James Hardie Industries plc (NYSE:JHX), the largest producer of fiber cement products in the US, has suffered in the beginning of 2016 and is beginning to look undervalued. The stock price of JHX has fallen from $12.67 to $10.29 since the last day of 2015, a 19% drop. Contrary to what the recent decline in market value might suggest, JHX has actually performed well and shown itself to be a consistent earnings performer since the most recent financial crisis. In the last 5 years, JHX's earnings before income tax grew at an average annual rate of 11.5%. JHX is only covered by a single broker and has a low volume of shares traded every day (average of 30,000) which means that the broader market may not fully appreciate the value of the company.
Additionally, the stock has price-to-earnings ratio of 14.1, well below both the S&P 500's (Pending:GSPC) price-to-earnings ratio of 19.81 and the Industrial Goods sector price-to-earnings ratio of 38.62. As a bonus, JHX is currently paying a very solid dividend of over 6%. I believe JHX is undervalued with respect to the broader market, however, it is important to look at how the company generates its earnings to make sure the earning's growth is sustainable.
JHX operates 2 geographic business segments, US/Europe and Asia Pacific, both of which manufacture and sell the same products. JHX's products are fiber cement based and include siding, panels and cement boards which are used for residential and commercial construction projects.
According to the JHX 2015 annual report for investors, the US/Europe segment generated $286 million in earnings before income tax (a 21% increase from 2014) from $1.28 billion in sales. I expect earnings in this segment to continue to increase at a double digit growth rate for a few reasons.
First, US demand for fiber cement is projected by Freedonia Research to grow at a rate of 8.5% through 2017. Every product that JHX produces is either composed of, or related to fiber cement. Additionally, annual housing starts (the number of new housing construction projects started) are projected to grow from 1.1 million in 2015 to 1.6 million in 2017, a 36% increase. As more housing projects are started, demand for construction materials, including siding will grow, bolstering demand for JHX fiber cement products. Finally, an interesting (and profitable) shift is taking place in the US siding market; cement fiber is beginning to overtake vinyl as the leading siding material for construction projects. From 2013 to 2018, demand for vinyl siding is projected to grow 28.4% while demand for fiber cement siding is projected to grow 48.6% which shows that the siding market is shifting quickly towards fiber cement. The US siding market as a whole is projected to grow 40.8% over the same time period, creating a growing market for JHX products.
With growing demand for fiber cement products, a growing US housing market and an increased siding market share for fiber cement, there are ample growth opportunities for JHX in the US. Opportunities exist in Europe as well but I only want to speak briefly about the European market because reliable data is difficult to find and 80% of net sales revenue come from the US, not Europe.
Asia Pacific Segment
According to the JHX 2015 annual report for investors, the US/Europe segment generated $90 million in earnings before income tax (a 8% increase from 2014) from $380 million in sales. I expect earnings in this segment to continue to increase based on a number of factors.
First, the worldwide housing market is expected to grow at a rate of 3.7% annually until 2019. That doesn't seem like a lot of growth but the key statistic is that 80% of that growth is expected to take place in Asia Pacific and Africa. Asia Pacific is clearly a growth market in terms of both housing market growth and economic growth. To support all of the new housing projects, construction materials, including siding will be needed. JHX has the opportunity to supply a large portion of those construction materials because it has 5 manufacturing plants located in the region as well as a local R&D facility which will allow it to meet demand.
Additionally, world demand for fiber cement is projected to rise annually by 5% through 2019 to more than 32 million metric tons. The Asia Pacific market is projected to be worth $4.59 billion of a total global market of $12.42 billion by 2020, or 37% of the world market. These 2 forecasts coupled together with the projected increase in the global housing market provide, in my opinion, a growth opportunity for JHX in its Asia Pacific segment.
JHX has competitors both in the US and globally who are also competing to take advantage of the growth opportunities in the fiber cement market. JHX's 2 largest global competitors by fiber cement market share are Etex Group at 10% and Nichiha (privately-held) at 6% according to a research report by IndustryARC (source above). JHX itself has the largest global market share at 13%. JHX has become the market share leader because of its distribution network and brand reputation.
Domestically, JHX has a fiber cement market share of over 80% according to Morningstar (90% if you believe the company's own estimates). JHX's domination of the US fiber cement market puts it in a strong position to grow with the growing US housing market. Due to its massive advantage in the US fiber cement market, its major competition is actually not other US fiber cement manufacturers (most of whom are regional and pose little threat), rather the competition comes from companies such as Saint-Gobain North America, USG (NYSE:USG) and Eagle Materials (NYSE:EXP) who produce siding and panels made of gypsum and other similar materials. These companies are able to compete with JHX outside of the fiber cement market and compete instead for market share in the siding market as a whole. I don't see these companies as a threat, because as mentioned above, fiber cement makes up a large portion of the US siding market.
Although JHX is undervalued and has major growth opportunities available to it, there is a significant negative associated with the company. The major risk associated with JHX is its obligation to divert some of its earnings every year into an asbestos compensation fund. Due to actions in the past, JHX is liable for injuries caused from its asbestos-containing products in Australia. In the past fiscal year, JHX paid $62.8 million, or 35% of free cash flow to the Asbestos Injuries Compensation Fund.
I believe JHX has become undervalued, with a P/E of 14.1, solid earnings growth over the last 5 years and a hefty dividend. JHX has ample growth opportunities as both the US and global housing markets grow and demand for construction supplies increases. There are a few risks associated with JHX, including asbestos compensation and a lot of long term debt, but overall, the stock is a good buy at its current price.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in JHX over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.