Owens Corning: Recent Weakness And Pricing Necessitate A Downgrade (NYSE:OC)

Over my time as an investor, I’ve been closely influenced by people like Warren Buffett, Philip Fisher, Benjamin Graham, Peter Lynch, and others. And one of many issues that I’ve realized from them is that, generally, one of the best funding prospects are essentially the most ‘boring’ alternatives that exist. And whereas the definition of ‘boring’ is perhaps subjective, few would argue that an organization that engages within the development and sale of fiberglass supplies, insulation, and different merchandise, can be thought-about ‘boring’ by many. That enterprise in query is Owens Corning (NYSE:OC). And since I rated the corporate a ‘sturdy purchase’ again in July of 2022, shares have generated upside of 59.9% at a time when the S&P 500 has returned a extra modest 13.9%.

The market tends to look previous how low-cost ‘boring’ firms could be. And it’s in that cheapness that we get the prospect to choose up some true bargains. However after seeing its share value rise so considerably for the reason that publication of that article, a good query can be whether or not the inventory nonetheless has additional upside from right here or not. I’d argue that, based mostly on current monetary efficiency that has proven some weakening throughout the board, and since the enterprise is not fairly the cut price that it was beforehand, it doubtless does deserve a downgrade. Besides, that positions the corporate as a stable ‘purchase’ candidate right now.

Time for a downgrade

On the time that I rated Owens Corning a ‘sturdy purchase’, the corporate was doing properly to develop each its high and backside strains. This, mixed with how low-cost the inventory was, led me to essentially the most bullish ranking that I can assign to an organization. Quick ahead to right now, and we’re beginning to see some weaknesses emerge. Take into account, as an illustration, how the enterprise carried out through the first nine months of its 2023 fiscal yr. Income for that point got here in at $7.37 billion. That represents a 13.8% drop in comparison with the $7.48 billion the corporate generated one yr earlier.

Administration attributed this decline to decrease gross sales volumes in each the Insulation and Composites cyclists the agency. Nonetheless, these had been offset to some extent by greater pricing that the corporate charged its prospects throughout this inflationary cycle. Curiously, whenever you dig a bit deeper, you see that not the entire firm’s operations had been the identical. The Insulation phase, as an illustration, reported a roughly 1% year-over-year decline in income. The large drop, then, got here from the Composites phase. Gross sales plummeted 14.4% from $2.07 billion to $1.77 billion. For the primary 9 months of the 2023 fiscal yr, the phase suffered from a 13% hit related to decrease volumes. You’d assume that the decline in quantity would have been bigger on condition that the corporate said very clearly that pricing helped to offset the declines to an extent. Nonetheless, the corporate did endure from overseas forex fluctuations, the affect of sure asset gross sales and asset purchases, and different components.

With the drop in income got here a decline in earnings. Web revenue fell from $1.12 billion to $1.07 billion. Working money circulation additionally took a beating, dropping from $1.09 billion to $1.02 billion. If we alter for adjustments in working capital, we additionally get a drop, this time from $1.42 billion to $1.41 billion. Even EBITDA pulled again, declining from $1.81 billion to only beneath $1.80 billion. Relating to the latest quarter, we’ve began to see some enchancment. Though income is down yr over yr as could be seen within the chart above, and internet earnings have adopted swimsuit, the corporate’s different profitability metrics have proven enchancment yr over yr.

Clearly what we’ve here’s a firm experiencing a little bit of weak point. However it’s encouraging to see some enchancment on the underside line in the latest quarter. Once we dig even deeper although, we discover out that the image is much more bullish for the latest quarter. And that’s as a result of, within the third quarter of final yr, the corporate booked a $130 million acquire on its fairness methodology investments. That’s the reason there’s a disparity between earnings and money flows. Along with that, nevertheless, the corporate was in a position to hold different prices in line. Advertising and administrative prices elevated modestly relative to income. Nonetheless, the enterprise reported a rise in its gross revenue margin from 27.4% to 29.3%.

Whereas this will not appear giant, that disparity, when utilized to the income generated within the third quarter alone, translated to a further $47.1 million in pretax earnings for the enterprise. And in accordance with administration, this enchancment was attributable to the good thing about greater gross sales costs, in addition to decrease prices reminiscent of decrease supply bills and decrease enter prices. What this reveals is that, at the same time as inflationary pressures have eased up on the corporate from a provide aspect, it has been in a position to seize extra revenue by not reducing its costs in tandem with the lower in prices it skilled.

Sadly, we do not know what to anticipate in relation to the remainder of the fiscal yr. But when we merely annualize monetary figures, we might anticipate internet earnings of $1.18 billion, adjusted working money circulation of $1.76 billion, and EBITDA of $2.23 billion. This might indicate solely a marginal worsening in comparison with what the corporate noticed in 2022. As you’ll be able to see within the chart above, utilizing two of the three metrics for valuing the corporate, the rounded pricing of the enterprise from a a number of perspective is similar from 2022 to 2023. And even the one which’s not, the price-to-earnings a number of, shouldn’t be materially completely different.

Within the subsequent chart above, I made a decision to point out how shares had been priced once I final wrote in regards to the enterprise. At the moment, the ahead figures would have been for the 2022 fiscal yr. As you’ll be able to see, whereas shares of Owens Corning stay extremely low-cost on an absolute foundation, they’re fairly a bit costlier than once I wrote in regards to the firm final July. Now, within the desk beneath, I made a decision to match the corporate to 5 related corporations. And what I discovered right here is that, utilizing every valuation method, it ended up being the most affordable of the group.

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Takeaway

Right now, I nonetheless stay a serious fan of Owens Corning. The corporate appears to be like extremely low-cost on an absolute foundation and it’s positively enticing in comparison with related enterprises. It is nowhere close to as low-cost because it was beforehand. However even with that change, it was tempting for me to maintain the corporate rated a ‘sturdy purchase’. The one purpose why I’ve determined to downgrade it to a stable ‘purchase’ is as a result of, whereas the inventory is affordable, it has skilled some weak point this yr on the underside line. Ideally, I’d need to see development on this entrance as a substitute. It would not take a lot for me to improve the inventory once more. If the fourth quarter, as an illustration, is available in very like the third quarter did, and if shares are nonetheless priced round the place they’re right now, I doubtless will improve the inventory as soon as extra. However for now, a ‘purchase’ appears to take advantage of sense to me.