James Hardie Industries plc (JHX) Q2 2020 Earnings Report, Transcript and Summary

Good morning, everyone, and thank you for joining us for the Q2 Fiscal Year 2020 Earnings Conference Call. I will start with key business and operational highlights on our second quarter performance; Jason Miele, our Head of Investor Relations will then cover the financial details for the quarter. Afterwards, I will come back to update you on where we are relative to the execution of our three-year global strategic plan. As our interim CFO, Anne Lloyd, has only been in role for about 8 weeks, I had asked Jason to present with me today based on his extensive experience in finance and Investor Relations at James Hardie. Regarding the CFO position, I will make a few comments now and will not be taking questions on this topic during Q&A. As you are aware, Anne Lloyd is currently functioning as our Interim CFO, and she will continue in role until we find a permanent CFO. She had served previously as a CFO of Martin Marietta. She also served currently as a member of James Hardie Board of Directors. Anne had done an excellent job running and jumping right in as adding value to our executive team as well as to the global finance organization. I'm pleased to have this transition progressing, and we're actively recruiting. And I would anticipate we'll hire a permanent CFO in early next year. Now let's talk about our results. The global James Hardie team executed well and delivered a very strong operational performance this past quarter. We delivered positive growth, in both net sales and EBIT in all 3 regions that we operate in: North America, Asia Pacific and Europe. I would like to put our second quarter results in a context of our 3-year global strategic plan. We are an organic growth company. We've built to drive growth above market, which is PDG in all regions of the world that we operate in and with strong returns. In North America, this means that we're on a commercial transformation journey to be a more customer-focused company by continuing to invest significantly in demand creation without end users, the builders, the installers, the R&R contractors, while building a robust account management capability to serve our customers much better, the dealer, the lumber yards, the distributors and the retailers. This is aimed at driving a sustainable growth above market of PDG in a 6% range for the long-term sustainability. We also drive lean manufacturing across all of our plants in North America to take advantage of our scale, to reduce variability and to improve productivity. We target to generate $100 million in cumulative savings over the 3 years due to lean. In Asia Pacific, our goal is to make a good business better. And hence, to continue to deliver growth of our market, even in a contracting market that we currently have in Australia and strong returns. In Europe, it's all about accelerating fiber cement growth based on a growing fiber gypsum business, while improving our EBIT margin. Now let's turn to Page 7, on the group results. We delivered volume growth above market in all 3 regions. Our net sales in local currency grew in all 3 regions. North America grew 6% in a quarter and 5% in the first half. Europe grew 5% in the quarter and 6% in the first half. APAC grew 2% for the quarter and 1% in the first half. Our adjusted net operating profit for the group grew 22% in the quarter, driven by strong operational performance in all 3 regions. We're pleased with this continued positive momentum in executing our global strategic plan. Now let's turn to Page 8, our North American results. Our exterior volume grew 6% in the quarter and 5% in the first half. We estimated that the blended market growth in the first half of our fiscal year was essentially flat. Our interior volume grew at the same level as the previous quarter a year ago, which is flat. And it is, however, a continuous improvement versus the prior 2 years. With increased volume through our factory and with lean savings, we delivered an EBIT increase of 25%, despite continued raw materials inflation, particularly pulp, in the quarter. Our EBIT margin in the quarter was 27.1% and in the first half, it was 26.1%, exceeded the top end of our long-term target range. Both commercial transformation and lean manufacturing continue to gain traction and are now delivering improved financial results. Now let's turn over to Page 9 for European results. Our EU team continue to execute well to deliver good fiber cement growth along with solid execution on fiber gypsum business. Housing market in Western Europe has been softening this year, particularly in Germany and the U.K. Fiber cement net sales grew 23% in the quarter and 30% in the first half in local currency. Fiber gypsum net sales grew in local currency 3% for both the quarter and the first half. EBIT margin was 10.3% in the first half, which is in line with our internal targets, and we're on track to deliver full year EBIT margin accretion. Now let's turn over to Page 10 for APAC results. Our APAC business delivered a solid quarter, driven primarily by a very strong operational performance coming from our Australian and Philippines businesses. As you're well aware, the Australian housing market continued to contract. Our addressable housing market in Australia declined 8% to 10% in the first half. Despite the headwind, our APAC team delivered net sales growth of 2% in local currency with flat volume. EBIT grew 5% in the quarter and EBIT margin is at 24%, which is at the top end of our long-term target range. The APAC team continued to execute well with price mix and lean manufacturing is gaining momentum across our APAC plants. Finally, on Page 11, following our updated key assumption for fiscal year 2020, that we see modest growth in the U.S. housing markets. It was roughly about 1-sh percentage. The first half was quite challenging for the new construction home starts in North America, but what we see right now is improving. And U.S. residential housing start forecast is still between 1.2 million and 1.3 million units. And we're raising our exterior volume growth from 3% to 5% to 4% to 6% PDG for the whole year of fiscal year 2020. And we also raised our EBIT margin for fiscal year 2020 from the top end of 20% to 25% to 25% to 27% in North America. In Europe, the housing market is down slightly across addressable market, particularly in Germany and the U.K. The key for us in Europe, we'll continue to introduce new fiber cement products that developed and made for the European markets and continue to replicate the lean manufacturing processes and systems from North America to Europe, so that we will deliver the EBIT margin accretion toward -- for the whole fiscal year of 2020. For Asia Pacific, the addressable housing markets in Australia is contracting, to the tune of about 8% to 10% in our assumption for the year. And APAC volume will deliver 3% to 5% growth above markets. And our EBIT margin in Asia Pacific would be in the top half of our stated range of 20% to 25%. With the continued improvement in our results, we are raising our full year adjusted net operating profit to be between $340 million and $370 million. And with that, I would like to have Jason to come up and share with you in more detail, the financial results of our quarter. Jason?

