The past 12 months have been a tough period for housing-exposed stocks.
Monetary tightening has adversely impacted the housing market (in the US and domestically), with higher mortgage rates ultimately translating to softer house prices and a decline in new housing construction volumes. While our base case is not for a GFC-style housing crisis, sentiment is very low. So, why invest?
- Buying stocks when sentiment is very low can be an astute way to generate returns. This is called contrarian investing.
- The macro is starting to shift in the US and in Australia, with central banks looking close to the end of tightening cycles.
- There are strong structural tailwinds behind the US and Australian housing markets.
Opportunity to Buy While Sentiment is Low
We like to have exposure to some contrarian stocks in the portfolio. The last time housing sentiment was this bad, stock-market returns were stellar over the following year.
The last two times US housing sentiment bottomed (GFC 2009 and COVID 2020), James Hardie (JHX) had some of its best performance. JHX posted a gain of more than 90% a year after sentiment hit its GFC-era low and 97% after the COVID lows of 2020.
Going into the end of last year, sentiment was very low both domestically and in the US. We thought this was the opportune time to add to our housing exposure with Nine Entertainment (NEC), which owns 60% of Doman Group (DHG), with valuations still at very low levels.
While we cannot say the bottom is in, we do feel that we are closer to the end of this than the beginning.
Monetary Policy Shifting – Headwind Easing
The two key factors the housing market needs to stabilise are hope that: 1) Inflation is receding, and 2) the Fed/RBA is close to the end of its hiking cycle.
We have started to see evidence that inflation is fading and that Fed pricing and RBA cash rate futures are starting to indicate that central banks are getting close to the end of their tightening cycles. While we are more hawkish than the interest rate futures market, we think the market is getting more dovish on the outlook for rates over the next 12 months, which will benefit housing-exposed stocks.
The first indication that confidence may be returning to the housing market was the new US housing starts data for March, which surged 9.8% to its highest level in 6 months. In Australia, house prices started to rise again in March, up 0.8% MoM. While one data point does not imply a trend, we do expect the macro setting to improve over the medium term.
Housing-related stocks have already traded well over the last quarter. We think that this is a good turning point for housing-exposed stocks and we expect a further improvement in sentiment.
Keeping It Structural
While housing is cyclical, we want exposure to stocks that are leveraged to structural trends in the US and the domestic housing market.
Undersupply, Ageing Housing and a Change in Consumer Preferences Supporting US Building Materials
Looking beyond the immediate cyclical headwinds facing the US economy, we believe the structural backdrop for companies exposed to the US housing market (the US is JHX’s main focus, with 75% of sales in North America) is highly attractive. There are a number of structural trends that are playing out which we expect to be supportive of the building materials sector - and specifically James Hardie Industries (JHX) - in the long term.
Structural Undersupply of US Housing
Since the GFC, the US housing market has been chronically underbuilt, with household formations significantly outpacing new home completions. A pullback in construction activity has been attributed partly to home builders going out of business or having a significantly reduced appetite for risk.
While the timing and magnitude of a potential recovery in housing supply are uncertain, it is clear that a significant catch-up of construction activity is needed. This would provide a meaningful demand tailwind for building materials.
Ageing US housing stock
The median age of the US housing stock is now over 40 years old, which is the oldest it has ever been. This is poised to create a growing repair and remodeling (R&R) market as old and deteriorating structures need to be renovated.
US housing construction activity is increasingly taking place in the R&R market (rather than in new construction activity). R&R is typically more resilient through economic slowdowns than home building due to its skew to non-discretionary, inelastic expenditures.
This backdrop is particularly positive for JHX given its focus on the R&R market, which represented ~65% of the company’s volumes in FY22.
Fibre cement is growing in popularity
Fibre cement is JHX’s core product. We believe there is a structural shift towards fibre cement in the US.
Consumer preferences have shifted over the past two decades towards the use of fibre cement for external sidings and away from conventional products like vinyl and timber.
The value proposition of fibre cement is strong, with key selling points being 1) aesthetics (the ‘weatherboard’ look), 2) superior durability (JHX offers a 30-year warranty) and 3) lower lifetime cost compared to alternatives (when considering labour, installation, and maintenance costs).
Fibre cement currently accounts for an estimated ~14% of North American exterior cladding market demand (or ~22% market share in new construction), leaving a large runway for growth.
Why James Hardie Industries (JHX)?
We view JHX as an attractive investment at this juncture given:
- Global leader - JHX is the global market leader in fibre cement, with a strong brand name, a premium product mix, and significant pricing power. JHX is the only player in its category of scale in the US with no significant direct competitors in fibre cement. The business currently commands ~90% category share in the US fibre cement market. Management has previously outlined a 35/90 target, which is for fibre cement to be used in 35% of new housing siding in the US; and for JHX to hold its 90% share of the fibre cement category.
- Growth from shift to fibre cement - We think JHX can continue to grow earnings through the structural shift towards fibre cement in the US. There is still a long runway for JHX to increase revenue and profits over the next 5-10 years.
- Resilience in a downcycle - In the current challenging backdrop, JHX’s earnings have held up relatively well (expected to be broadly flat in FY23) while it has been able to pass on higher prices to help offset rising costs.
