Morningstar | Steady Top Line for Narrow-Moat Dulux Despite Soft Resi- Outlook; FVE Cut 20% on Analyst Transfer. See Updated Analyst Note from 17 Dec 2018
We reduce our fair value estimate for narrow-moat Dulux by 20% to AUD 6.00 per share, following a transfer of analyst. We forecast a five-year revenue CAGR of 3.6%, which, while resilient in the face of a challenging two-year outlook for hardware retailing and residential alteration and addition work generally, is lower than our prior forecast of 4.9%. Despite expectations for continued paint volume growth over the coming two years, we’re more bearish on the outlook for Dulux’s more housing cycle exposed segments. Nonetheless we remain upbeat about margins with our expectations unchanged. We forecast group EBIT margins at an average of 12.1% over the coming five years, a slight improvement on fiscal 2018 operating margin of 11.1%. While we see room for slight margin improvement from operating leverage, we continue to see margins largely capped by powerful buyers. Trading at 1.17 times our fair value estimate, shares currently appear expensive.We reiterate our narrow-moat rating for Dulux and our medium uncertainty rating for the stock. Dulux possesses an intangible asset its strong brands--Dulux in paints and Selleys in adhesives--which resonate with the Australian retail hardware customer. Dulux therefore maintains a price premium over branded competitors and earns economic profits. While paint volumes are more insulated from the economic cycle than other building materials, idiosyncratic risks exist for Dulux, including its significant dependence on its largest customer, Bunnings, which represents one quarter of Dulux’s total sales. Therefore, Bunnings’ growth trajectory and the Bunnings relationship itself provide material risks to Dulux.
Dulux remains financially sound. Net debt/EBITDA stood at 1.6 times at fiscal 2018 year-end. Free cash flow generation over the forecast period will see net debt/EBITDA to fall to 0.8 times by fiscal 2023, thus providing balance sheet flexibility.
DuluxGroup is engaged in the manufacture, marketing, manufacture, marketing, sale and distribution of branded paint, coatings, adhesives, garden care and other building products to the residential home improvement, commercial and infrastructure markets across Australia, New Zealand and Papua New Guinea, China, South East Asia and the U.K. Co. supplies paints and coatings under the Dulux brand; consumer and construction products under the Selleys and Parchem brands; cabinet and architectural hardware under the Blum, Hera, SecureView, Assa Abloy and Breezway brands; and Yates garden care and home improvement products.
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