Thank you, Jack, and good morning, everyone. We will start with the group results on Slide 13. You could see a strong financial performance for the quarter and the half year for the group. At the top line, straight down through to the profit metrics. We'll start with the top line. Net sales were up 2% for the quarter, as well as for the half year compared to the prior corresponding periods. That was really driven by 2 two things: growth above market and volume for all three of our segments, so North America, Asia PAC and Europe delivering growth above their markets; as well as a higher net price in all three regions as well in local currency. Moving down to the profit metrics. Gross profit was up 16% for the quarter and up 11% for the half year. Adjusted EBIT of $134.2 million was up 26% for the quarter, and it was up 21% for the half year. Finally, adjusted net operating profit of $98.6 million for the quarter. That's a record high for any quarter at James Hardie. For the group, that was up 22% for the second quarter compared to the same period last year. And a solid result for the half year as well, up 17%. Finally, operating cash flow is up 37% at $251.8 million. A pretty simple story there, driven by the strong performance of all 3 segments in the operating cash they're generating. Moving on to North America, as Jack said, a strong top line result in sales volume, up 5% for the quarter and up 4% for the 6 months, driven by strong exterior volumes. PDG is on track. Exteriors volume, plus 6% for the quarter and plus 5% for the first half. And as Jack mentioned, that's on a underlying market for our 6 months of relatively flat. With that, we raised our PDG target for the fiscal year 2020 from 3% to 5% and now to 4% to 6% for the full year. Also, gaining momentum is our interiors business, flat volumes on the quarter as well as negative 2% for the first half, a marked improvement versus the last 2 fiscal years. Price is up 1% for both periods, compared to the same periods last year, favorably impacted, obviously, by our strategic price increase on the 1st of April 2019, partially offset by mix. That's a combination of customer mix as well as product mix. Moving down to EBIT. Excluding another record for James Hardie, $124.7 million in the quarter is the, our highest quarter to date. That was up 25% compared to the same period last year. And $238.2 million for the half year, up 15%. Jack talked about margins, 27.1% for the quarter and 26.1% for the half year. Again, both above our long-term value creation range. And as Jack mentioned, we raised our guidance on EBIT margin as well and added some more specificity to a range of 25% is 27% for the fiscal year. The EBIT results were really driven by the top line result volume and sales, or sorry, volume and price. Improved plant performance driven by lean as well as lower freight in the, in both periods. This is a chart most of you would be familiar with. We plot EBIT dollars on the left axis and EBIT margins on the right axis. The gray bars are, represent the EBIT dollars, and the green line is the EBIT margins by quarter, with the red range there being our long-term value creation range of 20% to 25%. As we've previously mentioned, 26.1% for the half year. Input costs. This slide's starting to look a little nicer than it has over the past few years. We'll start with pulp. Pulp was down 15% for the 3 months ended September 30 compared to the same period last year. I want to remind everyone, these are market prices that we show on the slide. The sources are down there on the right-hand corner. That's important with pulp, as you're aware, the market prices we see with pulp lag by about 1/4 into our P&L. And so for the quarter and the half year, as Jack mentioned, pulp was still a headwind for us. We'd expect to start seeing that favorability in the third quarter. Freight, similarly down 16%. A different dynamic for us, market price kind of flows through the P&L immediately. So we've been seeing the favorable impact in our P&L in the quarter as well as the first half. Something to note on freight. The first half of FY '19, the freight market in the U.S. was quite high and elevated, as we're seeing that favorability now. But certainly in the back half of this fiscal year, we'd expect that to narrow substantially. Cement, up 3% were, very similar to the first quarter result. Gas price is flat, is an improvement compared to what we reported 3 months ago. And electric prices down 7%, is consistent with the first quarter. Moving on to Asia Pacific. As Jack mentioned, a very strong result considering the Australian housing markets. Sales volumes were flat for the quarter and only down slightly 1% for the half year, really driven by growth above market in both Australia and the Philippines as well as a growing underlying market in the Philippines. Net sales plus 2%, AUD 164.2 million. There's an impact on currency translation there where that number comes through in US dollars at a lower rate, but good price as well. The price was up 3% in both periods compared to the prior year. In Australian dollars, an EBIT margin result of AUD 39.5 million, was up 5% in the quarter on flat volume. A good result for the team there. And AUD 74.9 million for the 6 months was flat year-on-year. EBIT margin of 24% for the quarter and 23.5% for the half year. Those are both on the top half of our long-term range of 20% to 25%, which is what we got it to for the full year, and we're on track to hit that target. You see the U.S. dollar EBIT result there being down year-on-year. That's just the impact of the foreign exchange translation. Europe continued strong. Net sales results for Europe, up 5% for the quarter and up 6% for the half year. The fiber cement for the half year was up 30%, and fiber gypsum in euros increased 3% consistent with Q1. At the EBIT level, EBIT excluding EUR 7.8 million