James Hardie Industries - Q4 2018

Transcript

Louis Gries (CEO)

Okay, good morning. Thanks for joining the results. We're gonna do it like we always do it. I'll cover the business overviews, and Matt will cover kinda all the financials and details behind that. We'll start on slide seven. Yeah, the results were good. Right across the board, I think, it's a little bumpy at the start of the year, and we'll get into that in North America. The only thing really worth calling out is, you know, understanding how we got to where we got on volume. But all our financials look pretty good, at least from our perspective. In North America, price was solid right through the year, so we had that increase a year ago, April. Everything stuck.

Technically, the guys in the U.S. have been doing better, so, not a lot of leakage in our price. Obviously, we were in a win-back situation on some volume loss when we were capacity constrained, so we handled that well without using a lot of price to get there. The EBIT got better as the year went through, and that was all driven by manufacturing. So we talked about, and you'll see a slide in a little bit, but, manufacturing traction's been good. And, also on the market side, our traction's good. So how did we get 1% volume in the fourth quarter?

I think when we talked earlier in the year, we acknowledged that, you know, having customers move over to other brands while we were out was creating a bit of a lag on our on the market side. All those customers weren't just automatically coming back once we got our capacity in place. So we were. I think we had a below-index comp for the year, okay? Now, we did two different things. One's exteriors, one's interiors. Let me get interiors off the table, so we understand that. When capacity was tight, just like any company, we looked at kinda where our profitability was with our different product lines and channels with interiors.

And we did exit some. We didn't participate as broadly as we had the year before. So that was a bit of the reduction in interior volumes. We got out of the gypsum channel, and we got a four-by-eight G2 backer. In addition to that, we just lost traction for a period of time with interiors, and it's important that we're in the process of fixing that, and I think that won't be an issue for us going forward this year. And all the products and all the segments we're servicing now, we like in interiors. There'll be no more pulling back from any positions we have. So in the fourth quarter, interiors was down about 8%. So that was a lot of the lack of volume growth.

Exteriors, you know, I think we kind of in a previous Q&A I talked about we thought we'd work our way back to market index by year-end, and we'd be positive against the market index in fiscal year 2019, and I think I gave the range three to five. Basically, both those things have played out. In the third and fourth quarters, basically, we're at market index as far as our volume growth in exteriors. Our order file right now looks pretty good, and we're pretty optimistic that we're starting the year in positive market index, you know, in a range. That was the main story. The U.S. business is running really well now.

I mean, certainly, there's a lot of upside, but the issues we had had when we ran out of, or that were caused by us running out of capacity, have pretty much all been addressed, and the organization has responded, and like I said, there's still upside, but traction's there. This goes into delivered unit cost. You would remember in the past, we talked about, you know, we woke up one day and decided we were underspending on basic maintenance in our plants. That would have been in parts of fiscal year sixteen and early fiscal year seventeen. So that's, you see the low bars in Q1 and Q2 seventeen. That, in addition to, we had startups during this period that would have helped cause that spike.

And then we've had raw material input costs increases right through those eight quarters. So the story is, we're kind of where we wanna be with unit cost of production and a step further, delivered unit cost of production. That's not to say freight costs aren't up, but our freight efficiencies are pretty good right now. There is more upside. So some of these lines have started up in the last two or three years. They'll definitely, you know, continue to become more efficient as we produce more board on them. But this is what, you know, this is what really drove the EBIT in that last half of the year. The EBIT improvement was strictly delivered unit cost. I shouldn't say strictly, but that was a big contributor.

This slide kinda just explained. You can see we went from the top of our range, and we dropped down to the bottom of the range as that unit cost spiked on us, and we've pulled ourself back up to the top of the range. Top of the range is just pretty comfortable for us right now in this market. Even with a lot of commodity cost increases, we still think we're gonna be able to be up on the top of the range as we run our programs in the U.S. Not much of a story last year on price, meaning it was 5%, and I think it was pretty steady right through the year, and it was, like I said, reflective of an increase we took, but also pretty good tactical pricing.

This year, we did take an increase, April one. We think we'll get over 2% on the increase this year and maybe even approach 3%, so it'll be somewhere in that range. Not as big as the improvement on last year. As far as any leakage in our pricing tactically, we've got most of that, so there's not much upside there. So you have your regional mix, customer mix, and your product mix. It'll determine where we end up in that 2%-3% range. And then, housing market's still pretty good, you know, gradually a little better every year, which we're good with. We just gotta get our, you know, market share growth above the index going, and we'll be fine as far as the chart on the right.

The international business had a very solid year. I'll talk about just one or two exceptions, small exceptions, but the business in Australia, well, I'll flip through the countries. The business in Australia was just really strong, very good on both the op side and the market side. So obviously, EBIT performed well also. New Zealand's kind of one of those exceptions. Obviously, New Zealand's good business for us with good returns, but they stubbed their toe a couple times last year, and you can kind of see it in the results. There's a reset going on there right now, that I don't think is gonna be that difficult to get them pointed in the right direction again. It's not a big problem. It's just...

But it's outside of a normal variance that you would see in a business, so it is something that needs to be addressed. The Philippines kind of New Zealand story last year. The Philippines has been reset, and it performed very well this year, so that's in good shape. And then the last thing, Europe, like you know, interiors in the U.S., was a bit of a reset, and I think we got to a point with what we were doing in Europe with fiber cement. It wasn't really leading us to where we wanted to go, and the profitability of some of the product lines, again, or the countries, wasn't where we wanted to be. So we did do a reset in Europe.

Pretty much all arrows point down, but I think we have a smaller but better foundation in Europe for our existing fiber cement products. Again, Europe and New Zealand are small potatoes compared to, you know, the overall international business. So as a whole, international ran really well. I wanna go into. This is your first shot, chance to get any information on Fermacell, so I wanna make sure I kinda covered that off, so I'll take a little bit more time than I usually do. So we did close April 3rd, so the first look you're gonna get at our numbers in Fermacell will be with the first quarter result. And again, I just wanna answer the question again, well, what are we doing with Fermacell? Why did we think it important for our company?

So everyone knows that our primary growth strategy over the last almost 15 years now has been fiber cement in North America. We've also talked about you know the importance of kinda other paths for growth in the future. So when 35/90 is kind of close to being reached, then we've got other growth initiatives that are kicking in. And those we put into two categories. We like to keep them simple, so non-fiber cement North America and non-U.S. fiber cement. Okay. And that's the first thing you have to understand about Fermacell. It's a really good company. We're really glad with the quality of company we were able to buy. It's very much set up like Hardie both on the market side and the op side.

The way they go to market, the way they approach their plants, the way they approach you know logistics, it's just really an easy business for us to get our arms around, and quite honestly, the Fermacell managers joining us, they also have the comfort in that our business is kinda set up like theirs. That's a good thing. The other thing is, you know, when we decided, you know, we wanna get some growth initiatives going that'll be important to us in the future, obviously, organizationally, we had to kind of prepare for that. That's why we brought Jack Truong into the organization. His job is to lead international growth in Hardie. This is his division. He's got everything outside of North America.

