Has the market overlooked the blue-sky within Dulux's growth pipe-line?
A 29% lift in the first-half profit to 31 March 2016 reported by Dulux Group (ASX: DLX) did little to ignite the investor appetite in the paint company, with the market seemingly paying little attention to its plans to A) capitalise on robust projections for Australia's home renovations market, B) expand its paint factory or C) implement a turnaround strategy for the underperforming parts of its business.
First-half profit in Dulux – which owns brands like Cabot's, British Paints, Selleys, and Yates – rose to $63.7 million, up from $49.5 million in the same period the previous year, with revenue for the six months to March 31 up a very modest 1.7% to $851.1 million, and having failed to meet the market's expectations, the share price closed down 19 cents or 3% at $6.22.
But given the termination of its relationship with Mitre 10 in NZ, and destocking issues associated with Woolworth's basket-case hardware arm Masters, which carries Yates and Selleys products, the group's paints business held up pretty well.
EBIT within the group's market leading paints and coatings business rose 5% to $82.6 million with margins expanding 50 bps to 18.3%.
This demonstrates that it's largely immune to broader market conditions like interest rates, and new home building – which makes up around 15% of Dulux Group's revenue – with the home renovation market, plus trade channels and partnerships-with-retailers helping to grow its market share.
By comparison, garage doors EBIT was flat at $5.5 million and consumer and construction products EBIT slumped 6.8% to $12.3 million.
But recent initiatives aside, the company still plans to report a full-year 2015-2016 net profit, excluding one-off items above last year's $124.7 million, and one of the biggest drivers is expected to be the continuation of the recent uptick in the volume of renovations work in Australia, up 4.4% on the previous year.
With the home segment comprising around two thirds of the company's revenue, the home renovation market is expected to remain strong with more than 4.6 million detached homes across Australia – more than 20 years old – in varying need of repair and renovation.
Another driver of future growth is the company's plans to turnaround the fortunes of Alesco, the underperforming asset – comprising B&D garage doors, Parchem construction materials and Lincoln Sentry cabinets – it bought late in 2012 for $210 million, and CEO Patrick Houlihan is standing on his track-record at turning around other businesses during his 17 years at Dulux.
Then there's the group's proposed $165 million Melbourne paint factory – on-track for commission mid-2017 – and a new distribution centre in Sydney which provides the additional capacity to cater for growing demand.
Both projects are expected to be fully operational by FY2019, with costs to be spread out over the next three years: $25 million in Financial Year (FY) 2015 – the current financial year, $50 million in FY2016, and $55 million in FY2017, while $17 million will be been set aside for redundancies at the old production and distribution sites.
While the factory in Rocklea will continue to produce solvent-based paints like Dulux Super Enamel and some wood-care products, the new Melbourne factory will handle all water-based products going forward.
Dulux is also expecting to net around $30 million from the sale of its Glen Waverley site in coming years.
Once both projects are operational, they are also expected to contribute operating cost savings that more than outweigh the expected depreciation on the assets of $5 million annually.
Given that the developments are expected to deliver a neutral net profit after tax (NPAT) in 2019 – the first year of operation – and then deliver positive benefits thereafter, investors who like the stock's future upside should be taking a longer view.
Another upside that's yet to be factored into future earnings are plans to vacate the distribution site next to its Selleys production facilities, which frees up the land for future opportunities.
With buy, hold and sell recommendations on the stock, analysts clearly struggle to value the future upside within Dulux's growth pipeline.
While net-debt to equity remains high at 108.42%, the company has been making efforts to bring it down. Excellent earning per share (EPS) is forecast to decline, but it is still expected to grow; from $0.34 in 2016 to $0.36 in 2018.
Similarly, while Dulux's return on equity (ROE) has averaged 48.40% since 2009, it is still forecast to remain above 30% out to 2018.
Equally encouraging, the stock's dividend yield is expected to be up around 4% by 2018.
Based on a price to earnings multiple of 18.6x – sector average 15x – a 26% premium to its intrinsic value, and a share price that's close to its peak of $6.70 earlier this year, the stock does appear to be fully priced.
But what the market struggles to quantify is the upside from future developments, which if all goes to plan will include a turnaround in the fortunes of Alesco businesses, and investors should watch out for future plans here. Similarly, watch closely for details on what plant expansion plans will do to net-debt to equity.
Believers in the stock's long-term upside should look for a more attractive entry point and buy on any future corrections.