Thursday, July 5th, 2018
James Hardie (ASX code: JHX) is the best producer of Fibre Cement board in the world and is proving that through market share gain in the US. Recent moves in Europe potentially open a new market for growth. US$ reported earnings translate well at current A$/US$ exchange rates.
James Hardie has a corporate history littered with bad management choices, from which the company has subsequently been saved by the underlying quality of its major product – fibre-cement board and associated products. The company infamously continued producing board (and brake pads) using asbestos after the detrimental effects were known in the 1970’s; attempted to diversify away from this risk by acquiring electrical contracting, pipe-making and bathroom products businesses (just to mention the large ones); and when asbestos had finally been removed from all products and replaced with cellulose fibres – changed corporate domicile in a fashion which, without government intervention, might have left compensation claimants with an empty shell to litigate.
The court cases associated with these issues are thankfully largely settled and the current incarnation of JHX is now a better example of corporate citizenship. The compensation fund was funded with the assistance of the NSW government and the company effectively tithes 35% of annual cash earnings to the fund to maintain an actuarially determined amount to pay compensation to asbestosis and mesothelioma sufferers. This result improves both the fund and the company’s security and makes them effectively co-dependent. Company reported earnings remain impacted by changes in the actuarial assessment of remaining potential claims. While the impact of asbestos related disease continues, the structure for compensation is now clearer.
One result of the changes in domicile and compensation liabilities is that James Hardie effectively has negative reported equity despite the essentially sequestered nature of the asbestos fund. This does distort valuation measures based on equity returns unless adjusted.
The best management decision in the modern era was to enter the US market. US solutions to lower cost housing siding and wet area backing board were lower quality and/or higher cost. After one abortive attempt, the company re-entered the market in 1990 and has been successfully growing volume and revenue since. Hardie’s now has a 90% share of the fibre-cement product market and is targeting a 35% share of the addressable exterior cladding markets in the US.
Figure 1. JHX Top Line Growth
Source: James Hardie FY18 Investor Presentation
The company consistently delivered growth in earnings for up to FY2017 when a mis-step in forecasting and subsequent high-cost solution to ensure supply met demand caused a slump in operating margin. The share price suffered accordingly and issues with succession planning were also exposed. Twelve months later, most of these issues have been addressed. Market expectations for FY2019 (to March) are that James Hardie will deliver continued revenue growth which will expand margins back toward previous high points. There is further management change to come with the CEO’s retirement expected in 2019 and the integration of a large (profitable) acquisition (Fermacell) aimed at providing an entry point to expand fibre-cement sales in Europe.
So, James Hardie is still defined by the quality of its underlying product – fibre-cement board. The company is the global leader in board quality and cost – a position supported by US$493m spent on R&D since 2000. We feel this investment will continue to support market share gains in North America and in the future in Europe. US margins are improving and market expectations are that FY2019 will be another year of strong earnings growth.
Clime Group owns shares in JHX