James Hardie Industries PLC (JHX) 2016 Q2 法說會逐字稿

Good morning, everybody. Thank you for joining the second quarter result. I'll walk through this -- or we'll walk through it the same way we always do. I'll take you through the just high level business result and then Matt Marsh, CFO of James Hardie, will walk you through the financials and then we'll come back to question and answer.

So we will go to the first page. There's a Group overview. I guess the pertinent things on the slide as far as the little graphs go, we are flat on net operating profit adjusted we are up 12%. So like I said, Matt will go through the financials and you will see how the arithmetic worked out.

The higher volumes, we did have higher volumes in all businesses, but I think everybody who follows Hardie knows we're not satisfied with the volumes we're getting out of the US. So I'll cover that when we get to the US. We did have average higher net sales price in all businesses as well in local currencies.

Obviously everything outside the US gets translated into US dollars, so in US dollars, some of the pricing was down, but in local currency, which is -- you know, reflects more the market position, everyone was up.

Plants continue to run well. Basically the businesses right through the Company continue to run well. The half year EBIT, 25.6%. Most of you would have seen for a quarter it was 24.8%, so we'll talk about a bit. That's US and Europe. Then a dividend of $0.09.

So going to the next slide. Go through the US. Net sales up 8% in the quarter. 7% on volume. Just 1% on price. Right off the bat on the volume, we think our market index is around 5% to 7% right now, so we're running flat to the market index. So PDG is flat. That's the headline for the Company, I think, both internally and externally.

Price, we took a 2% to 3% increase last year. We've only seen about 1% come through. That's partly because of the FX in Europe and Canada. A big part actually. Then there's also mix isn't working for us this year.

To the degree, we normally have gotten help from mix and that's because HardieBacker is actually growing faster than exterior products this year and our ColorPlus product, which basically is a value add feature going right on top of some our product shipped into the market. That's been flat. So those two things basically means mix isn't helping. It's not really hurting. It's just not helping.

On the EBIT line we are getting help from lower freight, lower pulp and lower gas relative to last year. At least for the time being or the short term, we expect that to continue.

Going to the next slide, you can see the last data point does fall just below the 25% top of the range. It doesn't concern us too much, but I know it gets a lot of attention externally. I guess, the biggest thing is the US business ran 26% plus. So the down is the FX in Europe and Canada and the windows loss.

The windows business that we're starting up, we put in our US/Europe fiber cement results. The losses in that business increased this first half as planned as we start participating in more markets with our window offering. So again the US business, 26% plus and it brings the number you see down to about a 24.8% when you deal with the FX and the FX out of Europe and the windows loss.

Top line growth, I guess I've already covered. We're just tracking with market index now, so it is going up, but it's not going up at market share. The share -- which is something we're addressing obviously.

Average price they also covered. Trends still good, but again, we're only getting 1% this year for those reasons I talked about.

Asia Pac had a pretty good result. Probably the market is good in Australia. Our businesses is well setup. Our Scyon product line continues to grow, which is the main initiative in the business. What pulled the result down a little bit was the Carole Park start up, the large high throughput line we put in Carole Park.

It didn't start up as planned, so there's some inefficiencies on both the cost of goods sold in the business due to the less than planned start up and we did have delay orders and some of that, not a lot of it, spilled into next quarter.

So that's the overview of the businesses, and I will hand it over to Matt for the financials.

Good morning. So we're on slide 12. The Group second quarter results, as Lou said, net sales are up about 2% on a reported basis. Volumes were up in all the operating segments and I'll show you those when we go through the segment results here in a minute.

He's also talked a little bit about higher averages of selling prices in local currencies year-over-year. Gross profit margins are up about 240 basis points, primarily as a result of the US plant performance and then we're getting help on input costs almost across the board on our key inputs. They're all down year-over-year.

SG&A expenses up about 3%. Really driven by two things, both stock compensation and FX losses. You will see that at the half year as well. Adjusted net operating profit for the second quarter is up 2%. That's on EBIT up 11%, so the operating businesses are up.

That gets compressed as a result of both higher income taxes as a result of the mix of earnings in higher tax jurisdiction countries, primarily the US and then gross interest expenses up about $5 million in the quarter. It corresponds to the higher level of debt.

If we go the half year, you see net sales up for the half year up 2%. Gross profits up 11%. EBIT up 25% and net operating profits up 22% for the half year all in comparison to the first half of a year ago.

Similar drivers and dynamics, if you will. Volume is up in the segments. Sales price is up in local currencies, compressed a bit by foreign exchange. We get some tailwind on plant performance, which is contributing to the gross margin rate increase of almost 270 basis points, as well as lower input cost.

SG&A again up very similarly, up about 3%. You can see it's up about $4 million. Half of -- almost literally half of it's foreign exchange and the other $2 million is stock compensation as a result of the change in the [share] price. Then you can see very similar dynamics on net operating profits.

