Thursday, March 15, 2007
Owens Corning (OC) held an investors conference on Wednesday, March 7th.. These things are usually a regurgitation of the most recent earnings call and to be honest, rather dull but, there were a couple of important take aways here that have me more enthusiastic about my investment than ever:
Management estimates income from operations in 2007 to be $415 million ($4.02 a share), down from $433 million ($4.20 a share) in 2006 for a 4% decline. Bad news? No. This is based on housing starts consistent with NAHB estimates of 1.56 million (down 14%). It does NOT include additional profits from the St.Gobain joint venture expected to close in mid 2007, nor does it include revenue from the expected sale of the vinyl siding business and it also assumes a hurricane season similar to 2006 (almost non existent) and the effects of the 5% stock buyback recently announced are not considered. In short, this is a painfully conservative estimate which is something I like to see.
Why is it conservative? Could we have a worse hurricane season that the ZERO major storms we had in 2006? No. Is there a chance it will be equal too? Yes, But that result is what these earnings estimates are based on. Will the St. Gobain venture get regulatory approval? Yes, the question is not "if" but "how much" it will add to earnings. Will they sell the siding business? Yes. None of these events are included in the 2007 estimate and all will add to 2007 earnings. Because management at OC has no way of knowing the "how much", they omitted their potential contribution. Good.
Now for housing, could it get worse? Yes. Will it? Not if you believe Toll Brother's (and me) who expect things to turn around late this summer. Let's assume it does get worse, OC did say that things would have to "dramatically deteriorate" for them to lower their forecast. I for one think we are at the housing trough and things are due to begin to climb. Now, that may take 4 months or a year, but OC has based its earnings, production and pricing forecasts on a 14% year over year decline. Any improvement here quickly adds to the bottom line. The following may an odd barometer but if nothing else it will teach us to pay attention to things other than our traditional data sources. I have a friend who is a firefighter. We were talking recently and he was saying how he has been really busy at work lately. When I asked why, he said "fire alarm inspections." When a property is bought or sold, a fire alarm inspection certificate is required on the property (both residential and commercial). The more work my friend does, the more properties are changing hands. He said the past 3-4 weeks have been unusually busy. This may be just a seasonal trend or a sign of a housing turn around but, either way, it is not bad news. Now, if this gauge is accurate it may not show up for another month or so in the housing data since inspections are done before the closing on the property. I will be paying close attention.
So, what do we have? An estimate of earnings that assumes a worse case scenario for hurricanes, a negative housing view and one that does not include the value of a segment sale and join venture. If the buyback is completed this year, it alone will boost earnings of $415 million to $4.23 a share excluding all other factors.
An interesting note here. There was a great discussion (and I think the analysts missed this as I have not read anything else on it) on the hurricane effect. In anticipation of the "end of the world" scenario forecasters gave us prior to the summer of 2006, OC ramped up production of asphalt shingles. They did this during the late spring and early summer as these forecasts began coming out which, unfortunately also happens to be the most expensive time of year to produce these shingles (demand for asphalt is higher). Even in low grade hurricanes (Cat 1 or Cat 2) the majority of damage is roofing related. As a result of the invisible 2006 season that resulted, OC was left with an unprecedented surplus of expensive shingles that then commanded lower prices due to the non-existent demand. This inventory has since been worked off and prices have firmed. Why does this matter for 2007? An active 2007 hurricane season of any substance (by "any" I mean more than zero) will help offset housing weakness. An extreme season has the potential to make the housing market almost irrelevant. Another rather morbid result of an active hurricane season is that it does stimulate the housing market by creating unanticipated demand for new housing. Please do not email me claiming I am hoping for hurricanes so I can profit. I am not, but we need to be realistic. As unlucky as we were in 2005, we were just as lucky in 2006. Somewhere in the middle is the number of storms we should anticipate and it is far greater than zero. They are as inevitable in the South as snow is here in New England. That being said, a return to mere "normal" hurricane levels will provide OC with a substantial boost to earnings. How much? This segment's sales which are about 25% of the total fell 38% last year. Even if this sales level stays the same, the lack of abnormally high priced inventory will improve earnings here.
In short OC has done a wonderful job of dampening expectations so that they are able to blow them away later or, if everything does go wrong, they are then able to meet them Even in the worse case scenario you have a company selling for just over 6 times earnings and buying back its stock Look for the first two quarters to be a bit slow with things really ramping up in the second half of 2007. Remember, as value investors we want to get in when things are at their worst, all of OC's markets are in troughs now yet they are managing the business brilliantly through it, when things eventually turn around (they always do)...... boom
In the cartoon the Pink Panther always won.....what makes you think he won't now?
Posted by Todd Sullivan at 6:55 AM