There's a lot of guys in North America on the senior management team that only have North American responsibility. Those would be guys like Merkley, Gadd, and Nielsen. Okay? So they're entirely focused on North America. So there's been, you know, some concerns about opportunity costs, and I guess what I would say is we anticipated that whatever we gain in Europe, we couldn't give up anything in North America to get there, so we anticipated it, and we structured accordingly. Okay, so like I said, Fermacell's a really good business. It doesn't make our returns, okay? We'll give you a look at the returns or an indication of where the returns are. But those returns can improve, and they've got organic growth left.

But again, the main reason we needed something in Europe, because we didn't think we could get to where we wanted to go in Europe without a kick-up, a significant kick-up in regional capability and access to market. So we're trying to find a company we liked that also provided regional capability and access to market, and that's what we think we've done with Fermacell. Now, you need to keep in mind, because this is a long-term strategy, Fermacell by itself doesn't get us there, okay? We got future funding that we need to really commit to for product development, market development, and manufacturing. So that would all be in a five-to-seven-year plan. Okay, now I'll show you a few slides we have and see if I can walk you through them.

Yeah, the first thing is just, you know, the change in Europe for us, which is obviously very significant. You go from 70 employees to 900. We were focused on a few geographies, very much so on the U.K., France, Germany, and Denmark, to a lesser degree. Fermacell is more right across Western Europe. We're basically, like we are in other markets, either new construction or R&R. Fermacell has a nice position in commercial. They're more of an interior business. Now, we do a good amount of our business in Europe is our backer board business. That doesn't clash with what they do. They kind of do sound absorption and fire. We do wet area, so they fit together fine.

They do have one small business, so you can see our, yeah, you can see our business in Europe is about 10%, our existing fiber cement business in Europe, about 10% of the new business, total new business. That's cement-bonded particle board, that's another 10%. So that's a smaller business that Fermacell had. It's okay. It makes okay returns. It's just not that big. Go to the next one. So there's three. So all this is done. The integration between Hardie and Fermacell has gone really well, so everything's in market. Day one went really well. Day 31 went really well. Day 45 went really well. We had no mess-ups anywhere along the way, so everything's going good. But these are the brands now that we have in Europe.

And like I said, the cement-bonded particle board, about 10%, our current James Hardie, about 10%, Fermacell, about 80% now. Their kind of footprint from a manufacturing standpoint, they have one plant in Spain, one in the Netherlands, four in Germany. One of them is cement-bonded particle board, and one's a raw material plant, and the head office is in Düsseldorf. On the other side of the organization, which was very important to us. So, like I said, Jack is President of International, has responsibility for Europe. Jörg Brinkmann has been with Fermacell for seven years. He's been running the business. We're really impressed with him and his management team.

So they bring what we need on that regional capability, that management team, plus, the rest of the organization really does deliver what we were looking for on regional capability. We did move in two experienced managers out of Australia, which I think are very good adds to that team. One of them is more of a product strategy guy, and the other is an organizational guy, so an HR head of HR. So like I said, we end up with 900 employees there when you combine them. About 200 of them are field sales. And again, we didn't get into, you know, we didn't buy Fermacell just for Fermacell returns. We bought it for what enables us to do.

You don't wanna get hung up on the third there, as far as the colors, but you know, this is a commitment to a major initiative in Europe. We're aiming for $1 billion in revenue with good Hardie-type returns. What did I do? I skipped over... Oh, we said the EBIT margins about 10%. Now, that's putting them and us together, and like I said, we just reset that fiber cement part, so the fiber cement pulled them down a bit. But they don't have Hardie-type returns at this point. And the fiber gypsum part of it, I think we'll see those returns, however you wanna measure it, in true returns or EBIT margin or EBITDA, you'll see those kind of come up over time. But again, that's not our main focus.

Our main focus is organic growth. We got some room in fiber gypsum, and more importantly, we're kind of starting from scratch, EUR 30 million base on fiber cement. Now, we think, you know, if you did pin me on those three bars, first, I wouldn't have three bars, but if I was making a slide, I have two bars, and the Hardie bar, the fiber cement bar, would be bigger than the bigger part of the bar. So maybe 60%, two-thirds, 55, somewhere in there, but we'll be a fiber cement company in Europe. It's not. We're not gonna be a fiber gypsum company, but it, but we'll have the two divisions, kind of like we do in the States, where it's interiors and exteriors.

We'll have the, you know, two divisions, but, fiber cement will be very important to European returns. Okay, hand over to Matt.

Matt Marsh (CFO)

All right, good morning. Thanks, Louis. We'll go through the financial results, just like in a typical quarter. We'll cover off on asbestos today, given that the annual actual report is out, and we'll get going. Overall, the fourth quarter we thought was pretty strong. We had good operational momentum in North America in the second half of the year that made up for kind of where we were coming into last year as a result of the capacity constraint, and then the first half result wasn't where we wanted it to be. The second half closed out pretty good in North America, and Australia had a really good year overall, very strong revenue growth. Gained market share and had good returns. Cash flow for the year was really strong and solid.

I'll take everybody through that. Our capacity expansion plans continue to be on track, as does our capital allocation strategy. So the last year and a half has been a heavy focus in the business on getting capacity built out in North America, and we've also announced projects now in Asia Pacific. We declared a second half dividend of $0.30 per share today, and you can see the adjusted NOPAT at 291, compared, you know, was higher, obviously, than the guidance. It was primarily driven by a tax item that at the time of the February result, I didn't have good clarity on, and so I'll take everybody through that. The underlying business also performed better, as well.

So we had strong results in the quarter, and then we had a one-time item that you'll see isn't gonna show up the same way in the financials in FY 2019. And that was as a result of an internal restructuring transaction that we did. I'll take everybody through. Okay, a little bit on the reported results. You can see we had net sales in the quarter of about $525.9 million. They were up 6% for the group, largely on higher net sales price and volume in North America, as well as just strong overall results in international, primarily driven by Australia and the Philippines.

We had a reported EBIT loss of 95.8, but the adjusted EBIT number of 103, and an adjusted net operating profit of 81 was up almost 49% in comparison to the prior year. A lot of that was a strong North American business off of an easy comp from the prior year, and just seeing manufacturing in that business turn around. You saw that on the delivered unit cost slide, and then international just had a kind of a top-to-bottom, really strong year. You can see for the full year, we reported net sales of 2 billion 54.5, up 7%. Very similar themes, largely driven by price in North America, with volume more or less for the year about flat.

Louis gave you a good indicator earlier on the exterior-interior dynamic, particularly in the second half, and how that played out for the year. And similarly, the international growth story that I talked about on the fourth quarter discussion carried out for the whole year. They performed well for all four quarters. We had a reported net operating profit of a hundred and forty-six point one. Keep in mind, that's got, obviously, the asbestos adjustments in it.

When you adjust those out, the adjusted net operating profit of 291 was primarily on the backs of adjusted EBIT up almost 12, and then the tax transaction that I'll take everybody through in a bit, that took adjusted ETR down for the year to a lower number than we had talked about in February. So I'll get into this some more in a bit. You can see foreign exchange between the Australian and U.S. dollar didn't really have a material result on the financials last year. You can see over on the bottom right, on a dollar and a percentage basis, fairly immaterial for the year. So the while it moved around a bit, it didn't really play a factor into our financials.