So strong EBIT growth of 25% growth, offset by income tax, gross interest expense being up corresponding to the debt and then you'll see about a $6 million swing in -- a favorable swing in other income and expense.

Some of that's unrealized foreign exchange, about $4 million in unrealized foreign exchange and about $2 million is the gain on sale for the pipes business here in Australia.

Foreign exchange here in Australian dollars, you can see the impact on the lower left side of the chart, your lower right, so a total foreign exchange impact of about $41 million on sales, almost $9 million on EBIT and $5 million on net operating profits. So the strong dollar is having an effect on our results in both Aussie dollars as well as Canadian exchange. We're seeing that through price and the European results, when we translate those.

You can see the impact that that has on a percentage basis, year-over-year, and we wouldn't typically talk about foreign exchange, but we felt like foreign exchange is certainly material enough to changing some of the operating discussions that we thought we had highlighted a little differently this quarter.

On input cost, so they've stabilized quarter-to-quarter, but year-on-year we're still getting lower input cost that are positively contributing to both gross margin rates and EBIT rates. So you can see pulp is down about 2% versus a year ago.

Cement prices are up. The cement industry in the US continues to be positioned well and pricing continues to trend up and we expect that to continue. Gas is down over 20%. You can see electricity is down a little bit. Electricity has kind of stabilized. So it gives you a sense on input costs.

So for the second quarter and half year, in the segments, you can see the US and Europe segment, first half in the quarter, EBITs were up 20% and 25% respectively, primarily on plant performance; a little bit with volume. But the real leverage that we're getting as a result of the plants performing better and input costs being down.

Asia Pacific results in local currencies for the first half were up 8% for the quarter and 11% for the first half in local currencies versus a year ago. It's a combination of higher volume, year-over-year. They've got about 6% price, which is a combination of list price changes that they executed, plus they're getting favorable mix and then offset a bit by the production costs.

Production costs primarily are two dynamics. One is they buy their pulp in US dollars. They're getting foreign exchange and Carole Park, which Lou mentioned earlier, is -- we had some of those costs built into the result and they're running a little bit higher than even those.

The other two segments. R&D. No real change in R&D. We continue to be within this 2% to 3% range of our sales. You will see some fluctuations. Very consistent with prior quarters.

On general corporate costs, you'll see that they're up $4 million. Like I said earlier, that's $2 million of foreign exchange, $2 million of realized exchange losses.

The actual increase in labor and marketing programs is also up, but it's not driving the result. Income tax we're estimating for the year to be 26.2%. Again, I'd say similar to last quarter. I think this was adjusted a bit, but pretty consistent. Rates are trending up, obviously, as we earn more in higher tax rate jurisdictions like the US. Our effective tax rate goes up.

We're paying income taxes, as we've said, in prior results, in Ireland, the US, Canada, New Zealand, the Philippines. Australia, we don't pay income tax as a result of the deduction we get from the asbestos contribution each year.

On cash flow, for the first half of 2016, $85.5 million of operating cash flow in comparison to $34.1 million a year ago. It's primarily as a result of the operating segments performing well and contributing operating cash flow. It's also as a result of lower contribution year-over-year to AICF.

You can see as a net change in working capital of a couple of million dollars, about 20% on a rate basis. AR and AP moved against us. So AR was up, along with our sales. Payables went down.

Payables went down primarily because of the capacity expansion projects that we were purchasing last year and our CapEx is obviously down year-over-year, so our payables balance comes down accordingly. Then you'll see those are largely offset by a reduction in inventory.

Lower CapEx as I mentioned. Almost 80% less CapEx. About $34 million in the first half. I'll show you a chart in a minute on those. As we wrap up our capacity expansion projects in the US and in Carole Park, obviously we've been signaling and telling you that we'll spend less on CapEx and that will continue to remain. I'll show you that in a minute.

And then you can see on the financing side a decrease in the dividend and an increase in the share buyback in the first quarter primarily. Then obviously we're drawing on debt.

So here's CapEx. About $42 million of CapEx in first half compared to about $117 million a year ago. That's almost all related to the capacity projects last year versus this year. That $15 million you see there related to capacity is just wrapping up those three projects; Cleburne, Plant City and Carole Park respectively.

Those are more or less done, so the CapEx that we should expect on a go forward basis is going to be largely maintenance CapEx.

On the balance sheet side, no real change to our capital allocation strategy or our balance sheet priorities. Strong margins and operating cash flows continue to drive the strategy. Our allocation remains the same, so we're funding organic growth first.

Obviously we're committed to the ordinary dividend within our payout ratio. That's reflected in today's $0.09 declaration. Then the priorities below that remain the same, so flexibility for strategic or M&A as it comes up.

Being able to withstand market cycles and then additional distributions above that. But as I said at the last result really the additional distributions above the ordinary is something that we're starting to pull back on and we have done so over the last six to nine months.

On liquidity, we've got about $600 million of banking facilities, $590 million to be precise. Good sufficient liquidity, almost 44% and almost a two year weighted average.

