Ten stocks riding the construction revival

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Trevor Hoey is a senior writer for Financial Review Smart Investor. For the last 13 years he has been uncovering quality small and mid cap stocks for The Australian Financial Review, Shares Magazine and BRW. Trevor analyses breaking company news as it happens, giving active investors an important edge.

Ten stocks riding the construction revival

Published 07 March 2014 07:21

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A rise in total dwelling approvals adds fuel to the suggestion the great Australian dream of home ownership could once more be achievable.

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The great Australian dream of owning your own home is back on the table leading some analysts to believe that after several false starts a rebound in stocks leveraged to the housing cycle could be imminent. The thesis has been bandied about several times since the global financial crisis, with some analysts suggesting activity had already bottomed. But while house prices remains resilient there was little flow through to the stocks most exposed to the building industry. But the release of new construction data combined with the Reserve Bank of Australias signal that rates arent going to move anytime soon has many analysts starting to believe that the types of buyers that fuel the construction and renovation of homes are starting to come back. More from Smart Investor:

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Ten stocks to hock (http://www.afrsmartinvestor.com.au/Page/Uuid/831ddd46-8c60-11e3 -bc67-54f3a9b70947) Healthcare stocks to buy, hold and sell (http://www.afrsmartinvestor.com.au/p/shares/healthcare_stocks_to_buy_hold_and_PHviAOUF4r7Xo4CxI4CTSK) Five stocks with winning form (http://www.afrsmartinvestor.com.au/p/shares/five_stocks_with_winning_form_Ckf93VUzItaPB96hH55RNM) According to the Housing Industry of Australia, total dwelling approvals rose by 6.8 per cent in seasonally adjusted terms, continuing the strong second half performance seen in 2013. This is reinforced by the fact that approvals over the past 12 months have totalled more than 182,000 the highest 12-month total since 2004. In the three months to January, annualised approvals were more than 200,000. One of the key stumbling blocks for the sector has been housing affordability, particularly for first home buyers. But Credit Suisse has just put a different spin on how this end of the market could behave, with the prospect of overseas capital investment increasing demand across all price points. In a recent paper, Credit Suisse said China is currently purchasing more than $5 billion (http://www.afrsmartinvestor.com.au/p/property/why_your_home_is_worth_more_than_mVEa4Tn2nJqxqgbdhi6hHI) of Australian residential property per annum, accounting for 12 per cent of new housing supply. The buyers are concentrating their buying on certain regions, currently acquiring 18 per cent of new supply in Sydney and 14 per cent in Melbourne. The broker believes further strong Chinese demand could push residential property prices even higher. Such a recovery would have a substantial impact on many ASX listed companies, but it is important to note that certain industries benefit at different stages of the cycle. Land developers and builders are an early cycle beneficiary. Bricks and mortar stocks are normally quick to follow. Distributors of internal items such as kitchenware, bathroom fixtures and fittings are impacted later in the cycle. Last, but by no terms least, are companies that provide a mix of essentials and creature comforts, such as white goods, furniture, bedding and entertainment goods. Below, we list 10 stocks that fit those categories - starting with Mirvac Group.

Mirvac Group
Investors looking at blue-chip companies that offer scale and geographic diversification would be well served to consider Mirvac. While the group is exposed to retail and industrial property, it generates a substantial proportion of income from residential housing. Furthermore, the groups land bank and projects in train suggest it can quickly respond to increased demand. In the first half of 2013-14, Mirvac achieved a record $1.5 billion in residential pre-sales and settled 1032 residential lots. It is also extremely active in the regions identified by Credit Suisse with large projects underway in Victoria and New South Wales. The group expects to achieve more than 10 per cent development return on invested capital at financial year end, and recently stressed that its overweight exposure to New South Wales and Victoria will continue to provide strong returns.

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Mirvac will release more than 1800 lots over the next 18 months, providing significant earnings momentum in 2015-16 and beyond. More than 1200 of those are located in New South Wales and Victoria.

Cedar Woods Properties

Though Cedar Woods Properties is much smaller in size than Mirvac, it punches above its weight in terms of shareholder returns, with a classy management team that consistently outperforms expectations and delivers returns on equity well above the industry group average. Despite tough conditions over the last five years, the company is nearly a 10-bagger, with its share price having increased from 85 cents in March 2009 to a recent high of $7.77. The companys five-year total shareholder return is 57.1 per cent per annum and the group has forecast a record profit in 2013-14. Despite this strong historical performance and buoyant outlook, Mirvac is still trading on a conservative price-earnings multiple of 12 relative to 2014-15 consensus forecasts. The Perth-based Cedar Woods took the decision to expand into the Victorian market as the residential boom was unwinding. Its cornerstone Williams Landing project has been a strong earnings driver and the December acquisition of Clayton South extends its position in that region. Construction of a 250 dwelling development is expected to commence in 2015. Cedar Woods had $150 million of pre-sales entering the second half of 2013-14 and a strong 2014-15 building pipeline. It continues to assess prospects of considerable scale in Victoria, Western Australia and Queensland. The company has the balance sheet capacity to fund more than $50 million in acquisitions without having to go to the market for extra capital.

