James Hardie Industries plc (JHX) Q2 2015 Earnings Report, Transcript and Summary

Good morning, everybody. We’re going to follow the same format as we normally do. I’ll take care of the operations stuff. Matt will take care of financials, and we’ll come back for Q&A. On the Q&A, we’ll go with investors first, media second. I guess [Oreck] is announcing at 10:15, so we’re on a tighter schedule. Some of you follow that company, so we’ve committed to be done by then. So Matt and I will try and by 9:45 walk through slides, give us enough time for questions for both investors and media. We have updated the slides, so hopefully they’ll kind of get to the point a little better than the ones we replaced, and start from there. Okay, I’m at slide six. This is our summary slide. You guys have seen 12% increase in sales for the group, pretty similar to last quarter. With the results, it’s really been in the latest quarter, is the bottom line is better than last quarter, pulling four year up to 7% comp. We have in here that the housing market is below expectations. It’s a little different than last quarter. Last quarter, we kind of got fooled by the forecast, and it resulted in some production scheduling issues at our plants that resulted in some inefficiencies. This quarter, we were aiming kind of where the market’s settled down at housing start-wise. So even though it continues to underperform, the forecast in the market, we’re now in sync with our production scheduling and market demand. So we don’t have the same problem we had in the first quarter. Pretty much everywhere volumes are up to varying degrees and sale prices are up to varying degrees, so revenue’s up. In the U.S., I commented on the production scheduling. We had a few other issues in some U.S. plants, really from that period starting about February, actually, and worked out of it in most locations. Now, Cleveland and [Peru] were the exception. They’ve been running well right through that period. Recently, since about July, we’ve actually had [indiscernible] and [Polaski] have gotten the improvements we’ve been targeting. We still have Reno and Tacoma lagging a bit, and the Fontana startup is being much better managed than it was in the first quarter, so we’ve got that kind of sorted out as well. So that’s a part of the bottom line improvement you see in the second quarter relative to first, is the manufacturing part of the business is running better. All that benefit isn’t in the quarterly results, because obviously inventory, so a lot of high cost board came out of inventory in the second quarter. So we should see continued improvement there. We like where we’re funding out initiatives, so I think we’ve got the right balance between the financials and the growth rate initiatives in the business. We’ll cover capacity in a later slide, but we’re pretty well set on capacity, both in the U.S. and Asia Pac. I guess just confirming as we did in August and September, the 20-25 range we’re operating in that range in the U.S. business. Feel pretty comfortable with it. And then dividend, no change. We matched last year, haven’t changed dividend policy. Matt will cover that some. So these are the numbers adjusted for asbestos, obviously. You can see the bigger kick up in the second quarter, kind of drives the half year up consistent with our guidance switch. Of course, we anticipated when we put out the guidance, so we got there. If we go into the U.S., even margins down just a touch, both quarter and half year, everything else is up, and pretty much the pricing’s similar quarter to quarter, you know, Q1 to Q2. But other things improved. The internal running of the business improved in the second quarter, which really drove the different result. It wasn’t a better market, it wasn’t better growth against a market index. It was really handling that extra volume in a more efficient way. So here’s our EBIT margin chart. You can see Q1/Q2 in range. Kind of mid to bottom, but again, we feel strongly that Q3 and Q4 will come in and leave us in that range, similar to last year. These are the volume revenue on starts. You can see starts, the bottom line, slope of improvement in housing starts is kind of less than forecasted, and less than our volume, indicating that right now the business continues to grow quicker than starts, and the revenue grows quicker than volumes. Net sales price, 679 for the first half, which is good. Right now, we talked over the last four or five quarters about improvements in [indiscernible] pricing. Those improvements now are built into the base, so the improvements you’re seeing in pricing are probably two-thirds to three-quarters market price, which we took small increases on the exterior product line earlier in the year, and then the rest of it would be just the product mix impact. Asia-Pac, good market. Housing starts very high in austerity, I think near historical. It doesn’t play one to one for us, just because of the move toward more density, for your housing starts, but it’s still a good market for us. We’re up slightly more than our index, and when I say slightly, within a percent of our index, I believe. So no big market share gain going on right now in Australia, but good business performance. Of course, we have new capacity coming online. We’re focused on market share gains going forward, but this year, slightly above our index for the Asia-Pac business. You can see the financials are good across the board. And just a little bit on capex. We used to put this in Matt’s section. We pulled it up into my section. Just walk you through it. Because it did change quite a bit, because we’re trying to protect the upside on some of those early housing forecasts, so we committed to bring on Plant City and Cleveland Three, Plant City Four and Cleveland Three in very close timeframe. With the settling down of housing starts over the last six quarters versus what they’re forecasted [indiscernible] of that, we’re early with that capacity. So we’ll complete it, but we’ll defer startups. Everything’s on track, both timewise and budgetwise, but we’ll just stretch out the startups and put more distance between the Plant City startup and the Cleveland City startup. So obviously we’re still working on current forecasts. If they change for the better, it might change what we do, but I would guess that Plant City Four will start up late next fiscal year and Cleveland Three will start up fiscal year 2017. Carole Park will start up early next fiscal year, so you’d probably ship board out of the new Carole Park line, off of the new Carole Park line, probably in May. And that has some unit cost advantages over existing capacity, so as we bring that line on, we’ll bring some existing capacity down so it’s not all new demand that that line’s coming out for. And then Tacoma, we did purchase the land and that’s a situation where we need to secure that land, which is adjacent to our site, even though we don’t need the capacity probably for three years. Probably three years, I would guess. So we can utilize the site to some degree. The new site has some buildings on it. We use it for warehousing. We had some offsite warehousing, but basically it’s to put a manufacturing plant on so that won’t happen for about three years. Outlook and guidance, I don’t think it’s anything that would surprise you. Most of you follow housing pretty closely. It seems like we’re in this quarterly downgrading of housing forecasts, still positive, but definitely lagging what forecasters had thought, assured us like six months ago. We don’t have a problem, so we’ve got caught on that. Like I said earlier in the year, we’re aiming for the low end of forecast, and will stretch up if the market’s better than that. The extra capacity in Plant City and Cleveland now give us an opportunity, if the market really got hot, we could bring that capacity on pretty quick and still meet demand. So we’ll aim low and stretch up, similar to how we did in the downturn. The $600 million we talked about several times over a three year period, $600 million. We’ll spend more than that this year than the 200 average, and we’ll spend less of it next year than the 200 average. Asia-Pac, fiber cement, like I said, business is running well, new capacity coming on, financials are good, more focus on market share growth when the new capacity comes on, so that’s all going as planned. And the guidance, we didn’t change our guidance. We think the range is good. The range is still pretty wide for when the fiscal year’s going to end. But we’re comfortable with the range. We thought about tightening it, and we decided to stay where we’re at. So no changes there. And then of course we can’t forecast the asbestos adjustments, so that’s just a comment that’s in the results every quarter. Handing it over to Matt.