The maturity, we're working on strategies to extend that. We remain well within our 1 time to 2 time target on the balance sheet. But I'm happy with where we are on the debt side and I feel like we've executed pretty well with respect to debt.

So the balance sheet is in good shape. We've got about $84 million of cash as of September. Almost $600 million of banking lines. More than sufficient liquidity. We had a $500 million net debt, which is right where we thought it would be and right where we'd like it to be, so it's in that 1time to 2 time net debt adjusted for asbestos range.

On slide 23 for fiscal 2016, we've adjusted guidance to $230 million to $250 million of adjust NOPAT. It's primarily a reflection of where we see the PDG coming in for the first half for the year and we note that the range that consensus was at was kind of in this $252 million to $270 million range. We think that $230 million to $250 million is more reflective of what we see for the year.

So with that, I'll open up for questions.

Hi. It's Michael Ward from CBA. Just, Louis, in the release you talk about the issues around PDG not being an external issue. I was just hoping you could elaborate on that a little bit, please.

Yes. I mean, the housing market is flying. I don't think there's been any shift externally between the products that are fighting for share. I think when you have a reduction in PDG, that doesn't mean you're losing share. It means you're not gaining share at the same rate you had been. I think that's a situation we're dealing with.

Most of you would have seen LP produced results below the market index, so at least for this half year, we don't think it's an LP situation. We really think that our programs against vinyl, we haven't run them as well and probably as broadly as we need to. So that's the adjustment we're trying to make in the next couple of quarters.

The management change in the context of all that?

Yes. The management change, basically it was triggered by the business running well, but not growing at the rate we expect it to grow at. Went through the analysis, external versus internal and then internal, how much was game plan design and how much was game plan execution.

We just feel like with the two divisions, really the northern division being the growth division against vinyl, we just weren't getting the traction we needed in our programs up there. We looked at the resources available in the Company and we just felt like the -- going back to a national structure was the best structure, considering what we were trying to accomplish and management resources available.

Okay. Also, just on the gross margins, there's some interesting detail in the release again around both the US and Asia Pac. I think you say that production cost benefit in the US is 2 basis points, 2.5 basis points or something. I was just wondering if you can split that between sort of raw materials and whether or not there's -- how much of that might be from improved manufacturing efficiency?

Probably one-third, two-thirds. One-third is raw material and two-thirds in efficiencies. You've got to keep in mind, the first half this year versus first half last year, it was -- the network didn't run well last year.

So the comp is just an easier comp, on top of the plant's ran just a lot better the first half of this year in comparison. So you're going to get more favorability in the first half for plant performance than you will for the full year.

Then in APFC it's the other way around. It's minus 2.5 [basis points] or so. When would we expect that Carole Park should actually be a positive contributor to that?

Yes. My guess would be starting next year. I think they still have a little bit this year, I mean, this quarter and hopefully next quarter to work through the rest of it. By fiscal year 2017, we'll get the benefits of the new line, both in service position and in lower unit costs off that line.

Okay. Thank you.

Thanks. Andrew Johnston, CLSA. Louis, could you comment on regional primary demand growth and how that's varied across different regions?

Yes. What I can tell you, Andrew, is we went through the business and we asked plenty of people to tell us if we were benefitting it or being hurt by a regional mix and it balanced out almost perfectly. So this isn't a regional mix story again from an external perspective.

I think our PDG in the north is less than it should be and that's where most of the vinyl is, so when I say it's internal that's what I'm saying. There's been a lot of speculation about the Texas market being not so good and other markets being real good, and when you average it all out for Hardie it comes out at about -- it's fine.

The regional mix isn't hurting us, but the vinyl is bias toward the north and I think our market share development programs in the north haven't been running as well as they need to for us to move forward on [3590].

I think a lot of that's short term -- say next couple of years. It's just running the programs better. I think there'll be some tweaks as we get into smaller segments or tougher value proposition type segments, whether it be small markets or things like that, but I think right now our programs are good. We just have to run them better.

You may have already answered this question, but is there any build up in inventory in the channel over this last quarter that would cause you to be more concerned?

Yes, we saw those comments in other results. We don't feel like it's affecting us at all.

Just with more focus on growing -- getting PDG back to where you want it, there doesn't seem to be a lot of increase in SG&A. In terms of percentage terms so far this year and perhaps looking out the next year what sort of increase in sales and marketing expenses have you had and do you expect to have?

What are we so far?

Yes, we've been in the 6% to 8% range. Most of that SG&A increase is within the segments with a little bit of increase in corporate. I'd say corporate's going to run lower than that, probably in the 3% to 5% range, but both in Asia Pacific and the US and Europe they've been running in the 5% upwards of even 8% and we expect that that will continue.

So we do have some organizational holes we're working hard to fill. Some of them are in the field and some of them are in areas like product and segment management, but it's not a big spend to get back on track. We do have to spend some to get our PDG kicked up, but it's not like there's no trade off being made here where we're going to trade growth for EBIT.