is up 7% for the quarter and EUR 17.0 million for the half year is up 1%. The EBIT increases are being driven by the gross margin performance and partially offset by higher SG&A as we stood up the corporate function there and exit the TSAs. Last thing is on EBIT margin, excluding 9.9% for the quarter, it was up 20 basis points and 10.3% for the half year is down slightly from the 6 months at the same period last year. But that's on track with our internal targets, and we're still on track to deliver EBIT margin accretion for the full year FY '20 versus FY '19. Lastly, I've spent about EUR 4.7 million of integration cost through the 6 months and approximately EUR 3 million left to spend in euros over the last 2 quarters of FY '20 as we wrap up the integration. Moving to the remaining segments, Other Businesses segments. You recall we closed our, we exited our Windows business last fiscal year. The majority of those charges were taken in the second quarter. So you're seeing the largest $17.6 million charge there in the prior year. And the current year, where all operations seized in the first quarter, and we're winding up the rest of that business. And there's small charges or gains or losses as we sell the remaining assets. So we'd expect very minimal activity the last 2 quarters within that segment. Research and Development. We continue to be committed to R&D investments. As Jack has talked about in our September Investor Tour as well as today, that will be an area of focus and area of investment for us going forward. You see the numbers there are down slightly for the quarter and for the half year, but we'd expect R&D activity to increase over time. Lastly, with general corporate costs, in line with our expectations are up a bit for the quarter and for the half year at $15.9 million and $31.9 million, respectively. But that's driven by the higher stock compensation expenses, which is being driven primarily by the increasing share price. Moving on to income tax. Our current estimate for our adjusted effective tax rate for the full year FY '20 is 17.9%, that is very much in line with what we would have reported three months ago at Q1 when we reported 18.2%. There's no real change in anything around our income tax, and we'd expect our full year ETR to be 17.9%. Moving on to the balance sheet. Our financial management framework remains unchanged. Reminders around capital allocation. Our first priority is our organic growth and investing in R&D and capacity expansion to drive that. Second is to maintain the ordinary dividend. And lastly, remain flexibility for cyclical market volatility, accretive and organic and strategic inorganic opportunities as well as further shareholder returns. You'll note in our media release this morning, we announced a first half dividend of $0.10 per security. Moving on to cash flow. Discussed this a little bit on the first slide. For the group, for the 6 months, operating cash flow is up significantly, 37% at $251.8 million. Again, primarily driven by the strong performance of all three business units. In the cash used for investing and financing, you'll see some large changes year-over-year, that's just driven by the fact that we acquired Fermacell in the first half of last year -- first quarter of last year and they're -- the large transactions associated with that in the prior period are driving that fluctuation. On to our liquidity profile. As of 30 September, 2019, really no significant change from 30 June. The same debt instruments remain in place, USD 800 million notes, EUR 400 million notes and a USD 500 million revolving credit facility, those are all -- remain in place. We remain on track to get back within our 1x to 2x leverage range. Last quarter, we would've said, "We're four quarters away." And we're still on track with that. We're currently at 2.3x in our long -- the range we want to operate in is 1x to 2x. Moving on to capital expenditures. $123.4 million for the six months, down from the prior year, down $16 million. We would have talked the last few quarters about an estimate of $200 million for fiscal year 2020. We're right on track with that. We expect to end up right around that number for the full year. In the first half, we completed the startup of our Tacoma 2 greenfield expansion. We continue construction in Alabama on our Prattville facility and remain in a position to open that in the first half of FY '21. And we continue our brownfield expansion at Carole Park. Lastly, you've seen the slide already, Jack went through it once, I'm just going to touch on the changes that we've made from last quarter to this quarter and our key assumptions and market outlook and guidance. Starting with North America. We've changed our PDG assumption around exteriors for fiscal year 20, increasing that from 3% to 5% to 4% to 6% PDG for fiscal year '20. Similarly, with EBIT margin, last quarter, we've had an assumption around the top end of our long-term range of 20% to 25%. We've narrowed that and added some more specificity to 25% to 27% EBIT margin for fiscal year 2020. I want to point out that does not change the long-term value creation range of 20% to 25%. In Europe, one change. As Jack had mentioned earlier, three months ago, we were expecting a slight increase in our underlying housing market. And today, as we look across all the countries we operate in, the segments, commercial and new construction, R&R, we see a slightly decreasing addressable market. It's not a massive change, but certainly, something has changed in our outlook for the fiscal year. No changes to our assumptions around Asia PAC for the fiscal year 2020. And finally, adjusted net opening profit, our guidance at this point last quarter, we provided, was $325 million to $365 million. We have raised that to $340 million to $370 million. With that, I'll turn it back over to Jack for a strategy update.