What has played a factor into the financials is input costs. They continue to, you know, trend all in one direction and all up. So the freight market has had several quarters now in a row, where we're getting both market price increases, as well as a truck availability issue in the U.S. That, I think, is gonna continue to be a feature of the result going into the new year, as will most of the raw material themes that I'm gonna talk through in a minute. You see pulps continuing to be up; it's up 19%. Cement prices were up 3%, electricity up 2%, gas was down, but certainly our major input costs are continuing to see inflationary pressure, sort of across the board.

So I think the teams are doing a good job of sourcing strategies, and we're, you know, we're outperforming these market conditions, but nonetheless, it's putting a bit of inflationary pressure on the cost structure in the business. You can see segment EBIT for the four segments, is what I'll take through next, for both the quarter and for the full year. For North America, for the fourth quarter, EBIT was up 36%, for the full year, it was up 11%. For the quarter, it was primarily on the backs of cost and cost management, lower production costs in manufacturing and overall manufacturing performance, kind of where we thought it would be, back into kind of a normal band of operating performance. For the full year, it was a combination of price, as well as.

That was partially offset for the, for the full year by the first half performance in manufacturing. As you, you probably remember in that delivered unit cost slide, the first half delivered unit costs were elevated above our target range, above the prior year. But that came down as the year went on, but for the full year, production costs were up. Internationally, for the fourth quarter, EBIT was up 10%, and for the full year, it was up 14%. Really, the story in international, strong Australia, strong Philippines. In Australia, it's a growth story. They've done a good job of getting market penetration. They've got the startup in Carole Park performing well.

As you probably remember, that was a slower start-up, and the teams have really kind of finished that real strong, and that plant's performing well now. In the Philippines, the market and competitive issue that we would have talked about a year ago, the team has done a nice job of working through that in a way that is a good solution for the market and a good solution for kind of the medium and long-term returns of the business. So that's. They've done a good job on that. The other business segment is our non-fiber cement business. You can see on a comparative basis, we're continuing to put about the same amount of money into that business.

We like where that business is at. We think, you know, the windows business can be a good business for us. And you can see the operating performance for the year. Research and development, no material change. It's approximately, you know, a couple percentage of sales. It's within a normal, you know, range of what we target. And general corporate costs, no real, you know, sort of extraordinary items in general corporate costs for the year. You can see that the change was primarily foreign exchange and stock comp. There's some underlying investment that we're continuing to do in the business, mainly organization and making sure we've got the right organizational infrastructure in place as we continue to grow and expand the company.

Okay, a couple slides on tax. The normal slide is adjusted ETR for the quarter is 20.6%. That's obviously lower than where we were in February, and I'll talk about that a bit on the next slide. You know, for the full year, adjusted income tax expense decreased, driven by a U.S. amortization of IP assets and intangible assets, as a result of an internal restructuring that we did as part of our normal corporate tax planning that happened to get executed pretty late in the fiscal year, in March. Income taxes continue to be paid and are payable in Ireland, U.S., Canada, New Zealand, and the Philippines, and I think, as many of you know, income taxes are not paid or payable in Australia, largely due to the asbestos trust.

So in the fourth quarter, we undertook an internal restructuring. As I mentioned earlier, we aligned some of our intangible assets with our U.S. business. That's part of just normal corporate tax planning that we had done. That resulted in the U.S. amortization of those intangible assets as allowed under accounting and tax rules. So that had a favorable impact in the quarter on effective tax rate, which is really what drove the $10 million benefit. I mentioned that in the context of also starting in April of this year, so the fiscal 2019 year, U.S. GAAP is changing, and as a result, the way that we report our tax items will change going into the fiscal year.

And I'll certainly give you more in the August result, on that, but starting in Q1 of this fiscal year, we'll end up recognizing a deferred tax asset, arising from all previous intergroup transactions. I think the main thing I want you to hear is that from an economic standpoint, so from a cash standpoint, I think overall, the impact on tax, I think, will remain either constant or improve from kind of current state and prior year.

And we'll give everyone good visibility as we get to the August result on how kind of the new adjusted ETR, while it may be more volatile, given the U.S. GAAP reporting requirements from an economic standpoint and from an underlying enterprise value standpoint, we don't think that that's gonna have an adverse effect on the company. Okay, so from a cash flow, we reported $295 million of cash flow from operations. You know, more or less flat from the prior year. Net income, if you adjust it for the non-cash items, was about flat. We built inventory levels back up last year after depleting them in the prior year, as a result of running tight on capacity.

We increased year on year the payment. You can see about 10%-12% to the asbestos fund. Then we had a favorable change in net operating activities. I'd say that's just from the normal course of business. I wouldn't read much into that. It's not like working capital moved in any particular way. So I think that could come back and just normal variation. We had a higher level of investing activities in the company, and we spent about $209 million on property, plant, and equipment, largely through the capacity expansions. I'll have more detail on that in a minute. You can see the results from the financing activity.

If we go to CapEx for the full year, like I said, we spent about $204 million on CapEx, up from about $102 million from the prior year. We had four major projects going on in the U.S. last year, or we had five projects going on at four of our sites last year. So we had two sheet machines that we brought online at our Plant City plant. Those are more or less completely through their start-up phases now. We commissioned our Summerville facility. That continues to start up as planned. It's been operating now for about a year, and we're pretty happy with how that start-up's gone overall.

We were just out at the Tacoma site a couple weeks ago, and they're right in the middle of starting to commission that plant and that site now. So that greenfield construction project is almost complete and will start producing at the site during this summer. Today, we also announced that we have a $240 million expansion of our plant network in Prattville, Alabama. That'll be a greenfield site. It'll end up being a two-sheet machine site that has the ability to be expanded to more than two sheet machines in the future. But when we open, it'll have two lines in it.

That site will give us a lot of opportunity to kind of optimize the network and delivered unit cost kind of across the natural markets and the various plant locations throughout the U.S. We're continuing to expand the capacity at our Philippines facility. So you know that we did we announced the capacity project there previously in phases, and we're continuing to make progress on that. And then in February, we also announced a AUD 20.5 million brownfield capacity expansion project in our Carole Park facility in order to keep the Australian capacity at or ahead of the the growth and demand that we're seeing in the market. No change in the capital allocation strategy or overall financial management objectives.

Our priorities continue to be in the same, and the way we kind of think about capital management and the balance sheet in the company continues to be pretty consistent. It starts with strong financial management, making sure cash flows are strong and margins are good. We try to govern the balance sheet and the financial policies of the company as though we're an investment-grade credit. Our priorities are in the green column in the middle. Number one priority in the company is to fund organic growth initiatives, either through R&D or CapEx, to make sure that we've got capacity across the world to continue to grow. Our second area of priority is the ordinary dividend and maintaining a dividend on an annual basis and the payout ratio. Then the third priority is really keeping flexibility.

We recognize that we're in a market that's cyclical, so we want to have the capacity to weather those storms and to have capacity in our balance sheet to take advantage of transactions like Fermacell that have good long-term strategic value to the company. From a liquidity and funding standpoint, as I've said before, I'm not gonna change the guidance range of one to two times leverage. That's still the target range that I think is right for the company. We're gonna be in this period of, call it, eight quarters, where we're gonna be elevated above the range as we work through the Fermacell acquisition. We've got good line of sight to seeing our overall debt levels come back down within our range. I'll take everybody through kind of liquidity in more detail.