It's on the margin. The amount of costs to go onto business it's real dollars, but that's not to fix. Spending twice as much on SG&A is not the fix. The fix is running our programs better. Having said that, there's a few gaps capability-wise that we need to address.

I probably had a similar question ultimately. It was just trying to get a better understanding of how much frontloading was in that marketing spend. You're suggesting that there was none. Could you talk us through how you see the payoff over the several quarters that you quote, how that will develop?

Yes, I mean the payoff for Hardie is real easy. I mean we get paid very well for volumes so if you're starting something from scratch -- like for instance, right now we have a top of the market initiative -- something like that that might run negative for three, four years, okay, but that isn't what we'd be talking about.

We're not looking at top of the market to deliver our PDG. We're looking for our existing programs either in new construction or [repairing] model to deliver more with roughly the same resources. Say you were looking for an estimate say another 7% or 8%, 10% more resources, but again not double and with our margins when the volume comes the payback is pretty quick.

Yes. Then perhaps just a broader question around the market and capacity. There's been a lot said about labor and its ability to deliver 1.3 million starts next year. How would you see that across your business mix, both R&R and you?

Yes, I would say we hear the same things directly from builders and residers so there does seem to be a shortage of labor in the construction industry. It's not great for us because of course we're a lot better than bricks and some other things that take a lot of labor per unit to install, but we take more than vinyl and wood. A lot more than vinyl and little bit more than wood.

So it's not great for us but it's not a crisis-type situation. I think that builders talk about it a lot because it really delays their closings so it's cash flow; very important for them in a business. I think starts are more important than closings for a business like ours, so if an order for a subdivision gets delayed 45 days or 30 days because of a tight labor market it really doesn't affect us that much.

So I do think the housing starts we're getting into a regular occurrence of forecast housing starts being higher than actual housing starts, and I think that's partly driven by the labor situation and it wouldn't surprise me if that existed again next year where the forecast weren't reached in actuality.

Good morning, Louis and Matt, Keith Chau from JPMorgan. A couple of quick questions from us. The first one is just around your targeted PDG. I think you spoke to PDG running below target. Just firstly to clarify what you mean by target PDG, I think a couple of quarters ago we were talking about 10%, 6%. So I just wanted to get a bit more color on that.

In relation to that just around the timeframe, I mean is this an FY17 or back end of FY17 story before we see some meaningful PDG?

Yes, just to get everyone up to the same page, coming out of the downturn several years ago we set a 6% to 8% PDG target and we're hitting it, and we're in a market that we really liked and the market wasn't really spiking at all.

It was a slow, steady increase so it really felt like this was going to be an extended recovery because it's not overheating at all, and that we ought to put more money into the growth side and try and get that PDG up to the 8% to 10% level, obviously without trading off the financial returns in the business.

So our timing on that was bad because I think we declared that about last year and now we're sitting pretty flat this year, so not the greatest forecast there on our part. So I think that if you look at how are we going to step into it, of course we see everything by market.

You don't see things by market, so by market's really important to us to tell how the different programs are running in different markets because your positioning's a little bit here and there, a little bit different here and there.

But if I get back to 5% and then push it under 10%, the 10% is still -- that 8% to 10% is still the right target, but I think it's pretty hard to go from flat to 8% to 10%. I think we've got to look for that step in between that we're at which was more the 6% to 8%, 5% to 7%. So I'd say short term 5% to 7%, maybe second year back to the 8% to 10% target.

Keith brings up a good point -- this thing has settled down over four or five quarters. It's not like our -- when you guys read our results you probably think it happened in the last couple of quarters, but again we track the business a little bit differently and we not only look at our sales we look at vinyl sales, we look at LP sales.

You can actually see vinyl declining, starting to slow, about five quarters ago and you can see our PDG start to slow at about the same time. So it only becomes clear I think to the market when you've got four quarter rolling and it's like we are now, four quarter rolling. I think we're somewhere around 4% or 5% four quarter rolling.

In order to get that momentum back it's going to take some time. You can't do it in one quarter. You can't post a 20% in one quarter and have that four quarter rolling all of a sudden come back up to 7% or 8%.

So my guess, well we've got a tough comp coming up. Matt talked about an easy comp in the first quarter on the EBIT side. We've got a tough comp coming up on the fourth quarter on the volume side because we're not going with a price increase in March this year like we did last year, so there'll be no pull forward volume which you normally get with an increase.

Now it's not a huge amount but it does make it harder to comp with the price increase not being there. Again it doesn't matter much to us because we look at PDG on a four quarter rolling basis, but we think we're probably fiscal year 2017 before we can realistically expect to be back at the 5% to 7% and probably fiscal year 2018 we can try and hit that higher target that we had set last year.

Thanks Louis and just a follow up one on mix. I think (inaudible) has been reasonably flat until now -- just how that's tracking -- and also interiors versus exteriors I think first quarter interiors was pretty strong.

