Owens Corning (OC): A Bull Case for a Real Economy Stock

Summary:

A global leader in the manufacturing of building and construction materials, Owens Corning (OC) sells its products in 30 countries. OC’s legacy business is divided into three segments: Roofing (~40% of sales), Insulation (~37% of sales), and Fiberglass Composites (~23% of sales). These percentages are before factoring in OC’s recent acquisition of door and door systems manufacturer Masonite.

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Why We are Bullish on OC:

• Most investors believe the company’s fortunes are inextricably tied to the ups and downs of the U.S. economy, and more specifically to the volatile housing sector.

• Such a macro-based analysis would be patently wrong, in our view.

• Management has successfully raised prices and controlled costs in all three segments such that its financial results look more like those of a growth company.

• OC’s roofing business, the company’s biggest and most profitable segment, is much more predictable than — and not nearly as economically sensitive as — many investors seem to believe.

• More than 80% of the business is repair, storm replacement and remodeling[1]. Such needs-based purchases are little affected by economic conditions or interest rate movements. Less than 20% of the company’s roofing business is tied to new construction.

• OC shares trade at less than 14x earnings and an 8% FCF/EV ratio. Multiples that are 50+% lower than the R1000 Index.

• This seems too low considering OC has posted solid results in good and bad economic environments.

• For each one-point increase in its P/E multiple, OC’s share price would be lifted by about $15.

• For each one-point increase in its EV/EBITDA multiple, OC’s share price would rise $27.

• OC used more than half of its free cash flow in 2023 and 2022 to buy back its own shares.

We also find it notable that both our Large Cap Value and Large Cap Core models rank OC in the top 100 despite significantly different loadings. Red box, OC is ranked 6^th in our Value model and 43^rd in our Core model. In our view, when a stock is highly ranked across models with divergent mandates, it signifies greater potential interest across the investor base.

What is the Bear Case?

The principal risk to an investment in OC shares is a potential further downturn in housing market construction. Such a scenario is certainly possible, particularly if inflation were to flare up again, which in turn would likely cause mortgage rates to scale higher. However, the large percentage of OC’s business which is geared toward repair, storm replacement and remodeling — not new construction — blunts a significant portion of this risk, in our view.

Company Description

A global leader in the manufacturing of building and construction materials, Owens Corning (OC) sells its products in 30 countries. In the U.S., OC’s business is strongest in the Midwest, the Rocky Mountains region, and on the West Coast[2]. The company manufactures its roofing, insulation, and fiberglass composite products in more than 100 different facilities mostly in the U.S., but also in Europe and Asia.

OC’s legacy business is divided into three segments: Roofing (~40% of revenue), Insulation (~37% of sales), and Fiberglass Composites (~23% of sales). These percentages are before factoring in OC’s recent acquisition of door and door systems manufacturer Masonite. See pages 9-13.

• Roofing: According to various industry sources, OC is the second largest roofing supplier in the U.S. (to the private company GAF Industries). OC’s primary roofing products are laminate and asphalt shingles. OC’s roofing business is both the company’s biggest and highest margin segment, generating an EBIT margin of 30% or more in each of the last four quarters. Management expects the profit margin of this segment to remain in this range in 2Q 2024[3]. Quite constructively, the company has been able to pass through price increases in its roofing segment (see pages 6-8).

Not surprisingly, increased storm activity has increased the need for OC’s products. In addition, repair and remodeling trends remain strong, as does new construction demand. OC expects all three demand drivers to remain powerful throughout 2024[4].

• Insulation: OC sells products that promote energy conservation and thermal functionality under well-known brands like Owens Corning PINK®️ FIBERGLASS™️ insulation. As in the Roofing segment, OC’s customers have accepted price increases, bolstering margins. More specifically, OC has been able to increase its Insulation EBIT margins consistently since 2019 (17% over the twelve months ended March 31, 2024, up from just 9% in 2019).
• Composites: The company’s glass fiber materials are utilized extensively in the building and construction, renewable energy, and infrastructure industries. Composites, which has the lowest margin of OC’s three units, was negatively affected in 2023 by declining Asian spot prices for the glass reinforcement product that the company sells.

Investors Seem to Believe OC’s Business is More Cyclical Than It Actually Is, Causing OC to Trade at a Far Steeper Discount to the Market Than it Deserves; This Perception is Destined to Change … and This Creates the Opportunity in OC’s Stock.

