Equity Strategy
24 January 2024
Cementing Returns
Removing James Hardie (JHX) -2% - Margins Peaking

James Hardie (JHX) has delivered impressive returns in the last 12 months (up ~93%). However, several factors keep us cautious over the next 12 months, and now is an opportune time to take profits.

The recent expansion of JHX's margins was largely driven by a confluence of tailwinds that now seem to be losing momentum. There is a risk that margins can not be sustained at current levels.

Figure 1: Margins in North America (largest segment) hit new highs this FY. We remain cautious on whether these levels are sustainable

Cost tailwinds fading: While the past two quarters saw lower pulp and freight costs supporting gross margins, future declines will be less substantial. Market expectations for further cost disinflation now look too optimistic.

Price lever nearing its limit: Management raised prices over the past year to offset volume declines. This strategy, however, has limited room to run before impacting volumes or requiring disproportionate marketing expenditure to maintain sales. Near-term price hikes may fall short of consensus.

Figure 2: Price growth moderates considerably over the next few years (average ~3%). Pre-pandemic price growth was ~2%

Rising SG&A headwinds: Consensus underestimates SG&A, particularly sales and marketing, which dipped during the pandemic but is now on the rise again. 

North American SG&A as a percentage of sales dipped to 13-14% post-pandemic; pre-pandemic levels were closer to 16-17%. 

Rate cuts might offer some organic volume growth, but not enough to reach the highs of FY21/22, at current SG&A levels, with rates normalising instead of plummeting. Consequently, marketing costs as a percentage of sales will likely need to exceed consensus.

Figure 3: JHX's projected volume growth may be challenging to achieve given current SG&A expenses

Upgrade Cycle Closer to the End

JHX’s earnings upgrade cycle looks closer to the end, pausing a key driver of JHX’s returns. Given expectations of cost disinflation and diminishing price leverage are now largely priced in, there is a reduced likelihood of earnings upgrades for JHX over the next 12 months. 

Valuation upside moderating

JHX has started to trade on a 12 month forward PE above its historical average and, while on a record margin, if margins are not sustained at current levels then the PE, via lower earnings, will edge higher. There is now less upside from a valuation perspective relative to other stocks in the portfolio.

Figure 4: JHX PE trades above its historical average

Macro improving but positive outlook priced in

Since November 2023, JHX shares have rallied by ~40%. While a portion of this meteoric rise can be attributed to improved earnings prospects – analysts have upgraded JHX’s earnings forecasts by 11% since then – the market, in our view, has already enthusiastically embraced much of the positive 2024 outlook (US rate cuts, resilient US economy), leaving less scope for further outperformance. 


IDP Education (IEL) +1% - Short Sighted Pessimism Creates Attractive Long-Term Buying

A few events have negatively impacted sentiment for IEL over the last 12 months.
Recent issues: 


Australia is tightening its immigration system over the next two years. Visa rules for students and low-skilled workers will be stricter, with students facing tougher English requirements and closer scrutiny for second visas. Reforms to Australia’s student visa policy aimed at curbing the number of ‘non-genuine’ international students have also impacted sentiment towards IDP Education (IEL)


Temporary cap imposed: Immigration Minister Marc Miller announced a 35% reduction in new student permits issued in 2024, down to 364,000 from the 560,000 issued in 2023. This aims to address concerns about the rapid influx of international students and ensure their quality education experience. 

Our views

While IEL will not be immune to the current regulatory crackdown, the share price reaction is overblown as:

  • IEL has a strong record of growth in different regulatory backdrops
  • IEL focuses on high quality students, which will be less impacted by the regulatory changes
  • This crackdown is likely temporary
  • IEL's long term structural story is firmly intact (as discussed below)

Long-Term Story Firmly Intact

The Asian middle class will drive structural growth in the coming decades

Despite near-term adjustments to visa policies, the structural pillars underpinning international education remain robust. IEL is well-positioned for long-term double-digit earnings growth, propelled by demographic tailwinds in key source markets, particularly India. 

