The previous 20 years for USG Corp. (USG) has been an exceptional period. The company suffered two bankruptcies and is crawling out of one of the worse cycles in the construction industry. The first bankruptcy was related to excess leverage. The second one in 2005 was related to asbestos claims. USG would end up debiting shareholders and bondholders a total $3.9 billion to cover asbestos claims in 2000 and 2005. The net losses for each of the last three years have totaled some $1.6 billion, which is no small sum either. A third bankruptcy is certainly a possibility. The company has some $600 million in equity, but also some $900 million in cash and guaranteed credit lines. Losing another $1.6 billion would not be an option, but the worse is for the most part behind the company and it has since throttled its operating costs.
There was confusion as to why Warren Buffett had invested in the company in 2005 as the company’s financials hardly met his criteria for a good investment. The earnings were erratic with huge losses, primarily related to provisions for asbestos and restructuring. However, excluding these items the earnings look a little steadier. The litigation relating to asbestos was certainly a one-off event and the warnings about asbestos dated back to the 1980s. Assuming a punishing loss like this would not occur in the future is a fair assumption and this was probably what Buffett had in mind when he was combing through the financials.
Immediately below is the actual operating and profit margins of USG and below that is one modified to exclude asbestos related expenses. The profit margins in the adjusted graph for 2005 and 2009 were skewed by valuation allowances and other provisions related to asbestos claims. These too could be adjusted to give a more accurate view of the company sans asbestos. In 2006 $528 million in interest expenses were also deducted relating to the asbestos bankruptcy. Here is a link to a spreadsheet of the last 17 years of income statements for USG along with the expenses related to asbestos.
Going forward interest expenses will be elevated with a higher debt load, but the company did gain a valuable asset during the housing tumult. USG has some $1.6 billion in net operating loss carryforwards, which amounts to over $500 million that can pad future earnings. These will be available until 2030 and will likely be completely redeemed. The company is also operating at some 50% capacity utilization. Just before the housing bust it had opened a wallboard manufacturing line in Stockton, Ca. that would become the worlds largest, producing 1 billion square feet annually. It would also operate much more efficiently and cheaper than their older plants in California.
Unfortunately timing was poor and with a plant of this scale, operating at reduced levels is not very profitable. USG should have the advantage when the housing market returns because of its operating leverage. Other sheetrock companies with smaller operations have been able to log a profit through the last couple years, but they likely haven’t idled as much manufacturing. After having some 85 consecutive years of profits up to 1987 the company was bound to have to a hiccup. If the company makes it through this downtown many profitable years will lie ahead.
Disclosure: Long USG
Josh Zachariah - for other articles related to USG