Given the nature of OC’s business, most investors believe the company’s fortunes are inextricably tied to the ups and downs of the U.S. economy, and more specifically to the volatile housing sector. Based on U.S. housing start data, which has been net flat over the last five years and has turned down quite decisively over the last 24 months, one might then surmise that OC’s revenue and EBIT are perhaps flat versus 2019 levels.

Source: Federal Reserve Bank of St. Louis.

Such a macro-based analysis would be patently wrong. Revenue and EBIT in each of OC’s three segments are much higher now versus four years ago, particularly the Roofing and Insulation units. Management has successfully raised prices and controlled costs in all three segments such that its financial results look more like those of a growth company which is little affected by variations in the economy.

Investors currently value OC based on the macro methodology discussed above, not based on the impressive sequential results the company has posted over the last few years — in the face of a difficult market for homebuilders. (Clearly, a factor which has helped OC has been consumers’ renewed interest in remodeling and, as noted above, increased storm repair-related roofing demand. Furthermore, many climatologists expect storm activity only to intensify.)

OC shares trade at less than 14x its earnings for the twelve months ended March 31, 2024, and at an enterprise value (EV) to adjusted EBITDA ratio of just 7.3x. Both figures represent 40+% discounts to the S&P 500 Index. OC’s valuation multiples seem far too low for a company which has posted impressive results in good and bad economic environments, and which carries less risk than investors factor in (see page 6).

Another positive for OC is its free cash flow position and management’s stated goal to return about half of free cash flow to shareholders over time (share repurchases and dividends combined), though that percentage will likely be reduced in 2H 2024 as OC pays off some of the debt it added to finance the Masonite acquisition.

Over the twelve months ended March 31, 2024, OC generated free cash flow (operating cash flow minus capital expenditures) of nearly $1.4 billion. Moreover, the company also generated more than $1 billion in free cash flow per year in the last three calendar years. OC used more than half of its free cash flow in 2023 and 2022 to buy back its own shares.

Important and Long-Lasting Housing Trends Favor Owens Corning

OC stands to benefit from two key secular trends in the housing industry. First, housing has been under-built in the U.S. for more than ten years, underscoring the need for OC’s products. Note the following statistics:

• According to realtor.com, about 17.2 million new households were formed between 2012 and 2023, including 1.7 million in 2023[5].

• In 2023, homebuilders started construction of 472,700 multi-family homes and 947,200 single-family homes. This brought total 2012-2023 housing starts to 14.7 million homes, of which approximately 10 million are single-family dwellings.

• As a result, the cumulative gap between total housing starts and household formations between 2012 and 2023 reached 2.5 million homes (17.2 million new households less7 million total starts). Furthermore, the 11-year aggregate differential between single family housing starts and household formations totaled a remarkable 7.2 million (17.2 million minus 10.0 million) at the end of 2023. See Figure 2.

When these huge deficits start to shrink, the incremental business that OC realizes for many years should be enormous relative to the 1.4-million total annual housing start level noted just above. Probably even more important, as millennials begin to buy homes — and remodel and repair them — OC’s core repair and remodel revenue will receive tangible and permanent boosts.

OC’s roofing business is much more predictable than — and not nearly as economically sensitive as — many investors seem to believe. Indeed, more than 80% of the business is repair, storm replacement, and remodeling[6]. Such needs-based purchases are little affected by economic conditions or interest rate movements. Less than 20% of the company’s roofing business is tied to new construction.

Because of 1) OC’s position as the nation’s second largest maker of roof shingles, 2) the “needs based” nature of the business, 3) the pressing need to build more housing, and 4) the quality of its products, OC has significant pricing power. Note that the aggressive price increases which OC has recently implemented in its roofing and insulation businesses seem to be easily sticking.

A second important mega-trend in the housing industry is a manufacturer’s ability to produce sustainable building materials. Increasingly, consumers base their buying decisions for many goods, including building materials products, on sustainability. Indeed, a recent McKinsey & Co. study showed that 66% of all respondents, including 75% of millennials, carefully consider a product’s environmental footprint and want to align themselves with brands that are compatible with their values[7].

OC fares well under this standard. According to the company’s 2023 Sustainability Report (its 18^th such edition; it began publishing these reports in 2006), 59% of OC’s 2023 revenue traced to products that can help customers save energy and lower carbon emissions. Furthermore, fourteen of OC’s products, which in aggregate represent a quarter of the company’s revenue, are certified made with 100% renewable electricity. (About 63% of OC’s 2022 revenue stemmed from energy saving, lower emitting products.[8])

Masonite Acquisition

On May 15, 2024, OC closed its $3.9 billion cash acquisition of Masonite International Corporation (formerly NYSE: DOOR), a leading global manufacturer of interior and exterior doors and door systems. OC announced it would acquire Masonite in February 2024 in a move to strengthen and broaden its position in building and construction materials. OC plans to fund the Masonite transaction about 50/50 between cash on hand and funds from new debt financing. Masonite employs about 10,000 people and operates 64 manufacturing and distribution facilities.