So now I'd just like to give you a quick update on where we are relative to our 3-year strategic plan that we shared with you back, about 9 months ago. Just to remind you that we, for this, here are the key metrics of our long-term value creation. For North America, it's about having the 35/90 goal with strong returns. And that's roughly 6% PDG and an EBIT return of 20% to 25%. And in Europe, it's all about creating the €1 billion business, with 20-plus percent EBIT margin in about 10 years. And for APAC, it's deliver growth of our market with strong returns with a 20% to 25% EBIT margin. So here are the key strategic priorities that we've set out as a goal for our organization, our global teams around the world. So how about in North America? We accelerate the exterior growth. And what that means is that we are, we will develop, market and sell the full Hardie solution for exteriors, the HardiePlanks, HardiePanels, HardieSoffit, HardieTrim and all, HardieShingles, everything about fiber cement that provide a total exterior wrap for home construction as well as R&R. Second is about leverage on the fact that we are the world's largest fiber cement producer. And also in North America, we have a very large scale. And it is now about having all of our 10 plants running the same Hardie Manufacturing Operating System to really take advantage of our scale and capability. And third is really about make interior business a growth business again. And so these are the 3 strategic priorities that drive a lot of the key plans and then the execution for our business in North America. Europe, it's really all about gaining market traction for fiber cement and that means that we're leveraging on the R&D capability and new product commercialization capability within the company to develop relevant new products in, for the European market based on European demands, so that we can really set out to grow our fiber cement business in Europe in a very meaningful way. While we're doing that, it's also important that we continue to drive fiber gypsum growth, to drive market penetration. This is also a profitable business for us that, also differentiated that we will continue to invest to grow in Europe. And really leveraging on the lean manufacturing system that we have in Asia Pacific and North America to really unlock the manufacturing capacity in Europe, to help drive EBIT margin growth for our business in Europe for the short and long term. And Asia Pacific is really all about continuing to drive growth above market. And that means in Australia, it's really about gaining share against brick. In New Zealand, it's really about fiber cement gaining share against timber. And in the Philippines, it's really about fiber cement gaining share against plywood. And to continue to drive lean manufacturing across all of our 4 plants in Asia Pacific, to really drive the strong returns as we grow. So just a quickly to give you a quick update on where we are in the commercial transformation in North America. This is where we essentially move from being a pull approach to push pull. James Hardie in North America, we have always been very, very strong of creating demand of our products with the builders and the contractors. So as we convert homes and jobs into fiber cement, those conversion must then be converted with our customers for sales. But we have not paid a lot of attention in the past about how to manage our customers, which is really the distributors, the dealers, retailers. And really a big focus for us during this year and going forward is really about a number one is that we will continue to invest significantly more and more in the pull side in terms of driving the demand creation. This is what we know how to do best. But as we create a lot more demand, we have to be sure that we also manage out the customers, which are the distributors, dealers and retailers, in the way that as they sell more of the James Hardie products that they make more money and then improve their working capital. And that means that for James Hardie, it's that we have to build the capability with our customers to be really based on analytics of how do we integrate our supply chain capability in with our customers to deliver the right product to the right end user, which are the builders and the contractors. And this is where we also invest in our systems to ensure that we are a lot more easy to do business with. And it's all about having the win-win approach with our customers. And so far, it's really, we have the early traction in this area. The shift to a pull to push-pull is really proceeding well. And we're on track now to deliver 4% to 6% PDG for the fiscal year 2020. And it is an area that as we continue to gain more profits, growth in our business that we will allocate more of those cash to invest in our market creation as well as the account managements to ensure that we can deliver the long-term value creation toward the 35/90. And another key part for our long-term success to the 35/90 is that we we'll come up with more of what we call the market-driven innovation. The innovation that really matter most to the market as opposed to being technology push. And that is really one of the key transformation within our company is more about understand what are the key trends in the marketplace, the hyper trends in the marketplace, which is labor shortage, the affordable housing and then the move to cities. And based on the trends and ends that we'll be working closely to our customers and end users to have the really the right insights in terms of what are those unmet needs. And based on those insights, and we turn those into action for our R&D team to really develop the right products and commercialize it quicker to the marketplace and make a big difference. It is one of the key four pillars for our global strategy going forward, not only to help North American business marching through that 35/90 objective, also a key driver for us to grow to the €1 billion business in Europe as well as in Asia Pacific. But having those key strategies is nice, but if we don't have the right team, the right skills, the right culture and the people to execute, then we won't be able -- we won't get there. And this is really a key area that really is moving quite well within our company as we move from being a big small company to now a small big company going forward. And that's really about moving from being managing top-down to really driving a lot more empowerment and accountability deeper within the organization. And this is one of the key drivers of success for our lean transformation in our plants where we make the operator being the center of our operations as supposed to being driven from the top. Working -- in the past, we were working primarily in different teams and different functions, it's really not connected. There's -- now we remove from being -- working in silos to working is a lot more cross-functionally with very clear alignments toward the -- delivering results for the total company, the total business as opposed to just suboptimizing per functions. And we're aware now with the acquisition of Fermacell, we're now creating a new business within Europe. And we're truly now a global building material company with significant operations in North America, in Asia Pacific and Europe. And it is an area that we were -- really take advantage of that value, that is taking the best that we have in our businesses around each region of the world and replicate where applicable. For example, we took the preliminary -- the early lean manufacturing approach in Asia Pacific and then to replicate that to North America, improve on it and then we took that and we replicate to Europe. And then now, some of those key advancement now replicate back to Asia Pacific. And for -- another example is that our interior business for our European business is very -- a lot more advanced than what we have in North America, and so there's a lot more of the interactions and know-how being transferred from Europe back to North America. And in terms of -- we're moving from being reactive to a problem to more -- to know about -- to having a clear plan going forward and know where the opportunities are and know where the pitfalls are and then to really plan it correctly, so that we can drive toward the results. We would -- not having a lot of big barriers in front of us. And so this is a cultural transformation within our company today. That's very, very important as we continue to grow that and our people, our teams, our employees around the world are really getting more and more energized to execute the plan, to deliver. So with that, that concludes our presentations, and Jason I will be happy to address questions.