Good morning. As Louis already covered, sales volumes and prices were up across all of our major businesses. We’re still seeing higher input costs, both in the market. The plants, although they’re running better across the network, we’ve mitigated some of the Q1 operating inefficiencies in the second quarter, so you can see that in the margin rates. Organizational spend’s up as we continue to invest in growth, largely around headcount and discretionary spend in product and marketing related discretionary items. Net operating cash flows are 34.1 for the half year. Those are down year over year, largely because of the AICF contribution. We’ll cover those in more detail on the cash flow slide. Louis covered the capital expenditures through the first half are about 160, 158, through the first half. In the second quarter, we drew down about $380 million on our debt facilities in line with I think what we’ve been communicating and in line with our financial policies and financial management objectives. Louis already covered the $0.08 dividend, in line with last year, and the previously announced second half of $0.32 and the two specials, paid in August, which you’ll see on the cash flow statement. So reported results, net sales up 12 on higher volumes and higher sales prices in local currencies and both major segments. Gross margins were up about 30 basis points. So sales price, partially offset by variable costs. Variable cost’s a combination of input costs, which are mainly market related. For the most part, we’re outperforming market price increases on the sourcing side. SG&A expenses are up, as I said on the previous slide. Mostly headcount and some market and product related investments, some of which we’ve pulled back on in the second quarter, but still up year over year. And between EBIT and net operating profit, interest expenses are up. Those are related to our debt position. And income taxes, expenses are up related to the higher earnings. So this is the normal page that takes us from reported to adjusted. You can see asbestos adjustments were favorable in the quarter, about 7%, because of largely foreign exchange, between the beginning and ending balance sheet dates. And that’s compared to a relatively flat change in FX for the prior corresponding quarter. New Zealand weather tightness for the quarter increased really related to one existing claim. You’ll see for the half that it’s down and there’s a good trend on that liability. Adjusted net operating profit was up 16 in the quarter, and 17 on EBIT. Results for the half year look similar to the second quarter on the top line, up 12. Again volume and average net sales price is both up. Gross margin’s up a little bit less, obviously, at the half, because of the first quarter performance gets added in there. But similar dynamics, higher average sales prices and volumes, partially offset by the input costs and the plant performance. Same result really on SG&A, and you probably remember from the first quarter, in addition to the interest expense, we also had some foreign currency as well as some interest rate swaps that flush through other income and expense. For the half year, asbestos adjustments are 5% favorable, again because of FX in comparison to 11% favorable change from the prior corresponding quarter. For the half, New Zealand weather tightness, the liability’s down. There’s less number of claims, and there continues to be a reduction in the number of new claims as well. So adjusted net operating profit increased 7%, which was 11% in the operating segments, and that was partially offset by some of the corporate items and interest expense. You can see gross profits over the last three years have been relatively stable and strong, despite some of the recent inflationary pressures on input costs. That’s in part because of the price increases that we’ve put through. We put through a price increase in ’14 and another modest increase here in fiscal 2015. Production continues to increase with good scalability and good efficiencies, and that’s despite some of the headwinds on the input cost side, which I’ll show you here in a moment. So you can see pulp continues to trend both higher than what we had originally forecasted at the beginning of the year. The [indiscernible] index I think I’d originally estimated a peak sometime in the spring or early summer, and it continues to really be at a pretty elevated level, although starting to flatten out, and you can see that. Electrical cost, electricity, is up. Natural gas has trended up quite significantly since 2013. Cement’s relatively flat, although we’re expecting some cement price increases in the market next year. Again, we’re performing in all of these input areas in most of our local markets better than the market rates, but nonetheless, the market rates are up and even when we outperform the market rates, it still causes some inflationary pressure on our margins. Okay, we’ll go through the segments. In the U.S. and Europe fiber cement segment, this is a slightly different chart than we’ve used. It’s trending for the quarter in the gray bars and in the blue bars, the half, EBIT for that segment, and the top is the U.S. and the bottom is Asia Pacific. So for the quarter and half year, EBIT in the U.S. and Europe segment was up about 11%, and 13% respectively, largely on the dynamics that we’ve talked about. The U.S. volume and price were both up, partially offset by some of the input costs and plant items that we’ve already discussed in SG&A. And in Asia Pacific, for the quarter and half, EBIT was up 16 and 17, compared to the same periods last year. EBIT in local currencies is up 16 and 10, though, so obviously foreign exchange working against us on a U.S. dollar reported basis, but in local currencies, Asia Pacific business is operating well. Research and development is broadly in line with what we showed you the last several quarters. There is some fluctuation you’ll see in the quarter, and then the half year results, over the last three years, there’s really not much to read into that. It’s just the normal fluctuation of us having people come on and off of projects. We tend to move people onto projects as the projects are brought up, and when those projects expire, sometimes there’s a little bit of a lag. But no material fluctuation in R&D. On the general corporate cost side, the most significant movement quarter to quarter or year-to-year would have been stock compensation. The share price was down, obviously, over the last 90 days, about 20% in comparison to about a 14% appreciation in the prior corresponding period. So that had an impact. That was partially offset by some discretionary spend