Fitch Affirms James Hardie’s IDR at ‘BBB-‘; Outlook Stable
By Business Wire News
Fitch Ratings has affirmed the following ratings for James Hardie:
James Hardie International Group Limited
–Long-term Issuer Default Rating (IDR) at ‘BBB-‘.
James Hardie Building Products Inc. (JHBP)
–Long-term IDR at ‘BBB-‘.
James Hardie International Finance Limited (JHIFL)
–Long-term IDR at ‘BBB-‘;
–Senior unsecured notes at ‘BBB-‘.
Fitch has also assigned a ‘BBB-‘ rating to the company’s $500 million unsecured revolving credit facility maturing on Dec. 10, 2020. The borrowers under the credit facility are JHIFL and JHBP. This facility replaces the company’s bilateral bank credit facilities (totalling $590 million with maturities ranging from March 2016 to May 2019).
The Rating Outlook is Stable.
KEY RATING DRIVERS
The ratings for James Hardie reflect the company’s dominant market position within the fibre cement industry, relatively diversified geographic and end-market diversity, and conservative financial strategy. Risks include the cyclicality of the company’s end markets, somewhat aggressive growth strategy, some customer concentration and exposure to asbestos liabilities. The Stable Outlook reflects Fitch’s expectation that the company’s end-markets within the U.S. will continue to improve during 2016.
LEADING MARKET POSITION
James Hardie is a world leader in manufacturing fibre cement siding and backerboard. Based on net sales, the company believes that it is the largest manufacturer of fibre cement products and systems for internal and external building construction applications in the U.S., Australia, New Zealand and the Philippines. Within the U.S., James Hardie believes that it has approximately 90% market share in the fibre cement exterior siding segment. However, the company competes with alternative siding products, including vinyl and wood siding as well as bricks, stucco and engineered wood products. Based on census data, fibre cement accounted for about 18% of the exterior siding material for new single-family homes completed during calendar year 2014 (from about 9% in 2005). James Hardie has a roughly 16% market share of the U.S. exterior siding sector during FY15 (ending March 31, 2015).
Fitch believes that this leadership position provides James Hardie with competitive advantages such as economies of scale, access to a wider range of distribution channels and a strong platform to execute its growth initiatives and geographic expansion.
James Hardie’s growth initiative revolves around the execution of its 35/90 strategy, which, over the long term, aims to increase fibre cement’s share of the total U.S. sidings market to approximately 35% (from 18% currently) and to maintain the company’s roughly 90% share of fibre cement sales.
James Hardie had previously undertaken an aggressive capacity expansion plan, expecting to spend, on average, approximately $200 million annually on capex during fiscal years 2015 – 2017. These capacity expansions were based on management’s growth expectations as well as strategy to capture a larger share of the overall residential exterior siding market. During fiscal year 2015 (ending March 31, 2015), the company spent $276 million on capex (16.7% of revenues), which included the purchase of certain land and buildings for future expansions. By comparison, the company spent $115.4 million on capex in fiscal year 2014 and $61.1 million in fiscal year 2013. The U.S. housing market has not been as robust as what management had expected and the company has scaled back on planned capital expenditures relative to earlier expectations. James Hardie spent $42.4 million on capex during the first half of 2016. Fitch expects capex will be roughly 4% – 5% of revenues during FY16 and will approximate 7% – 9% in subsequent years.
Fitch was previously concerned that James Hardie was undertaking capacity expansion plans while its utilization rates in the U.S. remained low. For FY15, management estimates that the company’s capacity utilization across its plants was an average of 65% and 84% in the U.S. and Asia Pacific, respectively.
Fitch is encouraged that the company quickly scaled back its capacity expansion plans when demand growth was not as robust as previously anticipated. The company still expects planned capacity expansions in FY17 and FY18, although at a more gradual pace. Management believes that these capacity expansion initiatives will, over the long term, help the company achieve its 35/90 market share goals.
SHAREHOLDER FRIENDLY ACTIVITIES
The company expects to pay ordinary dividends within its defined payout ratio. James Hardie seeks to distribute between 50% – 70% of its earnings (net profit after taxes) in the form of ordinary dividends. The company did not pay ordinary dividends during FY10 and FY11 and paid $17.4 million in FY12, $188.5 million in FY13, $93 million in FY14 and $176.5 million in FY15. The company paid ordinary dividends of $114 million during the first half of FY16. In November 2015, the company announced an ordinary dividend of $0.09 per share payable in February 2016.
