Alex Milton, Principal and Co-Portfolio Manager
Longer term investment but some housing sector headwinds in the medium term
GWA Group is in our Smaller Companies Fund and is one of our exposures to the housing construction and renovation market.
Capitalised at $780m, GWA is a major Australian owner and supplier of bathroom and kitchen brands such as Caroma, Dorf, Clark, Fowler and Stylus with a 25-year history as a publicly listed company. Key product lines include toilets, taps, sinks and tubs.
We thought it would be worthwhile selecting GWA as our stock in focus for the quarter because of the expected downturn in housing construction and renovation activity after what has been a strong few years for the industry.
While we fully expect to see earnings impacted as housing activity rolls off the peak, we will maintain a position in the fund given its solid industry position, growth initiatives and confidence in management’s ability to deliver on its longer-term strategies.
While precise industry data is not readily available, we note GWA comments it has been growing ahead of market implying some share gains. In addition, management are targeting some upside in segments where they are currently not as well represented including the commercial and residential replacement and renovation segments. We will be monitoring the extent gains in market share in these under penetrated sectors mitigate some of the broader cyclical downturn.
Strongly positioned to face cyclical slowdown
We consider the company well positioned ahead of the downturn for two key reasons.
First, after having embarked on, and subsequently unwound, numerous iterations of M&A since the early nineties undertaken originally for the purposes of earning diversification and growth, GWA is now a focussed water solutions business.
Success from diversification was always patchy at best. Selling doors and access products (locks etc), garage roller doors and hot water systems that go into the same home as toilets and taps may seem intuitive but the manufacturing, sales proposition, product cycle and product specific “know how” varies considerably and presents numerous challenges. After a number of divestments, GWA is now a more focussed group with an aligned product suite specifically targeting the water solutions segment.
Second, GWA management has always acknowledged manufacturing in-house in a relatively high cost country was never going to be realistic longer term given competition in a more globalised world. With manufacturing now outsourced to offshore partners (in Asia and Europe), management effort can now be better channelled into brand management, high level supply chain management and customer service.
As a result, GWA has become a less capital intensive business that can concentrate on the end user or retailer without the burden of running the factory. Following the exit of local manufacturing, GWA’s property plant and equipment on the balance sheet has fallen to $15m (at 30 June FY18) from nearly $120m at the beginning of the decade. Return on both assets and equity now sits in the mid-teens range.
In addition, funds raised from divestments and lower capital intensity in the business has seen financial debt decline nearly 50% over the same period.
A major consideration for us for any company we invest in is management and its ability to execute on stated plans and strategy.
Pleasingly, while some of the initiatives highlighted above have been underway for a long time, we have seen further substantial improvements across the board since new management arrived in early 2016. To highlight a few:
- Reinvigoration of the Caroma brand and increased spend on product innovation.
- Focus on improving relationships with trade retailers and importantly showing them that GWA has a suite of products and level of service that both tradies and consumers can relate to thereby making it worthwhile for retailers to engage with GWA.
- Improving back end supply chain and production systems and focusing on costs in order to maintain a high level of profitability and a strong balance sheet.
Growth initiatives despite slowing industry conditions
Further to these points, GWA stands to benefit from two other initiatives:
1) M&A, but this time focussed on core strategy – water solutions
Management has recently completed restructuring efforts to divest non-core businesses with the final piece being the sale of the Gainsborough doors and access business (announced in May last year) for $107m.
At the time of the sale management made the comment the transaction would allow the company to concentrate on its core water solutions markets being bathrooms and kitchens. For this reason, we were very comfortable with GWA’s decision (announced in December 2018) to acquire New Zeeland based, listed bathroom (showers and taps) company Methven for $134m. We note while the acquisition is subject to shareholder approval, the proposed transaction has the support of the board and its largest shareholder.
Including some synergy benefits expected from the integration, this acquisition will be earnings accretive for the group and further consolidate its position as a major water solutions provider to the Australian and New Zealand markets.
On our estimates, Methven adds approximately 16% to earnings before interest and tax and between 5-10% to earnings per share between now and 2021.
2) Water solutions with a technology twist
This initiative is longer term, but worth keeping an eye on. Management has commented a few times that commercial building managers have developed systems to monitor and control building access and security, air conditioning and lighting but little ability to monitor and efficiently control water flow in bathrooms.
Given water scarcity and the need for conservation is well understood the application of digital monitoring systems with building management system connectivity in a bathroom setting is something we believe will be in more demand over time.
We maintain the view GWA is a well managed business with a streamlined business unencumbered with non-core assets, has a strong balance sheet, good profitability ratios and earnings growth potential over time.
However, at the same time we recognise the industry is facing some headwinds after some strong years. That being the case, while maintaining a good sized investment we have taken some profits to mitigate the impact of any potential share price weakness in the short term with a view to potentially buying back at lower levels.