Company Reports

We raise our fair value estimate for Reliance Worldwide by 8% to AUD 4.20 on a more optimistic midcycle outlook for the North America segment, which accounts for around two thirds of group EBITDA. Reliance’s North America restructure delivered 200 basis points of EBITDA margin improvement in the first half of fiscal 2024, despite flat sales. We believe the restructure makes the North America segment a structurally better business, and as the housing construction cycle recovers, we think a midcycle EBITDA margin of 21% is achievable, up from our previous forecast of 19%. This lifts midcycle EBITDA by around 8% at the group level.

Reliance Worldwide is a leading plumbing supplies company, producing push-to-connect fittings, pipes, valves, fluid dispensers, appliance connectors, and other specialist plumbing products. Reliance Worldwide manufactures and distributes its plumbing products under the brands including SharkBite, John Guest, HoldRite, EZ-Flo, Eastman, and Cash Acme. Its biggest geographic exposure is in North America which accounts for 60% of earnings, followed by Europe at around 35% and Asia-Pacific at 10%.

We maintain our AUD 3.90 per share fair value estimate for no-moat Reliance Worldwide, with shares trading at an 11% discount to our intrinsic assessment. A reassuring trading update for the first quarter of fiscal 2024 shows the group tracking largely in line with guidance provided in August 2023.

No-moat Reliance Worldwide’s fiscal 2023 results disappointed. Despite this, we lift our fair value estimate by 4% to AUD 3.90 per share, mostly due to the time value of money. Minor changes to our earnings forecasts are broadly neutral to our intrinsic assessment. The shares sold off considerably after earnings and now trade at a level we consider fairly valued.

Policymakers are increasingly cognizant of the significant contribution from the manufacturing processes, transport and disposal of building materials to the carbon-intensity of our built environment. Assessing the associated degree of carbon-risk associated with many building materials is a complex task—for detail, please see our special report “Combatting the Carbon Intensity of our Built Environment” dated July 27, 2021.

Demand for Reliance’s plumbing fittings range remains elevated in late fiscal 2021, driven by COVID-19-induced buoyancy in repair and remodel activity across all of Reliance’s geographies. Nonetheless, Reliance has further benefited from a significant U.S. winter freeze event in February, providing an incremental boost to plumbing fitting demand in the U.S. in late fiscal 2021. Accordingly, third-quarter sales spiked appreciably for Reliance’s Americas segment—Reliance’s largest segment which accounts for 46% of group operating income. As a result, we upgrade our full-year fiscal 2021 EBITDA forecast by 6% to AUD 330 million. Third-quarter sales results for Reliance’s Europe, Middle East and Africa, or EMEA, and Asia-Pacific segments broadly tracked our full-year expectations.

The Australian Government’s targeted and highly effective fiscal support of the residential construction sector leads us to materially upgrade our near-term outlook for housing commencements and alteration and addition activity. Certainly, housing-related stocks under our coverage are set to benefit from the recovery in fiscal 2022, boosting earnings and improving balance sheet metrics. But with fiscal support for the sector now winding down, the valuation benefit of our upgraded near-term housing commencement forecasts to our housing-related coverage is modest at best.

Reliance confirmed its strong first-half fiscal 2021 performance, with first-half EBITDA of AUD 166 million climbing 32% year on year. The result offered little surprise, with Reliance having already reported strong headline numbers in late January, owing to elevated repair and remodel activity in Reliance’s key geographies of the U.S., the U.K., and Australia amid the ongoing pandemic. Our expectations for fiscal 2021 are largely unchanged. Nonetheless, we lift our full-year fiscal 2021 EBTIDA by 5% to AUD 296 million, as a result of better than expected fixed cost recovery in the Europe, Middle East and Africa, or EMEA, segment and a one-time inventory revaluation gain booked in the first half. We expect earnings to soften in the second half of fiscal 2021, as Reliance’s revenue growth rate decelerates and the recent appreciation of the Australian dollar delivers an earnings translation headwind.