that nets kind of to the modest increase for the half. In terms of foreign exchange, this is a graph that you’re familiar with, the Australian dollar versus the U.S. dollar. Had a favorable impact on the translation of the Asia Pacific results year over year, a favorable impact on corporate costs in Australian dollars, and a favorable impact on the translation of asbestos liability and that’s both in terms of reported income and for the balance sheet presentation. On income tax, we have an adjusted effective tax rate of 23.1% for the year. Adjusted income tax expense and adjusted ETR increased due to the mix of earnings and geographies with a higher jurisdictional tax rate. Income taxes are paid and payable in Ireland, the U.S., Canada, New Zealand, and the Philippines. They’re not currently paid or payable in Europe or Australia due to the tax losses in those areas, which are available to offset the taxable income. And the Australian tax losses obviously are primarily a result from the deduction relating to the contribution to AICF. First half cash flows from operations, you can see we’re at 34.1 versus a year ago, they were 175.4, so down about 80%, largely related to the annual AICF contribution of $113 million. Inventory increased slightly. Some of that’s related to us bringing online another plant with Fontana. Most of that is related to that. And then we did have a sundry receivable related to insurance a year ago that didn’t repeat, and that’s what’s causing working capital year over year to move. Capex is up substantially year over year. Most of that is related to four projects that Louis ran through earlier, the three expansions that we’ve been talking about, and the purchase of the Tacoma land. And net proceeds from debt, about $380 million. You’ll see that we’ve got net debt of about $320 million. So given that we’re in a debt position now, we wanted to broaden, really, the discussion on our balance sheet to more around financial management, which we’re really thinking about in these three ways. So it starts obviously with strong financial management, which is really underpinned by strong margins and operating cash flows in the operating segments. That’s then overlaid with a governance and a transparency framework, and the way in which we’re trying to manage the financials in the company are very much as though we were an investment grade, or an investment grade like financial management. So in terms of ratio and financial policies, and liquidity levels. In terms of capital allocation, really no change from what I think we have been talking about. We’ll continue to invest in research and development and capacity expansions to support organic growth. It’s really our number one priority. We will continue to maintain the ordinary dividend within our stated payout ratio of 57%. We’ll continue to consider other shareholder returns when those are appropriate, so it’s a combination of the share buyback program, which we announced in May, which is ongoing. And specials, as they’re appropriate, and maintaining flexibility from a capital structure standpoint and an access to capital, so that we can take advantage of accretive and strategic inorganic activity. In terms of liquidity and funding, we’ve got about $500 million of revolving facilities, about 37% of liquidity at the end of the September period. I’ll show you a maturity profile in a minute. We have a weighted average debt maturity of about 2.75 years. We are working on strategies to extend that maturity, and we continue to stay, and we’re now operating within our conservative leveraging range of the balance sheet of 1x to 2x adjusted EBITDA. So financial management’s consistent with what I think we have been saying. We wanted to broaden the discussion this quarter to give you a sense for how we’re trying to think about it in the company, and it’s really all around being able to withstand both market cycles on anticipated events and be opportunistic. This gives you a look at the $500 million of facilities and the maturity profile over the next several years. At the end of the September period, we had about $60 million of cash, $505 million of facilities, about 37% liquidity. We had net debt of about $320 million, compared to net cash of about $168 million at the end of March. So Q4 2014. We are within the target net debt range that we’ve been referencing. We’re in compliance with all of our covenants as well. As I mentioned earlier, New Zealand weather tightness continues to trend favorably. This is a chart that includes periods from the last three fiscal years. For the half year, we had an expense of about $1 million dollars. That was down from $4.9 million in the prior corresponding period. The decrease in this trend in the period was really fewer open claims and a higher rate of claim resolution, fewer number of new claims. Asbestos for the quarter and half year have some of the following highlights. The first claims received for the quarter and for the half year were up 19% and 10% above the actuarial estimate, respectively. Claims for the second quarter and the first half were 12% and 5% higher than the prior corresponding period. The higher [miso] claims experience that we talked about in last year’s results largely continued along a similar trend to the first six months of this year. Average claim settlements is down for the half year, down about 6% versus the same period last year and down about 16% versus the actuarial estimate. That largely has to do with the number of large claims that’s trended both below prior year and below the estimate, as well as you might recall, in the 2014 results, there were some large claims that had been pulled forward and paid early by AICF, and those claims obviously now are benefitting the run rate. I think you’re aware that on September 15 the company and the New South Wales government were notified by AICF of their intentions to enter into discussions with both parties on an approved payment scheme. So in summary, group sales up 12 for both the quarter and the half. Adjusted net operating profits were up 16% for the quarter, 7% for the half. The housing market remains below where we thought it would be at the beginning of the year, but certainly we’ve adjusted, as Louis said, our planning and our production scheduling accordingly, and we’re operating now with an ability to flex up. Higher volumes and net sales across our major segments, you know, we are continuing to invest in the business, both on a capex basis as well as in organic growth in the organization and product and marketing activities. EBIT margins we’re expecting to be in the range for the year, and the first half dividend of $0.08.

