A booming stock market does not usually allow for value buys. Most securities have been moving higher lately. The construction business and the housing market, however, have been going in the opposite direction. After the housing boom of the late 90’s and early 00’s, the market has turned sour. Looking at the assets and earning potential of companies in this sector, the securities seem to be generally undervalued.
United States Gypsum emerged from bankruptcy just this past June. USG manufactures an entire line of construction and industrial materials. USG thankfully did not go bankrupt due to poor business or management. The company was forced into bankruptcy by a windfall of asbestos claims against them. USG was organized under bankruptcy protection, and a trust was created to pay the remaining debt owed to the asbestos victims. The company has made an initial payment and will have to make another payment in the future. The future payments will depend on whether or not proposed legislation passes into law. Regardless, USG’s bank account is large enough to cover future payments especially with the tax credit the company will be receiving in 2007.
You might not know much about USG but chances are good, about thirty three percent that the walls surrounding you right now were made by USG. USG manufactures gypsum wallboard under the brand name Sheetrock, and produces one third of all wallboard sold in the North America every year.
The stock of the company had run up to about $120 earlier this year only to come tumbling down by sixty percent this spring. The stock now trades at around $50. I believe the stock is the best contrarian value buy available today. I will not go into exactly what I believe the stock currently worth, but I will say I consider it to be worth significantly more than it is selling for. You should know I am currently a USG shareholder.
Warren Buffet says, “It’s the most successful managerial performance in bankruptcy that I’ve ever seen.” I agree. Buffet has placed nearly 1.5% of his total portfolio in the company. He originally bought 15% of the company through a backstop deal agreed to during bankruptcy to purchase all remaining shares after the public offering. He apparently wanted even more. As the stock vacillated under $50 this past summer, Buffet bought another 5% of the company. Anytime the shares hovered under or close to $46, he bought more. He now owns close to 20% of the company’s outstanding shares. Buffet put nearly half a billion dollars into the company. When arguably the best investor in the world places such a large bet on a company, it is certainly worth a look.
USG is a vertically integrated company, meaning that they own everything from the factory to the transportation services. In some cases, companies who wish to become vertically integrated buy into trouble. They purchase companies to close holes, and subsequently find themselves in danger because the company requires different management and knowledge. USG has been managing its various companies extremely well. They have large transport ships that carry the gypsum board and other products from the factory to suppliers. Even the paper the company uses is manufactured at USG paper mills.
Some of the product goes to a fully owned USG supplier named L&W Supply. The company sells USG products directly to contractors and then delivers the material directly to the job site. Their stores are even stocked with food and supply the contractor’s lunch as a service. None of these subsidiaries are hard to manage, in my opinion, and USG has thus far done a superb job. L&W’s profit was up forty five percent last year and contributed significantly to USG’s over five billion dollars in revenue. Vertical integration, if managed correctly, can allow a company like USG to perfect and control what I like to call from “factory to shelf” or in this case, to the construction site. Therefore no hiccups of any kind arise in the transportation or creation of the product.
The management team at USG is outstanding. The CEO William Foote has led the company through bankruptcy and is loyally bringing the company back to supremacy. The management does not grant unwarranted options and certainly does not pay themselves a larger salary than they are due. The annual report is wonderfully written and about as upfront as an annual report can be. A loyal, smart, efficient management team is all a shareholder can ask for in a case like this.
The biggest attraction of USG is likely the company’s brand names. When a company’s brand name becomes a verb, the product is usually dominating the industry. Google (GOOG) for example has become a verb meaning ‘to search the web’. Many contractors say when putting up dry wall, “We have to Sheetrock it.” A company with a verb has the very moat Mr. Buffet demands of companies he invests in. The moat protects the company from competition and fluctuating economic cycles. A verb is a wonderful sign that such a moat exists in the public’s mind.
The Wall Street Journal just last week ran a rare article about undervalued stock. The paper reported, “At current prices, USG stock does look cheap.” The author explained that she believed USG was undervalued and should be considered by investors. The WSJ almost never writes articles about value buys, especially dedicated largely to a single company. The article is another good sign.
