Blended Australian Equities Portfolio
We have initiated a position in James Hardie utilising existing cash. JHX is a leading producer of fibre cement cladding and construction products in the US, with its smaller operations in Asia Pacific and Europe. The company experienced a sharp deterioration in line with residential construction markets in the US during the second half of 2022. At its Investor Day in September JHX gave a 2H23 (to its March 30 balance date) outlook for mid-single-digit percentage volume growth, but in its early November 2Q23 report this was revised to a 5-8% volume decline. This was a shock for some market participants who expected JHX to be far more defensive than the broader residential construction market in the US.
We have not been adherents to the argument that JHX is only 35% exposed to new residential construction and 65% exposed to the repair and remodel (R&R) market, which is less discretionary than new build, so it could continue to grow during a residential construction recession. In a downturn driven by extreme construction cost and finance cost inflation, maintenance can be deferred on a discretionary basis and the new residential construction backlog declines rapidly as order cancellations increase and completions exceed starts. These factors saw JHX stock post a 2022 annual return of -51.7% versus the ASX200 return of -1.1%.
There are, however, early signs of cost moderation in the US, which could presage an improvement in the second half of 2023. The US 30 year mortgage interest rate has declined to 6.33% since its 7.08% peak in November. Construction labour costs are now declining on a monthly basis though are still 6.1% higher than 12 months prior. Meanwhile the US Producer Price Index shows building materials prices contracting on a yearly basis and lumber costs are down to more traditional levels (~$400/t).
The US housing market has been in secular recession since the second half of 2022 for reasons outlined above, but as these cost pressures ameliorate, we should begin to anticipate a trough and recovery to commence in the second half of 2023, by which time at least the extent of the downturn will be apparent, if not the pace of recovery. This was the same logic we applied in adding to our resources exposure in late 2022 as China surprised the world by relaxing its Covid Zero policy. James Hardie currently trades on a forecast March 2024 PE ratio of 15.2 times and a dividend yield of 3.5%, albeit unfranked due to the US earnings base. With a forecast 2024 free cashflow yield of ~5% and active capital management underway in a $200m share buyback program, there is some compensation for the patience required for cyclical recovery.