I think financial management has been consistent. We're trying to manage the company. We very much try to manage the company as though we're investment-grade credit, and I'm pretty happy overall with where we are on the balance sheet. You can see from a liquidity standpoint, the available facilities are outlined on the left, with our outstanding debt in the second bar. We've got about $281.6 million of cash on the balance sheet at the end of the period, about $603 million of net debt, and about 80% liquidity, so very, you know, very strong liquidity position. We've got a three-tiered debt structure, along with a bridge financing for the Fermacell transaction, and we'll refinance that bridge financing at some point during fiscal 2019.

You can see those outlined on the right. As I said, the 1.24 net debt as of March, while accurate, obviously doesn't reflect the actual purchase of Fermacell, because that occurred in April. So you'll see us in the August result and for the first quarter of fiscal 2019. That's where you'll see the net leverage jump up over 2. That'll reflect the additional Fermacell debt. Okay, on asbestos. You know, the actuarial report, you know, gets updated every year, and consistent with that process, it was updated at the 31 March balance sheet date.

The undiscounted and uninflated central estimate increased to about AUD 1.4 billion, so that's up from the AUD 1.386 billion in the prior year. The increase of about 113 million on a net present value basis was really driven by 3 factors. So one is the underlying actuarial assumptions were up about 200 and let's call it $69 million. Then there was a decrease of $83 million due to the payment that we made to the fund, and then another decrease of about $73 million as a result of the amendment that was made to the AFA in December of 2017, which removed the gratuitous service costs in Victoria.

Last year, we talked about those asbestos Sullivan versus Gordon. Those costs were removed during the year. I think the number, obviously, that I think many will focus on is the actuarial assumptions increasing. The number of total mesothelioma claims over the last five years has been elevated, and if you remember, back in two thousand and thirteen, the actuary determined that there'd be a temporary increase in the number of claims, and then they'd model out kind of the normal curve beyond that. With the elevated level of claims that we saw in fiscal 2018, it was determined that there'd be a permanent shift up in the number of claims over the longer period of the actuarial study.

Sort of offsetting that, though, is the payment dollars per claim, and a lot of the other underlying drivers of the actuarial study are all trending in a positive direction. So while the total number of claims has gone up, you'll see when we get to the next page, I'll talk a little bit about some of the drivers of the underlying economics and cash flow that I think are positive. For the quarter and the full year, you can see the total claims received were about 10% and 2% below the actuarial estimates. And you can see that mesothelioma claims were about 5% higher than both the actuary and the prior year.

So 5% higher than the actuarial estimate and 5% higher than the prior year. So while meso claim reporting was 5% unfavorable, things like average claim size is tracking better than expectations. Aging of the population and of the claims is playing more favorably into the overall economics. Large claims continue to be very favorable. There was one large claim paid last year, which continues a trend of a favorable trend. Nil settlement rates and then the cash outflow from the fund are all trending more favorably than had been previously discussed. For fiscal 2019, a few things that we're thinking about. One is we see a housing market, like Louis said, that's overall very, you know, healthy and strong in the U.S.

So we expect the market growth in the U.S. in fiscal 2019 to look a lot like fiscal 2018's, kind of mid-single digit, modest kind of market index. You can see that we're working off of a U.S. residential housing starts forecast of between 1.2 million to 1.3 million, total starts. It's towards the higher end of that range, but it's certainly within that normal range. We expect our EBIT margins to be at the top end of our guided range of 20%-25%. You know, there's the normal disclaimer on there that, you know, that assumes that things like our plants, exchange rates, and inflationary trends for input costs, all continue kind of at expectation.

I will say that input costs, you know, do continue to change on us from quarter to quarter, and really month to month, so the commodity markets are fairly dynamic at the moment, and it's an area that we're watching. Our Australian business is expected to largely grow in line with the market index for Australia, and where we do the majority of our business in domestic repair and remodel and single-detached housing, and then in Europe, we think the overall macroeconomic conditions for the new fiscal year will be a lot like fiscal 2018, so kind of very low, you know, market index growth in that region, so in summary, you know, overall good operating momentum in North America. We like where that business is at now.

I feel like it's really well-positioned for growth in fiscal 2019 and getting back to, to our PDG levels, throughout the year. We think Australia will continue its strong performance. From the year, we had strong cash generation and disciplined capital allocation. In the year, we invested almost $204 million in CapEx, did about $178 million in capital returns to shareholders, and closed an acquisition on Fermacell and funded that on April 3rd. So with that, we'll open... We'll, we'll open it up to questions. Lou, did you wanna?

Louis Gries (CEO)

Yeah, before we go to questions, most of you know that I'm getting ready to kind of get my time at Hardie. So I'll be retiring sometime in the next, oh, maybe a year, 18 months. The board and myself have succession plans in place. We're going through a process. It's been tracking very well, actually. So we're all encouraged that, sometime later this year, we'll probably announce that I will be leaving Hardie, and we'll announce my successor, and I'd stay for just a short transition period, maybe four to six months, during the handoff.

The reason I wanted to give you an update is, during the two days I'm down talking to investors, I really don't want to take questions on that subject, so that's the update. All right, so we'll go to questions now. Same as always, in the room, then on the phone, and then if there's any media questions, we'll take them right at the end.

Andrew Scott (Head of Industrials Research)

Hi, Louis. Andrew Scott, Morgan Stanley. Just a few from me. Firstly, to your credit, you haven't called out the weather, but a number of your competitors and customers have. Can you talk to us about what weather impact we might have seen in the period?

Louis Gries (CEO)

Yeah, we don't factor it in. It would be in the normal variance category for us. It wasn't a terrible winter that we'd call out. It might have impacted us a little bit, but we wouldn't worry about it.

Andrew Scott (Head of Industrials Research)

Thanks. And secondly, just on PDG, I think you spoke to, I think you said exteriors, you're expecting 3%-5%?

Louis Gries (CEO)

Yep.

Andrew Scott (Head of Industrials Research)

Can you tell us what you expect in interiors or in aggregate?

Louis Gries (CEO)

Yeah. Interiors is. There's a few things going on in interiors, both in the industry and the company, so I'd probably be looking for flat to slightly up, say, one to three points, if we can get it.

Andrew Scott (Head of Industrials Research)

And then, Matt, just two housekeeping ones. Prattville, you mentioned two sheet machines. Can you tell us the volume there?

Matt Marsh (CFO)

Yeah, it'll be about 600 million in nameplate capacity.

Andrew Scott (Head of Industrials Research)

Perfect, thanks. And then the European integration costs, I assume you'll take those above the line?

Matt Marsh (CFO)

The integration costs? Yeah, they'll be above the line.

Andrew Scott (Head of Industrials Research)

Great. Thanks, gents.

Peter Steyn (Managing Director)

Thanks, gents. Peter Steyn from Macquarie. Matt, could you just run us through the Fermacell numbers, and particularly the 10% EBIT margin, what you've taken into consideration there? In light of your answer now on the integration cost, are we to think that that's above the line, i.e., the ten is net of that? And then what is the current state of the European business and its contribution, and how does that influence the 10% outcome?

