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Why the Reece share price could soon be trading at a higher premium

The Reece Ltd (ASX: REH) share price has dropped over 20% from its all-time high of $12.61. Currently, the Reece share price trades at $10.03 which could be an opportunity to accumulate.

Reece’s share price dropped as a result of the market sentiment

When the charts for Reece and All Ordinaries (ASX: XAO) are compared, the obvious pattern of a weak third and fourth quarter for 2018 is evident. With macroeconomic issues such as the trade war and potential interest rate hikes, optimism in the markets was low. As a result, the Reece share price has now dropped to a point where value can be found.

From Reece’s 2019 half-year results, sales revenue, normalised EBITDA and EBIT reported increases of 104%, 45%, and 25% respectively. Although net profit was down 7.6%, this was primarily due to the finance costs from currencies.

Such an issue shouldn’t be overly concerning to Reece investors given its operating profit remains high and continues to grow. The cash flow statement also showed strong organic growth through an increase of 87% in receipts from customers. As a result of this performance, dividends remain at current levels.

In 2018 MORSCO, the leading distributor of plumbing, waterworks, and HVAC in the US was acquired by Reece in a $1.9 billion buyout. This one-off transaction had a negative effect on its statutory NPAT, but Reece has reported that MORSCO is performing to expectations.

Outlook

Current valuation has Reece trading at 24 times earnings which is in line with the industry trading at 21 times earnings. This is reasonable as Reece expects the acquisition of MORSCO to boost its FY2019 earnings per share by 5 to 9 cents. This means investors can expect to see between an 11% to 20% increase in its earnings per share. Provided this forecast is met, Reece’s share price deserves to trade at a premium to the industry.

Future outlook for Reece is optimistic with its New Zealand presence continuing to strengthen and MORSCO having the potential to deliver over $3 billion in sales from the US. Additionally, Reece has increased its cash holdings which can be used for future acquisitions.

Foolish takeaway

Reece provides investors with diversified growth at a reasonable valuation. Despite the downturn of the domestic housing market, Reece has shown that it’s still capable of growing its earnings under such conditions. If the MORSCO acquisition meets expectations, the Reece share price may start trading at a much higher premium.

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Motley Fool contributor Elton Wang 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.