We recently renovated a bathroom. Ouch! Who would have thought a small ensuite would cost so much to rebuild. Friends said we got out of it cheaply.
Bathrooms, they warned, are “trades heavy” and can have dear products. I told myself a new bathroom added value to the house and, with property prices rising again, the timing was right.
The bathroom project was a painful reminder of how much money one can pour into even basic home renovations these days, and the effect of the property cycle on renovations demand. And why it’s a good time to look at bathroom and kitchen companies on the ASX.
Master Builders Australia’s (MBA) building and construction industry forecast is for modest growth in renovations activity (4.6% cumulatively) over 2023/24. Ultra-low interest rates should drive an improved renovations pipeline.
Released in August 2019, MBA’s forecast might prove a touch conservative. There has been a 25 basis point interest rate cut since then, auction clearance rates have soared and property prices in key Sydney and Melbourne markets are recovering strongly.
The residential property market looks a lot stronger now than in mid-2019. On some estimates, house prices are up 8% since their mid-2019 trough. Price gains of at least 10% in the next 18 months would not surprise if there is another interest-rate cut.
As homeowners watch the value of their property race back to peak levels, it’s likely that renovations activity will strengthen. During the last price boom, I recall my suburb and surrounding ones awash with tradies each morning working on renovations.
Not for a minute am I suggesting a renovations boom. Slow wages growth and high household indebtedness remain headwinds. Longer term, growth in apartment living and renting is a threat to the renovations market because most activity occurs in detached housing.
Still, there’s enough to suggest the property market is recovering faster than most pundits expected and that the housing-construction downturn might not be as bad as first feared. That’s good news for renovations activity and kitchen and bathroom companies.
Here are 3 stocks with strong leverage to home-renovations trends:
1. GWA Group (GWA)
The maker of bathroom and kitchen products has had a solid 12 months as the market factors in stronger property activity. The total return (including dividends) over one year is almost 33%, Morningstar data shows. Over three years, the total return is an annualised 20%.
GWA posted a reasonable interim result for FY20 this week. Underlying earnings of $38.1 million were in the company’s $37-41 million guidance range. Importantly, GWA maintained its full-year guidance of $80-$85 million in earnings before interest and tax.
Management said recent capital-city house-price gains, improving existing housing turnover, and early signs of improving housing-construction activity supported anticipated improvement in residential property market conditions in FY21.
There’s a lot to like about GWA and its work to cut costs, drive synergy gains and grow the business through acquisitions. But a forward Price Earnings (PE) multiple of almost 20 for FY2020, based on consensus forecasts, is already factoring in the recovery.
Another nagging concern is increasing bathroom-products competition in Australia as foreign players grow in this market and what that will do to GWA’s margins.
In broking parlance, GWA looks like a hold for now.
Chart 1: GWA
Source ASX
2. Reece (REH)
The supplier of plumbing and bathroom products has been an excellent, if lower-profile ASX stock for a long time. Its five-year annualised return is almost 16%.
Reece also supplies heating, ventilation, air-conditioning and refrigeration products in Australia, New Zealand and the United States and has a valuable retail network of 601 stores here.
Reece grew FY19 earnings by 38% to $522 million – a strong performance in the slowing Australian residential market. Normalised after-tax profit rose 6% to $202 million.
Reece’s US growth strategy (it has 175 branches there) impresses, as does its focus on distributing exclusive brands and digitising the customer experience. Increasing the company’s geographic and customer diversification is smart given the cyclicality of its industry.
CEO Peter Wilson’s presentation at the Annual General Meeting neatly explains how the Reece is moving from a local company that exports to a global company with a local presence – a similar strategy employed by another home-products maker, Breville.
I like the transition underway in Reece to drive its next stage of growth. It is not well covered by brokers and is tightly held by key shareholders. At $11.57, Reece is on a trailing PE of 27 times, Morningstar data shows. That’s high for a cyclical stock.
However, Reece deserves a significant premium given its ability to grow earnings in good and bad markets and rapidly expanding global footprint. The company’s innovation focus does not get the market recognition – or valuation premium – it deserves, making it an interesting idea for prospective long-term portfolio investors, even after the recent price rally.
More will be known when Reece reports its interim result later this month.
Chart 2: Reece
Source ASX
3. Reliance Worldwide Corporation (RWC)
Like Reece, Reliance has significant growth opportunities in the US and has been among my favoured mid-cap ideas for The Switzer Report in the past few years.
Reliance designs, makes and supplies water-flow and control products used in plumbing and its main focus is on the renovation and residential repair markets. The company is best known for its innovative SharkBite branded push-to-connect (PTC) fittings, used in behind-the-wall plumbing systems to connect pipe lengths and valves.
Reliance listed on ASX in April 2016 through a $919 million Initial Public Offering and its $2.50 issued shares rallied to $6 in mid-2018. It became a market darling. But a surprise earnings downgrade in May 2019, insider selling and unfavourable weather conditions from a colder-than-expected US winter, saw Reliance smashed to $3.10 in early August 2019.
Although Reliance has since rallied to $4.67, the market remains sceptical and there are plenty of short-sellers wanting to bet on further share-price falls.
The acquisition of John Guest in May 2018 for $1.22 billion remains a concern. The deal made sense – the UK-based John Guest is a global leader in plastic PTC fittings – and a natural fit for Reliance and its European expansion strategy. But too many mid-cap acquisitions come unstuck a year or two after the deal when the initial euphoria fades.
An average share-price target of $5.73, based on the consensus of 10 broking firms, suggests Reliance is undervalued. I’m not as bullish, but expect a continued recovery over the next two years.
I’ll be watching Reliance’s interim results announcement on February 24 closely for an update on the John Guest acquisition and trading conditions in the company’s key markets.
My hunch is the market has been too bearish on Reliance. For all its woes last year, Reliance looks much stronger today than when it floated in 2016 and has good long-term prospects.
A pause in the US trade war, more favourable US weather conditions, less Brexit uncertainty and improvement in Australian residential-housing activity are other factors in Reliance’s favour in the next 12 months. Like Reece, Reliance looks moderately undervalued.
Chart 3: Reliance
Source ASX
Tony Featherstone is a former managing editor of BRW, Shares and Personal Investor magazines. The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 19 Feb 2020.
