Building the case to buy in a dip

This month, the stock in focus is James Hardie (JHX). We frequently talk about how often value is created by short-term problems within companies. If a company’s stock is sold down on an issue impacting earnings, and if the issue is short-term in nature, or less material than the market and analysts realise, then this can create a good entry point for buying the stock. Such an opportunity recently presented itself with James Hardie.

James Hardie produces building materials for the residential and commercial construction industries. They have operations in Asia-Pacific and Europe, but their main operations are in North America. Their flagship product is fibre cement, used primarily in external cladding, where James Hardie enjoys a 90% market share in the US. Fibre cement currently represents around 19% of the external cladding market in North America, with alternatives being vinyl (26% market share), wood (21%) and brick (8%).

While their market share and product advantages put them in an excellent position in a growing market, execution of strategy is also vital – and this is where James Hardie performed poorly last year. Poor manufacturing performance led to issues with the supply of product into market. This, in turn, led to lost revenue, cost blow-outs and concerns that relationships with key distributors and customers would be at risk. Concerns about these relationships and the capital expense involved in fixing supply issues (for example, adding production capacity) resulted in the share price falling dramatically.

How to assess the opportunity

As a fund manager, deciding whether this is an opportunity or a situation to avoid, involves doing your homework to determine the efficacy of management’s plans to turn the situation around, and hence the underlying value of the company. In this case, it involved engaging management so they could articulate their outlook directly to us, as well as utilising research, which surveyed key customers to see whether those relationships were permanently impacted. After much in-depth research and discussion, it was determined that the company maintained a very strong advantage in a market with an excellent thematic, and the sell-off was considered an opportunity.

Going forward, it is important to continually assess the execution of management against their own plan and their competitors.

Quick Stats:

  • Total sales reached US$2 billion in 2016
  • James Hardie employs 3,577 people in North America, Asia and Europe
  • They are the largest fibre cement producer in North America.