Peter Steyn from Macquarie. Jack, just came to get a bit of an understanding of what happened in the North American, particularly the plant performance and essentially your input cost delta there, 270 basis points of improvement. Could you give us a sense of what freight contributed to that relative to plant performance? Just want to try to get an understanding of what's cyclical and what's potentially structural.

So we've, if you look at our operational, the operational performance, we, so we have lean savings, we have freight savings and those, and they will offset with the overall raw material headwinds in the quarter. So we take all 3 together, I would say about 50% of that is due to lean and about 40% is due to freight, and then the rest are materials, I'm sorry, 50%, 30%, 20%.

Perfect. And then perhaps, just a shout-out on Asia PAC, a really strong performance particularly from a volume perspective. You've pointed to Philippines doing reasonably well. But you're, what, from an underlying point of view, is driving the very strong performance from an execution perspective in volume, in particular, in that business?

It's really driven primarily with the, and yes, we have very, very good volume performance in the Philippines. And we also have very good growth above markets in Australia. And so despite the contraction in the Australian business of 8% to 10%, our business in Australia has performed a lot better than that. And then given now that with the focus of Hardie Manufacturing Operating System that replicate back into Asia Pacific, that's also enhanced the performance, the financial performance of our plans in the Asia Pacific. Sort of combination of volume growth and also improved, much improved operational performance in the plans.

I guess it just sort of strikes me that they're potentially doing better than the 3% to 5% PDG guidance that you've given for the full year at this point in time. So, sorry, one last one for me. Just on cash performance, working capital and lock, particularly strong. There's been a couple of movements there, but really trying to understand whether there's something fundamentally improving your inventory position. It's only up 7%. And if you think about price movements and cost movements and underlying market growth, it seems like that's a pretty decent performance. Is that some of the restructuring you've done from a supply chain point of view of the last 12 months coming to be there?

Absolutely. It's really, we discussed this back in February is that lean with the Hardie Manufacturing Operating System is really about driving a lot more of the predictability of our output. I saw a reduction in variability of our output. And at the same time, we would be able to produce more volume per hours within the, within our plants. So by now, as we continue to improve with lean that we have, of course, we can be more predictable with our output. And that would then allow us to manage our inventory better than it has been. And of course, there are just continuous improvements.

Jack and Jason, just 2 questions from me. First of all, your exceptional performance in 2Q. You've hesitated from changing any long-term targets. I guess can you just explain why the hesitation today when things are continuing to improve from where we sit today, given all the internal initiatives that you're driving? Why you're sticking to the 20% to 25% EBIT margin?

Okay. Sophie, that's a good question. There is I think 3 factors. One is that the housing market is still quite variable and then two is that we also need to make sure that we invest back into our business, particularly in innovation, particularly into how we are going to continue to do a better job, much better job of managing our key accounts, our customers. And so that means there's going to be more investments, investment in systems and so on. So it's very, very important for us to make sure that we have the right investment in place for tomorrow and be able to continue with this type of sustainable performance. And I think the third which is very, very important is that we want to be sure that we establish a good track record of delivering sustainable lead and consistently to be able for us to make some decision on what that guidance, if we need to change the guidance or not.

Okay. And then just in terms of North America, prices were up 1%. Your key competitor was talking around rebates. Can you just update them update us in terms of why that pricing increase was probably a little bit lower than expectations? And have you had to pull the rebate levers?

Well, if you remember the first half of last year, our price was relatively large. I think it was about 4% or 5% price to the same time period last year. So we're confident against a higher number. No, we don't really have to focus too much on price and how we approach the market. And it's really now more about what is growing into more we call it the mix of customers and products. And with the lean manufacturing approach now that allows us to have better operational performance that we now can afford to move into these segments like multifamily, which tend to be a lower margin than the new construction for single family, for example. So now it's really about allows us to grow into new segments. So we just worry about the price mix. So yes, we did have an increase in the invoice price, but then that's offset by the mix of customers and products.

Peter Wilson, Credit Suisse. Just following up on that kind of the relative performance. So you've printed strong volume growth by market today, LP also printed a very strong growth, above market today. Do you think, there any sense that maybe the market was stronger than you think? Or are you both just reaping share from vinyl?

Well, I think first of all, I think there's one thing I'd just like, I mean to reinforce is that for James Hardie, we are focusing on driving demand. So our sales are really based on our product get on the wall. And then as they get into the wall, then that will flow back to our dealers for a resale for our business. So it is more business more really relate back to the actual demand in the marketplace. Whereas, LP would be more, what I would call, on the push side. So it's a -- tend to be more sell to the distribution, and then -- and not so much on the pull side. So that's why you have the -- so it's when you compare the two, it can be quite different.

Okay. I know that push side, these sales go through distributors. Are that -- who are they winning distributors off or volume off? Is it -- are they winning off of you or someone else?

No, it's a push. It's really -- I mean it's -- you don't really -- first is that we don't really get the sales until they've actually been used in -- on the wall with the builders because -- that's why we're correlating more with the housing starts and R&R because that is really more about how we built our business. It's about demand creation when our product get on the wall.

