The Long and Short
Value in Owens Corning
Meredith Contente | September 29, 2023
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Owens Corning (OC – Baa2 (p)/BBB/BBB) continues to post solid profit growth despite a weaker housing start market, as the company realizes the benefit of positive pricing actions. OC’s balance sheet is strong for the current ratings, providing for a sizeable cushion should the housing downturn persist. Furthermore, the repair and remodel market continues to be robust, largely accounting for growth. Free cash flow generation is solid which adds to the strength of the balance sheet. A positive ratings outlook at Moody’s could be a catalyst for further spread improvement, as leverage remains below Moody’s target level for an upgrade.
OC still trades wide of peers Vulcan Materials (VMC – Baa2/BBB+/BBB) and Martin Marietta Materials (Baa2/BBB+/BBB) despite maintaining a stronger credit profile and similar free cash flow conversion. OC spreads could collapse closer to peers as earnings results continue to come in stronger than expected. The maintenance of leverage below its target could lead to an upgrade by Moody’s in the intermediate term. With continued demand for long duration paper, OC’s 2047 and 2048 bonds have value.
Exhibit 1. BBB Building Materials Curve
Fiscal 2Q Beats Consensus
OC’s solid second quarter results were underscored by margin growth despite witnessing volume declines. Management’s pricing actions last year coupled with further price realization this year led to the margin growth. OC produced adjusted EBITDA margin growth of 100 bp despite a one percent decline in the top line. Management’s conservative financial policies led to a strong free cash flow growth rate of 3%. Free cash flow/sales was a strong 14.5%, up 60 bp from the year-ago period.
Management reiterated its capital allocation strategy with its first priority remaining maintaining leverage in the 2-3x range. OC ended the most recent quarter with total debt/EBITDA of 1.3x. On a net basis, leverage is roughly 1.0x. Its second priority is to maintain safe and sustainable productive operations. OC’s recordable incident rated was a strong 0.59 in the quarter. Management noted that two-thirds of facilities have operated injury free this year, with more than half of facilities operating injury free for over a year. Its third priority is to invest in targeted growth opportunities via organic growth and acquisitions. OC has only completed one small acquisition year-to-date but has launched seventeen refreshed products spanning its core platforms in roofing, insulation and composites. This follows fifty-four new or refreshed product launches in 2022. OC’s last priority is to return cash to shareholders via dividends and repurchases. OC returned 43% of free cash flow to shareholders in the quarter with a target return of 50% over time.
Credit Profile Stacks Up Favorably to Peers
The company’s credit profile compares favorably to peers given management’s conservative financial policies and strong free cash flow generation. While OC’s EBITDA margins trail peers largely due to is product lines, OC’s leverage is eight ticks lower than VMC and 1.5x lower than MLM. OC’s next debt maturity is not until December 2024, and with no pending acquisitions, there is little need for the company to access the public debt market. Furthermore, OC’s liquidity remains strong with nearly $970 million of cash on hand and an untapped $800 million revolver (due 7/23/26). With approximately 50% of free cash flow going to shareholders, management has time to build its cash position further ahead of it $400 million maturity in November 2024. Additionally, its strong balance sheet relative to peers provides for extra financial cushion should housing starts continue to trend lower or should we see some softness in the repair and remodel market if consumer gets squeezed further.
Exhibit 2. OC Peer Credit Profile Comparison
Repair & Remodel Driving Roofing Market
Despite the slower housing starts, OC has seen considerable growth in the roofing market driven by repair and remodeling. For the past five years, repair and remodeling has accounted for over 50% of the US asphalt shingle market. Major storms and weather events have also outpaced new construction over the same time period. That said, even with lower housing starts, OC’s roofing business continues to grow and is currently outpacing 2022 annual net sales on a LTM basis (Exhibit 3). OC has noted that 9 out of 10 roofing contractors prefer to install OC’s Duration Series Shingles with their SureNail Technology. By investing in the quality of both their shingle products and components business, OC has seen both product portfolios grow. In fact, OC’s components business has grown faster than the market given recent investments and management believes there is further room to grow as it creates a more reliable roofing system.
Exhibit 3. OC Roofing Five-Year Performance (2019-LTM 2023)
Another Upgrade by Moody’s?
Moody’s placed OC’s ratings on positive outlook in January 2022 when it upgraded the company’s ratings by one notch, to Baa2. The upgrade and positive outlook was rooted in Moody’s expectation for OC to maintain strong operating performance, which includes EBITDA margins above 20%. The stronger profitability would translate to better leverage, remaining below 2.0x for 2023. Moody’s noted that the positive outlook could lead to an upgrade should OC maintain leverage in the low 2.0x area, while preserving is healthy liquidity and the maintenance of management’s conservative financial policies. With leverage still closer to 1.0x and liquidity very strong, Moody’s could look to upgrade the ratings to Baa1, over the intermediate term, which would be a catalyst for spreads to collapse closer to MLM and VMC.