Owens Corning Price Dips, While Acquisition Will Generate Growth (NYSE:OC)

jetcityimageInvestment thesis for Owens Corning Building materials giant Owens Corning (NYSE:OC) is on a roll. Its roofing, insulation, and composites businesses are going strong, and it has just acquired the door and door systems firm Masonite. It also has a dividend that has delivered a CAGR of 21.48% per year over the past five years. And the share price dipped 18.62% over the first five days of August, before regaining 2% over the following two trading days. I argue the stock is currently undervalued, at $157.03, have a one-year target price of $186.46, and rate it a Buy. About Owens Corning Founded in 1938, the company develops and manufactures building and construction materials. Its roofing materials are used in residential and commercial buildings, while its insulation products have multiple uses. In its 10-K for 2023, it reported it has operations in 37 countries. Operations are now conducted through four segments: Roofing, Insulation, Composites, and Doors. Composites involves a wide range of products, including building structures, roofing shingles, tubs and showers, pools, flooring, pipes, and tanks, and even wind turbine blades. The Doors segment holds the assets of Masonite; Owens Corning acquired all outstanding shares of it in a deal announced in February 2024, and Masonite’s last day of trading was May 15. In the news release announcing the purchase, Masonite was described as a “global designer, manufacturer, marketer and distributor of interior and exterior doors and door systems.” The $3.9 billion deal is expected to provide a new growth platform for Owens Corning. It said the acquisition will push up revenue to $12.6 billion in 2025, an increase of $2.92 billion or 30.16%. A couple of other financial estimates were released as well. First, it projects adjusted EBITDA of $2.9 billion on a “synergized pro forma basis.” Second, Masonite is expected to deliver low double-digit percentage accretion to free cash flow by the end of 2025. There may be another change ahead, as the company considers the future of the glass reinforcements business, a part of the Composites segment. Owens Corning is a favorite among institutional investors, which held 93.34% of its shares at the latest report. At the close on Friday, August 9, its shares traded at $157.03, and it had a market cap of $13.49 billion. Competition by segments Roofing: The primary product of this segment is asphalt roofing shingles, which are sold through distributors, home centers, and lumberyards. Residential repair and remodeling, as well as new residential construction, determine demand. In addition, major storms can generate demand. This segment competes mainly with other asphalt shingle manufacturers in the domestic market, and in the 10-K it argues it is the second-largest producer. In a September 2023 article, Roofer Digest reported the top three producers were Owens Corning, Malarkey Roofing Products, and GAF. The Insulation segment produces various forms of fiberglass insulation products, including thermal and acoustical batts, loose-fill insulation, spray foam, and more. It is best known for its PINK brand of batts. Demand originates with new residential construction, repair and remodeling activity, as well as commercial and industrial construction. It competes mainly with American fiberglass insulation manufacturers. Major names in this area include Johns Manville, Guardian, and Knauf. Composites: Owens Corning has reported that its glass fiber materials are present in over 40,000 end-use applications, and mainly within the building and construction, renewable energy, and infrastructure markets. It said in the 10-K that it competes with glass fiber and building material manufacturers around the world. On a consolidated level, its gross margin was 30.23%, compared with 32.310% for the Industrials sector. The EBITDA margin was 23.18%, well ahead of the sector’s 13.81%, and the net margin was 10.66%, which is 73.63% higher than the sector median of 6.14%. Most impressive was its return on common equity of 20.06%, which is 56.97% greater than the sector median of 12.78%. Based on its leading positions in many of the markets it serves, as well as the margins and ROCE, I believe Owens Corning has a medium moat. Second-quarter earnings The price of Owens Corning shares slid in anticipation of and after the Q2-2024 earnings release on August 6. The problem? Revenue missed estimates by $120 million, to a total of $2.8 billion. Earnings were solid, and its Non-GAAP EPS was $4.64, which was $0.29 above the estimates. Details included: Net sales of $2.8 billion, up 9% over Q2-2023; foreign sales were $649 million, up from $574 million last year. Diluted EPS of $3.24 and adjusted diluted EPS of $4.64, versus diluted EPS of $3.81 last year. Operating cash flow of $493 million, compared to $494 million last year. Free cash flow per share of $3.85, down from $4.11 last year. Returned $52 million to shareholders through dividends. CEO Brian Chambers summed up the quarter by saying, “Owens Corning delivered another outstanding quarter, generating strong margins and cash flow while completing the acquisition of Masonite and continuing our review of glass reinforcements.” The earnings release also provided a first look at Masonite’s contributions. For the May 15 to June 30 period, it added $311 million in net sales, $61 million in EBITDA, and other selected information from the income statement: OC income statement excerpt (OC Q2-2024 earnings release)The following slide, from the Q2 earnings presentation, summarized data from its balance sheet and cash flow statement: OC balance sheet slide (OC Q2-2024 earnings