- The housing downturn is an opportunity – we think JHX is well placed to take advantage of market softness to strengthen its market position and drive further profitable volume share gains.
- Valuation is oversold on cyclical challenges - as a result of downbeat sentiment towards US housing exposed stocks, JHX currently trades on a price-to-earnings ratio (PE) of 17x, which is 1 standard deviation below its 10-year average. Notwithstanding the immediate headwinds, we think JHX is very attractively valued for ‘patient capital’ considering its long-term structural earnings growth potential underpinned by sector tailwinds.
- Rerates are quick - JHX could re-rate quickly in response to a change in the macro setting (e.g. a Fed Pivot).
Therefore, we see now as an attractive opportunity to buy a high quality, genuine global market leader with a strong growth outlook, at a reasonable price.
The Forgotten Structural Story in Australia
Like the US market, Australia's property market has been marked by a persistent undersupply of housing, particularly in the major cities of Sydney and Melbourne. Despite the construction of new dwellings in recent years, population growth has outpaced the rate of new home building, leading to a growing gap between supply and demand. This undersupply of housing has contributed to a steep rise in property prices, particularly in the sought-after suburbs of the major cities.
With limited new supply on the horizon and continued population growth projected in the coming years, and a potential surge over the next few years due to migration, property prices are likely to remain high or even continue to rise, particularly in areas with strong demand, over the medium term. We think online property classifieds stocks (Domain and REA Group) provide the best exposure to Australian housing.
Nine (NEC) a Key Beneficiary of Australian Housing via Domain (DHG)
We have exposure to the Australian housing market through our holding in Nine Entertainment, which owns 60% of online classified Domain (DHG).
- Activity should increase - DHG should benefit from higher house prices and as there tends to be more churn in the real estate market as buyers and sellers look to take advantage of favourable conditions. This can lead to increased demand for DHG's services, as more people may be looking to buy, sell or rent properties.
- Raising prices on higher prices - The key for DHG is that, as property sales prices or rents increase, it can result in higher commissions and fees for Domain. This can help to boost the company's revenue and profitability.
- DHG > REA on fundamentals - We have a preference for DHG over REA group (REA). REA sits on a forward EV/EBITDA premium of 42% vs DHG, while DHG has stronger expected earnings (EBITDA) growth CAGR vs REA (19% vs 16%, (FY23-25))
We own NEC rather than owning DHG directly as:
- A diversified media portfolio - NEC has a diverse portfolio of assets including television broadcasting, digital media, and publishing. The company's broad range of media offerings could help to mitigate risks associated with any one area of the business.
- Strong market position – NEC is one of the largest media companies in Australia, with a significant market share in TV and digital media. The strong market position should help protect its revenue streams and position NEC for continued growth.
- Focus on digital transformation – NEC has been actively pursuing a digital transformation strategy in recent years, with a focus on expanding its digital offering and engaging with audiences across multiple platforms. This focus on digital could position the company for continued growth in the medium term.
- More resilient than market expects –We think the business is more resilient than the market is currently implying, due to the higher % of subscription revenue that NEC generates.
- Growth at value prices - An investor can buy NEC at a FY24 PE of 11x, providing a cheap price to get leverage to DHG.
- Yield - NEC has an expected FY23 dividend yield of 5.7% (fully franked).
- Hidden value - NEC on a sum of the parts basis presents value and we like to hold stocks that present hidden value.
NEC Presents Value on a Sum of the Parts Basis (SOTP)
NEC has hidden value. When using the market value of listed Domain Group (DHG), it seems the market underappreciates the intrinsic value of NEC’s core media assets.
Using reasonably conservative multiples (using global peers) indicates 28% upside for NEC. This analysis is presented in Figure 8.
With the potential for DHG to continue to rerate over the next quarter this hidden value might start to look even more attractive.
| NEC Stake | EBITDA FY24 ($m) | EV/EBITDA x | EV ($m) | ISG Comment | |
| TV - Free to Air | 100% | 138 | 4.8x | 664 | Global peer average |
| TV - BVOD (9NOW) | 100% | 127 | 5.8x | 732 | 20% premium to TV peer group given higher growth/margin profile |
| Broadcast - Radio | 100% | 31 | 5.2x | 164 | Domestic peer average |
| Streaming (STAN) | 100% | 52 | 13.8x | 711 | Global peer average (20% discount due to limited reach) |
| Publishing | 100% | 194 | 6.3x | 1,225 | Global peer average |
| Other - corporate costs etc. | 100% | -42 | 7.0x | -291 | NEC headline multiple |
| NEC ex DHG | 501 | 6.4x | 3,204 | ||
| DHG market valuation | 60% | 142 | - | 1,450 | EV of $2,416m x NEC ownership |
| Total Enterprise Value | 4,654 | ||||
| Less net debt | -480 | FY24 estimate | |||
| Equity value | 4,173 | ||||
| Number of Shares | 1,588 | FY24 estimate | |||
| Implied Share Price | $2.63 | ||||
| Current share price | $2.05 | ||||
| Implied upside | 28% |
Source: Refinitiv, Wilsons.
Written by
Rob Crookston, Equity Strategist
Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.
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