With a burgeoning middle class exceeding 500 million individuals under 25, aspirations for overseas study and capacity constraints at Indian universities combine to create a potent driver of student placement growth in the coming decades. This demographic megatrend, coupled with the enduring popularity of international education, ensures IEL's continued trajectory towards sustained profitability.

Figure 5: The Indian middle class is expected to rise substantially over the next decade; IEL will be a key beneficiary of this growth

Fastlane ramping – platform for scale and higher margins

The old model: Student placements relied heavily on individual counsellors, limiting margin growth as student placement growth led to a higher headcount for IEL.

The new model: IEL’s online platform FastLane connects students and institutions, promising higher scalability and improved margins in the medium term as IEL can leverage the platform to drive placement growth.

Early traction: Though still in its early stages, the FastLane platform has seen impressive progress with a 5x increase in student offers (17,500 vs. 3,000) and a 32% rise in partner institutions (93 vs. 61) in just one year.

Figure 6: IEL’s margin expansion, coupled with steady revenue growth, is a key driver of the next leg of growth, supported by FastLane

Attractive Valuation for the Growth

IEL looks attractive and a good buying opportunity in an environment that seems like peak pessimism and with a strong structural growth story that could last for decades. On a 12 month forward PE of ~30x and EPS CAGR of 20% (FY1-FY3), the stock looks well priced considering the growth outlook. 

Figure 7: IEL valuation looks attractive considering the growth expected

Adding to Worley (WOR) +0.5% – Pullback Creates Discounted Buying Opportunity

Worley (WOR) has de-rated after the company announced it was unable to resolve arbitration relating to historic unpaid receivables by a state-owned enterprise in Ecuador. The unresolved contract is recorded as a non-current liability on WOR’s balance sheet, and is worth $58m on a net basis. 

WOR has been oversold following this news in our view, considering:

  • Immaterial financial impact – the potential write-down of the Ecuadorian contract on WOR’s balance sheet will have zero impact on WOR’s earnings, and will have only a modest impact on gearing (likely increasing ~3% to 25%) while WOR has ample equity ($5.6bn) to offset this. WOR will have to pay Ecuador $US6 million, which is immaterial to its FY24 results. There does not appear to be an ongoing investigation related to the matter. 
  • New management, stronger governance – the allegations of wrongdoing (which have been firmly rebuked by management) relate to work performed between 2011 and 2017. Since Chris Ashton became CEO in 2020, WOR has made meaningful strides in strengthening its corporate governance and the degree of conservatism it employs when taking on work. 
  • Reliable jurisdiction focus – in the last 5 years, WOR has become increasingly selective when it comes to the customers and jurisdictions it works with. We note the vast majority of WOR’s revenues and work backlog is from highly reliable jurisdictions with its major projects being concentrated in North America, Western Europe, and the Asia Pacific with blue-chip partners. WOR has not worked in Ecuador since 2017. 
Figure 8: Major project case studies - WOR’s work backlog is focused on blue chip partners in reliable jurisdictions
Strategic area Location Major Project - Case Study
Low-carbon energy / Solar and energy storage Australia Supporting RayGen, an Australian technology provider, with their plans to build a utlity-scale, grid-connected solar plant with a world-leading GWh-scale storage capacity in South Australia.
Low-carbon energy / Hydrogen Australia Delivering a study for Cadent Gas, as part of the East Coast Hydrogen Project, to understand how to transition natural gas supply into hydrogen, including sizing and routing of a pipeline that is to be converted from gas to hydrogen service.
Low-carbon energy / Integrated gas USA WOR has recured a reimbursable EPC (engineering, procurement and construction) contract for Venture Global’s Calcasieu Pass 2 LNG export facility in Louisiana, USA.
Conventional energy / Carbon capture UK Has been awarded a FEED (front-end engineering and design) contract by SSE Thermal and Equinor for a new low-carbon power station in Peterhead, UK.
Low-carbon energy / Carbon capture USA Signed the EPC (engineering, procurement and construction) contract for Stratos', Occidental’s and 1PointFive’s first direct air capture plant currently under construction in Texas.
Conventional energy / Upstream USA Providing the engineering and design services for the Sparta project, a floating production development approximately 270 kilometers off the Louisiana coast.
Chemicals & fuels / Chemicals USA Providing FEED services to expand Shell’s linear alpha olefins (LAO) capacity in the US Gulf Coast.
Chemicals & fuels / Low-carbon fuels Australia Supporting BP on the Kwinana, Australia refinery conversion to produce sustainable aviation fuel (SAF) and renewable diesel (HVO).
Resources / Low-carbon fertilizers UK WOR has been awarded the program management agreement (PMA) for the entire scope of the Woodsmith Project - a unique development comprising a mine site south of Whitby in North Yorkshire, with a 37-kilometer tunnel to transport a naturally occurring mineral, polyhalite, to processing and shipping facilities in Teesside.
Resources / Energy transition materials Mongolia Supporting the reccomencement of production at Oyu Tolgoi, which contains one of the world’s largest known copper-gold resources.
Resources / Water stewardship Morocco Delivering a fast-tracked desalination solution for OCP, the world’s largest supplier of mined phosphate fertilizer products, to deliver their industrial water needs for the Safi and Jorf Lasfar sites and drinking water for surrounding communities.
Resources / Bioviersity Canada Building large-scale biodiversity for the Iona Island restoration project including developing preliminary designs for 10 foreshore ecological restoration projects.