Okay, we’ll start with questions. Yes?

Emily Smith from Deutsche Bank. A couple of questions, please, Louis. I think you mentioned that [indiscernible] in the Q1, leading to ramping up plants and things would last a couple of quarters. So I just was hoping we could get a bit of a sense for if there are any costs in the Q2 that might not be there in the Q3 as that’s sort of worked through. Secondly, on U.S. market share growth, just wondering if you can make a comment on that. And maybe a question for Matt. If you’re able to give us any more color around the capex expectations for this year and next year?

Okay, so unit cost coming out of the factories Q1 versus Q2, Q2’s down, but what we actually produced in Q2 was down greater than what was booked, basically. So we do have some of that coming through the Q3. Having said that, we’ll produce less material in Q3 than we did Q2, so I don’t know if it kind of all balances out or whatever, but we’ve got some benefit of the lower unit costs produced in Q2 coming through to Q3. As far as growth against the market index, we’re in the mid to kind of higher PDG, so 5 to 8, and that’s four quarter rolling average. And it’s relatively consistent, so I’d say the market’s kind of doing what it’s doing, and we’re doing what we’re doing, and the difference in what our actual PDG is and what we’d like it to be is that LP’s doing better than we’d expect them to be doing. So that’s kind of how we’re working. We’re LP positive, vinyl negative, but we feel we’re not getting our full share of the vinyl decline at this point. So that hasn’t changed over the last six to eight quarters. It’s letting out, but not going the other way, which is what we’re trying to do. As far as capex, I’ll take that question for Matt. Like we said, the guidance for the three years is about the same. We’ll come in closer to 300 this year than 200, and we’ll come in closer to 100 next year than 200. Now, that’s pretty far out, so it might change, depending on demand, but that’s what it looks like to us. You know, a bit of a spike this year, dropoff next year, and coming back to what we see as the underlying number for the third year.

A couple of questions. Lou, you referenced yourself, in terms of the breadth of the effect of the second half guidance, about $30 million on that second half. Is your concerns around where the market might land, is it cost concerns?

It wouldn’t be internal concerns. So it would be the exactness of the market forecasts, yeah. And right now, usually I give a head’s up where we’re at on our order file when we announce results. Right now our order file is similar to what it’s been the last two quarters. If it’s anything, it’s a hair short, rather than a hair long. But it’s very similar growth against the market we’re looking at right now. So it’s a pretty wide range. We have big debates, but then we thought, what is it? It doesn’t change much, so we just left it where it was.

And then a question for Matt. I might have this wrong, but my recollection was in the first quarter, on the mesothelioma issue, there was an indication that this quarter, if they would clarify in terms of [KPMG advice] as to whether that peak was going to occur later. And so the result in that, I think they said a 22% increase in that central claim. [indiscernible], a lot of this has gone down. I presume that’s maybe more FX, but where are we on that? Because maybe it’s just me, but when we look at those points around that liability, there’s quite a variety of issues going up and one incidence going down. So can you talk about that specific issue in terms of where your liability stands?