Yes, interiors was strong first half so it continued in the second quarter. So we had concerns about interiors probably not quite two years ago, maybe a year and a half ago, and we did a similar assessment to what we've just done on exteriors and I think we've got interiors the way it should be. I think we're going to see potentially some acceleration (inaudible) and interiors so we expect that to continue. So exteriors is really where the gap is on the volume side. It's not interiors.

Any questions on the phone?

Your first question comes from the line of Emily Smith from Deutsche Bank. Your line is open, please go ahead.

Good morning Louis, good morning Matt. Just a couple of questions from me. I'm just wondering is it only the PDG side of things that's changed between the last result and today that's changed your overall guidance expectations?

Also just wondering if you can give us a sense for how the December quarter is looking at the moment, and obviously the price up 1% this quarter you've outlined it at -- it relates predominantly to mix. Do you expect at some stage that that mix change might turn around and you might start to get a positive benefit from mix again and what are you looking for for that to happen? Thank you.

You asked three questions, I forgot your middle one, so I'm going to give that one to Matt.

The change has really been our volume forecast, so the guidance already had a tax rate that we seem to be tracking to. The FX isn't far off of what was in our forecast, so the reduction in our guidance is the reduction in the volume that we think we'll sell this year in the US. Now again we hadn't decided not to take the price increase in March until just recently so that would have let some more volume slip out of the year so that played a small part in it.

As far as the price 1%, Backer on a good roll, not sure if we'll take a price increase next year but we normally take it in the spring, so if we get through to spring without an increase I'd say the probability of an increase that would affect our numbers very much next year is fairly low.

I would think price would be flat to up 2% and it could even if Backer went on a real tear it could even be flat to minus 1% or something like that, but I'd call it flat. We're not looking for big price improvement over the next five quarters, six quarters actually.

I remember your middle question now -- what do we look like right now this year, this quarter? We look very much like we have the last couple of quarters. So the business is tracking in that same range it's been tracking I think for four quarters now.

So we think we're growing at probably just a little bit above the market index. Plants are running well, input costs are staying favorable relative to last year so, yes, everything this quarter's going to, in my mind, track a lot like the previous three or four quarters.

The 1.7 basis point benefit you got from lower production costs how much of that would be manufacturing efficiencies versus input costs savings?

Yes, I don't know if you heard Matt's earlier response but just a rough estimate is two-thirds due to plant performance and one-third due to input costs, but he gave a little warning there that our plants started running well in August and -- well about September last year so the comps in the winter on that performance in plants is going to be a tougher comp than what we've had so far.

So we won't get the same benefit just because we're against a better running system this time last year.

What was the --

Having said that -- sorry Emily -- having said that, I think that's one of the things we want to keep in the front of your mind. We actually think we're on a long term improvement trend line with our manufacturing plants, we've got the Carole Park blip here, but we think in both regions we're pretty optimistic we're going to be able to continue to drive greater efficiencies in our operating plants.

So that'd be one of the areas we're pretty pleased with as far as what we think we can deliver over the next couple of years.

Great, and sorry just finally, what was the reasoning behind not proceeding with a price increase in March?

We wanted to keep the field focused on executing. A lot of what we're trying to change, as Lou said, is internal execution and we're trying to take the distractions away from the sales team.

So we just felt like we were happy with where price has been over the last couple of years, and the benefit of taking a modest price increase next year versus the work that that would require of the team over the next couple of months to get that in place, just weren't as great as keeping everybody focused on getting growth back to where we want to get it to and getting PDG back to where we need it to be.

Okay, thanks.

Your next question comes from the line of John Hind from Merrill Lynch. Your line is open, please go ahead.

Oh good morning gents. I'm just wondering how you expect to grow PDG is this slower environment without really having to reduce prices to some degree. Obviously flat pricing coming up is a little bit of a flag for me.

Also with some of the problems with PDG-- is it the west who's market share is sort of at its limit and some of the easy wood gains have already been made? I mean how much stickier is vinyl that you'd previously thought?

Yes, well I'll start where you finish. So I think the vinyl equation's the same as it's always been, so first thing we want to do is address the price problem. This isn't a situation where you can increase PDG by lowering price because PDG stands for primary demand growth meaning you're growing from others outside of your category.

So again it's not market share growth within your category; it's growth outside of your category, so less vinyl more Hardie and that's the equation we're dealing with.

So because we sell at about twice the premium from an installed cost to a builder about maybe 50% or 60% for our resider or home owner, the price of the product doesn't play a big part okay because if say vinyl were to drop their price 10% the premium they put on Hardie would go from $4500 to $4680. Okay, so there are large premiums that a builder actually has to deal with when he's deciding to go away from vinyl and come to Hardie.