Yeah. So the 10%'s obviously a mix of fiber gypsum and fiber cement. I think we've said before that the— I'll start with fiber cement. You know, so we've, historically, we've had about a EUR 30 million business that doesn't generate any cash. And so you can, you know, conclude pretty quickly that the EBIT margins aren't very good with it. The underlying Fermacell business is obviously above the 10%. You know, so it's a low double-digit sort of EBIT return business, still below kind of a Hardie level of return, so we've got some work to do there to get the returns where we want them to be. The 10% is kind of the ongoing operations, you know, excluding any of the integration costs.

We'll invest fairly heavily in the business in the first couple of years. As I think I've mentioned on either the February or the November result, we're carving out the Fermacell business from private equity owned. It had been private equity owned for quite some time, and a lot of the back office was a shared service organization for quite some time, and that shared service organization is gonna be transitioned to us via a transaction via a service agreement, but we'll have to go through a process of standing up and carving out a back office and investing some applicable costs in it, and then we're obviously incurring normal integration costs sort of on top of that.

So we'll give you good visibility starting in August of what the underlying business looks like with and without those costs, so you can kind of see those, and that they don't sort of distort the underlying operation, and you can see kind of where we're investing money for the long term.

Perfect. And then just, in light of Lou, some of your comments on plant performance and that you still see further upside for unit costs, or I suppose downside, therefore, positive margin outlook. If you think about your expectations for FY 2019 margins at the top end of that range, a few moving parts there, but I think there's probably a general expectation that you hold above the 25%, in the context of what you've achieved in recent periods. So how would you think about that?

Louis Gries (CEO)

Yeah, I mean, I probably wouldn't be too different than the way you described it. The key now in the U.S., you know, we did have a bumpy road we had to take care of, which I think we have. But we got to build on our momentum in both the market and the plants. And then we're funding strategic initiatives for future growth. So we've actually moved forward on some pretty key initiatives that are shaping up well. So we'll be putting some money into those this year. So top of the range is fine now. And if we end up a little bit above, it's probably because things performed a little bit better than we thought they might.

Peter Steyn (Managing Director)

Okay. And then maybe just very quickly, is there anything we need to worry about in terms of price pull forward in this last quarter, that could impact, the short-term performance?

Louis Gries (CEO)

No. In fact, I kind of indicated our order file right now looks good, so, we're through the price increase, all that, all that board's at full price, and orders are pretty good right now.

Peter Steyn (Managing Director)

Perfect. Thanks. I'll leave it there.

Simon Thackray (Senior Analyst)

Thanks. Simon Thackray, CLSA. I just want to follow on that, PDG, you know, the usual, Lou, we calculate it one way, you calculate it another way in terms of market index. But your comment, Matt, you expect a similar level of growth in detached housing starts. R&R looks like it's growing 6%-7%. It's a reasonable number. You're talking 2%-3% price. You're talking 3%-5% PDG on top of market index. So I just want to be absolutely crystal clear, are you expecting close to double-digit growth in volume in North America?

Louis Gries (CEO)

I think if everything lined up, we could approach 10, but we wouldn't have our market index the size you.

Simon Thackray (Senior Analyst)

Right.

Louis Gries (CEO)

So you said six, six or seven for R&R, and we'd be more like a four. And, I forget who we use. We disclose who we use.

Simon Thackray (Senior Analyst)

Dodge?

Louis Gries (CEO)

Yeah, Dodge.

Simon Thackray (Senior Analyst)

We use Dodge. Cool.

Louis Gries (CEO)

We'd say, hey, if the market index was four or five and we have four or five, you're kind of closing in on ten. But remember, you and then interiors won't be at that level, so that the headline number for the corporate for the business in North America could be a bit lower. And I'm not, you know, we're early in the year, but the thing I'd say on the market is, you know, obviously, we had that drag on our order file, and we've worked through that. We thought we'd get back to market index, we did. And we thought we'd be positive this quarter. Now, quarterly variances are tough, you know, but meaning you shouldn't put too much in them. But we look good, you know.

But I think we can build momentum with the programs we have. So speaking to you guys and the organization, I'd like to see us go harder in the market, and I'm sure that's what everyone's trying to do.

Simon Thackray (Senior Analyst)

Just, I mean, there's a lot being made, obviously, cost inflation in the U.S. I know Peter made reference to it just before. Across the input costs, a lot of the competitors in the commodity space, not necessarily competitors against you, but in building materials, are just seeing this cost inflation, particularly on freight and disruptions in supply chain and lumber. So the background inflation and price rises that the industry are talking about, obviously, are far and above the tactical pricing that Hardie refers to. I just wanted to understand whether in that final quarter, that actually dampened the pull forward of demand, given your, you know, installers and builder customers, you know, had broader inflation and were looking elsewhere to secure volume.

Louis Gries (CEO)

Yeah, no.

Simon Thackray (Senior Analyst)

Does that make sense?

Louis Gries (CEO)

You know, before you asked the question, I never thought about it. We're pretty simple on our price increases. We allocate enough board to customers so they can cover their commitment. So as soon as they're through that allocated part, it just flips to the new price. So we wouldn't have made any big change in how we went around about the price increase. And like I said, I don't... You know, there's always some slop between quarters when you have a price increase, but I don't think it's material. I don't think it dramatically slowed down the fourth quarter, or it's not gonna bump up the first quarter. It's just-

Simon Thackray (Senior Analyst)

Got it.

Louis Gries (CEO)

It worked pretty well.

Simon Thackray (Senior Analyst)

Got it. And then finally, on the delivered unit costs, we talked about it, you know, ongoing improvement as those plants continue to ramp up. Matt, you made the point, better throughput, we should be getting unit delivery costs down as well. Just, is that enough to obviously offset the Tacoma commissioning increase as well? How should we be thinking about that with Tacoma coming online?

Louis Gries (CEO)

Yeah, I don't know if I'd get that fine with it. I think Summerville-

Simon Thackray (Senior Analyst)

Philippines fine.

Louis Gries (CEO)

You know, I mean, lately at Hardie, it's been well, what'd you do well, and what'd you do poorly? And we did a few startups poorly. Now, that's by our standards, so you know, maybe we're a little rough on ourselves, but we definitely thought we could have done Plant City better than we did it, and we thought we could have done Fontana, which Fontana is still not at the level we want it to be at. But having said that, we did Cleburne very well. We did Summerville well, and we're coming up Tacoma, and I think that's gonna be a pretty good startup. So I think the good news out of Tacoma is we'll probably we should have a very good efficient startup. Like Matt said, we all went up there recently.

We've kind of approached it in the right way, both organizationally and, you know, how we're gonna spend our money during those first 130 days when you don't have the big denominators to, you know, offset the cost.

Simon Thackray (Senior Analyst)

Got it. And then just quickly on Fermacell, the integration costs, Matt, are they above the line, below the line, just for the purposes of?

Matt Marsh (CFO)

For fiscal 2018, they're, the integration costs were taken out. They're largely transaction costs.

Simon Thackray (Senior Analyst)

Yep.

Matt Marsh (CFO)

As well as some due diligence and leading up to day one type costs. So those are all taken out of the result on the adjusted numbers. You can. They're in the appendix.

Simon Thackray (Senior Analyst)

Yep.

Matt Marsh (CFO)

It was about $10 million in total that was taken out.

Simon Thackray (Senior Analyst)

And then the total?

Matt Marsh (CFO)

Going forward, we'll put them above the line-

Simon Thackray (Senior Analyst)

Okay.

