GWA group – Finding value in the midst of share price uncertainty

16TH OCT, 23

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Roger Montgomery

Montgomery Investment Management

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Back in February 2020, and just before COVID-19 sent the world into a tailspin, GWA (ASX:GWA) shares were on a high, trading at nearly $4 each. Today, shares in the small cap building materials company and distributor of Caroma, Clark and Dorf bathroom and kitchen accessories, tapware and sanitary ware are trading just below $2, a decline of just over 50 per cent.

It has left many investors scratching their heads and asking is now the right time to invest in GWA?

GWA recently showcased its financial year 2023 (FY23) results, and for some analysts they were impressive. But despite robust cash flow and a commendable dividend, the company's share price, puzzlingly, now trades below its pre-result level.

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This dichotomy intensified when, post its FY23 announcement, the share price surged, rising from $1.84 to $2.17 between August 8 and 15, only to have declined again by 17 per cent since. Barrenjoey’s analysts speculate the sell-off could be due to a fund manager losing a mandate. Of course, if the dip isn’t related to the performance of the business, it will prove temporary, thus proving to be an astute buying opportunity.

In the company’s FY23 results presentation, GWA noted a 1.6 per cent decline in full year revenue and a 6.6 per cent decline in normalised net profit after tax. They don’t sound compelling but the company’s response to slowing market dynamics resulted in “improved earnings before interest and tax (EBIT) and EBIT margin in H2”, and “improved cash flow from operations and free cash flow with a cash conversion ratio of 112 per cent”.

Meanwhile, GWA’s current trading metrics, like 10x one-year forward price earnings (P/E) and 8x EV/EBIT multiple, make it good ‘value’, especially when coupled with a dividend yield that’s tipping over seven per cent.

Meanwhile, it’s the improving outlook that appears to be ignored by the share price malaise.

The FY23 result presentation from the company shone a light on several forward-looking statements that appear to be more optimistic than the company’s previous trading update following the 2023 half-year results. The commercial sector has seen “increased demand’, which Barrenjoey analysts suggest is a key hint that conditions have improved from six months ago when the company observed “continued demand”.

Barrenjoey also believe there’s a clue in the outlook for GWA’s residential business. The company noted “solid level of completions to continue into 1H FY24”. This compares to the first half statement; “momentum expected to continue”. A new sentence was also added to the presentation; “Increasing activity in multi-residential, social and affordable housing and build to rent”.

Furthermore, management's innovative strategy, aptly named "Win the Plumber," is already showing promise and gaining momentum, highlighting the company’s drive for continuous evolution and growth.

Back at the end of May this year, when the share price was $1.80, broker JP Morgan initiated coverage on GWA, saying, “We initiate coverage on GWA Group with an Overweight rating and a May-24 price target of A$2.25. We see upside to both earnings … and GWA’s multiple, given very low expectations at this stage in the cycle. Consensus is only factoring in 2 per cent EBIT growth in FY24e despite moving into a less disrupted operating environment in FY24e. We expect higher-margin commercial work to recover off [sic] pandemic lows, and strong execution will see GWA maintain prices ahead of cost inflation. We see destocking risks factored into the share price at current levels, at an undemanding circa 10x FY24e PER and 8 per cent dividend yield. GWA is the cheapest building materials company under coverage.”

There’s also a combination of positive factors highlighted by various analysts including a staggering cash flow conversion rate at 114 per cent, an improved and robust balance sheet, boasting 1.6x gearing, unwavering EBIT and EBIT margin in H2, and earnings projections that are in lockstep with the consensus estimates.

We recently wrote about Australia’s residential construction shortfall which will inevitably support prices for high-density residential. In turn, this will lead to another construction boom, and that should translate into another boom in demand for GWA’s products.

Residential and multi-residential markets are expected to be key revenue drivers in the coming years. And while renovations, which represent a significant chunk of GWA's revenue, appear to be a mixed bag at present, commercial prospects remain high and steady.

We also note GWA Chairman, Darryl McDonough purchased 30,000 shares at the start of August.

In a nutshell, GWA Group is an industry heavyweight whose golden years may be just around the corner. The stock market is typically impatient and will wait for evidence of rising momentum. For long-term investors however, the time to invest is when the outlook is darkest and few investors are even interested. And in the shorter term, if the company can achieve analysts’ improving forecasts for FY24, the company’s shares may not be offered any cheaper.