Yeah, so from a liability, it went down this quarter, because of FX and only FX. So the liability only changes really once a year in terms of its substantive underlying assumptions, and that’s when the actuarial report is issued, and that’s issued as part of our March results. And it’s really only at that point in time that a full study is completed, and any changes in either the claims cost that are anticipated, or the claim numbers in the future would get adjusted. So KPMG has not typically made any adjustments in a period or at the half to what those trend lines would normally do. So when you see the other three quarters of the year, for the first half result, it’s just changes in foreign currency.

And I guess to the extent that you’re seeing those claims continue to rise, is this the indication that we’re headed towards a high number, or will you sort of reserve judgment on that at this point?

Yeah, I think it’s best to reserve judgment on that, and I think you’ve got to keep in mind that the liability has several big assumptions, one of which is claims, but another of which is the average claims cost. The average claims cost is trending below both the actuarial estimate and the prior year, and that has partly to do with the type of claim, and it has part to do with the size of claim, and it has part to do with foreign exchange. And so because those four variables can really move the liability quite a bit, and we talk about that in our MD&A, we don’t feel like it’s appropriate to go through an adjustment on an individual quarter or on the half, not to mention that the only time we would go through an adjustment is the annual study, and the annual study that KPMG does is only done once per year.

Matt, just a question on cash flow. Just taking out the asbestos, what’s happening to the cash flow in the business?

Well, we’ve obviously had a large cash outflow related to the dividends that we declared last year and paid in August, so there was three dividends that made up the $355 million on the cash flow. That was probably the largest outflow. That’s the second half ordinary for fiscal 2014, the 125 special from fiscal 2014 and the special dividend from fiscal 2014. So those three dividends were paid out in the first half. So that’s the largest outflow, and then really capex, I think, is at 158 at the half year. So those two outflows, which are in line with, from a capital allocation standpoint, and from what we’ve been communicating, are in line with kind of what our expectations were. The underlying operating cash flows are very good in the business. You know, operating EBIT is up more at the half than revenues are across the segments. And the underlying working capital performance is in line with expectations. It was the use of cash for the quarter, largely related to inventory. We built about $10 million of inventory. That was largely with the recommissioning of the plants, as well as a little bit of replenishing, but nothing really material. The underlying operating receivables are performing well, and the underlying operating payables are performing well. We had that one sundry receivable item year over year that didn’t repeat. So in terms of how I think about underlying operating cash flows in the company they’re quite strong. Free cash flow is in line with where we thought it would be, given that we went from a net cash position to a net debt position over the last 12 months.

And Louis, just on the housing starts numbers, we’re seeing a bit of a divergence between the official numbers coming out of census and what we’re seeing out of some of the major home builders. Just wondering if you’ve got any sort of comment on your views on that. And then your business tends to do really well when the market’s running really strongly in terms of PDG, primary demand growth, but you’re still putting some pretty reasonable primary demand growth numbers, even though the underlying market is flat. And just sort of interested to how you’re seeing the business now in relation to that past relationship of market share growth versus PDG.

I think the last time the market grew really strongly for housing was really back before the downturn. I think the main difference in our PDG growth rates during the downturn and before the downturn now is just LP. So LPs getting some of the vinyl decline, where before the downturn, they weren’t getting much of it. They were holding a position with panels and trim, and that was about it. That was how they were participating. So they’ve had some market share growth since then, and that’s what’s kind of dampened our PDG a bit. So it’s obviously something we’re working on. You know, their value proposition is they’re cheaper than Hardie, they’re easier to install than Hardie. But we don’t think that offsets the benefits you get on our product in durability and maintenance versus their product. But we haven’t demonstrated that. We can show that to the market, to start turning our trend line the other way. So we’re still working on that. As far as the market itself, I saw some of the big builders came out a little bit more optimistic. There’s theories that big builders are getting more to market, so they would do better than the overall start. If that’s the case, we’re well-positioned with the big builders. We sell 20 out of 20 of the top builders. A lot of them are tied exclusively to us, either in fiber cement or what we call hard sidings. So when they grow, we grow. They still use vinyl in vinyl markets, but where they use fiber cement, they use Hardie. They’re a lower priced segment. A lot of [indiscernible] goes into that segment, so we get the volume benefit, but not the same degree revenue benefit. But it’s still a good business for us. As far as the housing market itself, to me it’s been very similar when you look at it maybe two years now. Everyone’s expecting it to take off, and it does get better, but it doesn’t take off. So that would be our guess next year as well. It will be up, but it won’t be up significantly. And I think some of the forecasts did have it up significantly next year, and now they’re coming back to more moderate increases, and we’d be planning below the moderate increases. As far as being able to grow demand for our product in a market like this, we should have no problem. So like I say, it’s really a one factor equation for us, and vinyl continues to shrink, LP continues to grow. The problem for us is LP, taking some of that vinyl decline. So that’s what we’re working on.