James Hardie paid special dividends totaling $106.1 million during FY14, $213.6 million during FY15 and $92.8 million paid in 1H16. Management has indicated that it is unlikely that the company will continue to pay special dividends going forward. Management may also deploy excess cash for share repurchases. Through the first half of FY16, James Hardie repurchased $22.3 million of its stock. This compares to $9.1 million of share repurchases in FY15 and $22.1 million repurchased in FY14.
LIQUIDITY AND FREE CASH FLOW
As of Sept. 30, 2015, the company had cash of $83.6 million and $322 million of borrowing availability under its bilateral bank credit facilities (totalling $590 million with maturities ranging from March 2016 to May 2019). On Dec. 10, 2015, the company entered into a new $500 million syndicated unsecured revolving credit facility that matures on Dec. 10, 2020. The facility can be increased by up to $250 million (subject to additional commitments). This facility replaces the company’s existing bilateral bank credit facilities. Fitch believes that James Hardie will continue to have access to its revolving credit facility as the company has sufficient room under the revolver’s financial covenants. In February 2015, the company issued (for the first time) $325 million of 5.875% senior unsecured notes due 2023. Proceeds from the notes issuance were used to repay borrowings under its bilateral bank credit facilities.
The company generated negative $486.8 million of free cash flow (FCF: Cash flow from operations less capex and dividends [including special dividends]) during FY15. This included $213.6 million of special dividends, $176.2 million of ordinary dividends, $113 million of asbestos payments and $276.2 million of capital expenditures.
For the latest-12-month (LTM) period ending Sept. 30, 2015, the company generated negative $169.2 million of FCF (10.1% of revenues). Fitch expects the company will report negative FCF of about 5% – 6% of revenues during FY16 and FY17.
STRONG CREDIT METRICS
Leverage as measured by debt to EBITDA was 1.7x and FFO adjusted leverage was 2.6x for the Sept. 30, 2015 LTM period. Fitch expects debt to EBITDA will be roughly 1.5x at the end of FY16 (ending March 31, 2016) and 1.7x at the end of FY17. This is in line with management’s goal of managing net debt to EBITDA between 1.0x – 2.0x. FFO Adjusted leverage is projected to be 2.1x at the end of FY16 and 2.8x at the conclusion of FY17.
The company reported EBITDA to interest of 18x and FFO interest coverage of 13.6x for the LTM ending Sept. 30, 2015. Coverage ratios are projected to be strong, with EBITDA to interest coverage remaining above 10x for FY16 and FY17. FFO interest coverage if forecast to be 9.8x and 7.6x for FY16 and FY17, respectively.
James Hardie is required to make payments to a special purpose fund that provides compensation for Australian asbestos-related personal injury and death claims for which certain former James Hardie companies are liable. In 2006, the company entered into an Amended and Restated Final Funding Agreement (AFFA) with the Australian government related to these asbestos claims. The AFFA requires James Hardie to contribute up to 35% of its annual Free Cash Flow (defined as operating cash flow) to the Asbestos Injuries Compensation Fund (AICF).
The AICF was formed to implement and administer the agreement (AFFA) between James Hardie and the Australian government. This commitment extends to 2045, with recurring automatic ten year extension periods, unless the parties agree to a final payment. Between 2007 and 2015, James Hardie has contributed A$799.2 million to the AICF, including A$81.1 million ($62.8 million) paid on July 1, 2015.
Although James Hardie has no legal ownership of the AICF, it consolidates the financials of the AICF for financial reporting purposes. The consolidation results in a separate accounting recognition of the asbestos liability that is not, in Fitch’s view, a reflection of James Hardie’s annual funding obligation. As of Sept. 30, 2015, James Hardie reported asbestos liabilities of $1.26 billion.
The asbestos liability is based on the actuarial estimate of future asbestos related cash flows as prepared on an annual basis by KPMG Australia. If the AICF does not have sufficient funds to pay all claims as provided for in the AFFA, it may either have to borrow funds under an existing stand-by facility provided by the New South Wales Government and/or consider rationing the payment of claims.
Fitch does not include the asbestos liability as debt in calculating James Hardie’s financial ratios. However, Fitch subtracts the actual annual cash outflow (paid to the AICF) in its calculation of recurring EBITDA. James Hardie’s FFO and FCF measures are also reduced by the asbestos cash payments. Fitch believes that this method of treating the liability and the cash outflow best represents the risk associated with this contingent liability.
GEOGRAPHIC AND END-MARKET DIVERSITY
The sale of fibre cement products in the U.S. accounted for 75%, 73% and 70% of James Hardie’s worldwide net sales for fiscal years 2015 (ending March 31), 2014 and 2013, respectively. The company’s activities in the U.S. are also diversified with manufacturing capacity across the country. During FY15, management estimates that 55% of its U.S. siding volumes was directed to the repair and remodel segment, with the remaining 45% to the new construction market. Additionally, exterior products accounted for about 75% of sales while interior products represented roughly 25%.
