Investors have a knack of underestimating the duration of megatrends. They overpay for stocks when hype about a trend abounds and lose interest when valuations fall, believing underlying structural or cyclical trends have run their course.

True megatrends take years or decades to play out. Identifying top-quality companies in favourable industries, and buying them when they trade below their intrinsic or fair value, is a smart way to create long-term wealth without excessive risk.

Online media is an example. It was obvious a decade ago that print advertising would continue to migrate to online media platforms. REA Group, Seek and Carsales.com were prime beneficiaries, but many commentators argued they were too pricey.

By focusing on simplistic Price Earnings (PE) multiples, these analysts underestimated the growth potential of online media companies and the power of the underlying trend. The exceptional growth prospects of internet-portal stocks warranted high PEs – and still do.

The same is true in travel. Webjet (WEB) has soared in the past 12 months as more consumers book travel online. Flight Centre (FLT), a mostly bricks-and-mortar travel agency, has gone the other way. The migration of travel bookings to online platforms has years to play out.

I’m a great believer in industry analysis as a basis for stock-picking. Of course, one should balance “top-down” market insights with “bottom-up” company analysis. But it pays to focus on industries and, as they say in the market, “let the trend be your friend”.

The US housing recovery is not as sexy as technology-based megatrends or those based on emerging markets. Arguably, it has more substance as the US housing market continues to recover from the 2008-09 Global Financial Crisis.

US housebuilding starts in January 2017 were up 10.5% on a year earlier. Although slightly down on December figures, the latest homebuilding data suggests the US housing recovery remains on track, thanks to the country’s record-low interest rates and strong labour market.

Higher US interest rates this year could temper demand for mortgages and new homes. Offsetting that is the lift in consumer and business confidence in the US since Donald Trump won the Presidency and its effect on US homebuilding starts.

Home starts in the South hit a seven-year high in January 2017, suggesting the Trump effect is boosting construction. Like or loathe him, the data implies Trump’s pro-growth stance has had a positive effect on homebuilding confidence. The question is whether it lasts.

The US housing construction recovery was well entrenched before Trump’s election and it is hard to see his Presidency derailing the trend, unless excessive government spending leads to an inflation outbreak and the need for higher-than-expected US interest rates.

On balance, Trump should add a bit more fuel to the US housing recovery.

Benefiting from US housing construction

James Hardie Industries (JHX), Boral (BLD) and Reliance Worldwide Corporation (RWC) provide the best leverage of ASX-listed stocks to US housing construction. I have been bullish on James Hardie for several years and Reliance has caught my eye.

Reliance took the market a little by surprise when it listed on ASX in April 2016 through a $919 million Initial Public Offering – that year’s largest. The plumbing manufacturing business had a relatively low profile by IPO standards. I doubt enough investors understood the scale of the business or its global footprint.

It was not well known that Reliance (then owned by the Munz family) was one of Australia’s great family companies. Established in 1948, the business had become a leading player in the US plumbing-products market through a series of innovations and bolt-on acquisitions. Post IPO, the Munz family retains 30%, giving ownership continuity.

Reliance designs, makes and supplies water-flow and control products used in plumbing. Its focus is on the renovation and residential repair markets, which are less cyclical than building-materials companies exposed to the new housing starts.

Reliance 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. SharkBite fittings are faster and easier to install than traditional copper joining.

The company has excellent distribution channels in the US, including Home Depot and Lowe’s. As the Australian experience shows, securing decent shelf space at Bunnings is critical for companies exposed to the renovation market. So, too, in the US.

Reliance’s $2.50 issued shares rallied to $3.40 in August 2016 before hitting a 52-week low of $2.68. There was no obvious catalyst for the extent of the price fall. As often happens with hot IPOs, Reliance rallied too far, too fast before valuation reality set in.

Source: Yahoo

Strong earnings performance

Reliance’s half-year FY17 result impressed. Released last week, the result suggested Reliance should slightly exceed its FY17 prospectus forecast. It’s always a good sign when IPOs beat forecasts and prove their prospectus was more fact than fiction.

Revenue rose 4% to $282 million on the prior corresponding period. Underlying earnings jumped 18% to $63.7 million. Although a solid rather than spectacular set of numbers, it showed Reliance is on track to deliver on its earnings guidance.

Good growth in Reliance’s Americas division reinforces my view on US housing. Sales rose 8% in the Americas division and 5% in the Asia Pacific, offsetting a 13% fall in emerging markets and weakness in the United Kingdom.

Margin gains, good cash flow growth and debt reduction were other positives in the interim result. Lowly-geared companies with good cash flow, expanding margins and core growth engines (in Reliance’s case, the Americas division) appeal.

The roll-out of Reliance products at US hardware giant Lowe’s is another positive.

Reliance said at its interim result: “RWC expects continued market penetration of SharkBite PTC fittings and accessories in the Americas, which will benefit from our expanded USA retail distribution network.”

Longer term, I like Reliance’s potential to disrupt the small-diameter global pipe, valve and fitting market this decade and next. Cross-linked polyethylene tubing (used in SharkBite) should continue to take share from traditional copper and CPVC piping.

Plumbing-trade shortages, lower-skilled workers doing plumbing work in the US, and rising plumbing costs are driving demand for innovative product solutions. Reliance’s demonstrated capacity for innovation and disruption, in a staid global plumbing-products business, is underestimated by investors.

Valuation stacks up

Two of seven broking firms that cover Reliance have a buy recommendation, four have a hold and one has a sell. A median target price of $3 suggests Reliance is almost fully valued at the current price. A forward PE of 20 times FY18 earnings, based on consensus, is fair for a business with an expanding global footprint and strong industry position.

Expect Reliance to do a touch better than the market expects at its full-year result. It won’t shoot the lights out, but the business is benefiting from favourable cyclical trends (the unfolding recovery in US housing) and favourable structural trends (innovation in plumbing products and more plumbers looking for time-saving devices and techniques).

A total return above 20% (including dividends) for Reliance would not surprise in the next 12 months, the caveat being that US interest-rate rises are gradual and broadly in line with market expectations this year.

Tony Featherstone is a former managing editor of BRW and Shares magazines. All prices and analysis at 1 March 1 2017.

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