You made the comment that organizational costs were up in the period. Can you just maybe elaborate on what that actually is? And then secondly, whether or not, given the market’s clearly softer than you thought it would be, would you actually maybe pull back on some of that investment that you’re actually making?

No, we think we’re pretty well balanced, actually. Again, I know some of you would like to see us in the top of our 20 to 25 range. That’s not where we’re trying to be. We’re trying to balance the financials with the investment in growth. We’re very comfortable where we’re at. [indiscernible] cost is up for obvious reasons. Headcount would be one. And then programs we’re running in the market would be another. And we do have some headcount going into capacity on that, which is obviously related to growth. If we didn’t have the growth, we wouldn’t need the capacity, but we’re pretty comfortable with where we’re at. We’re spending money, I think, pretty effectively. So if we were spending it, you know, at a rate that we weren’t doing it well, we’d definitely pull it back, but I don’t see that being the case.

A few years ago, you were investing at a rate maybe well above where the market was. It’s not [indiscernible], it’s at a lower level than that, you would think, is what you’re suggesting?

Yeah, I mean, I don’t know, a few years ago, basically if I look at the history of the business, I’m just doing it off the top, we were really a new construction company until about 2005, and then we started focusing resources on repair and remodel. And as we got into the downturn, we really reallocated a lot of resource away from the construction onto repair and remodel, quite successfully. And you know, so when we’re coming out of a downturn, we’re holding and adding to some of those remodel programs. Those of you that were there in September would have heard about the Ambassador program, but we’re also ramping up new construction, so reallocating back in the new construction. And we need to do more in small markets, so we’re pretty well situated in all the tier one markets, but there’s tier two and tier three markets that we’re underweight in, so we have to get resources up into those tier two and tier three markets. You know, I think the reality is that as the business model evolves, the year after is harder than what you’ve already gotten, and sometimes it takes a bigger investment. And then for the first time, we’re having to look behind us at the same time as we look forward, meaning we’re having to look at LP, trying to put a hole in the bucket at the same time that we’re trying to create more demand against vinyl, so that adds to it a little bit as well. So our Midwest resources, which is by far LP’s strongest region, have gone and will continue to go up. We need to do a better job in the Midwest.

And maybe if I could just add, I’d say that we did adjust spending in the second quarter versus the first quarter, and you can see that in the operating EBIT leverage. So for the second quarter operating EBIT was up 17% for the half. It’s up 11 on sales at 12 for both the quarter and the half. So for the quarter, which gives you a better indication of run rate, while we’re still investing, we’re not investing ahead of top line sales. So that would be one thing to look at. The other thing is I’d say SG&A as a percent of revenue, while SG&A dollars are up, revenues are also up versus 2013 levels. So as a percentage, those are broadly tracking in line.

Can I also just ask, on capital management, I appreciate you giving us a bit more detail around that, but there was sort of a distinct lack of any captive management in the quarter. I was just wondering if you can give some further comments around what factors may have influenced that this year.

It’s a good question. We talked a little bit about this in September with a few of you. I think if you were to look over the last several years, we’ve historically not been very active in the first half of the year from a share buyback perspective. The main reason for that is if you go to the financial policy slide that we laid out, it obviously starts with underlying group results, and we feel like those are good, but second is around transparency and governance. And there’s a number of blackout windows and dates within the first half of the year, just given how we’ve historically released results. So May, we do obviously the final year results, June we announce the annual general meeting, and August we do the general meeting, we do the first quarter results. My bias is, on any kind of share buyback program, to be more programmatic than opportunistic, and to move an adequate amount of share activity within a period, that program’s got to run over a longer period of time. And when you have a lot of blackout windows, it makes it difficult to put an effective program in place that I feel good about standing up in front of everyone and saying we had share buyback activity in the quarter and it was material. So it becomes very difficult in the first half of the year to do that, given some of those constraints that we put on ourselves. That being said, I think the activity that we had in the first quarter is very consistent with what we’ve historically had as well. Traditionally, at the half, we’ve only done kind of an ordinary dividend. Any special dividends have only really been considered at the full year results. So at least from our perspective, what we’ve done for the first six months of the year is very much consistent with what we’ve historically done. We probably haven’t done as good of a job of explaining why the share buyback activity doesn’t tend to occur in the first half of the year, and it tends to be biased more towards the second half of the year, with some of those blackout windows, and you don’t have as many of those blackout windows to navigate.

Just on the reference to Fontana and the ramp up inefficiencies there, just wondering if you can give us a sense of the timeframe of those inefficiencies [going] into that ramp up, and how significant those extra costs are?

I can’t remember if we gave you the magnitude in the last quarter. No? Okay. So we’ve got one machine running at Fontana now, and it’s pretty close to design. So it’s, over the last couple of months, ramped up from about 60% to now it’s approaching design, which is very good. The time to get to kind of 60% was longer than it should have been. But having said that, that’s a two-line plan, so we won’t get our good unit costs out of that plant until we have it utilized at about 75% or something like that. And that will probably take a little while, meaning even next year, with a good summer, that still may only be about two-thirds utilized, that facility. So when you look at it, we brought up Waxahatchee last year, extra line at Waxahatchee, and we’ll bring up, like I said, at the end of next year, we’ll probably bring up Cleveland. So bringing up a line is kind of normal. It’s going to happen a lot over the next three to four years if the market keeps expanding. What I tried to flag is we just didn’t do it well enough. Now, we’re kind of past that point. We’re doing it well enough now so that problem’s behind us, and that doesn’t mean we don’t have higher unit costs in Fontana, and we will in the future, but that will be more utilization related rather than how well the plant’s being managed.

