Battle of the Building Material Makers: Owens Corning vs. USG Corp.

Includes: IR, OC, PRSG, USG
by: James Cullen

Here are updated thoughts on a few stocks I frequently talk about here.

First, thanks to Jeff Annello for bringing a presentation recently done by Primus Guaranty (PRS) to my attention. I found it to be a very good explanation of some potential sources of the mispricing in the stock, as well as offering a good glimpse into the workings of the CDS market.

Jeff and I have alternately argued that Primus is a very misunderstood company because it is a tiny company operating in the fairly esoteric field of credit default swaps. Add in some accounting standards that make for starkly different presentations of financials, and I believe you have a recipe for an undervalued stock . Jeff seems to feel the same way.

I've copied the two slides I found most concise and relevant below; one discusses Primus' performance since its IPO and the other offers a nice explanation of GAAP vs. Economic accounting. If you'd like to view the entire presentation, follow this link and then view the PDF file.

This article from Prudent Speculations suggested that Owens Corning (NYSE:OC) was a much better bet on the housing market than USG. While I can agree with Prudent Speculations that the, ahem, generally prudent thing to do is avoid specific homebuilders and focus on the better-positioned upstream materials companies, I feel he knocks USG unnecessarily to try to build Owens Corning up.

He leads off by saying that Owens Corning will rebound more quickly from the housing slump because it is more levered to home renovations than home construction. I did a quick scan of Owens Corning's Investor website, and found the following data:

Compare that to this data on USG's end markets:

If that second image is a bit blurry, the gist of it is that 30% of USG's revenues come from remodeling (both residential and commercial) and 40% of revenues come from non-residential sources – in other words, a very similar makeup to Owens Corning's business mix… although I'll grant that USG doesn't have the same amount of international exposure.

The second questionable point is on drywall, and USG's vulnerability to price declines – could there be a more self-evident statement than a manufacturer's profitability is tied to the prices it realizes on its production? Regardless, it doesn't make much sense to harp on wallboard being a commodity product when USG has THE recognized brand name in the space (i.e. Sheetrock), and Owens Corning can't really claim to have widely known, differentiated products.

The final odd point (I'll ignore the whole outsmarting Buffett thing) is that Prudent Speculations likes Owens Corning because it is at "a discount to book value." This depends on what you could as book value. If we take total equity of $4 billion, that's one thing – but stripping out the intangible assets, or even marking them down, tells a different story. More than half of that equity is a combination of goodwill ($1.17 billion) and intangibles ($1.2 billion), so you're actually paying more than 2x tangible net assets. USG, by comparison, is going for a little under 1.8x net tangible assets…

So what are the pros doing? Marty Whitman's Third Avenue has increased its stake in USG by more than 400k shares, or 8%, in the last quarter, judging from the firm's 13F filings. Additionally, Bruce Berkowitz's Fairholme added nearly 2 million shares in the last quarter, upping his stake by 30%.

On the side of Owens Corning, Harbinger Capital Special Situations has amassed a more than 10% stake, and looks to be buying in the low $20s. While I'm not familiar with the fund, a quick check of their last 13F shows an interesting combination of calls on the bond insurers, puts on Lehman (LEH), and my personal favorite copper producer Freeport McMoRan (NYSE:FCX) as their second largest long position.

Wrapping this up, those of you who looked at Berkshire Hathaway's 13F released last week may have been disappointed by the lack of any substantial changes or new positions. I will note, however, that the largest percentage increase of any position in Buffett's portfolio was Ingersoll-Rand (NYSE:IR), another stock I really like.

In unrelated news, it is said that great minds think alike.

Disclosure: I own USG, and am looking to purchase PRS but have not done so yet.