Villa World
Villa World is a smaller, Queensland-based residential developer that tends to fly under the radar. However, both financially and strategically the company is outperforming many of its larger peers. Similar to Cedar Woods, it was ahead of the curve in terms of targeting the Victorian market, a move that has proven to be extremely lucrative. From a financial perspective, Villa World has excelled in 2013-14, doubling pre-tax profit guidance in mid-January and reaffirming full year guidance in a range between $17.5 million and $19.5 million. It then went on to deliver an outstanding interim result in February when it again upgraded profit guidance, and it now expects full-year earnings of about $21 million. Analysts at Moelis see Villa World as strongly positioned to capitalise on the improving residential market, and with second half revenue largely secured via pre-sales, delivery of carried-forward sales will be the focus. The broker expects momentum to continue into 2014-15, underpinning robust year-on-year growth with total lots on hand having increased from 2647 as at June 30, 2013 to 3052 at December 31, 2013. Moelis said Villa World has a strong balance sheet with an undrawn debt capacity of $86 million, giving it the headroom to build on its land bank over the next 12 months.

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Villa World has demonstrated its intention to expand its portfolio, announcing on Thursday that it had acquired a 250 lot residential site at Plumpton, a fast growing and well serviced outer northern suburb of Melbourne.

Adelaide Brighton
In terms of financial performance and operational discipline it is difficult to go past Adelaide Brighton in the building materials space. It is another company that has grown earnings in the face of difficult market conditions. Adelaide Brighton has market-leading cement positions in South Australia, Western Australia and the Northern Territory, as well as healthy emerging activities in the ready mix concrete markets in Victoria, New South Wales and south-east Queensland. Analysts at Bell Potter see the company as benefiting from increased demand for cement from the residential sector, and following a better than expected full-year result for the 12 months to December 31, 2013 the broker upgraded 2013-14 profit forecasts by 7.8 per cent. It also substantially increased the 12 month price target from $3.40 to $4.63. The companys concrete masonry products stand to benefit significantly from a rebound in residential building activity. Management noted in February that this area of its business was improving, led by demand from New South Wales. Adelaide Brighton has already identified one of the companys areas of focus in 2014 will be its pre-mix concrete and aggregates products in expectation of a recovery in residential construction. With leading brand products across concrete bricks, blocks, pavers and stone, Adelaide Brighton is much more than just a cement company and it will be one of the early beneficiaries of a rebound.

CSR
Analysts at Bell Potter reviewed the prospects of CSR in late January when the companys share price was $2.87, noting at that stage it was trading at a 15 per cent discount to small and mid-cap peers. While its share price has made up most of that ground in the last month, analysts are generally of the view that the companys multi-faceted exposure to residential building activity through its aluminium and glass businesses leaves it well placed for a rerating. The companys Viridian glass business has been restructured and should start to generate strong earnings commensurate with its prominent market position. With regard to CSRs building products division, management noted in its half-year commentary that improved pricing, margins and lower operating costs contributed to a 19 per cent uplift in earnings, despite relatively flat volumes. With household names such as PGH, Monier and Bradford among its stable of building products CSR has a strong competitive positions. On Friday, Bell Potter increased its 12 month price target on CSR from $3.15 to $3.50.

Fletcher Building
Fletcher Building is a New Zealand-based company that is involved in the distribution of most building products with exposure across both the residential and infrastructure sectors. However, residential products account for 47 per cent of revenues and Australia is its largest market.

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Fletcher competes across most of the basic sectors such as cement, concrete and aggregates, but it also has strong exposure to products that are used in internal construction. The company has developed an impressive stable of brands over recent years, including Laminex and Formica in the laminates and panels sector and Iplex and Stramit in the piping, roofing and cladding product segment. Fletcher has strong positions across plasterboard, insulation and coated steel, and it also has a distribution arm that operates under the Tradelink brand in Australia. Tradelink plumbing centres have been established for 150 years and the companys network of more than 200 branches services both the trade and consumer markets. With such a wide range of products, Fletcher is exposed to most areas of construction. As such, it will benefit at most stages of the cycle, with revenues from interior products, for example, likely to be affected after cement products.

