Lazard sees a Hardie opportunity behind asbestos cloud

September 03
FUNDS manager Lazard, which specialises in selecting unpopular stocks with good businesses, announced at an MLC breakfast yesterday that James Hardie met its criteria.

Accordingly, Lazard had been buying the stock. That Lazard announcement highlights the way the market is coming to grips with the asbestos uncertainty that may be part of James Hardie for a long time.

The amazing feature of past reports on Hardie is how little was said about asbestos, which is why shares rose above $7.80.

In the depth of the crisis, they fell to $4.95 but have been climbing and reached $5.60 yesterday – a rise of 16c in two days.

Any institution that buys into the stock is clearly taking an asbestos risk in the hope that, longer term, the fabulous US and Australian businesses that stand behind the Hardie crisis will emerge.

In the US, Hardie has been increasing market share, constructing a 300 million square foot greenfields plant in Nevada to service the West Coast and upgrading its plants in Pennsylvania and Texas.

The company earned 39c a share in the year ended March 31, 2004 and, in the first quarter of 2004-05, it earned an annual rate of 46c.

Barring a consumer boycott, profits are clearly headed above 50c a share. That means James Hardie shares are selling on a future price earnings ratio (PE) of only 11.2. Before the crisis, the company was selling at about 17 times its expected earnings.

So, at the current market price of $5.60, it is priced about 17 times its theoretical earnings of 33c a share.

On the basis that it will earn at least 50c a share next year, on market sums, that leaves at least 17c available for asbestos claims, or about $110 million a year before tax at Australian rates ($78 million after tax).

James Hardie faces three great dangers: firstly, the sheer magnitude of possible asbestos claims, which could conceivably hit $2 billion; the possible adverse affect on the business, particularly in Australia from the adverse publicity; and making sure the losses are tax deductible.

In the past, James Hardie directors have done almost everything wrong.

The right strategy was that adopted by rival building products group CSR, which simply met claims as they came through.

James Hardie transferred domicile but created a $1.9 billion uncalled liability.

Last year, directors cancelled the liability even though asbestos claims were escalating and, despite the assurances made at the court case approving the scheme of arrangement that allowed the group to go overseas.

This was one of the factors that triggered the crisis that left the company's business vulnerable to a product boycott, potentially leaving it less capacity to meet the payments and creating a vicious circle.

Directors' personal assets were potentially in danger as a result of the uncalled liability cancellation.

The board is beginning to rectify its mistakes and its first priority now must be to make sure that the business remains unimpaired, which will require meeting the asbestos claims as defined by the courts and the parliament.

People buying James Hardie shares are punting that growth in the US will continue to explode and swamp the asbestos problems.

James Hardie is working very hard to contain asbestos claims and, if it is successful, it would be a big boost for the shares. But community expectations are now very different from five years ago.