Matt Marsh (CFO)

And then we'll give you good visibility going forward of what's in, you know, of what's ongoing versus what's one time.

Simon Thackray (Senior Analyst)

I know this is now beyond your tenure, Lou, but I'll ask it anyway. That two-thirds fiber cement in Europe in a future state, does that imply higher R&D costs as we go forward beyond the-

Louis Gries (CEO)

That's what I tried to cover in my comments is, buying Fermacell doesn't. It enables growth. It doesn't deliver growth, other than the acquisition growth. So it's product development specific for Europe, market development specifically in Europe, and then manufactured in Europe. And your timeframe is about right. It's, you know, five to seven. All that stuff will happen.

Simon Thackray (Senior Analyst)

Yeah.

Louis Gries (CEO)

In the next five to seven years.

Simon Thackray (Senior Analyst)

And is that R&D for the European business-

Louis Gries (CEO)

Yeah, R&D.

Simon Thackray (Senior Analyst)

Or is that in corporate?

Louis Gries (CEO)

Yeah, they'll do platform development.

Simon Thackray (Senior Analyst)

Yeah.

Louis Gries (CEO)

I mean, it's a different market. It's masonry construction.

Simon Thackray (Senior Analyst)

Right.

Louis Gries (CEO)

There's some growth in frame construction, but we've got to participate in the masonry part of the market, so it'll be speed of construction or ease of construction, not so much the same value proposition we deliver with frame construction.

Simon Thackray (Senior Analyst)

But at the bucket, is it caught in the corporate R&D, or will it be allocated specifically to-

Louis Gries (CEO)

You're out of my league now.

Simon Thackray (Senior Analyst)

Yep, no worries. We can deal with that. But it goes up, is the answer.

Keith Chau (Head of Basic Industrials Research)

Morning, Louis, Matt, Keith Chau from Evans and Partners. So just a couple of quick questions. The first one on PDG. You know, positive start to the year, 3%-5% target, you know, a strong order book. But is there anything you're hearing from your sales team directly, so you know, even one layer before the order book, which suggests that momentum can continue? Is the... I guess, has the sentiment within the sales team in the U.S. changed over the past twelve months?

Louis Gries (CEO)

Yeah, I mean, we don't have. You know, they're not trying to overcome the issue of capacity shortage. That's well behind us. So, no, I mean, our sales organization, like most sales organizations, would be very optimistic. So if anything, you gotta discount what they think rather than you know. But anyway, we're good. Management right across the company feels we're in a positioning it back into positive growth against the index, and that's what we're here for, and that's what we'll do, and that's why we're building capacity. We're not building capacity for our current market share. We're building capacity for future market share.

Keith Chau (Head of Basic Industrials Research)

Sure. Thank you. And then, just a second one on pricing. In FY 2018, you know, average realized prices benefited from a favorable shift in mix. As we look into FY 2019, how does the mix balance out between geographies and markets and obviously, you know, shift back towards interiors, or, you know-

Louis Gries (CEO)

Yeah.

Keith Chau (Head of Basic Industrials Research)

Is it gonna be continually favorable?

Louis Gries (CEO)

It's. You know, I mean, we do have a few more things running around in price. I said we have a few good initiatives going on. We'll be repositioning a few product lines, and we'll be taking an increase on other product lines. So the two to three is a pretty good estimate now. The difference between two and three is probably, like you say, how much happens in the south versus the north, how much happens in backer versus exterior, and that's the difference between two and three. But the calculation right now is, you know, we kind of tuned up our pricing right through the businesses, and we think we're good to go, you know.

I think, I don't know if Simon's question had behind it, A, are you gonna cover your cost? Will your price increase, cost increases, will your price increase? I think the answer to that is probably yes, but I also think you guys know that that's not how we price. We never cost plus.

Keith Chau (Head of Basic Industrials Research)

Thanks, Lou.

Louis Gries (CEO)

Okay, looks like the questions in the room are finished. Are there any questions on the phone?

Operator (participant)

To ask a question, please press star on your telephone, and your name will be announced. If you wish to cancel your request, please press dot two. If you are on a speakerphone, please pick up the handset to ask your question. Your first question comes from Lee Powell from Deutsche Bank. Please go ahead.

Powell Robinson (VP)

Thanks, all. Just Lou, just on exteriors growing at the market index, do you think you got any benefit from the planned transport issues that a few of your competitors have had in North America, or do you think that just comes out in the wash?

Louis Gries (CEO)

No, I think it-- I think everyone's ready to supply in the U.S. I don't think there's any... Yeah, there's no tailwind in growth above the market index. You got to get customers to change from what they're doing to what we're doing, and it's a normal process, and I don't see any of that.

Powell Robinson (VP)

And then you mentioned you were down at the Tacoma plant recently. It looks like, just from your 3Q estimates, there's some slippage just around the timing, at both Tacoma and Philippines, just a quarter. Is there? I mean, can you talk to that? What drove that slippage over the last quarter?

Louis Gries (CEO)

Yeah, Matt and I are looking at each other here. We're not thinking of it as slippage. Right now, we've got the capacity we need. They're timed to come online. Just a real short story on plant startups. They start up way cheaper when you don't need the board than they start up when you do need the board. So basically, on a situation like we have in the Philippines and now in the U.S., we cost optimize the startup. So the length of your run is basically what you're trying to learn during that run. When you get into a shortage and you're starting up a plant, then the length of your run stretches out because you're trying to make board for customers that need the board.

So we much prefer to be in the situation we're in with these two startups. And that did cause some of our problems on our earlier startups. Both Fontana and Plant City were started up when board was very tight. So part of the reason they cost us more is 'cause we weren't able to cost optimize the startups. So we don't think of them as behind, so we're very happy with both sites and both startups.

Powell Robinson (VP)

Definitely. And then, just on Fermacell, have you—I mean, is there any specific strategies or incentives you got in place around the existing Fermacell management to keep them kind of incentivized and on board?

Louis Gries (CEO)

Yeah, we've got all the normal stuff in place. I can say, I was with Jack last week in Europe before the board meeting, met with the managers at Fermacell, and saw another one of the sites I hadn't seen. I believe the Fermacell organization is extremely pleased to have an owner like Hardie that kind of understands organic growth, understands how to add capacity, understands how to deliver financial returns. Like I said, the parallels between the two businesses are pretty amazing. The fit right now looks really good, but we have all that normal stuff in place, and just like our Hardie employees, they'll have their incentive plan for fiscal year 2019 already in place, so it's all been taken care of.

Powell Robinson (VP)

Excellent. Thank you.

Operator (participant)

Your next question comes from Sophie Spartalis from Merrill Lynch. Please go ahead.

Sophie Spartalis (Senior Research Equities Analyst)

Morning, it's Sophie Spartalis from Merrill Lynch. Just two questions from me. This year, we didn't see the usual seasonality that generally goes on throughout the year. Should we expect that in the FY 2019 year? And then the second question, R&D was up 10% for the fourth quarter and the full year, given the spend on the other businesses and the increasing number of projects. Can you just talk through some of those initiatives, please?

Louis Gries (CEO)

I can talk through in general terms, but as far as seasonality, you're right, it's easier to make money in the summer in the U.S. than it is in the winter. It did flip around on us this year, and the reason for that was the delivered unit cost issue in the summer of last year, which I talked about. Now we had twenty-fives third quarter and fourth quarter, I think, and it's pretty hard to get a twenty-five third quarter fourth quarter, but you know, but you know, things were... Like I said, when you have positive momentum in a business, a lot of times, you know, you get the help, and it falls to the bottom line, and I think that's probably what happened.