Source: Worley.

Growth at a (even more) reasonable price

Following the recent correction in its share price (accompanied by no changes to forward earnings expectations), WOR now trades on a 12-month forward PE of ~18x. This offers compelling value for a company compounding its earnings per share at ~20% p.a. over the next few years and considering the long runway for double-digit earnings growth from the energy transition.

Figure 9: WOR’s PE has de-rated materially since late 2023

Energy transition tailwinds remain strong

  • Riding two waves: WOR is winning contracts in both green energy and under-invested traditional energy sectors.
  • Double boost to earnings: More contracts (driven by decarbonisation spending) + higher margins.
  • Margins improving: Increased focus on high-margin sustainability services and strong engineering demand pushing up prices.
  • Quality uptick: Expanding margins and improved ROIC expected to enhance quality metrics over time.

Adding to Evolution Mining (EVN) - Downgrade due to Red Lake Overdone

Evolution Mining's (EVN) stock tumbled after it revised FY24 gold production guidance at its Red Lake mine in Canada, down from 170k to 125-130k ounces. While materials issues (now resolved) and a seismic event disrupted Red Lake, group guidance remains unchanged at 789k ounces (+/-5%). EVN management (on the result call) seemed positive that its key Cowal asset could compensate for Red Lake's shortfall in FY24.

Hitting target in 2H24 requires a substantial production ramp-up, which raises uncertainty. However, consensus estimates are cautious at 743.5k ounces, implying the market anticipates a slight miss even before the Red Lake revision.

The recent sell-off seems excessive, presenting a potentially attractive buying opportunity in our view.

EVN remains the most cash generative gold miner

Even with conservative consensus expectations following the Red Lake production downgrade, EVN is still set to be comfortably the most cash generative large/mid cap gold miner over the medium-term with a free cash flow yield of 11.3% in FY25, compared to Newmont Gold at 7.5% and Northern Star at 6.2%.

Figure 10: EVN offers the best value on a free cash flow yield basis

Remain constructive gold as rate cuts loom

Over the medium-term, gold should be supported by lower real yields in our view, with multiple rate cuts by the US Federal Reserve likely this calendar year which should support higher gold spot prices. EVN has high quality assets and is now starting to generate significant cash flow from its NSW gold asset, Cowal, and from its QLD gold-copper asset, Ernest Henry. We expect group production and cash to improve markedly over the next half. 

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Written by

Rob Crookston, Equity Strategist

Rob is an experienced research analyst with a background in both equity strategy and macroeconomics. He has a strong knowledge of equity strategy, asset allocation, and financial and econometric modelling.

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