Plumbing, air-conditioning and refrigeration equipment distributor Reece Group ((REH)) has managed to avoid the impact of subdued renovation activity and poor sentiment in Australia, as sales revenue held up in the first half.
The vast potential for growth in the US is expected to underpin the business going forward while Australian conditions are still likely to be difficult through 2020. First half sales growth in the US was 19% and 11 branches were added to the network.
While operating earnings increased 13% in the US, margins declined slightly to 5.6%, attributed to further investment including the opening of three pilot stores. Baillieu estimates underlying sales growth of 8% over the next two years in the US.
Nevertheless, the Australasian business accounts for 75% of earnings so this is could still weigh. First half operating earnings were in line with expectations for a flat result, up just 1% to $263m, and Australasian operating earnings declined -3.8%.
No guidance was provided for FY20 but Citi calculates, based on consensus forecasts, that operating earnings (EBITDA) are expected to grow 6.9%. However, while the acquisition of Todd Pipe should contribute some incremental earnings, the second half is looking a little ambitious and Citi retains a Sell rating and $10.50 target.
Morgans, on the other hand upgrades to Add from Hold. Margins are expected to improve as the company deploys an accelerated store roll-out and bolt-on acquisition strategy. The company has added 11 new stores in the US and five branches across Australia bringing its total to 825 stores worldwide.
Reece acknowledges that dwelling construction in Australia is yet to find a bottom, particularly as plumbing is a late-cycle product, and anticipates the next 12 months will be challenging. In the medium term Australia is expected to turn more positive as building approvals recover on the back of housing initiatives stemming from the recent bushfires.
Underlying margins were strong across the company’s business in the first half, which Baillieu believes this testament to the strength of the Australian franchise and a pick-up is expected in 2021.
The broker suspects operating conditions in the second half of FY20 will be similar to the first half, albeit amid branch network expansion and market share gains in the US. The broker believes the Australasian operations are providing the strong cash flow that can fund the US expansion.
Moreover, executed well, the US offers a growth opportunity that could ensue for a decade. Baillieu also upgrades the stock, to Buy with a price target of $12.90, assessing the multiples do not reflect the potential of the US.
Meanwhile, the company expanded its footprint in 2019 to 33 branches in New Zealand with the acquisition of Edward Gibbon and Heatcraft NZ. This allowed Reece to commence operations in the South Island for the first time.
The company sources products from 30 countries, of which China is a large part, although Chinese factories are back manufacturing so at this point the company is confident the coronavirus impact will be limited.