presentation)Of note, capital expenditure was $157 million, up from $122 million in Q2-2023. Comments: Owens Corning has been and will continue to be a solid growth stock, a steady performer in both the building/construction industry and in the Industrials sector. Growth First, for context, let’s review its revenue, EBITDA, and net income history: OC 10-year revenue, EBITDA, net income chart (Seeking Alpha)As the chart makes clear, net income is the issue for the company. On the other hand, an aggressive repurchase program led to a reduction in the share count and higher EPS: OC 10-year EPS, shares outstanding chart (Seeking Alpha)Again, EPS has trended downward over the past four quarters, and perhaps the Masonite acquisition will help get earnings headed upward again. Looking ahead, Owens Corning expected the third quarter to see strong revenue growth, in the low 20% area; this will include a full quarter of revenue for the Doors segment. It does not offer an outlook for net income or EPS. Wall Street analysts see mid-single-digit earnings growth this year and next year: OC EPS estimates table (Seeking Alpha)Earnings are also being assisted by heavier capital expenditures. They slumped between 2018 and 2021, but have been rising since the latter year (the chart treats CapEx as a cost, so lower points on the chart are higher spending and vice versa): OC CapEx chart (Seeking Alpha)This slide from the Q2 investor presentation summarizes its growth strategy: OC growth strategy slide (OC Q2-2024 presentation)Comments: Owens Corning has shown it can grow revenue successfully, but I want to see net income growing proportionately. EPS has grown, but as we’ve seen, that growth has depended on share buybacks and capital expenditures. Dividends The company has an attractive dividend, and yields 1.53%. Its payout ratio is a low 14.88%, so there is lots of room to grow it further. The dividend has increased rapidly over the past five years, from $0.88 in 2019 to $2.08 in 2023, for a CAGR of 21.47%. Valuation of Owens Corning This excerpt from the Valuation page at Seeking Alpha shows the company is relatively cheap when compared with traditional ratios (such as P/E) and when compared with the Industrials sector: OC excerpt from Valuation table (Seeking Alpha)Other ratios of interest include Price/Sales, which is graded C+ on a TTM basis and B- on a FWD basis. Price/Book gets a C+ grade for both TTM and FWD. With the August 9 closing price of $157.03, the three-part calculator at Alpha Spread shows Owens Corning undervalued by 30% on an intrinsic value basis, and even more heavily undervalued on a DCF basis. When compared to the value of similar assets (relative valuation) it is undervalued by 18%. Intrinsic Value Calculator Wall Street analysts have a one-year, average price target of $186.46, which would be an increase of 18.74%, and a high target of $215.00. It is also close to the July 31 price of $186.38, and below the 52-week high of $191.13. Their forecasts have been quite accurate: OC target prices vs actual prices chart (Seeking Alpha)A nearly 19% increase seems ambitious when earnings are expected to rise by mid-single digits this year and next. A 30% gain in a year seems even more challenging. For my price target, I’m going to adopt the analysts’ $186.46 figure. I know the company will do well over the next year, but the other estimates seem too high, except for the relative value. For those who have the previous high of $191.13 as their anchor price, I would say that 18% or 19% is still a hefty gain for an Industrials company. It is also enough for me to give it a Buy rating. One other Seeking Alpha analyst has posted a rating in the past 90 days, and that, too, is a Buy. The Quant system rates it a Hold. Among the Wall Street analysts, six have given it a Strong Buy, one has rated it a Buy, and 10 have Hold ratings (averaging out to a Buy). Risk factors The first and most obvious risk is that the Masonite deal does not work out as intended, and Owens Corning fails to get all the benefits envisioned. Any acquisition means exposure to financial, operational, and reputational hazards. The Masonite purchase also means a greater commitment to the residential and commercial construction markets, as well as remodeling and repairing. The housing market, in particular, is sensitive to economic conditions, interest rates, and other external factors. It operates in highly competitive markets, which means it may be unable to raise prices when its input costs go up. In such markets, there is always a risk of new and disruptive technologies that could see competitors bring out better products at lower costs. Owens Corning operates in 37 countries and thus has international risk exposure. Issues can range from currency exchange rates to war, and can disrupt its inputs, distribution of manufactured products, and its supply chains generally. Of the $3.9 billion committed to acquiring Masonite, roughly $3 billion came from debt, and that’s on top of the approximate $3 billion that was already on the books on December 31, 2023. Management takes the debt load seriously; in the Q2 investor presentation, it said it was prioritizing debt repayment. Conclusion Investors in Owens Corning are well positioned for capital gains and a growing dividend. This is a strong company that should continue to grow in coming years as it hones its current businesses and expands into adjacent areas such as doors. Thanks to the disappointment of short-term investors with the quarterly results, the stock is now available at a discount. For long-term investors, this is a fair candidate for consideration, which is why I have rated it a Buy.

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