USG has a long and distinguished history. The company was started 104 years ago and has been operating ever since. USG has been forced into bankruptcy twice. The first time was in the early1990’s and the second time was discussed above. The company emerged both times stronger and trimmer than before.
The future has shades of bright colors. USG is launching a new faux finish interior paint called “Michelangelo” that is now being test launched in Home Depots (HD) across the country. The company is also trying to increase the efficiency of the factories that make the gypsum board by closing those with lowest efficiency and opening six new high-efficiency factories. Without loosing focus, USG seems to be expanding using both creativity and competence.
Although the current housing industry slump is going to impact USG’s business to some degree, the market will eventually return as cyclical markets always do. Forty percent of the company’s sales come from the commercial industry while thirty five percent of the residential sales come from remodeling. The WSJ reported that “Some of [USG’s] other businesses, such as plaster and joint treatments, help reduce its exposure to the new-housing market, and supporters like that they steadily generate a lot of cash.” I believe many shortsighted investors are allowing a macro slump to cloud their thoughts. Not buying this stock because of the short-term market trend is letting a perfect pitch sail by.
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User Comments:
Nice work Evan. I assume you have mirrored the article written by Buffet about GEICO some years ago and included with the most recent Annual Report of Berkshire. A nice touch.
I would disagree with you however that the Sheetrock brand name provides much competitive strength. Gypsum wallboard is a commodity product and so USG is forced to accept the market price. Its product is really not different (in quality or otherwise) to other producers that it can charge a higher price. Indeed, builders just use what is cheapest and that becomes the market price, for USG's product and the product of other producers. USG's competitive advantage is in its scale and cost efficiency. The market price of the wallboard reflects the industry-wide cost of its production and delivery. By being cheaper that its competitors in production and delivery, USG can earn a higher margin and thereby prosper earn excess returns. (I think the "verb" concept is often correct but not always. I've been hoover-ing my carpets for years but haven't to my knowledge used the Hoover brand.)
Heres the link to another useful analysis of USG (including an explanation of the commoditised nature of its business) by a successful Australian investor:
[www.westernpacific.com.au]
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Kidna off topic, but can you edit hte subject to say USG in it :-)
Thanks
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That Western-Pacific article is a little weak. The one pager doesn't make a strong case for USG, meerly stating that it has significant marketshare and it has been "over-punished." He still cites the cyclical aspect of the business, to which my question would be: If the housing market declines, and the stock is still cheap, won't the price of the stock be slower to grow?
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what if u buy usg at say 46 and buffet buys the whole co a 40 ur forced to sell at a deficit
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I see very little original analysis here, although I think this is a good company your assumptions are wrong.
1. The share price fall was mainly due to a 1:1 rights issue, the market cap of the company is about the same as it was at its high, so the perceived share price fall is not real.
2. I don't think the stock is undervalued, it's real current P/E is about 13 (ignore the 7 you see quoted it is based on historical numbers)
3. The housing market could get worse before it gets better, and if we see a general fall in the market this stock will go down with it.
4. I think there will be better times to buy this, but you need patience.
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this is many good things up there, but I do not have a insurance company to cover asbestos lawsuits damages, a little further I do not have good lawyers to back me up,
I am not jealous to see someone to take a ride with warren anyway
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yervand,
It's nice to see little Buffetts here.
By the way, your research has got some facts wrong.
The company doesn't have any more asbestos liabilty.
you wrote:
The company has made an initial payment and will have to make another payment in the future. The future payments will depend on whether or not proposed legislation passes into law.
10K wrote:
On December 21, 2006, we also paid $3.05
billion to the Asbestos Trust. This additional
$3.05 billion payment was due because the plan
of reorganization required that we pay this
amount if the 109th Congress did not pass the
Fairness in Asbestos Injury Resolution Act of
2005 or substantially similar legislation before
Congress adjourned. Because the 109th Congress
adjourned in December 2006 without passing
this legislation, we made the $3.05 billion
payment to the Trust. As a result of this payment,
we have fully funded the Trust and have no
further payment obligations to the Trust.
A billion here, a $3.05 billion there, before you know we're talking big money here.
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