Building materials stocks have been doing it tough but some in the sector may be oversold and could be primed for a recovery, according to Citigroup.
We are already starting to see some life coming back into these stocks but there's plenty of room to play catchup given that the Boral Limited (ASX: BLD) share price, James Hardie Industries plc (ASX: JHX) share price and CSR Limited (ASX: CSR) share price have fallen between 18% and 36% over the past year.
In contrast, the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index has rallied over 6% in the past 12 months.
Light at the end of the tunnel
Investors have dumped these stocks due to the domestic housing market slump, although stocks like Boral and James Hardie have also come under pressure following signs of weakness in the US construction market as well.
But housing in both markets may have troughed, and that means the sector could be set to outperform the broader market in the near-term.
Citi sees selective opportunities in the sector and noted that the US market is on a comeback.
"US home builders, building and construction materials stocks have rallied strongly YTD as housing market fears ease on improving data (although mixed). While existing home sales in March missed expectations (-5.4% y/y), new home sales beat (+4.5% y/y) as lower mortgage rates feed through," said the broker.
"While Australia remains in downswing, there are signs that we may be approaching peak weakness. In the meantime, the outlook for infrastructure activity remains supportive."
Compelling valuations
The broker has stressed tested valuations in the sector by using trough earnings from the 2010 to 2012 downturn in FY20.
"Assuming long-term valuation multiples, we believe BLD and JHX are trading below trough valuations," added Citi.
"In addition, a review of peak to trough performances during the 2010-12 downturn suggests that the market may have already visited trough level performances."
What's more, dryer than normal weather forecasts for the US and Australia could provide an additional tailwind for the sector (as wet weather impedes construction activity) and the rising raw material costs that have crimped margins appear to be easing.
Citi has a "buy" on James Hardie and Boral, but points out that the latter may have a bigger upside as it has yet to bounce to the same extent as James Hardie or CSR.
The broker has a "neutral" recommendation on CSR.