Yeah, I would expect this year to return more to normal, where you sell the better part of your volume in the first six months, so your financials are better, and then you get into the, you know, slower months, and you take more downtime in the plants. Now, we didn't take any downtime in the plants this year. We went into a new program we call distributed inventory, which I think is something that we may do again next year. It seems to have worked very well. But I still would agree with you. You know, normally, first half is two, three points better than the second half, and I would guess that may be the case again this year.

As far as, I think you said R&D was up. There's two ways we spend R&D. The biggest way is market demand. So, I said we had a couple initiatives in the market that we're liking, and we're gonna crank up some funding. Now, that won't show up in R&D, that'll actually show up in our SG&A. But we would have spent a lot of money on those initiatives over the last several years to kinda get them to where they are. The R&D stuff is product platform, mainly, and some of that product platform may be replacement of raw materials, as raw materials supply gets to be in question or too expensive. It could be new products. You guys know we density modify.

We're one of the few fiber cement producers that knows how to deliver both density and durability. So, if our R&D is up, which I would hope it would be, it's because we're funding good projects. It's not... You know, we don't specifically try and tie our R&D as a ratio to our revenue. We fund R&D and then expect that revenue will increase in the future as the projects are successful. That's kind of a long non-answer, but sorry.

Sophie Spartalis (Senior Research Equities Analyst)

Do we expect the R&D expense to be at the level posted in FY 2018 then?

Louis Gries (CEO)

Yeah, I think what I would do if I was following the company, I'd just have a positive trend line on R&D costs. I'm sure over time we'll continue to find more and more things to invest in, in R&D, that'll deliver returns in the future. So like I said, we don't have really handcuffs on the organization, as you know, tying it to a ratio. So I would expect that it will be up as a rule, as we move forward, but not up dramatically to where it starts impacting our financials.

Sophie Spartalis (Senior Research Equities Analyst)

Okay, great. Thank you.

Louis Gries (CEO)

Yeah.

Operator (participant)

Your next question comes from Peter Wilson from Credit Suisse. Please go ahead.

Peter Wilson (Equity Research Analyst)

Thank you. Maybe just to follow up, follow on from that last question. I mean, you've mentioned a couple of times these, these market demand initiatives and programs you've got in place. Can you maybe just give us a little bit of color on, if you can, you know, what they are and why you might have such confidence in the success?

Louis Gries (CEO)

Yeah, I'm not gonna tick them all off. I mean, we'll probably cover. We usually cover stuff like that at our September tour. It's pretty hard on a phone or just in a short period of time to, you know, really get into what we think can drive further market share gains in the future. But I, you know, I just a quick reminder, fiber cements, whatever, about a 20% market share. We're very committed to see it get to 35%. In order for it to get to 35%, we have to open up more opportunities, either through market development initiatives, product development initiatives, and in some cases, some product platforms where fiber cement can deliver more in certain ways than it does now.

Yeah, the market initiatives I referred to, which are getting in their expensive part of their cycle, are the stuff that Sean Gadd and his team probably would've covered last September. It's not so much new. It's just that we have them to a point where, you know, we're pretty excited about. They're ready to go and putting a little more money into them, put more resources in the programs.

Peter Wilson (Equity Research Analyst)

Okay. Fair enough. Thank you. And, and just on the Fermacell in Europe, kind of revenue targets and breakdown that you've sketched out, can you just maybe, for the, for the growth in the existing fiber cement products, can you just lay out your vision a little bit? And what I mean by that is, you know, is the growth coming from just leveraging off Fermacell's existing distribution footprint? And, you know, if so, how immediate might that growth in that, in that segment be?

Louis Gries (CEO)

Yeah, we will get the benefit of their market access, but that's a small part of the equation. We will get that, you know, fairly quickly, meaning the first three years, starting this year, and then maybe picking up a little momentum, second year and possibly third. But the big part of the equation is similar to what, you know, roll back the clock, what Australia has done down here as far as substituting for brick construction, you know, offering architects design options that they couldn't get to with other materials. In the U.S., same thing.

You know, we were growing new demand for a category based on a value proposition, which was very important in the U.S. market, especially when we entered the market. I think this. It's the same challenge in Europe. You know, it's a really good market. Population's good. You know, their ability to spend money, their GDP per capita is good. Everything's good there, but it's just masonry construction, so we have to do the platform development to deliver a value proposition that really starts to penetrate in the masonry construction market.

So if you look at the, you know, kind of like the stuff that's right in front of you, market access will give us a bump in sales in our current products. And then you look at the frame construction, which is growing. Frame construction normally in the couple markets I've seen now is meaning factory-built components rather than everything site-built, like it's normal in the U.S. And we can do well with the, you know, with the frame construction increasing, but that's like a 30 or 40 year penetration of frame construction against masonry. It's not gonna happen fast enough. But that'll be easier than the masonry construction.

The masonry construction, you know, there's a lot of possibilities, and we just gotta do the work to find out, you know, degree of difficulty versus size of the prize. We gotta do the work to decide which way we're going. And we got some good ideas. And like I said, one of the individuals we moved on to that team is a guy that did similar work to that down for us in Australia. So, so yeah, we'll get a bump on the market access. We'll benefit from growth in frame construction. But the big hit that ends up being $1 billion is more find our positioning for masonry construction.

Peter Wilson (Equity Research Analyst)

Okay, excellent. Thank you.

Operator (participant)

Thank you. Once again, if you wish to ask a question, please press star on your telephone. Your next question comes from George Claflin from Arnhem Investment Management. Please go ahead.

George Claflin (Summer Analyst)

Yes, Matt, just on the CapEx, which was increased sharply this year, what's the guidance for CapEx this year, given Prattville and a few other expansions?

Matt Marsh (CFO)

Yeah, thanks for, thanks for that question. On, I think the last couple of results, we had profiled the, for three years, about $750 million over a three-year period.

I think that's still about right. Obviously, we're now talking about an additional period. So I think for FY 2019, CapEx will be in about the $350 million range. So, we've underspent a bit, a little bit, in FY 2018. You'll see some of that carry over with the various capacity projects we've already announced. So $350 million in 2019. We think that goes to $250 million in 2020, and $150 million in 2021. So $350 million, $250 million, $150 million.

George Claflin (Summer Analyst)

Okay. And just the guidance for your net debt at the end of this period with the Fermacell acquisition, what would that, where your net debt be?

Matt Marsh (CFO)

Yeah, depending on the period that you're speaking of, I think we'll be above our one to two times debt range for, you know, six to eight quarters or so. So I think we're well into the backside of fiscal 2020 before we're starting to come down below the 2x level. Obviously, subject to, you know, business performance and market conditions, but we think we're above our range for, you know, for at least fiscal 2019 and into fiscal 2020.

George Claflin (Summer Analyst)

Okay. So just the absolute number, though, roughly?

Matt Marsh (CFO)

Yeah. I wouldn't guide you on it. I wouldn't give you an absolute number. I'd just give you the range.

George Claflin (Summer Analyst)

Okay, and just finally, CapEx for Fermacell, does Fermacell require much in the way of CapEx?

