Despite a stellar rise in its stock price this year, shares of Owens Corning (NYSE: OC) still offer investors a good value. While other areas of the stock market are starting to look expensive, Owens Corning's stock price rise has been backed by earnings guidance hikes and ongoing strategic improvements which are preparing the company for good long-term growth.
There are two key arguments that make it a good buy, which I'll go into in detail below:
- Its valuation remains compelling
- Like Home Depot Inc (NYSE: HD), Owens Corning has good long-term growth drivers derived from an improving housing market
A good value stock
Back in March Owens Corning looked like a good value, and despite a 44% increase in its stock price the following charts suggest it's still a good value now. As you can see below, its valuation is compelling on both an absolute and relative basis. (I'll outline why Home Depot and Lowe's Companies, Inc. (NYSE: LOW) are good comparisons shortly.)
Readers already know that by June analysts had upgraded EPS estimates for 2017 to $4.01 from an estimated $3.86 at the start of the year. Fast forward to the second-quarter earnings report in July and management's upgraded expectations for all three segments (roofing, composites, and insulation) caused analysts to raise EPS estimates to $4.29. In a similar vein, 2018 EPS analyst estimates have been increased from $4.33 at the start of the year to $4.90.
For reference, the following chart shows how the company generated earnings before interest and tax (EBIT) from each segment in the first-half.
The company's glass fiber composites sell primarily to building & construction, transportation, and consumer end markets. Management sees glass fiber end demand growing at 1.6 times industrial production, so you can think of it as a geared play on the industrial sector. Moreover, the buildup in industry capacity relative to end demand in the 2005-2009 period has reversed and global demand is now rising faster than global capacity -- which is usually bullish for pricing and margin. Indeed, the composites segment EBIT margin was up to 15% in the first six months compared to 14% in the same period last year.
The roofing and insulation segments both have upside potential from an improving housing market. Just as rising house prices and strong home sales encourage sales growth at home improvement stores Home Depot and Lowe's, they also encourage homeowners to repair and remodel their roofs.
For reference, nearly 80% of roofing revenue in the second-quarter came from U.S. & Canada repair & remodeling, with only 8% from U.S. & Canada residential new construction. CEO Michael Thaman said on the second-quarter earnings call, "I think most folks in a home today have some amount of equity in their house and some confidence that an investment in their home can get paid back through time. So I think that's why we're seeing the reroof market come back."
In addition, roofing has variable demand from storm activity -- this can move its roofing revenue around from year-to-year. The recent bad weather is likely to be a net positive for the company
As you can see below, U.S. home sales and prices remain positive for the reroofing market. Moreover, Home Depot reported 6.6% comparable same store sales growth in its U.S. stores in its most recent quarter, while Lowe's U.S. home improvement comparable sales were up 4.6%. Both companies reported above average growth in building materials, a good sign for Owens Corning.
The Insulation division derives some of its revenue from the repairing and remodeling of pre-existing homes, with 23% of insulation segment revenue coming from that area in the second quarter. That said, the insulation division is more of a play on new residential construction as U.S. & Canada--36% of insulation revenue in the second-quarter with the balance coming from international and commercial customers.
Unfortunately, the slump in new house building after the last recession left the insulation market with overcapacity, and it took a while before EBIT margin got back into positive territory.
Don't worry too much about the decline in 2016, though -- it was due to a sales decline of 5%, primarily caused by expiring contract manufacturing agreements. Meanwhile, the decline in 2017 EBIT margin is partly due to increased costs related to starting up a mineral wool facility.
The underlying performance is much better. Management implemented a pricing increase at the start of the year, followed by another in June and another to come in September. Thaman said on the earnings call, "We remain optimistic of our continued positive price realization throughout the year. We believe we may be at a significant inflection point for this business."
Given that insulation is a business with high fixed costs, this means margin could improve strongly in the coming years, particularly as housing starts remain strong and housing affordability is still high on a historical basis.
A play on housing
All told, Owens Corning is an attractive way to play an ongoing housing recovery. All three segments have solid growth opportunities and given a good housing market Owens Corning should see strong margin expansion in the coming year. Throw in a compelling valuation and Owens Corning is an attractive stock to buy.
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