Will Reliance Worldwide benefit from the US freeze?

Roger Montgomery

Montgomery Investment Management

Reliance Worldwide (ASX: RWC), is a global provider of water control systems and plumbing solutions. The company sells innovative plumbing fixtures to enhance productivity and efficiency for end-users including plumbers and home handymen. Reliance’s core product is the “Push-to-Connect” (PTC) fitting to connect two ends of a copper pipe, marketed under the Sharkbite brand.

This week Reliance released the outcome of operating for the first half of the 2021 financial year noting the US is almost three quarters covered in snow – the significance of which will be explained momentarily.

Reliance Worldwide reported underlying EBITDA of $166 million. This was within the range articulated by the company of $164-167 million in its trading update on 26 January. Net profit after tax of $99.3 million was also in line with consensus expectations. A six cent per share dividend was a cent higher than we had expected.

Key highlights in the result

On a constant currency basis, North America grew at 22 per cent with management attributing about half the growth to COVID-induced sales. The remainder came from the market growing 2.6 per cent, market share gains or ‘above market’ growth of just over 4.5 per cent and new customer/product initiatives contributing just under four per cent.

Operating cash flow – up 17 per cent to $155.6 million, implying EBITDA cash conversion of 94 per cent. Net Debt declined to $226 million as of December 2020, which was a $76.2 million reduction vs. June 2020. As indicated at the January 2020 trading update, net debt-to-EBITDA has dropped to 0.88-times from 1.39-times as of last June.

In the US, January sales were up 20 per cent. For the UK and Europe, the Middle East and Africa (EMEA) geographies sales comparisons will be strong compared to the previous period when sales fell to just a third of pre-COVID levels in April, May and June. But investors should note that from March the company will be ‘comping’ COVID-impacted 2020 performance and so growth rates could understandably change significantly.

The company said conditions are expected to remain encouraging/supportive in the second half. In January, EMEA sales were up six per cent versus the previous corresponding period. In the Asia Pacific, which includes Australia, demand has been firm with January sales up one per cent versus 2020. We would expect a strengthening trend in terms of comparisons because housing construction (excluding high density) and renovations is very strong compared to the weakness seen during the beginning of the pandemic. Demand is currently so strong builders and sub-contractors have all raised prices.

On the cost side, cost-out benefits came to $9.5 million in the first half and the company noted it is on target to meet its $25 million cost-out target by the end of June. Impressively, synergies associated with the John Guest acquisition came to $6.3 million, which is higher than expected.

Two major manufacturing cost inputs are copper, which is used in the production of brass, and resins used in the production of plastics. For FY2020 the average copper price was approximately US$6,000 per tonne and in its second half guidance, the company provided an estimated average copper price of US$6,900/t representing a 15 per cent increase. The current price of copper, however, is US$8,800/t which represents a near 50 per cent increase on the average for the full year 2020 and therefore a downgrade risk. The company noted it is aiming to ‘largely mitigate these cost impacts through product design, supply chain changes and price.’ Whether it can recover the full extent of the cost increase remains to be seen of course.

Benefit of frosty conditions in the US

The company has previously benefitted from significant freeze events in the US. When the water in copper hot-water pipes freezes, the pipes burst, requiring replacement. The record low temperatures in Texas and the extent of the country blanketed in snow should be a material positive development however the company provided no insights into the potential benefit to sales and earnings but we note the lack of a freeze event in the second half of the 2019 financial year was said to have impacted EBITDA by $6 – $7 million.

During the conference call, we noted talk of a $4-$5 million investment into admin and marketing once COVID impacts subside with margins likely to fall incrementally as a result. Beyond the copper price headwinds, the company noted additional headwinds of circa $10 million. The company reiterated its multi-pronged approach to pricing which it is looking to implement to neutralise any impact from higher commodity prices. The CEO referred to 2005-2006 where there were “multiple” actions taken, and indicated the pricing strategy will need to be dynamic in the immediate term.

Reinvesting in operating expenditure and staff has been a common theme for many of the COVID winners. The market tends to frown on reinvestment because of the uncertainty of the return and its timing. This has resulted in some sharp sell-offs, especially for those companies where share price performance has previously been strong offering a profit-taking opportunity (such has been the case for RWC).

Without definitive statements about pricing (due to their commercially sensitive nature) and with the benefit from the US freeze still too early to define, the market appears to have adopted a wary position despite the positive January and February trading updates.

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Roger Montgomery
Founder and Chairman
Montgomery Investment Management

Roger Montgomery founded Montgomery Investment Management in 2010. Roger has more than three decades of experience in investing, financial markets and analysis. Roger also authored the best-selling investment book, Value.able.

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