So pricing's not it at all. If it was competition within a category then pricing becomes important but that's not what we're talking about here. You can see, as I said, five quarters ago the rate of decline in vinyl market share started to slow down and you can see in about the last -- looks like three or four months so it's too early to call -- you can see it start accelerating again. Now it's not anywhere near where it was five quarters ago but it has started to come down a little bit again.

I think selling against vinyl is market development where the Company does market development, so if we don't do it it doesn't get done, and I think the reality is we haven't been doing as well as we should do and vinyl's had a temporary benefit from that, but I don't see the position of vinyl in the market has changed one bit.

It's been in decline for a lot of years. It's still on decline; it's just in decline at a slower rate than it has been. We think that rate will pick back up.

Thank you. I mean obviously clearly there's a few issues with margins -- EBIT margins outside the US which you have addressed. I'm just wondering, obviously windows has had a negative impact on EBIT. Given the impact, is it appropriate for you to provide a little bit more detail around revenue and potential run rates for the business yet?

This is the windows business?

Yes.

I mean number one because we look at the margins so closely in the US business -- and when I say we I'm talking external -- it gets a lot of attention but it's not at all material to the Corporation. It is a marketed development initiative. It's meant to cost money.

It's what we talk about when we talk about when we talk about balancing growth with returns. This just happens to be outside of fiber cement. So normally when we talk about growth and returns, we're talking about market initiatives within fiber cement, but there's a market initiative outside of fiber cement.

It's a very small business. You guys are going to quickly be able to figure out how many dollars I'm talking about and estimate how many are foreign exchange, and then you can come up with your guess on windows.

It's not insignificant, but it's not going to break the bank. We do expect this year's loss will be the highest of that initiative. We'll move into a lower loss position next year.

That would be the kind of -- we think in about two and a half years if the initiative runs the way that we expect it to before we make further investment decision in windows. We'd be at a neutral position on EBIT, so it wouldn't be pulling down the EBIT line for the US.

We haven't gone through that gate yet, so we've got a relatively small investment in this initiative. We haven't gone through the reinvestment gate, which would be a significant decision by the Company. Of course when we get there we'll lay everything out.

If we reinvest and decide to try and grow windows, fiberglass windows, into a large business, we'll lay that out for you guys on why and how we're going to do it. At this point we haven't made that decision.

Okay. Thank you very much.

Your next question comes from the line of Andrew Peros from Credit Suisse. Please go ahead,

Thank you. Sorry Lou, just to clarify your last comment on the windows business. Can you confirm whether that's now included in the US and Europe fiber cement division, or whether that's still being carried elsewhere in the business?

Yes, no it's in the numbers you see for US and Europe. The numbers haven't been big enough until this year for you to care about it. So last year the EBIT loss, because we'd just -- were just starting up the business, would have been smaller than we're dealing with now.

Yes. So I guess my question is, why would you put it into that divisional contribution if you're not sure if you're going to continue with it longer term?

Well again, if I have a market initiative that has a three year stage-gate process and say I don't go ahead with the business, the next three years from now it comes out, it looks a lot like a lot of initiatives we run in the US business. Again, it just doesn't happen to be fiber cement. It's fiber glass.

So we have debated that, but if we reinvest in the business, and we think there's good reason from a shareholder perspective to pull it out of the fiber cement numbers, we'll do it at that time. Again, our investment is small and the losses relative to the US business are small as well.

Okay. Just a question for Matt around the balance sheet, capital management. You obviously haven't been very active with the buyback for the past quarter.

I think Matt you made the comment that you're pulling back on distributions above ordinary dividends. Does that mean that you won't be paying any special dividends if you don't execute that 5% on market buyback?

Yes. We've -- I think we started seeing probably last February, and certainly in the May result, that our focus on distributions would be on the ordinary first. Then anything above the ordinary we'd move away from specials.

I think at that time I said it was because I felt like there was confusion around some guesswork. I really felt like everybody was guessing what the special dividend would be. There's really no need for that. Some of the specials that we've done over the last couple of years, I think the circumstances aren't the same as they will be going forward.

So now that we've got the balance sheet where we want it, if we do distributions above and beyond the ordinary it would be in the form of share buyback. Our focus going forward is really around maintaining the ordinary in that 50% to 70% range. Obviously we've got the buyback.

We haven't been active with that since the summer, and so we'll continue to operate with that -- with the buyback open. Our focus is on maintaining the ordinary in the 50% to 70% range and you shouldn't expect a special dividend in the second half of the year. Any additional amounts would be done through share buybacks.

Okay then. So that was a deliberate effort to pull back on the buyback, is that right? Or was it because there weren't any trading windows I think, which was kind of an issue that you had in the past?

Yes, no the trading window restrictions are definitely greater in the summer than they are in the fall. So that was -- it was obviously a conscious decision that we were making as we were going through the last couple of months.

Okay, thanks for your help.

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

Thanks guys. Just a little bit more expanding on some of the pricing and margin impacts. So Louis, I think 7% or 8% of your volumes are in Canada and Europe. Now both those currencies are down circa 15%, which-- you know-- simple count would have taken about 1% off your average price, and something a little bit less than that would obviously alter your margin.

