This column has been bullish about residential property since January. It seemed a no-brainer: record low interest rates, low unemployment, and a new Federal government would boost confidence and encourage people to buy existing homes and, eventually, build new ones.
My focus was on stocks directly related to the residential property boom and financial services, notably Bank of Queensland (BOQ) and Suncorp because of high exposure to the improving South East Queensland property market. BOQ, in particular, looked a strong idea given its long underperformance relative to the big-four bank stocks.
Bell Potter Securities this week increased its BOQ price target from $10.80 to $11.40, against the current $10.88 share price. Bell Potter has called the bank well and, like me, is bullish about an East Coast property recovery and the potential for low rates and rising property prices and shares to boost confidence.
The broker wrote this week: “We believe BOQ will be able to exceed its stated 2015 targets. This is based on momentum from a higher exit Net Interest Margin in 2H13 (including declining price tension for term deposits and wholesale funding costs to peak in late 2013), further efficiencies and a more favourable Bad and Doubtful Debt outcome.”
Bell Potter’s view makes a lot of sense. However, I am not as bullish on a strong housing-construction recovery just yet, and prefer stocks with leverage to established property. A stronger-than-expected 10.8 per cent increase in building approvals across Australia in July, according to Australian Bureau of Statistics data, was encouraging, but many housing-related stocks have taken off well in advance, and current valuations may overestimate the speed of a housing-construction recovery.
An unemployment rate above 6 per cent in the next 12 months will be a headwind for first-home-buyer confidence and there may only be one more interest rate cut in November in this cycle, although much depends on the Australian dollar. A higher dollar would strengthen the case for two more rate cuts to help export sectors in the next 12 months.
A less considered factor – terrible infrastructure in capital-city outer suburbs – could also play a big role in this housing-construction cycle. Younger first-home buyers might prefer to wait longer and save a bigger deposit for an established home closer to town, rather than spend years of their lives on congested roads.
For now, I’ll stick with second-tier banks that help finance the property boom and have more scope to outperform after years of lagging behind big-bank stocks, and property stocks leveraged to established home sales in capital cities.
Companies exposed to stronger renovation activity and home furnishings should also benefit as those who buy established homes are motivated to improve them, and those who cannot afford to upgrade – due to higher prices – renovate rather than move.
The obvious beneficiaries are Bunnings and Masters, owned by Wesfarmers and Woolworths respectively, but those stocks are retail plays. This column also favourably mentioned furniture stock Nick Scali in early 2013. Its one-year total shareholder return (including dividends) is 117 per cent.
Better leverage to the do-it-yourself renovations sector comes via plumbing group Reece Australia, paint provider DuluxGroup, and bathroom products manufacturer GWA Group. Each is a quality company, but after strong share-price gains in the past 12 months looks fully valued.
Of the three, DuluxGroup offers the best exposure to the DIY renovations trends given its paint and Selleys Yates businesses, and should have a spot on portfolio watchlists. It could be worth buying during any sharemarket pullback or correction, but would need to fall well below $4 to be near value territory.
Micro-cap Gale Pacific is also worth further investigation. It makes and distributes screening, shading and home-improvement products for Australia, the US, China and the Middle East for consumers and industrial markets. Retail brands include Coolaroo products such as gazebos and shade sails, Riva window furnishings, Highgrove Glass Solutions and the Zone range of home hardware products.
Gale had a reputation for erractic financial performance before the GFC, but has lifted its consistency and quality, off a low base, in the past few years.
Sales rose 9 per cent to $120 million in 2012-13, earnings before interest and tax lifted 4 per cent to $12.9 million, and after-tax net profit rose 7 per cent to a record $9.1 million. Importantly, net debt has fallen to a low $3.2 million and interest cover is 15 times. Net debt/equity was 72 per cent in 2006-07.
In a recent presentation, Gale Pacific said: “Trading conditions are expected to remain highly competitive in all markets. Retail conditions in Australasia are generally weak, but we are seeing improving consumer spending in the US and improving construction activity in the Middle East.
Gale has paid down debt, funded acquisitions from cash flow, and increased dividends in the past two years. Return on Equity (ROE) has doubled from a terrible 3.5 per cent in 2008-09 to almost 11 per cent in 2012-13 and should tick higher in the next few years. Rising ROE is a strong sign of improving corporate performance and often a precursor to a higher share price.
Gale appears to have made reasonable progress in a market characterised by weak demand, price pressure and highly competitive trading conditions. If those headwinds turn into tailwinds as housing construction improves and renovation activity increases, the company could lift ROE beyond 15 per cent in the next few years.
It has rallied from a 52-week low of 23 cents to as high as 38 cents, before retreating to 30 cents. Gale would be interesting around 25 cents, and far cheaper than most stocks leveraged to improving housing-construction and renovation cycles. A trailing yield of 9.1 per cent, 90 per cent franked, is another attraction.
As a thinly traded micro-cap stock, Gale suits experienced investors comfortable with higher risk.
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Tony Featherstone is a former managing editor of BRW and Shares magazines. The column does not imply any stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at September 25 2013.