Purest Housing Play: Drywall King USG
The purest play on the housing recovery – which is broader now than in previous periods of the rebound, as seen in the Case Shiller index – might be the company that supplies the most drywall, USG (USG).
USG, which sells about 25% of the drywall used in the U.S., making it the number one supplier, typically enjoys expanding margins as sales rise. But, as a consequence of having enormous fixed costs, during times of slack demand profits are blotted out. It’s a classic cyclical industry that is also able to pass along steep price increases during periods of high demand, but that is forced to discount heavily when demand is low, magnifying the cycle. Thus does revenue soar and plunge:
Right now, of course, it’s rising and swiftly, and profits are rising even faster. On a 15% sales increase in the second quarter, USG’s operating profit nearly tripled. The stock, meanwhile, has nearly tripled since a low point two years ago.
During the second quarter, USG’s United States Gypsum Co. unit, sold about 1.29 billion square feet of wallboard, up from 1.15 billion a year earlier. That’s a 12% increase in volume. But price increases were even steeper, rising 16% to $153.77 per thousand square feet from $132.09 a year earlier.
The question now: where does volume and price go from here, given that those two factors drive sales, profits and the USG stock price. The industry has been aggressively raising prices even as the housing recovery has experienced fits and starts. Drywall sold by USG hit a quarterly low of $104.41 per thousands square feet in 1Q 2008, and remained as low as $112.59 through 4Q 2011. Since then, however, USG and competitors have successfully pushed through numerous price increases – despite the fact that volume remains far below output during the mid-2000s housing boom.
For instance, USG’s 2Q 2013 sales of 1.3 billion square feet is less than half its peak output of 3.0 billion square feet in 1Q and 2Q 2006.
The industry retired or mothballed a lot of capacity since the housing bust, according to USG, down to 32.7 billion square feet this year from a peak of 39.6 billion square feet of capacity in 2008.
The question for investors is whether USG and competitors can push through substantially higher prices going forward, and whether the housing recovery will accelerate and thus require a lot more drywall. Charting USG’s PE ratio is a mess, given a bankruptcy last decade (related to asbestos exposure in a relatively small business unit), and a jumble of charges to earnings. Price to sales is a cleaner way to look at valuation.
Other than the bubble-induced peak of 2006, recent months represent a high point in the ratio at USG, suggesting caution. Also, while industry capacity has been reduced, high prices and rising sales inevitably encourage one or more players to take old plants out of mothballs or build new ones, and that can zap pricing power.
Early last year bears had sold short a significant portion of USG's stock. The short position then fell sharply, but un recent months it has been on the rise again.
Many housing related stocks -- Toll Brothers (TOL), Pulte Homes (PHM), Lennar (LEN), DR Horton (DHI), Home Depot (HD) -- have rallied ahead of results and seem fully priced now. A significant expansion of the housing recovery, however, could give them all more room to run, and USG is among the simplest ways to capitalize on such conditions.
Jeff Bailey, The Editor of YCharts, is a former reporter, editor and columnist at the Wall Street Journal and New York Times. He can be reached at firstname.lastname@example.org. Read the RIABiz profile of YCharts. You can also request a demonstration of YCharts Platinum.
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