Have you thought about -- or have you announced any price recovery in those markets or thought about pushing prices up in those markets, just given all your costs, or a lot of your costs, are obviously in US dollars?

Yes. No Matt, we market price on all our markets. So we don't pass costs on, and we don't drop prices when costs go down. So at this point we haven't had any discussion about adjusting Canadian prices beyond the normal little bit of tweaking we did up there recently, which had nothing to do with our -- the exchange rate.

Then in Europe, same thing. So no, we wouldn't try and recapture the cost in price. We want to be price-positioned right for what we're trying to do with volume and markets. So that's that.

Yes, but obviously you've got some pretty big cost headwinds there with the currency. Louis, just to allow us to do that calc you mentioned before a little bit better, on the windows loss, when you said the US business on its own was doing 26% plus margins, is it a low 26%, a high 26%?

Let's call it mid, how's that?

Okay. Okay. So maybe a $3 million loss-ish, something like that, out of windows? $2 million or $3 million?

How much? How much?

$2 million or $3 million?

You can have -- do your own work. Yes, but it's not hard to figure out. You guys could figure it out.

Yes. Sorry Louis, just going back to the PDG thing, as you said LP is probably down 10% year-to-date, to you guys, to your year. The vinyl guys are sort of flat at best in a growing market. So where -- even though that might only be a few percent, where do you think that PDG growth is going?

It's obviously not bricks, we can see that in Boral. But is stucco picking up, or is it really -- and can you give us a little bit more color on your regional mix? Is it one region doing a lot worse than others? I know you mentioned the northeast and the north, but your heartland's in the south and the west.

Are they still growing or have they flattened out? Just a bit more color on that would be good.

Yes, the first part. We did go through that exercise of hey -- if we're not getting it, vinyl's not getting it, LP's not getting it. Who is getting it? I'll be honest with you, we didn't find it. So it is just a couple of percent. Of course with our numbers -- with our volumes we know exactly what they are.

With vinyl we use published numbers, but you can't be certain how accurate they are. With LP we used their results which are hard for us to interpret at times. We don't track the bricks much.

Then you get -- you hear all the delayed closings and stuff like that. So we just stopped, okay. The reason we stopped is because we went back to that -- by the way, you said we were like 10 points ahead of LP so far this year, but we only look at things four quarter rolling. Four quarter rolling, they're kind of flat. They're zero. I think we're [6%] or [7%]. So we're pretty sure it's not LP.

Now LP being flat the last year, that's another thing you've got to keep in mind. We don't know how much their capacity has played into that and how much is -- some of the other stuff they've done, like pricing or if the market shifts, seeing that chipboard probably isn't the answer for a cheaper alternative to fiber cement.

So we can't interpret that until they're back in free supply. It doesn't look like they've sold their capacity over the last year, but maybe they have and we're just not aware of it.

The compelling chart, if you plot vinyl over that five quarter period, you're going to see the rate of decline is slow. You're going to see during that same five quarter period, you're going to see our rate of PDG slow down as well. So theoretically their rate of decline during that period is slow, so there's less coming our way.

Again, what -- our market sits on a standard, unless there's a compelling reason to move. We started against vinyl when they were something like 36% of the market, and the compelling reason to move was fiber cement. Okay? It was a big premium, but it had value to target customers greater than the premium, to move to Hardie.

We've done a lot of good things in the US business over the last two or three years, but I think we're just not as good at market development against vinyl, as we had been two or three years ago, and as we need to be to keep driving toward that [35%]. So the whole game is us against Vinyl, keeping an eye on LP, who is trying to sell themselves as the cheap alternative to fiber cement. So that's the market model on the exterior siding.

Just your observations by region, has there been any marks--

Sorry, you wanted me to answer both questions.

Yes.

The -- it's vinyl. I guess that's the reason I didn't answer it. The midwest, northeast, Canada, Carolinas, it's all the same. Those are the big vinyl regions, and one of them is not doing significantly better than any others. They're just -- we're just not doing as well against vinyl as we were two or three years ago.

Yes, no worries. Thank you.

By the way, I'll give you a bonus answer too, because I forgot that one. Segment-wise we see the same thing. It's not one segment, new construction or R&R. It's both segments. We're just not doing as well as we need to do.

Your next question comes from the line Simon Thackray from Citi. Please go ahead.

Thanks very much. Lou you made a point earlier about interior being a -- had made a strong contribution in the mix, and that was obviously affecting price to a certain degree. Eighteen months ago you were a bit worried about that and you wanted to deal with it. You obviously dealt with it, and it's accelerated.

Can you talk to that strategy and then talk to your strategy around PDG, because you guys sound pretty somber I've got to say, in terms of where PDG has ended up. You were like this about interiors 18 months ago and now it's a strong contributor.

