Ceasing on GWA

Building fixtures and fittings supplier GWA has shown signs that its market share is stabilising after a weak earnings downgrade in November last year. The share price is up nearly 30 per cent since the recent half-year result, from $1.80 to $2.30.

We are maintaining our hold recommendation, but selling the stock from our Growth First model portfolio. The reason for this is that although there doesn't appear to be much downside, the growth thesis is not compelling enough to be one of our key portfolio holdings. Further, in the current weak market conditions, we prefer to increase our cash position to buy other quality growth stocks that may get sold down.

The stock is currently supported by a management buy-back and an approximate six per cent yield. The $30 million buy-back is nearly complete, which will remove some buying support. The dividend looks sustainable given the low payout ratio (40 per cent), strong balance sheet, interest cover and minimal capital requirements.

The company is trying to execute a re-structure that has involved the sale of non-core assets, and cost-out initiatives. Progress has been slower than expected, with a loss of volumes last year, and cost issues blamed on currency impacts from offshore manufacturing. The timing to shift manufacturing offshore wasn't great, given the decline in the Australian dollar since this decision.

GWA is a late cycle play on the housing construction market, as explained earlier in the year.  Although this currently places GWA in a better position than other building materials companies such as Boral (BLD), CSR (CSR), and Adelaide Brighton (ABC), the cyclical housing construction cycle is likely to peak at some stage this year.

This cycle has included a far greater composition of apartments, a negative for GWA as because products are more in demand from houses. GWA is also highly exposed to the renovation market, which Bunnings, Reece and Dulux have all reported is in good shape. But the good conditions won't last forever, and as such it is a risk for the company that it hasn't been able to achieve higher growth during positive market conditions. After the housing construction market peaks, GWA is likely to continue operating in strong market conditions for up to 12 months. But then after this, there is significant downside earnings risk if the housing cycle was to weaken sharply.

Management is planning price hikes to partly offset negative currency cost impacts. Given the loss of volumes last year, the price hikes could trigger further market share losses. But corporate costs have been reduced, and there are further cost-out opportunities.

The stock is not expensive on a FY16 PE of 13. But given the risk to management's ability to execute its restructure, the cyclical nature of earnings and fact we are towards the end of the housing construction cycle we prefer to focus our attention elsewhere. As such we will be ceasing coverage of GWA, with a final hold recommendation and $2.34 valuation.