USG (USG)

One of the greatest endorsements a company can get is an investment by Warren Buffett, one of the wealthiest men in the world and an investor who has realized annualized gains in excess of 20% over his lifetime. To put it into perspective, $1000 invested in 1965, at the start of his fund, would be worth over $3.5 million today; that's an appreciation of 350,000% (this is not a typo).

In 2000, Buffett's Berkshire Hathaway (BRK) took a 17% stake of all outstanding USG shares. The company will issue an additional 45 million shares very soon at $40 per--doubling its current float--and the Oracle of Omaha pledged to buy any shares not purchased by investors. This could increase Buffett's share in the company to over 50% if demand for the new offering is low.

Like every one of Buffett's investments, this stock is for long-term value buyers. When the U.S. housing market picks up again--and it will some day--USG will be minting cash as does in any housing boom.

As a cyclical performer, USG's returns are heavily dependent on the recovery of the economy - particularly the residential and commercial real estate.

Demand/Supply Analysis: Current estimate of wallboard demand holds at ~18 billion sqft. The southeast is still incredibly weak. The Midwest is fairly stable, solid in relative terms, as well as the intermountain area and Texas, and then obviously there's weak pockets in Arizona, Vegas, and California. So it is a regional demand scenario and there's differences in regional prices as well. In terms of capacity in the industry, current estimates is ~35 billion sqft. This translates to a simplistic industry averaged capacity utilisation of 51.4%. Currently, USG presented in the quarterly discussions that their plant utilisation ~46%.

Pricing Analysis: USG's pricing philosophy has not changed despite the recessionary pressure to maintain sales and market share. With the value proposition they provide, such as new products, research and development, marketing and their sales coverage, USG will continue to market as a premium product brand. USG realised an average selling price of $115.33 per thousand sq ft compared to their competitor Eagle with an average of $92.70 for the last quarter.

Cost Base: With workforce reduction (SG&A now at 9% of rev), curtailed operations at older less efficient wallboard lines, optimisation of their L&W supply network, reduction of plant operations, USG is trying hard to lean out its operations.

With its strict disciplined cost management, continued focus on innovative and industry leading products, a strong competitive advantage of local presence (as opposed to Mr Jay's view that transportation of massive wallboards is a negative for USG, it is actually a positive moat against foreign imports!), USG just needs to wait it out for the tide to come in again.

One of the greatest endorsements a company can get is an investment by Warren Buffett, one of the wealthiest men in the world and an investor who has realized annualized gains in excess of 20% over his lifetime. To put it into perspective, $1000 invested in 1965, at the start of his fund, would be worth over $3.5 million today; that's an appreciation of 350,000% (this is not a typo).

In 2000, Buffett's Berkshire Hathaway (BRK) took a 17% stake of all outstanding USG shares. The company will issue an additional 45 million shares very soon at $40 per--doubling its current float--and the Oracle of Omaha pledged to buy any shares not purchased by investors. This could increase Buffett's share in the company to over 50% if demand for the new offering is low.

Like every one of Buffett's investments, this stock is for long-term value buyers. When the U.S. housing market picks up again--and it will some day--USG will be minting cash as does in any housing boom.

USG reported first quarter 2010 net sales of $716 million, an operating loss of $82 million and a net loss of $110 million, or $1.10 per diluted share based on 99.4 million average shares outstanding. Wallboard prices fell over the quarter causing margins to follow.

Not fantastic news compared to other cyclical sectors/companies who have seen strong recovery in their earnings. However, sentiment for the homebuilding sector is picking up. Like i said in my earlier post, USG was diligent in the downturn and had cut a sigfig amount of cost out from its structure by closing down less efficient production facilities. The recovery in its share price is a matter of patience in waiting out for the recovery of the industry.

Share price recovery has been dramatic, the counter performance over the first quarter was close to 70% jump from its $14 range.

I continue to be a long term bull on USG as the company will benefit from its low cost base as demand continues to pick up.

However, in the short term, given the strong rebound in share price in the last quarter, i will be cautious in entering new positions for this counter.

In support of my qualitative argument below, i have uploaded the figures on my blog for your viewing:

http://edequityresearch.blogspot.com/2009/11/quantitative-analysis-on-usg.html

Ed's Call: Buy Intrinsic Value: US$19.07 Price at time of call: US$14.60

Did a DCF valuation on USG. The parameters I used were:

http://4.bp.blogspot.com/_0APGKMRBfYA/SwVBDpVCH9I/AAAAAAAAACA/UzxiCAzG_nY/s400/dcf.jpg

As the company currently has negative earnings, i did a normalisation on the earnings for the DCF model. The normalised earnings using a historical average approach was ~$400mil

Relative Valuations: - Relative valuations were lowest in the most recent year. This is easily attributed to the economic and business cycle.

http://2.bp.blogspot.com/_0APGKMRBfYA/SwVDNKyu5sI/AAAAAAAAACw/iHv8b0__ee4/s1600/Value.jpg

CF Analysis: - Notice the high CapEx leading up to 2007. This is seen similarly across the industry as the homebuilding sector was booming and material manufacturers were adding capacity to their production lines.

http://1.bp.blogspot.com/_0APGKMRBfYA/SwVBN_xOabI/AAAAAAAAACI/q7J6bR1kDT4/s1600/cd.jpg

Balance Sheet Analysis: - Cash conversion cycle increased dramatically to 46 days as inventory turnover slowed and receivables increased. - Debt levels increase with LT debt totalling $1.4Bil - Common share holding diluted over the last 2 years. - Book value holds at ~$15/share

http://3.bp.blogspot.com/_0APGKMRBfYA/SwVC2RzKlvI/AAAAAAAAACg/6gpDInSpHxE/s1600/bs.jpg

Income Analysis - COGS as % of Rev = 95.833%. This signifies that the company is barely breaking even. Pricing pressure remains as competitors depress price to clear inventory and try to gain market share. USG on the other hand has a consistent and firm pricing policy. It charges above market price for its wallboards, marketing them as premium high quality boards.

http://2.bp.blogspot.com/_0APGKMRBfYA/SwVDBjF8jSI/AAAAAAAAACo/Ass8rSjVHXQ/s1600/income.jpg