The GWA Group Ltd (ASX: GWA) share price rallied to a one-month high in after lunch trade after the stock was upgraded by a top broker.
Shares in the building fixtures and fittings group jumped 3.4% to $3.18 when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index gained 0.7% at the time of writing.
The analysts at Macquarie Group Ltd (ASX: MQG) reckons the market doesn't fully appreciate how the housing market recovery could positively impact on the group's earnings in the coming year.
Earnings outlook improving
"Rising dwelling prices have historically led residential building approvals by several months," said the broker.
"Stronger house prices and other indicators (listing volumes, clearance rates, housing turnover) suggest that approvals could be close to forming a base before growth through 2020."
The house price rebound aside, the stock may be oversold as investors have overreacted to the fall in new home construction activity.
Upside potential from low market expectations
The GWA share price fell around 15% over the past six months but Macquarie noted that GWA has relatively low exposure to detached and multi-residential homes. Instead, it's the commercial and restoration and renovation markets account for around 72% of GWA's income.
There isn't much good news priced in the stock at current levels either. Management provided earnings before interest and tax (EBIT) guidance of $37 million to $41 million for the first half of FY20 and $80 million to $85 million for the full year.
Consensus forecasts are at the low end. The average analyst estimates are only at $38 million for 1HFY20 and $81 million for FY20.
Short-squeeze provides additional boost
Throw in the fact that GWA is heavily short-sold with short-interest standing at around 15%, and you can see that it won't take much for the stock to pop.
Short-sellers are those who borrow shares to sell on-market with the hope of buying it back at a lower price later. If the outlook of the shorted company improves and the share price jumps, it could force short-sellers to rush back into the market to buy the stock to close their positions. This rush is called a short-squeeze.
"Short-interest suggests a miss to FY20 guidance, but GWA's recent track record of earnings delivery, ongoing cost-out, and flexibility in the cost base provide confidence they will hit the relatively low expectations," said Macquarie.
"Strengthening housing prices and leading indicators point to an improving outlook for GWA's end markets.
"While market conditions are expected to be tough 2Q20, we expect improvement in 2H20 and growth in FY21."
Macquarie's 12-month price target on the stock is $3.60 a share.