Okay. And then interior, so improving momentum, has that -- I'm trying to sketch out, I guess, the -- has that business actually turned the corner? Have you actually had some tangible improvement in product placement? For example, it explains that performance. And should we expect that momentum to continue?

Yes. I think, Peter, that's a very good question. It really come down to what we discussed in New York Investors Day is that for interior business for the short term is that we have to get better placement, which we began -- our team began to get some of that and will continue to improve. Second is that we got to -- we have to have better promotion. So better promotion here is our product have to be better positioned on the retail shelf that -- be able to tell the end users, contractors out there that this is James Hardie back here. Here is our key benefits and so on and so forth. And third is really about new products. So the position and the promotions are -- start to improve, and that will continue to improve. And then we just launched the HydroDefense, the first waterproof backer board in the marketplace. And so that should continue to gain traction in the marketplace. But it's just more about [gain our position, hold our position]. But growth really come when we start to improve our new products' introduction, starting to bring new product to the category that really give us that true, sustainable growth for the long term.

Okay. And then North American margins, you've attributed 90 basis points to the gross margin increase to lower start-up cost. Would we be right to assume that, that benefit continues for the rest of the financial year. But then next year, as Prattville comes online, for it to actually reverse and maybe even double so actually a negative effect into next year?

Yes. The thing is -- or that's -- you know that this year, we -- don't forget that we also have a start-up with Tacoma 2. And so it's -- so Tacoma 2start-up commission and -- is really -- is also baked in the numbers. So for us, it's all about -- we have a long history of being -- investing to a capacity for growth. And our business is quite -- is, in terms of cost structure, very -- is highly variable. So we say, as we move on to commission the Prattville facility, that's -- that would be just a normal course of how we would manage our business.

Lee Power, CLSA. Jack, just on plant performance, you haven't increased the lean target. Is it coming through quicker than you expected?

Lee, a good question. Yes, I think we are ahead of our plan to date. It's really the key, yes, it's better than expected because the key foundation for our Hardie Manufacturing Operating System is really about driving the employee and operator engagement. And then we have targeted that product they delivered, longer time to get traction, but that's really gained significant traction. And that's how we're able to help us get better results to date.

Okay. And then in terms of the amount that you're reinvesting into growth, I mean we heard Peter's questions around LP printing some pretty big numbers. Did you put more down to the bottom line or, than you expected? Or was it the same as you we into the quarter when you delivered earlier than you expected? Did you deliver the same proportion back into growth? Or did you say we've delivered more early and we'll flow that to bottom line?

Yes. Do you know it's to invest in innovation and then to, and then all the capability for account management, for example, is really take time to make sure that we develop the plan correctly before we put money behind it. So it's just most of our investment will, which will begin in the second half. So most of the lean savings that we had in the first half has really dropped to the bottom line.

Okay. And then can you talk to that FY '20 target, what, how much higher you think that will be, lean being delivered early?

Well, Lee, I think once you know that, I'd like to know that, too.

Fair enough. And then just on interiors, you talked about know-how coming across from Europe. Can you give some examples of that? Is that on new product development, merchandising? Like where is that actually?

Yes, I think the, first and foremost, it's really about merchandising, make sure that we have the right brand placement, make sure that we make that into, our category become a destination category. Let's make it easy for contractors to find, make it easy for new contractors, who don't know about our value proposition and be able to see the product on, in retail and know why they need to pay a higher price for our products. So those are the basic retail blocking and tackling that we have to do, which is really an area that we didn't have the expertise here into North America. So that's an area that we had beefed up recently. I think at the last earnings call, I shared with you that we would just hire a Vice President for, of Interior Sales for the North American business, who, this is a leader that used to run the Home Depot account for 3M company. So he knows how to deal with the big box retailer, the different levels and how to drive the push-pull effects to the big box. So that's what help, that would be the first step towards that direction.

We can take questions from the phone.

Multiple questions on our phone. The first question, it's from Simon Thackray from Jefferies.

Just a couple of really quick ones, some of mine have already been answered. But I just want to go to Europe for a second. Jack, well, I'm trying to understand how fiber cement can grow 30-plus percentage and the fiber gypsum only goes 3% and the margins go backwards year-on-year when fiber cement was, always meant to be a higher margin product. Maybe I'm missing something. But can you set me through how margins go backwards in Europe on that kind of mix?

Yes. Simon, I think that -- this is Simon, right?

Yes.

Simon, it's just normal variations in the business. And it's just a timing of some investments. But as the year go on, we should see that smoothen out and then we still expect that for our EBIT margin for the year to be accretive and that was our expectation for Europe as we set out in the plan.

So is it just that the fiber cement is growing on such a small base that the number looks impressive but it didn't really make much difference to the overall result? Is that the better way to think about it? Or am I...

No. It's just a -- it's more investment that we've put into the business to drive growth.

And would that investment continue in this current half? Or is it likely to slow down that rate of investment? I'm just trying to understand how the margin, when the margin goes back to reflecting what should be growing margins, pretty aggressively growing margin on that kind of volume growth, what...

