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Morningstar | Reliance 1H Result Includes a Welcome Guest, but Shares Remain Overvalued

Reliance Worldwide's first-half fiscal 2019 result was buoyed by the integration of the John Guest business acquired in June 2018. NPAT of AUD 66 million represents an increase of 58% on the previous corresponding period, or pcp. Revenue was up 50%, or 7% when excluding John Guest, and grew across all segments. However, margins in the Americas business were softer than expected. We have adjusted our near-term forecasts slightly, but our long-term thesis and AUD 3.60 per share fair value estimate remain intact. We continue to expect Reliance to significantly increase its share of the fittings and pipes market, but for competition to constrain on margin expansion. Reliance lacks an economic moat, and this is demonstrated in the firm's difficulty passing through increased costs, not least of all the higher price of copper, in such a competitive environment. Last trading at AUD 4.89 per share, shares in Reliance remain overvalued.

Higher input costs crimped Americas segment margins more than we’d previously expected. We’ve trimmed our fiscal 2019 EBITDA forecast by 2% to AUD 287 million to reflect this headwind. Management reiterated guidance for fiscal 2019 EBITDA of between AUD 280 million and AUD 290 million. Prior to the result, we were slightly above the range but now sit in line with the midpoint of management’s full-year guidance.

Net sales in the Americas, Reliance's largest segment, grew 21% to AUD 324 million, or 14% when excluding John Guest and one-offs in the pcp. However, higher copper prices and supplier-related quality issues saw first-half EBITDA margins contract to 17% from near 20% a year earlier. While the impact from copper should be more muted in the second half, we reduce our full-year EBITDA forecast for the segment by 5% to AUD 120 million.

Given Reliance's struggles in reaching critical mass in Europe, Reliance's acquisition of John Guest immediately adds scale in the U.K. and continental Europe. Following the integration of John Guest, the previously unprofitable EMEA segment boasted AUD 43 million in EBITDA in the first half and is now the firm's second-largest segment. We continue to expect low double-digit EBITDA growth in EMEA over the next five years, driven by revenue growth from continued penetration in the continent, and expanding margins from AUD 30 million in annual synergies between the legacy business with the recently acquired operations.

Asia Pacific segment revenue grew 7% to AUD 130 million. However, with similar cost impacts as affected the Americas business, margins continued to fall. This dragged EBITDA down 18% to AUD 25 million--in line with our AUD 52 million full-year forecast. We are cautious on the Asia Pacific business moving forward, given its exposure to new construction in Australia. New construction in Australia has peaked, in our view, and we forecast EBITDA from the segment to remain flat over the next five years.