We’re positive on Reliance’s strategy to build upon its innovative PTC fittings position through continued investment in product development, supplemented by acquisitions of innovative plumbing system technologies. We believe this strategic focus provides Reliance with the best opportunity to generate shareholder value long-term. To this end, Reliance spent USD 13.0 million or 1.6% of net sales on product development in fiscal 2020. The alternative business model available to Reliance would be to dramatically reduce spending on new product development and become a commodity plumbing system manufacturer that brings to market generic versions of plumbing systems. But with cost advantages in raw materials procurement difficult to come by, even for those with superior manufacturing scale, we view such a business model as inferior to the innovator model.

We’re positive on Reliance’s strategy to build upon its innovative PTC fittings position through continued investment in product development, supplemented by acquisitions of innovative plumbing system technologies. We believe this strategic focus provides Reliance with the best opportunity to generate shareholder value long-term. To this end, Reliance spent USD 13.0 million or 1.6% of net sales on product development. The alternative business model available to Reliance would be to dramatically reduce spending on new product development and become a commodity plumbing system manufacturer that brings to market generic versions of plumbing systems. But with cost advantages in raw materials procurement difficult to come by, even for those with superior manufacturing scale, we view such a business model as inferior to the innovator model.

The impact of the coronavirus on Australian residential construction activity, house prices, and rental markets in 2020 has proven far less pronounced than we'd originally feared. Dwelling construction activity, house prices, and rents contracted during the height of the pandemic's shock to the Australian economy in mid-2020. However, a rapid reversal is now apparent in the final quarter of 2020, largely the result of highly effective fiscal stimulus directed toward the housing sector. Consequently, much-needed cyclical earnings relief is afoot for the building and construction materials sector. However, equity markets have already spotted the impending inflection point in construction activity and investor optimism abounds once more. With housing-exposed stock prices already incorporating the sector's imminent earnings recovery, we recommend investors look elsewhere in their search for value as the sector is likely to underperform in 2021. For further detail regarding our 2021 outlook on Australian housing, please see our report “Imminent Recovery Is Overbuilt Into Housing Exposed Stock Prices” dated Dec. 10, 2020.

We make no change to earnings estimates or to our AUD 4.20 per share fair value estimate for Reliance Worldwide, despite strong first-quarter fiscal 2021 Americas sales. Elevated demand in big-box retail and specialty hardware distribution channels has continued into early fiscal 2021 for Reliance’s largest segment which accounts for approximately 45% of group operating income. Heightened DIY home improvement activity continues as a theme of the coronavirus pandemic to-date in the U.S., stimulating strong inventory stocking of Reliance’s behind-the-wall plumbing fittings range in these distribution channels. Restocking in the wholesale channel also contributed to the approximate 22% growth in first-quarter Americas sales. Elsewhere, Reliance’s first-quarter sales in Europe, Middle East and Africa, and Asia-Pacific tracked our full-year expectations. After rallying strongly in response to Reliance’s first-quarter fiscal 2021 trading update, shares in the no-moat name screen as fairly valued.

We’re positive on Reliance’s strategy to build upon its innovative PTC fittings position through continued investment in product development, supplemented by acquisitions of innovative plumbing system technologies. We believe this strategic focus provides Reliance with the best opportunity to generate shareholder value long-term. To this end, Reliance spent USD 13.0 million or 1.6% of net sales on product development. The alternative business model available to Reliance would be to dramatically reduce spending on new product development and become a commodity plumbing system manufacturer that brings to market generic versions of plumbing systems. But with cost advantages in raw materials procurement difficult to come by, even for those with superior manufacturing scale, we view such a business model as inferior to the innovator model.

As we anticipated, Reliance Worldwide’s exposure to inelastic demand from repair and maintenance plumbing work drove a resilient fiscal 2020 result despite the coronavirus pandemic. Group EBITDA of AUD 251 million tracked our full-year estimate of AUD 253 million. Europe, Middle East, and Africa segment earnings were substantially affected by a government-imposed lockdown in the United Kingdom during the second half of the year. However, Reliance’s Americas segment offset that weakness, with a strong second-half result driven by the retail channel. Some of this second-half strength in U.S. sales is unlikely to repeat in fiscal 2021. Nonetheless, we expect a largely flat fiscal 2021 result for Reliance owing to the resilience of demand for Reliance’s behind-the-wall plumbing fittings from essential repair and maintenance plumbing work. We forecast flat group EBITDA of AUD 251 million and expect earnings growth to resume from fiscal 2022. Long term, we continue to forecast strong secular growth for the no-moat name, with the continued growth of Reliance’s push-to-connect plumbing fittings franchise to deliver a largely unchanged five-year operating income CAGR of approximately 12%. Shares in Reliance screen attractively, trading at an approximate 20% discount to our unchanged AUD 4.20 per share fair value estimate.