So, the way to think about it, Simon, is that our 4 factories, the fiber gypsum factory in Europe, as is, is now gaining more momentum in terms of running the factory more efficiently and now we open up more for capacity. And so as we get a volume of fiber gypsum growing back to where the plant is, and that's why we will get the force multiplier effect for margin accretion. That's why we'll see EBIT growth and then we still expect that as we grow more fiber cement sales. And that fiber cement has a higher margin to fiber gypsum so that would also be more accretive.

Okay. Okay. That's helpful. A small one. Jack, when do you sort of weave your magic in New Zealand? You've called that plant performance, yet again, in New Zealand. It seems to be a perennial issue with New Zealand. What's the plan for New Zealand?

Oh, yes. The New Zealand plant performance during actually during in the past 2 months is that has a step change in improvements. And then, we should expect that to continue to improve going forward. This is a case of being the new culture within our company now is that in terms of how we become more, have a global mindset and really sharing best practices as well as resources. So, as we now implement the lean manufacturing in North America and have really good success there, and what we did is that we took really, the number two leader in our Waxahachie plant and now made him the plant manager for our plant in New Zealand and effective this month. So we would expect that really an improvement and our New Zealand plant will continue to improve, if not continue to have step change improvements.

So when you were in charge of international, and that was under your remit, and you obviously demonstrated great success with Carole Park, as it just a question that New Zealand just didn't get on the bus, didn't get on the journey when you were driving change through the region? Is that the right way to understand it? Now you're fixing that with the Waxahachie manager going there?

He's asking why Penrose lagged, the other three plants in Asia Pac.

Oh, right. It is a -- it is also -- Simon, this -- that's a good question because it is also part of the priority and because Carole Park was -- it is our biggest plant in Asia Pacific. And then the second one is Rosehill, the third one's Cabuyao in the Philippines and Penrose is our smallest plant. And then it's just in terms of how we prioritize our resources to focus on the biggest opportunities, and -- which we did, and then now to -- all three plants, Cabuyao and to Carole Park and to Rosehill performed at the exceptional level, which kind of contribute to the good performance that you see in Asia Pacific this past quarter, so now we can then to -- reallocate the resources to and to really take Penrose to that next level.

Question is from Brook Campbell from JP Morgan.

Just one on the SG&A line in North America. It looks like, I guess, the first half of that SG&A expense line looked 2% to 3%. And so your comments earlier on about costs picking up in the second half, was that just relating to R&D? Or should we see SG&A expense increase in the second half? And if you could help us understand what sort of magnitude of increase we should be looking for.

Yes, Brook, thanks for that question. We talked about 3 areas of spend, our investment, it's going forward; demand creation, which is certainly would be -- most of that would be in the SG&A space; customer and management capabilities as well as customer-led or consumer-driven innovation. So how that impacts our P&L will be in a variety of places, so within the segments that may show up in SG&A. Depending on the program, it could show up in cost of goods sold. And certainly, in our R&D segment as well as our general corporate costs are all kind of the places that it could show up. We're not in a position today where we're going to provide guidance on the increase and spend, but certainly, investment is a focus going forward.

Brook, the way to think about that too is, for example, with innovation. Yes, we work in these -- the additional funding to develop new products but then as we develop those new innovative products, sometimes we need to have a new -- a certain new manufacturing process to put in to make them in the lower-cost environment and so on and so forth. So to think about it, it's -- for innovation, it cut across several different P&L lines.

That's really helpful. Jack, and one more for you while you're there. Just interested to understand if the -- I guess the hiring in the senior management team is now done. Are there any sort of open roles, I guess apart from the CFO position, which we're not talking about today, that you're looking to fill at the moment? Or restructure going forward?

Yes. I think -- yes, we're looking to have a new CFO as well as we're looking for a new Head of Manufacturing for North America.

Okay. And just one more for Jason just on mix in North America. Talked about this already, but you mentioned that you do both customer and product mix, I'm just wondering if you can sort of dig into that a bit deeper, maybe provide some examples first just to help to understand really that mix and drag in the period.

Yes, I don't know that I described it as a drag. Obviously, in the numbers, it comes through as a drag. We executed our price increase and that went into the market successfully, so the team did a good job with that. And then as you're aware, we sell across a variety of segments as well as to a variety of customers in a variety of products, so in any given year, one may be growing faster than the other. I think the key is we're doing a good job across all of our segments and across all of our products and the fact that, that's coming out with a negative mix impact is not something we're concerned with. We're trying to grow across all those spaces and we're effectively doing that. Some examples that you guys would be familiar with for any period, I'm not going to be specific to this period, but if you sold more multifamily than say, new construction, that would have an impact on mix, more prime product than a ColorPlus product, that has a product impact on mix. So it's all those types of dynamics that could impact that mix equation.

The bottom line is that we're managing our business holistically now. So the key is that we focus on driving the, our growth above our markets at the target that we have and also we are driving our EBIT to the target that we have. So anything in between is what we do to manage our business to deliver those 2 outcomes that really drive the value creation.

And our next question is from Daniel Kang from Citigroup.

Just, firstly, on, can you just provide some color on underlying markets that you've seen? I think I heard you say, Jason, that the addressable market was relatively flat in the period, can you talk about the underlying drivers there and what you're seeing, in particular, in the R&R market? I think you also mentioned that you're expecting that to be a drag for the year. That's my first question.

