It’s a difficult time in the home improvement sector. Many investors have picked up splinters as the post-pandemic boom rapidly fell to a bust and share prices followed declining earnings.
After surging in lockdown, spending on home improvements and related construction products fell off a cliff as a worsening domestic landscape and rising interest rates took their toll on consumers’ finances and sector spending.
Being housebound due to lockdowns encouraged consumers to do home renovations or be more active in their gardens. The strong growth in the DIY (do-it-yourself) industry was driven mainly by the “essential business” status of home improvement shops, which allowed them to stay open. Thus, this became a fast-growing retail segment in both in-store and online sales.
The building products and DIY market experienced double-digit growth and from mid-2020 share prices surged. Cashbuild rose 230% and Italtile rallied 82%. Even cement company PPC, battling its demons and restructuring, surged 100%.
But the bubble soon popped.
South Africa’s monetary policymakers started raising rates in November 2021 and kept on doing so to contain runaway inflation. Interest rates capped out in November 2023 at a repo rate of 8.25%, more than double the October 2021 rate of 3.5%. Similarly, the prime lending rate rose from 7% to 11.75%.
This surge — alongside a rapid rise in the cost of living, food and fuel prices, increasing Eskom load-shedding and a stagnant economy — slammed the brakes on home renovations as spending was redirected to debt servicing and day-to-day costs.
Government data also remains gloomy. The latest available figures for building plans passed in South Africa’s larger municipalities showed value dropped 17.6% year on year to R8.08bn in February 2024, dipping further from a 13.5% decline in the previous month. Building permits declined 22.3% for residential buildings, 14.4% for nonresidential buildings and 10.2% for additions and alterations, according to Stats SA.
Unlike overseas markets — where a variety of specialised stocks service the DIY and residential sector — the JSE is a little skimpy in its offering to investors wishing to consider any trend changes.
IM looks at the general sector and the scant choices available — namely Cashbuild and Italtile.
The general DIY sector peaked in late-2021 when the surging share prices of Cashbuild, Italtile, PPC and Sephaku all rolled over on their backs as the government started to increase interest rates and sales waned along with Covid.
IM noted with interest that Pepkor in late 2020 decided to exit The Building Co (BuCo) as part of its streamlining after the Steinhoff debacle. This, in hindsight, seems like an inspired decision.
Cashbuild had offered to buy the BuCo business for R1bn in August 2020, only for the Competition Commission to block the merger in May 2021. That may have been a disguised blessing, because a debt-financed deal as the segment slumped would have taxed Cashbuild management. Its acquisition of Limpopo and Mpumalanga-based DIY and hardware player P&L Hardware for R430m in August 2015 has been a disaster, and that was only 37 regional stores. BuCo had 183 outlets across numerous brands.
It’s advisable not to rush headlong into the sector. There are no green shoots of recovery yet, and then there is the policy uncertainty hanging over the election
In February 2024, Pepkor sold BuCo alongside the Tiletoria brand to private equity business Capitalworks for R1.2bn. The business is the second largest in South Africa after Cashbuild. IM notes the price paid by Capitalworks was a premium to the original Cashbuild offer. With deep pockets, and with BuCo having undergone restructuring, this might have been an astute buy — especially given the expectation that interest rates should start to be trimmed most likely into 2025.
It’s advisable not to rush headlong into the sector. There are no green shoots of recovery yet, and then there is the policy uncertainty hanging over the election; IM prefers to wait and see where the cards fall.
With a market valuation of R3.6bn and a share price of R153.50, sector stalwart Cashbuild is 55% below its pandemic peak and the share year to date is down 9%. The stock hit a low in mid-March at R126.01, but has subsequently rallied 22% despite terrible interim results to December 2023.
A third-quarter update in mid-April was a catalyst for Cashbuild to push higher. Sales through the 312 stores scraped modestly higher compared with the prior second half period disclosure. P&L Hardware continued to be the festering sore despite a R137m impairment at the interim results. IM wonders, after nine years of misery, when Cashbuild will fix this problem child — or will it just exit?
Cashbuild probably hit rock bottom at the time of its interim results to December 2023.
Revenue for the six months increased a meagre 2% to R5.8bn with the impact of the P&L impairment slamming operating profits 81% lower to R50m and profit before tax 89% lower to R25m. Headline earnings slipped 20% to 551.8c a share and the dividend was cut 19% to 325c a share. Cashbuild has no debt but cash on hand dipped 8% to R1.6bn as inventory rose 10% to more than R2bn.
At R153.50 and a p:e of 12.6, Cashbuild is hardly the sector bargain. But given its mass-market sector positioning, it will be the first to rally should any glimmer of hope return to the domestic economy from lower interest rates and inklings of growth. IM can see the stock moving to R165, then R190, should that recovery spark be lit.
Italtile, trading at 932c, is down about 12% year to date and 49% from its pandemic high. With a market cap of R12.2bn, the company is the 800lb gorilla in the sector, given its scale and vertically integrated business model spanning all consumer price points and brands. Italtile’s cash hoard rose 76% to R1.5bn at interim results to December 2023 as the company battened down the hatches.
Interim results saw turnover dip 2% to R6.1bn with a 3% slide in gross margin hitting overall profitability. Profit before tax fell 14.8% to R1.17bn. Headline earnings declined 15% to 67.2c a share with the dividend cut 16% to 27c a share.
Italtile has three main retail divisions. The high-end Italtile business saw consumers hold off on purchases in light of the uncertain environment — though Italtile said the market size is declining. The mid-market CTM brand was harder hit as the squeezed middle market trimmed spending. Sales and profits declined by middle single digits and remain a concern. The affordable segment Top T, which has grown its branches number to 92, grew in the low single digits. The hardest hit division was Ceramic Industries, where profits slumped 32% as higher input costs, excessive domestic capacity and aggressive competition hit the manufacturing arm.
Italtile’s financial 2024 results to June are ahead and IM does not anticipate any recovery on the weak interim results. On a p:e of seven, forthcoming headline earnings will push this out … but not too much, IM contends. As a tightly run business, Italtile — like Cashbuild — is well placed to move higher as economic conditions allow.
On any whiff of interest rate cuts, the sector will start to rally; keep a keen eye on both Cashbuild and Italtile.
For IM, looking at their respective positioning and valuation, Italtile is the preferred recovery play given its lowly rating; IM values the stock at R12 (+29%). However, the stock has probably not yet bottomed. IM recommends waiting for the financial 2024 voluntary update and results.
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