CODGF - Saint-Gobain Benefits From Specialty Position And Renovations

2023-05-31 14:57:11 ET

Summary

• Despite sharp declines in new construction, Gobain is managing excellent operating profit and sales growth thanks to resilience in renovation markets.
• Even markets highly affected by the energy crisis in Europe are managing thanks to low-energy consumption initiatives by governments supporting sustainable renovation.
• Specialty positioning is allowing Gobain's pricing to outrun raw material price increases.
• On the debt side, substantial portfolio rotation has helped net debt decline, and the debt is hedged, mostly with long-term contracts, eliminating IR risk.
• The PE multiple prices in a late-cycle company, and while some earnings declines are reasonable to expect, there is downside protection in green initiatives and recovering APAC.

Saint-Gobain ( CODGF ) delivers excellent performance despite its markets being directly in the way of higher interest costs and a real estate slowdown. While new construction markets have indeed taken a hit, regulatory backstops that support an already more resilient renovation market as well as Gobain's specialty positioning in building products keeps its profits growing. Asset rotations help deleveraging, and IR risks are limited thanks to lots of longer-term interest rate hedges. While underlying growth is faltering, the PE multiple reflects a troubled market and probably demonstrates overshot expectations as far as earnings declines go.

Q1 Breakdown

Organic growth is at 4.7% . Volumes have seen pretty meaningful declines, but prices are offsetting that across its markets. Volume declines are being driven by new construction declines, but there is business momentum in renovation markets (around 50% of sales), including light building products as well as recently acquired product lines like those from GCP, which would factor into the 'structure' component of the headline growth breakdown, leading to the 3.3% figure compared to organic growth thanks to disposals and FX.

Asset rotations, which have cycled a third of the sales since 2018, offset some of the recent acquisitions in their contribution to run-rate sales growth.

Renovation strength as it associates to government initiatives is best observed in Southern Europe, where all these markets are being supported by various initiatives to support sustainable renovation to reduce household passive energy consumption like EcoBonus. Volume declines have been more limited in these markets despite exposure to energy issues.

Northern Europe's exposure to inflationary energy pressures is a bit too much pressure on households to make the renovation component sufficient enough to stop overall organic declines in sales. This is the only organically declining market for Gobain in terms of sales, even when accounting for the substantial structural component. The fact that disposals are concentrated in this area does tell markets something about how Gobain views the future of business in this geography.

The GCP consolidation is the most evident in the NA segment for the headline growth evolution. But even without that, and a more bubbly construction market in 2021 and 2022, organic growth would still be achieved.

APAC is one of the regions with the most sustainable growth. It also has 50% higher margins than the majority of Gobain's European businesses. They are supported by secular growth from India, whose demographics favour Gobain's markets, as well as the lack of a credit-intensive economy to limit real estate cycles. Moreover, there is the recovery of China in Q1 that has helped deliver some results.

Finally, the HPS automotive exposure is being held up by pent-up demand for automotive. We are concerned about how the results will evolve once pent-up demand from the pandemic is exhausted.

Bottom Line

The main concern, besides new construction which should continue to go lower, would be the HPS segment, whose contribution to earnings is quite substantial and whose risks are higher with respect to a higher interest rate environment where cars are a credit-fueled market.

Besides that, the fundamental picture looks rather predictable. Earnings should start to see pressure as inflation fails to support further price action and sales support by Gobain, but declines shouldn't be too dramatic. The 9x PE multiple implies markets don't foresee a lot of growth in earnings. As of the Q1 update, there isn't disclosure on margins or on EPS.

Moreover, FCF generation has been quite high, and a calming environment allows them to reduce their inventories. Asset rotations have likely also contributed to servicing net debt, where Gobain also benefits from the fact that interest rate risks are very limited by substantially long-term hedges, more than five years in contract duration. The higher interest rates should not factor into Gobain's results for some years.

Ultimately, this is an exposure levered to residential construction, but it should be pretty resilient relative to other less specialty building products companies, and the sustainability initiatives should continue to support their results. However, we'd still be underweight the whole sector.

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