James Hardie has two major customers that individually account for over 10% of the company’s net sales in one or all of the past three fiscal years. During FY15, the largest customer represented 10.7% of sales while the second largest customer accounted for 8.7% of net sales.
HOUSING RECOVERY CONTINUES
The company markets its products to the construction industry. Within the U.S., James Hardie markets its products primarily to the residential construction market. New housing metrics increased in 2014 while existing home sales fell during the year largely due to fewer distressed homes for sale and limited inventory.
Housing activity has ratcheted up more sharply in 2015 with the support of a steadily growing economy throughout the year. Total housing starts grew 10.8% during 2015. Through the first 11 months of 2015, existing home sales grew 6.4%, while new home sales improved 14.5% versus the same period last year. Fitch projects existing home sales will advance 5.5% while new home sales should grow 14.4% in 2015.
Sparked by a slightly faster growing economy, the housing recovery is expected to continue in 2016. Although interest rates are likely to be higher, a more robust economy, healthy job creation and further moderation in lending standards should stimulate housing activity. Existing home volume growth should again be midsingle digit (+4%). New home sales should increase 14.6%, while total housing starts expand 9.6% during 2016.
Home improvement spending is expanding at a steady pace. Robust housing turnover in 2015 and gains in home prices during 2013-2015, combined with growing strength in the economy and falling unemployment, should positively influence remodelling spending this year, particularly for discretionary home improvement expenditures. Fitch expects home improvement spending will grow approximately 4.5% in 2015 and 2016.
Fitch’s key assumptions within the rating case for James Hardie include:
–U.S. housing starts expand 9.6% during 2016, while new home sales increase 14.6% and existing home sales improve 4%;
–U.S. home improvement spending grows 4.5% in 2016;
–Revenues grow low single-digits during FY16 and mid-single-digits during FY17;
–Debt to EBITDA settles between 1.5x and 1.7x during FY16-FY17 and EBITDA to interest coverage is above 10x during FY16-FY17;
–Negative FCF margin of 5%-6% during FY16-FY17 (including 35% of previous year’s cash flow from operations utilized for asbestos payments).
Future ratings and Outlooks will be influenced by broad economic and construction market trends, as well as company specific activity, particularly free cash flow trends and liquidity.
Positive rating actions may be considered in the next 12-18 months if the company continues to adhere to a disciplined capital allocation strategy and the company’s strong credit metrics are maintained, including debt to EBITDA consistently below 2x and interest coverage above 10x, and there is no material change in the company’s obligations to fund its asbestos liabilities.
Negative rating actions may be considered if there is a sustained erosion of profits and cash flows either due to weak residential construction activity and/or meaningful and continued loss of market share, and the company resumes an aggressive capital allocation strategy, leading to debt to EBITDA consistently above 3x and interest coverage sustained below 7x. Fitch will also review the ratings if there is a meaningful change in its obligations to fund its asbestos liabilities or if new, meaningful claims arise from other jurisdictions.
–James Hardie Industries plc (ASX: JHX) is the parent company domiciled in Ireland.
–James Hardie International Group Limited (JHIGL) — IDR rated ‘BBB-‘ — is a direct subsidiary of the parent company and is a guarantor of the revolving credit facility and the senior unsecured notes.
–James Hardie Building Products Inc. (JHBP) — IDR rated ‘BBB-‘ — is an indirect subsidiary of JHIGL and holds most of James Hardie’s U.S. manufacturing and sales operations. JHBP is co-borrower under the revolving credit facility and a guarantor of senior unsecured notes.
–James Hardie International Finance Limited (JHIFL) — IDR rated ‘BBB-‘ — is an indirect subsidiary of JHIGL and maintains James Hardie’s treasury function. JHIFL is the issuer of the senior unsecured notes and borrower under the revolving credit facility.
The rated entities above have the same IDRs based on the strong degree of linkage between the guarantors and the subsidiary borrower(s), including the downstream guarantees of JHIGL and JHBP.
The senior unsecured notes rank pari passu with James Hardie’s revolving credit facility. JHBP, which is a co-borrower under the revolving credit facility, is not a co-issuer on the senior unsecured notes but is a guarantor. The guarantee of the notes is a senior obligation of the guarantors (including JHBP), ranking pari passu in right of payment with all other senior obligations of the guarantors, including obligations under the bank credit facility.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Dodd-Frank Rating Information Disclosure Form
Robert Rulla, CPA
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
Sandro Scenga, +1 212-908-0278