So would you say what’s embedded in the result today is, as you go forward and roll out more plants and ramp up those other plants, it’s kind of on a run rate basis, embedded in the results?

Yeah, it’s certainly in our 20 to 25. I mean, we talk about these things on the margin. And then we won’t repeat our mistakes at Fontana. So to me, those are one-off mistakes that we won’t repeat. Right, it looks like we’re done with questions in the room. Do we have any investor questions on the phone?

Your first question comes from the line of Simon Thackray from Citi.

Just a quick one going back through the rising cost and the input cost strategies you’re talking to, Lou. I’m sorry if I’ve missed this. Could you just talk about the strategies that you want to adopt in terms of the input cost strategies? Is it more around the pricing environment? Or are there other strategies that need to be engaged to deal with the rising input costs that you talked to in terms of cement, electricity, gas, pulp, etc.?

No, I don’t think we have any big strategy. Commodity costs only go up as market demand improves. And I think when you look at cement, power and gas, that’s likely to continue to be the case. Pulp, for some reason, has been running on a different curve. You know, it was expected to soften. The demand hasn’t been that high, and they’ve held their prices. They’ve gone up a bit more, so that’s been a little bit off the forecasted curve. So what we do with those commodities is we buy against indexes, and as Matt said, we try and make sure, if something goes up 10%, we don’t go up the full 10%. And we’re kind of in that, so we’re buying pulp a little better than the index. I don’t want to mislead you, we buy pulp well discounted to the index, but our increase is slightly less than the increase in the index. And power’s a little bit different. It’s not as competitive a market. Some of our sites are tied to certain providers. Gas, more, again, a pure commodity. We’re not that sophisticated in purchasing in gas, but we’re okay at it. And cement, we’re probably pretty good, because we’re a base load for most of the plants we do business with, so we end up at the bottom end of their price range for their net realized price back to mill. So other than just a basic purchasing strategy, on how you buy things in different types of markets, we don’t have anything. You know, you can’t substitute power. We don’t use coal or anything, substitute gas. We don’t use anything to substitute pulp, and we don’t change our formula when the price of cement goes up.

Not to read too much into it when you say you’re going to look at import cost strategies is the point, which is what you put in your release.

Oh, okay, sorry about that. No, that’s just procurement. Just trying to become more sophisticated in how we buy things.

No, that’s all right. No drama. And of course, Lou, the whole issue around capacity and capacity expansion you’ve talked to in detail, and quite eloquently about that. The point of staying ahead of the competitors in terms of making sure you’ve got the capacity to absorb the market when it moves, and so they cannot establish a competitive foothold, is clear. What are you seeing, what are you anticipating in terms of the competitors and their capacity, and also, some discussion about LP, with its same product, making a move back into Texas?

Okay, we’ll start with the direct competitors. Fiber cement, we’re not aware of any expansions in fiber cement capacity in North America. Those businesses have kind of been in the position where they are for several years now. When we get to LP, that’s where the change is taking place. LP has added capacity in response to their success in growing market share. Texas, not so much. Most of their gains, from our perspective, are still trim. Kind of in broad markets. And a lot of that trim goes on our homes, so Hardie siding with LP trim, so they have a good position there. But their growth in planks would be largely in the Midwest. So Texas, not so much. I’m sure they have some increases in Texas, kind of just as we do, because it’s a good market right now. But that wouldn’t be where most of your market share gained. Most of your market share gain would still be in the Midwest.

Weren’t there issues the last time LP was in there with the product in terms of its performance in the climate?

LP has two basic technologies. One’s hard board, which goes back to the 60s, and one’s OSB siding, which goes back to the 70s. And both of those products did have product performance issues, and most of the participants in those technologies have gotten out of the industry. So you would have had most of your big [forest] products companies in there, like Weyerhaeuser and GP, Boise, of course Masonite I think was the category creator for hard board. LP was the category creator for OSB. Omni [would have followed] LP. So almost all of them have gone out. You have LP in there, and you have some smaller players, like Collins, up in Oregon, small company. LP has [can excel] in Canada. There’s a company called [Mirtech], who I think is owned now by Masonite doors. I can’t remember if they sold it, but they’d be a trim producer. So yes, there is a history of product performance. Obviously, LP is successfully communicating to at least some of the market that those performance problems wouldn’t be the same in their current day product as they have been in the past. So I guess that remains to be seen.

Your next question comes from the line of David Leech from UBS.

You mentioned Carole Park was expected to show some unit cost improvement, so I was just wondering if you could give us some sense of what percentage, or just some sort of a feel for how much more competitive you’ll be in the Australian market?

