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Sheetrock Producer USG - Not out of the Woods Yet

March 23, 2012 | About:
Josh Zachariah

Josh Zachariah

38 followers
The sheetrock producer USG (USG) has been in the news of late as its stock price has steadily marched upwards. The company announced that it logged an operating profit of $5.7 million but a net loss for the first two months of 2012. The company credited the success with a higher wallboard price, but gave no mention to the fact that these two months were some of the driest and warmest in years as evidenced by an incredibly low natural gas price. In that regard, the 16% gain in net revenues is not as impressive. The $30 million loss in two months is also a reminder that the company may produce more red ink than it will sheetrock. With that said this continuing loss should come as no surprise. Housing starts are still way below historical averages and have a long ways to go before USG will start yielding a profit.

USG gets the bulk of its sales from the U.S. at slightly over 80%, but it does get some 12% of net revenues from its Canadian operations. Though I’m not an expert on the Canadian housing market, a quick search of “bubble” and “Canada” will yield plenty of opinion. House prices in Canada have doubled in the past decade and have grown at double digits in the past few years as household income debt jumps.

If we’ve learned anything from the U.S. housing collapse it's that no worse scenario is too conservative. But if the U.S. housing market continues to impress with small gains, then even a catastrophic housing collapse in Canada could be offset.

The shares of USG at $18 are still not exactly lofty. As I wrote in a previous article, the company has the ability to produce several hundred million in profits when the cyclical housing market changes direction (so just as long as you can wait till "when"). It’s a race against time for USG to break-even so their cash pile stops dwindling. This should be the primary concern for the long-term USG investor. Fortunately, USG comes with a "Buffett put." The likelihood that Buffett, as the company's largest shareholder, will let the company die of cash flow asphyxiation is very unlikely.

It will take years for the company to produce the kind of operating earnings it did in the mid 2000s (net earnings were widely skewed by the asbestos bankruptcy). But the industry is unlikely to change. Unlike the smartphone or tablet market, the sheetrock/interior wall market has not exactly attracted the eye of innovators. Sheetrock remains and will likely remain the low-cost material for interior walls for the foreseeable future.

On previous articles I was questioned why invest in USG and not other industrial companies like Vulcan (VMC) or Eagle Materials (EXP). The problem with Eagle is that they generate more revenue from their cement segment than sheetrock (I have yet to read their 2011 10-K). The cement market is much more fragmented with the top 10 producers making up only 30% of the market. USG alone currently makes up 25% of the sheetrock market and only seven other competitors make up that consolidated market.

A large market share lends itself to greater bargaining power and that may have contributed to the higher sheetrock price USG was able to extract despite lackluster demand. USG previously made up some 30% of the sheetrock market, but as it shut down its operations that had depended on high volume, it temporarily relinquished market share. But market share is truly valuable when demand for the product is strong.

Take the oil cartel OPEC as an example. OPEC accounts for just over 30% of global oil production which is not much higher than USG’s. Unlike OPEC, USG can switch on or off production without the consensus of others and without much customer revolt. The value of OPEC’s market position is clear today. The value of USG’s stable market position will once again be clear when the housing market returns.

About the author:

Josh Zachariah
I credit my father and Warren Buffett for molding me into the investor I am today.

Rating: 2.8/5 (12 votes)

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