Yes. We wouldn't have R&R as a drag for the year. So underlying housing market in North America, Daniel, we assume, we are assuming that the data we see would be, R&R would be up 3% for the full year. And we see that consistently through the full year. So our first half, we'd be looking at, our assumption is a 3% R&R increase in the underlying markets, new construction is the space where it's a bit more, a bit, a case of 2 halves. You can look at various sources externally, including U.S. Census data. And through the 6 months ended June 30, the market would have been down 4%, 5%, 6%, looking at, depending on which data source you look at. And I used June 30 because that kind of activity lags by about one quarter into our PDG calculation. If you look at those same data sources, you're now seeing a 3% or 4% or 5% increase in, for the 3 months ended September. And so we'll see that's kind of housing markets underlying for new construction kind of impact us in our third quarter. And so Jack talked about it earlier, when he went through the assumptions page, we are still assuming, which is what we're assuming last quarter, a slight underlying housing market increase and that's when you blend, the 3% R&R increase along with something below 0%, maybe negative 2%, negative 3% for a new construction. You blend those 2 together and you end up at something right around and Jack talked about a plus 1% for our underlying market for FY '20 is kind of where we're seeing it.

That's great. And just on margins, 27% margins in North America, clearly a strong performance. But the lower pulp cost, we didn't really see much impact from that. So should we expect that 3Q, given the favorable impact of that, 3Q margins should actually be higher than 27%? Or is there other factors that I should be taking into account?

So we certainly are confident in EBIT margin that's why we raised the guidance to 25% to 27%. I think your question is what are the puts and takes going into the back half of the year. As I flagged earlier, certainly, the favorability we've been getting on freight in the first half of the year, we don't see that repeating because the freight market started correcting in the back half of last fiscal year. So that comparison will tighten. Certainly, pulp will be a tailwind for us in Q3. But then you got to remember, we've talked about investment quite a bit today, so investments would be the other thing. It sounds like you're not considering as you talk about margin going forward.

To be more continued lean improvements.

Yes.

And Jack, in terms of you spoke in the past in terms of base customer erosion that you're looking to narrow. Can you update us on the progress there? Has the base business begun to stabilize?

He's asking about base erosion.

Oh. Yes, it is really as we continue to focus more and more expand our focus more into our customers, we'll begin to gain more trust and credibility with our customers. And then also as we also bringing the demand to our customers. And so we see that our customers tend to substitute less and less, so I think that's an improvement and that's why you see some of the result that you see here is really due, in part, to that.

Our next telephone question is from Grant Slade from Morningstar.

Just one from me on the lean program in North America. I just wondered if you did have any sense as yet as to how much latent capacity in the North American manufacturing network will be, ultimately, unlocked by the lean program.

Yes. We would estimate that probably would be the equivalent of about 1 additional sheet machine for the next 12 months' capacity that we don't have to build.

Right. And how much is that in terms of million square feet?

Roughly 200 million to 250 million standard feet.

Right. Okay. And that's the total that you think, that's the total amount of latent capacity you think you'll unlock?

Right.

Okay. Is there any more questions on the phone?

We have another question from Paul Quinn from RBC Capital.

Congratulations on the results. Looks like you have a pretty good short wind -- tailwinds here. Just trying to understand the longer-term picture in the 35/90. We saw LP put up almost 7.5% growth year-over-year, you guys were 5% on volumes. Does -- to be able to get to your 35/90, does LP's growth have to slow? Or do they have to shrink?

Yes. I think -- Paul, I think they -- this is why I mentioned earlier, our growth is really coming from the demand on the marketplace where our fiber cement board to actually on the wall. And that's -- and that could be driven back to create our sales. Whereas of the competitors more in terms of selling into the channel with not a lot of the pull through, so it is a -- two different type of -- so when you look at those numbers, you have to -- you can't really compare them from period -- at the same period, you got to look at it on a long-term view to make sure that you see that as being the flow-through to the market because our -- in our case, it's really more about the flow-through to the market than being on the wall.

I completely understand the difference in methodologies. But when LP post a number of years -- and we can go back five years, and you can still see the same type of growth. The question still remains, if they're growing at this stage, does that put in jeopardy the 35/90 goal? That's all.

No, I think it is -- for us, is that we're -- the key for us to continue to drive our game plan and that is about driving the -- from pull to push-pull, and really drive the lean transformation that would allow us to expand into new markets and create a lot more demand. And then the key to 35/90 for the long term for us is innovations. And also, all of that have to deliver a strong profit growth and strong margin. So that's -- that is our game plan. That's our long-term value creation of which we are on the path and that's what we are delivering, it's really about driving that growth of our markets with strong returns and consistently and sustainably and that's our game plan.

Fair enough. Congratulations, good results and good luck going forward.

There's no further questions at this time. I'd like to hand the call back to the speakers for any closing remarks. Please go ahead.

So thank you all very, very much for your questions and your interest. I think it's -- we are, at James Hardie, a global team. We're happy with the results that we have -- just delivered in Q2. And this is about -- all 3 of our regions delivered positive growth in sales and EBIT. And then at -- which allow us then to raise our PDG target for fiscal year 2020 from 3% to 5% to 4% to 6% in North America. We also raised our EBIT margin in North America from the top of 20%, 25% range to 25% and 27% range. And also, with strong performance too in Asia Pacific and good performance in Europe, now then -- that allow us then to also raise our full-year guidance and our adjusted net operating profits to between $340 million and $370 million. Thank you.

Thank you.