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Why the share price of DuluxGroup Limited is falling despite its strong profit result

The share price of DuluxGroup Limited (ASX: DLX) couldn’t hold on to early gains despite posting stronger first half profits and an increase in its interim dividend.

The stock fell 1.1% to $7.96 in lunch time trade after hitting a high of $8.20 this morning when management reported a 9% uplift in net profit to $79.2 million and a 4.2% increase in sales to $918.1 million for the six months ended 31 March 2018.

The result should dispel any concerns that the mature Australian and New Zealand (ANZ) market is leaving the paint maker with little space left to grow as the group reported growth across all its business segments for this market.

DuluxGroup notes that there are 10 million dwellings in Australia and around 70% of them are older than 20 years. That’s a lot of houses that could potentially need repainting and the maintenance and home improvement market makes up 65% of its core business.

The slowdown in the residential market also shouldn’t have too much of a negative impact on sales as new homes contribute around 15% to its core business and softening property prices (as long as there isn’t a hard landing) won’t impact on the need for paint in this low interest rate and high consumer confidence environment.

But given that the stock has been strongly outperforming the market, it is understandable why the stock has come into some profit taking today. Shares in DuluxGroup are up over 17% in the past year when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index is up around 5%.

In contrast, the performance of other home renovation-related stocks has been a mixed bag. Metcash Limited (ASX: MTS) and Reece Ltd (ASX: REH) have surged 50% to 60% over the past year while Fletcher Building Limited (ASX: FBU) has crashed 18%.

Investors may have also not liked the big 25.8% drop in DuluxGroup’s operating cash flow despite the strong sales and profit lines. Cash conversion has been weighed down by higher tax and costs relating to the sale of its China coating business and excess land at Glen Waverly, Victoria, as well as start-up costs for its new Merrifield factory.

Investments in the group’s expansion into the UK and Indonesia are also sucking out cash and may have reminded investors of the struggles facing the Bunnings home improvement business owned by Wesfarmers Ltd’s (ASX: WES).

Bunnings is having a disastrous time expanding into the UK market and DuluxGroup is a supplier to the business.

Corporate Australia’s expansion into Indonesia is also another sad tale that harbours more failures than successes.

At least DuluxGroup is putting up an optimistic front with management tipping an increase in FY18 profit over the previous year, although it declined to provide a figure.

But that isn’t saying much given the robust half year performance and the 7.7% increase in interim dividend to 14 cents a share.

One would have thought that’s pretty much a given.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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