The transaction expands OC’s leadership in branded residential products in a category that complements OC’s current exterior (shingles) and interior (insulation) offerings. Furthermore, Masonite represents a new scalable growth platform for OC. OC believes Masonite’s total addressable market (TAM) is approximately $27 billion[9], of which Masonite has about a 10% market share based on its current revenue run rate.

With the Masonite door brand now part of OC’s product offerings, OC is providing an increasing quantity of building materials to the average home. In turn, a growing number of builders, contractors (see page 13), distributors, home centers, and homeowners are becoming more familiar with OC’s offerings. Figure 5 is a good depiction of the degree of OC’s involvement in residential construction.

Put another way, OC’s buying Masonite represents an expansion into an adjacent building material category that will leverage OC’s materials science expertise and R&D capabilities to launch new door products and systems. In the process, OC’s consolidated TAM expands to about $75 billion (~$50 billion from OC’s core business plus $27 billion from Masonite). See Figure 6.

The combined OC-Masonite company will realize about $125 million in operating and cost synergies (most of which should be realized within two years). Taken together with Masonite’s 2023 adjusted EBITDA of about $450 million, this implies that OC’s Masonite purchase multiple was a reasonable 6.8x pro forma adjusted EBITDA ($3.9 billion divided by approximately $575 million).

OC believes the Masonite transaction will boost its annual free cash flow by more than 10% by the end of 2025. Interestingly, OC believes the door business is structurally less capital intensive than OC’s legacy business. That would imply that if OC can increase the EBITDA margins in the doors business, door-business free cash flow will increase by an even greater percentage.

Masonite’s revenue has increased at an 8% average annual pace over the last five years, and its adjusted EBITDA has grown at an even faster 13% rate. See Figure 7. About 80% of Masonite’s revenue is from North American residential sales. Of this total, about 55% stems from repair and remodeling projects, and the balance from new construction. This represents a good complement to OC’s core products business mix (see page 6). If Masonite can increase the percentage of revenue it realizes from repair and remodeling, that would likely favorably impact future consolidated OC profit margins.

According to OC management, one source of significant commercial opportunity for the combined OC-Masonite entity is the huge number of exterior contractors that utilize OC products. OC believes that many such contractors will start to make Masonite exterior and interior doors part of their offerings to clients as well.

Principal Risk to the OC Story: a Housing Downturn

The principal risk to an investment in OC shares is a potential further downturn in the housing market. Such a scenario is certainly possible, particularly if inflation were to flare up again, which in turn would likely cause mortgage rates to scale higher. However, the large percentage of OC’s business which is geared toward repair, storm replacement and remodeling — not new construction — blunts a significant portion of this risk.

Another source of concern could be OC’s ability to integrate the Masonite acquisition into its operations and to realize the full magnitude of projected cost savings. Masonite’s substantial size — its revenue is about a third of OC’s legacy business — could complicate matters, but the complementary nature of Masonite’s business to OC’s should make an efficient combination easier.

Valuation: Owens Corning Stock is Very Sensitive to a Narrowing of the Discount at Which It Trades to the Market

As noted on above, OC trades at a P/E multiple of only about 14x based on its earnings over the twelve months ended March 31, 2024. The R1000 Index, on the other hand, trades at around a 28x multiple.

OC’s adjusted EBITDA over the twelve months ended March 31, 2024 totals $2.39 billion. The company’s stock market capitalization is approximately $15.54 billion, and its net debt as of March 31, 2024 is $1.82 billion (debt of $3.08 billion offset by $1.25 billion of cash). All this implies that the ratio of OC’s EV to its adjusted EBITDA over the most recent twelve months is only about 7.3x.

These statistics underscore the magnitude of OC’s potential share price upside from just a small narrowing of its valuation discount to the stock market. More specifically, for each one-point increase in its P/E multiple, OC’s share price would be lifted by about $15. An improvement in OC’s EV-to-adjusted EBITDA ratio would have an even more pronounced effect: each one-point rise in this ratio equates to a $27 boost in OC’s stock price.