of 300 bps, with energy costs the main driver at +62% YoY. As a result, EBIT margins ended at 10.3% for the Europe segment – a generally weaker than expected margin result as costs increased significantly across the board. Overall EBIT margins were stronger at 25.9%, although cost inflation also played a role. The largest costs were pulp (+16% T/T) and freight (+9 T/T), followed by natural gas, labor and cement (+5% T/T) /T). In total, these costs resulted in a massive increase of c. 310 basis points of net gross margin pressure. Still, the company’s plan to implement further price increases should bring relief. In Asia-Pacific, for example, the company has shown that it has the power to set prices to recover significant cost increases, while the increase in prices in North America (from July) is also expected to cause improved margins throughout the year.
Orientation lower but well positioned to exit on top
Unsurprisingly, James Hardie lowered his adjusted net profit guidance range for fiscal 2023 to $730-780 million (previously $740-820 million). By region, North America net sales growth is guided at 18+% (vs. previous guidance of 18-22%), with EBIT margins of 28-32% (down from 30-33% previous) which are expected to increase Q/Q through FY2023. Management noted the following impacts as drivers of the lower guide – inflation, a weaker European outlook, unfavorable currency movements, as well as uncertainty of the housing market. In light of the cost pressures and uncertainties prevailing in the market, a reduction seems logical to me. In fact, the slightly lowered guide could even be conservative, given that management has also outlined various scenarios where growth could exceed the previous upper bound of the forecast at 22%.
Interestingly, the price/mix forecast remains strong into “low teens” with further momentum from the upcoming ColorPlus and Trim capacity increases and marketing efforts gaining momentum in America North. The company’s previously announced price increases in June in Asia (approximately 5% effective in September in Australia and October in New Zealand and the Philippines) will also be key to boosting margins after the cost inflation seen in Q1. 23. As 2023 approaches, JHX plans to implement even more price increases, which should support margins in the upper half of the 25-30% range for the coming year. Also noteworthy is management’s indication that it expects to revert to value-based increases in January, potentially indicating expectations of moderating cost inflation trends. Even without cost moderation, expectations of sequential improvement in margins throughout the year seem very likely as recent price increases take effect.
Faced with a slowing new housing market, the fact that James Hardie obtained c. 65% of its business coming from less cyclical R&R (“repair and refurbishment”) markets will be a welcome relief. According to management, the backlog remains strong, with a healthy backlog remaining intact in R&R and volumes expected to continue into the coming fiscal year. Management is also anticipating any potential inventory issues by “starving the channels,” which could yield a potentially favorable outcome given the macro uncertainties ahead.
In general, commercial relations with distribution partners seem to have improved, allowing better management of demand according to the evolution of final demand. For example, management noted good visibility, even in the R&R market, through Q4 ’23. In addition, the company has also developed various scenarios to deal with a possible market downturn. These include suspending non-critical hiring and implementing a return-on-investment approach to SG&A spending. Capacity additions are also on hold given the uncertain outlook, which should further strengthen the very strong balance sheet (net leverage was around 0.7x at the end of the quarter).
James Hardie’s strong execution capabilities were on full display this quarter as the company continued to deliver positive growth and market share gains throughout the cycle through successful price increases and strategic initiatives to move up the value chain. With management also positioning the business for future uncertainties and maintaining its outsized exposure to the resilient repair and refurbishment end market, the company is well positioned to navigate slower markets. Overall, the recent stock price discount (to a historically significant discount) looks overdone at this point, and I view the current pullback as a buying opportunity. While I recognize the downside risk in real estate activity, the implied rate cuts in fiscal 2023 (based on the forward yield curve) and the wide margin of safety at current valuation levels should reassure investors. Going forward, next month’s Investor Day could be key to lifting excess management succession and refocusing the market on the medium to long-term growth story.