Matt Marsh (CFO)

The guidance that I gave on $350, $250, $150 does include some CapEx for Fermacell. So there is, you know, there are some things that we wanna do in the business in order to be able to invest in it. We also see lots of opportunity in the business. So, you know, for now, I'd say the $350 for next year does have some money set aside for Fermacell, as well as $250 in the following year. As we get to a point where we're ready to talk about kind of material capacity projects or other related investments in Fermacell, those will be in future periods. But we'll certainly provide visibility to those, just like we do on large capacity-related projects on the fiber cement business today.

George Claflin (Summer Analyst)

And just a final one, is what's the sort of impact of the, you know, skyrocketing lumber prices on your competition?

Matt Marsh (CFO)

Yeah, I wouldn't be in a great position to talk about the raw material input cost impact on our competition. I'm. You know, for our business, raw materials, almost across the board, are all up, you know, double digits. You know, in fiscal 2019, we probably had between freight and raw material input costs, you know, somewhere in the vicinity of $25 million of fiscal 2018 versus 2017 type of inflationary pressure. I think that that'll increase. The very different mix that was weighted towards freight last year. Both the freight market was very, very competitive, and then we had a number of inefficiencies in our freight costs last year, particularly in the first half of the year, as we were coming through and out of the capacity constraint.

We weren't obviously taking advantage of lowest landed costs out of each of our plants, and we were having to incur some expedited costs, and then on top of that, we weren't mode optimized like we would normally wanna be, so freight last year was probably half of the input cost inflation. I think that $25 million number in fiscal 2018, you know, could grow to as high as $30-$40 million of fiscal 2019 compared to fiscal 2018 type of inflationary pressure, but the mix of that will be much more slanted towards raw materials.

So while the freight input, while the freight costs are definitely up, the raw material costs on cement pulp, and utilities, and some of our other raw materials are up, you know, to a pretty significant degree. So for us, there's some additional cost pressure that we're gonna have to make up through, you know, performing really well in the manufacturing plants. And obviously, some of that will get absorbed as a result of our growth.

George Claflin (Summer Analyst)

Thanks, Matt.

Operator (participant)

Thank you. Your next question comes from Brook Campbell-Crawford from JPMorgan. Please go ahead.

Brook Campbell-Crawford (Research Analyst)

Yeah, morning, listen, Matt, a question on interiors in the U.S. Just picking up on your comments around volume growth to be flat to up and modestly in FY 2019, I think, is what you mentioned. Do you feel that the market and product strategy you have in place is enough, or is there more you need to do really to get that business to where you want it to be?

Matt Marsh (CFO)

Did you get the question?

Louis Gries (CEO)

Was it for exteriors specifically?

Brook Campbell-Crawford (Research Analyst)

For interiors in the U.S. Just picking up on the kind of flattish outlook for volumes, interested to know, you know, is there much that needs to be done for the market or product strategy?

Louis Gries (CEO)

I still didn't get it. You wanna take it?

Brook Campbell-Crawford (Research Analyst)

Yeah.

Matt Marsh (CFO)

Yeah, so we don't think it's a product issue on the interiors business. You know, when we came through the capacity constraint, you know, 18 months ago, like a lot of businesses that are under a capacity constraint, you kind of have to make strategic decisions about which products, you know, get prioritized. And I think that helped us or caused us to kind of look at some of the products in our portfolio that we probably should have been looking at all along. And so we decided to exit on the interior side, certain products and certain segments of the business that are good for kind of long-term returns of the company, or will certainly have a benefit on the long-term returns of the company.

And so there's that component that's certainly, you know, weighing on the overall result when you look at it, when you look at interiors growth last year. So if you look at kind of active products within interiors, you know, we like kind of our product positioning overall, and we don't think we've got kind of a product gap or overall product positioning issue on the interiors business that that's kind of being factored into the low levels of growth last year. So we expect, you know, to get back to kind of a growth game on interiors in fiscal 2019.

Obviously, not to the same extent as the exteriors business, but overall, we think we'll start to come out of this, you know, 4%-7% negative comp on interiors and start to track back towards our normal growth rates on the interiors business.

Brook Campbell-Crawford (Research Analyst)

Okay, thanks. And one more, if I can, and hopefully you can hear me. But the margins for Fermacell, talking about low double digit, clearly a lot lower than what you're used to operating at. But given the similarities in manufacturing, between the two businesses, can you help me understand what are some of the key drivers of the margin difference? And I guess, can you help them lift margins from where they are now?

Louis Gries (CEO)

Yeah, I can take that. I guess the first thing is, Fermacell margins are good, they're just not as good as Hardie. And, I think our Hardie margins are, a lot driven off market position, how we go to market, and how we create demand for our product. So I wouldn't put it all on manufacturing. I actually think, we have some, more performance to get in manufacturing, and my first look at a couple Fermacell factories, I think they have that same opportunity. But, again, our, kind of bar for buying a business wasn't really what the short-term, EBIT margin or returns in that business would be.

Obviously, we wanted it to be a positive for our shareholders, but we didn't. If we, if we set out to only buy businesses that has as good a returns as ours, we couldn't buy any businesses in building materials. So they got good returns. There's definitely upside, there's definitely upside on the organic growth. And normally, when you, you grow new business, grow new demand for your product through market development, you do get better returns than your base business. So, so there's upside, you know, for their returns. But I, I don't want you to think that we think they should equal Fiber Cement US. I just that's the wrong way to think about it.

Now, what you should think about, or the way we want you to think about it is, is this a step in the right direction for Hardie becoming large in Western Europe with good Hardie-like returns? And I think that's. We're pretty confident we've made a good step in the right direction for trying to deliver on that objective.

Brook Campbell-Crawford (Research Analyst)

Thanks. Just one more, if I can, on sticking with Fermacell. The comment from Matt around CapEx and some of the guidance for Fermacell in the coming years. Is the idea to add some new lines into the existing Fermacell plant network, or is it building whole new plants for Fiber Gypsum?

Louis Gries (CEO)

Yeah, we haven't had the business long enough to have a capacity strategy for Fermacell. One of the things, you know, you sign up for when you set an organic growth strategy is you're gonna build capacity. So there, you're gonna need more capacity. As you generate demand, more demand, you need more capacity. They don't have a lot of excess capacity, so they fall into that category. As they generate more demand, they will need more capacity. Now, there's three ways you can get more capacity. You can get through debottlenecking existing plants, you can get through brownfield investment in existing plants, or you can get through greenfield investments. Normally, that's the order you wanna go in. Normally, your highest returning, it'll be debottlenecking, second would be brownfield, and third would be greenfield.

There's some exceptions to that, I'm afraid, if you got a hole in the market freight-wise. But we just haven't had the business long enough. They have enough capacity to do what you know, both the buyers and the seller case said we're gonna do over the next couple of years. So we don't have a short-term problem with capacity in Fermacell. And I think you know, maybe down the path later this year or this time next year, we'll probably have a capacity plan for Fermacell that we can talk about.

Brook Campbell-Crawford (Research Analyst)

Appreciate the comment.

Operator (participant)

There are no further questions from the phones at this time. I will now hand back to Mr. Gries.

Louis Gries (CEO)

All right, that's good. Appreciate everyone joining the call. Thank you.