EUR 850.00 For Business Accounts Only

Morningstar | Bathrooms and Kitchens Are Taking Share, But Narrow-Moat GWA Group Remains Overvalued

We increase our fair value estimate for narrow-moat-rated GWA Group to AUD 2.80 from AUD 2.65 following the release of fiscal 2018 results, which saw the firm grow net profit after tax, or NPAT, by 1.1% to AUD 54 million, in line with our forecast. We are now more optimistic on the bathrooms and kitchens division's ability to grow share in the higher-margin repair and remodel segment. However, despite small positive adjustments to our near-term housing forecasts, we continue to expect softer housing completions beyond fiscal 2019 to weigh in on bathroom and kitchen sales, and shares in GWA remain overvalued.

Fiscal 2018 represents the final full year of door and access systems business following its sale in July 2018. This divestment allows GWA to focus on its core bathrooms and kitchens division, which underpins the firm's narrow moat rating. With revenue growth of 2.5% outpacing the market, bathrooms and kitchens grew share over the year. We have adjusted our revenue growth forecasts to reflect further market share gains in the repair and remodel segment, along with higher capital expenditure assumptions to reflect the firm's focus on growth.

We also expect the firm can continue to grow operating income by 2.4% CAGR over the five years to fiscal 2023, higher than our previous 0.3% forecast. We're encouraged that the bathrooms and kitchens segment grew EBIT by 2.5% to AUD 89.8 million, maintaining fiscal 2017 margins of 25%. Going forward, we expect share gains in the higher-margin repair and remodel market, which contributes approximately half the sales in bathrooms and kitchens, to drive higher profitability than we previously assumed.

Approvals for new residential homes have rebounded in recent months, and we expect this recent strong performance to lead to better near-term construction performance versus our prior outlook. June-ending detached housing approvals rallied month-to-month after a couple of challenging periods, but the final fiscal quarter saw markedly slower growth than the prior--up 3.8% versus 8.8%. For the fiscal year 2018, detached housing approvals increased 5.3%, compared with a fall of 3.1% in the prior year. However, we remain cautious about the medium-term prospects for residential construction.

Our outlook is based on our view that the relationship between population growth and new home construction will return to a long-term average, versus the elevated level the country has seen recently. As such, slight changes to our near-term forecasts do not have a major impact to our valuation for GWA, given greater construction now would only serve to bring forward demand, in our opinion, limiting the need for new building construction in the future. Nonetheless, while we see a sizable dip to fewer than 110,000 detached home completions by fiscal 2020, we remain optimistic about long-run detached home completions, forecasting a rise to more than 120,000 by calendar 2025, compared with about 112,000 in calendar 2017--a CAGR of about 1%.

We expect GWA will continue to enjoy mid-single-digit repair and remodel demand growth. But we caution our outlook here also faces some downside risk should home prices fall more than we currently anticipate. Repair and remodel demand has historically correlated with home prices; as homeowners have seen their property values rise, they've felt confident in investing in additions and alterations, and vice versa. Nonetheless, we expect the investments management is making will offset some of this concern, and remain comfortable with our forecast.