In the wake of a long-running housing construction and renovation boom – no doubt helped along by DIY shows like The Block – it's no surprise DuluxGroup Limited (ASX: DLX) has been such a success. Dulux shares have risen 160% in the past five years, and that's before dividends, which are today a reasonable 3.5%, fully franked.
Yet is there more where that came from, or are Dulux's best days behind it?
- The buy case
One of the attractive things about Dulux is it does not appear to be overly expensive, with its Price to Earnings (P/E) multiple of 20 being just above the ASX average. Dulux's P/E ratio has remained at about this level for several years, and management's focus on incremental improvements and efficiency has delivered attractive returns at this price level.
With ongoing cost savings, some small acquisitions and the potential of niche markets like cabinets and construction products, Dulux has potential for continued growth. Management noted in its recent presentation that of the approximately 10 million dwellings in Australia, roughly 70% are older than 20 years.
That's an attractive statistic and should underpin continued demand for Dulux's products in all market conditions – although management also noted that the expected underlying volume growth was 1% to 1.5% per annum, which is hardly spectacular.
- The bear case
Although not expensive, Dulux is also not cheap for a company growing volume at an estimated 1.5% per annum. Unexpected circumstances could quickly lead to a cash crunch and higher debt, given the company's generally poor cash conversion. Only 80% of sales recorded in the year will be received as cash, and this figure can drop into the 50's (56% in recent half) due to timing on sales.
Management noted four key things in the core Home Improvement Market (which accounts for 65% of Dulux's sales): GDP growth is stable, interest rates are low, house prices are high, and consumer confidence is mixed. A reversal in any one of those metrics could quickly lead to a decline in sales, although readers should keep in mind that painting is a relatively low expense compared to other renovations, and demand is fairly defensive in nature.
The new housing market (15% of Dulux sales) is mixed, with new home approvals having peaked, although management notes there is still work to be done due to the lag between approval and construction. Dulux also faces headwinds in the commercial segment due to lack of civil infrastructure spending and a weak resources sector.
Even though Dulux is quite robust, it has low margins and high inventory requirements and a series of unfortunate events could result in significant detriment to shareholders.
Well, should I buy it?
Overall, I find Dulux an attractive company at today's prices. It's not an explosive growth business, but as we can see from this chart it's a reliable earner – even in the depths of the GFC.
With the new distribution centre and factory coming online over the next few years, and some growth potential available through overseas sales and diversification into parallel industries, Dulux should remain a reliable earner. Key risks remain around a housing market slow-down, as well as poor capital allocation if its diversifications don't pan out. Debt is at comfortable levels although investors should watch it doesn't creep up over time.
For those prepared to take a 5-10 year view of their investment, Dulux shares could be an attractive purchase at today's prices.