We retain our optimism for no-moat Reliance Worldwide’s long-term growth prospects despite a softer than anticipated start to fiscal 2020. First-half fiscal 2020 Americas sales were a major disappointment while the segment’s operating margins also underwhelmed. Accordingly, we’ve reduced our fiscal 2020 EBITDA forecast by 10% to AUD 247 million, excluding the impact of new operating lease accounting standards. While growth is proving elusive in fiscal 2020, Reliance’s market-leading push-to-connect, or PTC, plumbing fitting franchise retains a substantial, long-term disruptive growth profile in North American and European behind-the-wall plumbing fitting markets. Therefore, we continue to forecast a largely unchanged 10-year EBIT CAGR of circa 10% and retain our fair value estimate of AUD 4.20 per share. Investors sent Reliance’s shares sharply lower after delivery of the soft first-half result and Reliance’s shares screen as undervalued, trading at an approximate 18% discount to our fair value estimate.

Reliance’s strategy aims to build on its innovative PTC fittings position through continued investment in product development, supplemented by acquisitions of innovative plumbing system technologies. In fiscal 2018, Reliance spent USD 13.8 million or 2.3% of net sales on product development. We view the strategy positively which we think provides Reliance with the best opportunity to generate economic profits prospectively. The alternative business model available to Reliance would be to dramatically reduce spending on new product development and become a commodity plumbing system manufacturer that brings to market generic versions of plumbing systems once associated intellectual property protection has ceased. But with cost advantages in raw materials procurement largely unavailable to plumbing industry incumbents, even for those with superior manufacturing scale, we view such a business model as inferior to the innovator model.

Having attended U.S. investor days for narrow-moat James Hardie, no-moat BlueScope Steel, no-moat Reliance Worldwide, and no-moat Boral in September, we came away confident of secular trends which provide avenues for long-term growth for each of their respective U.S. operations. We note the recent spate of weak U.S. macroeconomic data that calls into question the durability of the U.S. economic expansion--now the longest in U.S. history. Nonetheless, we remain upbeat and believe the business cycle's peak is still years away.

No-moat Reliance Worldwide’s delivery of EBITDA of AUD 262 million in fiscal 2019 aligned with our forecast for AUD 260 million and accords with our unchanged view that Reliance’s secular growth story still has a long runway ahead of it. The continuation of gains in category share for push-to-connect, or PTC, plumbing fittings will deliver further substantial earnings growth. We anticipate operating income will grow at a robust 10-year CAGR of 10% as a consequence. In fiscal 2020, we forecast net income to increase by 16% to AUD 154 million, near the midpoint of guidance. We maintain our fair value estimate of AUD 4.20 with shares trading at a significant discount of 18% to our valuation.

Reliance’s strategy aims to build on its innovative PTC fittings position through continued investment in product development, supplemented by acquisitions of innovative plumbing system technologies. In fiscal 2018, Reliance spent USD 13.8 million or 2.3% of net sales on product development. We view the strategy positively which we think provides Reliance with the best opportunity to generate economic profits prospectively. The alternative business model available to Reliance would be to dramatically reduce spending on new product development and become a commodity plumbing system manufacturer that brings to market generic versions of plumbing systems once associated intellectual property protection has ceased. But with cost advantages in raw materials procurement largely unavailable to plumbing industry incumbents, even for those with superior manufacturing scale, we view such a business model as inferior to the innovator model.

We raise our fair value estimate for no-moat Reliance Worldwide by 17% to AUD 4.20 per share following a transfer of covering analyst. Much of the revision in our fair value estimate relates to our revised cost of capital assumption, which we now estimate at 8.3%, down from the prior 9.9%. A reassessment of operating leverage in Reliance’s cost structure has resulted in our revision. We now anticipate a five-year sales CAGR of 14%, inclusive of John Guest revenues in fiscal 2019, down from a prior 16%. Following recent share price weakness, value has emerged in Reliance, with shares trading at an approximate 15% discount to our fair value estimate.