GWA Group
Despite delivering a disappointing interim result which was below most analysts expectations, the share price of GWA Group has held up reasonably well. This could be attributed to the fact it is perceived as a bottom of the cycle play, not just in terms of the industries it services, but also as far as the operational side of the business is concerned. The company has undertaken several restructuring and cost-cutting initiatives in the last 12 months, aimed at refocusing the business on areas that are most profitable and exiting poor performing operations. Much improved efficiencies, combined with better industry conditions, should see earnings pick up substantially over the next two years. The company has strong market positions in the kitchen and bathroom fittings segment, boasting prominent brands such as Caroma, Dorf and Fowler. These cover most price points, leaving the company well exposed to both new homeowner business as well as more upmarket projects. However, management highlighted in February that GWA generates the majority of its revenues at the completion stage of building. Other products aligned with a similar stage of building are its door and access systems where its Gainsborough product range has a solid market share.

Harvey Norman Holdings

With construction completed, the attention turns to decking out the new house. In the case of new homeowners that can equate to a significant investment, but even for those upgrading or perhaps downsizing it is a good excuse for a bit of retail therapy. Harvey Norman Holdings covers most bases as a retailer of furniture, white goods and electrical entertainment products. The companys first half result which featured global sales of about $3 billion up 4.9 per cent on a like-for-like basis and a 60 per cent increase in pre-tax profit initially received a positive response, but the share price hasnt undergone any significant rerating. The first home buyer market is a crucial one for Harvey Norman, as it has a significant focus on the sale of goods at lower price points than some of its competitors. The companys shares increased by about 150 per cent in the 12 months following the initial introduction of the first home owner grant, and that is indicative of how its share price could perform if that market picks up.

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Chairman Gerry Harvey said last week that the companys Australian franchising operations showed strong sales momentum, with the December quarter outperforming the already promising previous quarter. It is significant that the company has a valuable property portfolio, and consequently its net tangible asset per security is generally higher than its peers. As at December 31, 2013, it accounted for 75 per cent of the share price.

Nick Scali
Nick Scali is a furniture retailer that has demonstrated it can move with the times, having adapted extremely well to varying industry conditions by entering new markets and adopting interesting and innovative sales strategies. Historically, the company has targeted more of a high-end market, but the launch of Sofas2go saw it establish a range that met a lower price point, effectively broadening its consumer reach. Its online strategy, launched in mid-December, is arguably even more innovative, and could provide substantial sales momentum. The company now offers an exclusive collection of replica and designer furniture that is in part of the regular Nick Scali range. The furniture is only available for purchase online and the product range is displayed in a selection of showrooms in each capital city. iPad kiosks have been installed in store for easy online purchase, and with the ability to quickly and competitively move its prices, there is the flexibility not normally available in bricks and mortar businesses. Nick Scalis interim result was impressive, featuring profit growth of 22.1 per cent and same-store sales growth of 8.5 per cent. Despite the 10 per cent share price gain following the result announcement, the company still looks good value, trading on a price-earnings multiple of about 15 relative to 2014-15 consensus forecasts. Analysts at Moelis upgraded earnings forecasts following the interim result, and they have a 12 month share price target of $3.40 on the stock, implying upside of 13 per cent to the companys current trading range.

JB Hi-Fi
JB Hi-Fi s traditional electrical goods market spans many areas, from high end home entertainment systems through to computers and gaming products. But it will most likely be televisions and associated hardware and software that receives a kick in sales on the back of increased residential building activity. For more than 50 years, televisions have been the bread and butter of companies such as JB Hi-Fi as they have continued to evolve from black and white to colour, from chunky to flat panel and small screen to big screen. It is a market where there is continual technology -led change, and history shows the old faithful television will get kicked to the kerb for a new state-of-the-art model when decking out the new media room. One of the few stumbles in television sales as far as bricks and mortar retailers are concerned occurred when the Australian dollar spiked and online sales surged. The pullback in the Australian dollar has decreased the economic viability of consumers buying overseas, and this, combined with the likes of JB Hi-Fi developing their own online sales platforms, should see a business-as-usual environment if demand picks up. It is also worth noting that JB Hi-Fi has entered the $4.6 billion home appliance market via the launch of its HOME stores. While this is in its early stages, the company can easily and quickly expand the operation, given that it has the potential to convert existing traditional stores into multi-product outlets.

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For example, in the first half of 2013-14 one new HOME store opened and seven existing stores were converted, taking the total number of HOME stores to 16. By the end of 201314 management expects to have a total of 22 HOME stores across Australia. Management is of the view that gross margins from these outlets will be above those traditionally delivered over the medium term.
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