So can you just really help us nail down -- I know you're going to say we'll wait for September for strategy, but talk to exactly what we should be expecting from -- in terms of initiatives over the next four quarters?

Yes I think -- I don't think you should expect any new initiatives in the next four quarters.

Not even--

Our focus -- Ryan's focus, Matt, with the new structure, they've spent a fair amount of time doing a current state assessment on the business and working out the game plan, both short term, medium term.

The short term game plan is execute what we do better. So we like our (inaudible) box we use in new construction. We like R&R program and vinyl markets.

We know what to do with the channel now. We've gotten better with the channel. We just need more attention on the growth side of the business.

Now, Simon brings up the point that we did have a problem, which I agree with 100%, on HardieBacker market share maybe 18 months ago, maybe a little bit longer. The organization has responded quite well.

Now the problem is, we've also -- if you can remember two, three years ago we were operating for I think two years in a row just below our 20% base on out EBIT margin range. We took care of that. We had tactical pricing problems, which was a big part of taking care of that. We took care of it.

I think the story for our organization internally has been, hey we can do it one at a time. We've got to do the interior things right, and then we've got to run our exterior strategy. We've got to have our tactical pricing. The plants, they have to go.

So I think Hardie, coming out of downturn now five, six years ago, whatever it's been, has become a much better Company. We're still not a Company -- we're not that juggler that can keep six balls in the air. It seems like we're always finding a way to drop one of them. I think the one we drop now is growth against vinyl. We've got to get that back in the air without dropping one of the other ones.

So that's what you should expect out of Hardie, is a lot more intensity around how well we're executing, and the fact that we're executing all segments, all product line strategies, at the same time. Which will be -- it will be a challenge.

So I'm very confident we've got it done. That's what drove the organizational structure change, but you're going to have to see how the results come out.

Yes, and I guess that's the following question, which you've just answered really, is that the management structure that you've now put in place supports that strategy to be able to juggle all those six balls at one time.

Yes. Yes, I covered it earlier Simon. The structure -- there's a lot of reasons we went with the structure we went to, but it was triggered by our inability to grow or take market share at the rate we're intending to take market share. So that's what started the process of evaluation.

We ended up with the structure change. We ended up with execution as being our main thing we need to change over the next four or five quarters, to get back on track PDG-wise. There's a lot of game plan enhancement, value proposition bumps, that we're going to do over the next five years.

That's not what we're focused on right now. We've got some people working on that, but the majority of the organization is committing to a higher level of execution on existing game plans.

Lou, just one final question if I can. Housing starts certainly for October were pretty lackluster, just a bit above 1 million starts. So that's sort of okay. The trajectory is certainly a lot slower than people would expect.

Now we used to think that that was a benefit for you guys, both in terms of PDG and manufacturing cadence. What's your expectation now, that an acceleration would be much better for the business, or that it's irrelevant, you just need to be executing a lot better?

We like the market. I know if the market was larger now, market demand were more, just because of more housing, we'd make more money. We like the market. I'm not an economist, I tell you guys that all the time. I think X number of houses are going to be built in this recovery, and you can either build them in five years or you can build them in nine years.

It looks to me like if it doesn't just take off, it's going to be a longer recovery. A longer recovery for a market share company is good, because you've got more years to build on the momentum of the previous year. So we like the market. No complaints about the market.

Okay. Thanks so much gentlemen.

Your next question comes from the line of James Rutledge from Morgan Stanley. Please go ahead.

Thank you. Good morning. Just wanted to clarify how we should be thinking about price increases going forward, given I guess it seems at least on the face of it that no price increase this year seems to be because of how PDG growth is tracking.

If, as you say, hopefully these initiatives work and you see PDG growth return to that 5% to 7% over the next 12 to 18 months, should we be expecting a 2% to 3% price increase in 18 months' time?

I think if you go with the history of the business, we review prices every spring. Most years we take 2% to 3%. We're careful not to be greedy on price. We don't want to kill potential -- we don't want to lower the terminal share for fiber cement by creating a perception that we need more price every time you turn around. So we've been very disciplined on pricing.

Every once in a while we skip a price increase and it looks like this year, at least this spring, we're going to skip the price increase. I think Matt summed it up well. I actually didn't know how to answer that question, but he did answer it well.

Our focus on the exterior side of the business is volume. We just didn't want a lot of distractions for the people that are trying to execute on our strategies. So we took a pass on pricing. I wouldn't expect that would be a regular occurrence. I would think that would be more of a one-time occurrence.

Okay, thanks. Just -- I'm not sure if I missed this earlier, but can you clarify what the exterior versus interior growth was for the half or the quarter? I think you indicated that interior was stronger.

Interior was a bit better than exterior. So if you look at our overall growth and go a little bit higher on interior, and a little bit lower on exterior, you're probably pretty close.

Okay, thanks a lot.

It appears as though we have no further questions. I'd now like to hand back for any additional closing remarks.

Okay. We appreciate everyone's interest in the Company. Thank you very much.