Good question. I don’t have an answer for you. I’d tell you, it’s not a game changer. When I say that, what I’m trying to indicate is almost all of our capacity is competitive enough to where you can’t build a new line and shut one down and come out ahead. But what you do sometimes get is either a freight or a product advantage with new capacity, and what they’ll do is, in Carole Park, they’ll get some unit cost advantage through the sale of the machine, but the main unit cost advantage they will get is in freight and in the product itself, because that line will eventually produce products that are currently being shipped up to Carole Park from Rose Hill. So that’s where they get the edge, but we built that new capacity for demand creation purposes. We would not have built it if the size of the Australian business were going to be the same in 10 years as it is today. We wouldn’t have built that capacity, just on a unit cost basis. We would not be ahead investing the amount of money we put into that plant if all we got back was a unit cost advantage. But since we have invested it, you can kind of incrementally get an advantage by bringing it up and reducing freight, reducing some product cost, and then getting the scale advantage.

Your next question comes from the line of Matthew McNee from Goldman Sachs.

Just on the recent data, I know it’s hard to track, but the A&A data we’ve been seeing is a bit softer. Is that what you guys are seeing as well? Or how are you seeing the A&A market tracking at the moment?

Yeah, I think they forecast that right. I think they came in pretty bullish at 7%, and they’re well off that now, which I think is right. Having said that, we do like our growth in what we call R&R. Now, are you talking A&A in Australia?

Yeah, R&R.

R&R in the U.S. originally came in with a really high forecast for the year, 7%, which is super high for the R&R segment. And they’ve come off that some. We’re getting good growth in the segment. Part of that’s due to the segment being better, and part of it’s due to programs against vinyl have done very well.

And so do you think year to date, would it be 3%, 4% growth, or 5%, something like that, do you think, in that underlying R&R?

Matt says 4% to 5%. He keeps track of that stuff.

Your next question comes from the line of Steven Johnson from the Australian Associated Press.

Just in terms of your four year forecast, you’ve kept the guidance the same as the previous quarter, but you do have some short term concerns about the U.S. housing market. Could that affect your full year guidance?

I’ll be honest with you, we had that guidance in August, and we stuck with the guidance. Now, the business has really done what we thought it would do in the second quarter. So far in the third quarter, pretty much on track. Housing’s pretty much where we thought. You know, with the U.S. market forecasts moving around a lot, we just didn’t think tightening up the range did us much good. So I think most people know kind of where we think we’ll come in. Our EBIT margin in the U.S. kind of drives a lot of it. We’ve already confirmed the guidance there. That was just one of those things we didn’t think it was worth changing. We didn’t think the market would learn anything by us moving it around, because that’s where we thought it should be in August, and that’s where we think it should be now. And I acknowledge that three months have gone by, so we could have taken a little bit off the range, but we didn’t take anything off the range.

And Louis, just to add, in your statement, you say there’s continued uncertainty about the short term recovery. Could you tell me what you think the uncertainties are, and what the variables are with the U.S. housing market [for much of your earnings]?

I’m not an economist. When I say uncertainties, I just look at the forecasts the guys bring us. And it seems to me the forecasts are always kind of downgraded as you move quarter to quarter, rather than there’s no forecasters up there that I’m aware of that are actually showing higher forecasts than they would have thought three months ago. The U.S. economy’s not in bad shape. Housing is not recovering at the anticipated rate. I’m sure there are some good underlying reasons for that. I’m not sure I can pinpoint them. But I think the important thing for our investors is number one, do you believe that housing’s going to continue to increase rather than go into a downturn, and we certainly feel that it will continue to increase. And then two is the level of market activity kind of play to our strength as far as organic growth and balancing that with financial returns, and we think we’re in a decent window, even though it’s only a million starts, which is historically low for the U.S. We still think it’s a good window to operate in, so outside of the manufacturing blip we had earlier in the year, we’re doing what we want to do, and then I’ve covered, again, we don’t like that LP’s getting what we consider more than their fair share, especially in the Midwest. So we’ve got some work to do there.

And then also, on Australia, I know it’s a smaller part of your market, but do you think that attached housing segment of the Australian market is looking relatively promising?

I think yeah, the Australian market’s good right now. It doesn’t play as well to our strengths as we’d like. We’re more a single family, new construction type product in Australia than we are medium density. And the density’s moving in Australia, so we’ve got a little work to do on kind of product line development to make sure we’re more balanced across the segments in Australia. But I don’t want to underplay how well the Australian business has positioned itself and how well they’re currently running. I think we have a really good business in Australia.

And finally, asbestos liabilities, do you see any unanticipated increases coming up in the full year?

Well, no. Again, our asbestos liability is tied to the [indiscernible] so that’s a calculation on our net operating cash flow. So we have our forecast for our cash flow, and we know what percentage we pay into the fund next July. So I’d say that’s as accurate as our financial forecast. There’s nothing outside of that.

It appears as though we have no further questions.

All right, thank you very much. Appreciate it.