THE HEDGEYE EDGE
Construction activity remains cyclically depressed, but has likely begun the long process of recovery. A large multi-year rebound in construction should provide a tailwind to OC shares that the market appears to be underestimating. Both residential and nonresidential construction in the U.S. would need to roughly double to reach post-war demographic norms. As credit returns to the market and government funded construction begins to rebound, construction markets should make steady gains in coming years, quarterly weather aside, supporting OC’s revenue and capacity utilization.
OC’s markets have improved structurally over the past decade. Both OC and many of its competitors filed for bankruptcy in the late 1990s/early 2000s to free themselves from asbestos liabilities. With those matters resolved, many areas of the building products industries have emerged into more consolidated industries with fairly rational competitors. Regulations, such as building codes, should also support demand for many of OC’s products.
A significant, multi-year rebound in OC’s end-markets combined with structural improvement should allow the shares to be rerated by the market.
INTERMEDIATE TERM (TREND) (the next 3 months or more)
We estimate that more than half of OC sales are to supply new construction projects, so a gradual trend of rebounding construction activity should provide a tailwind. While there may be volatility in 1Q construction activity, bad weather can also increase demand for certain OC roofing products. We also expect to see continued improvement in OC’s insulation margins in 1H 2014, a segment where returns have the most rebound potential.
LONG-TERM (TAIL) (the next 3 years or less)
Our base-case valuation range for OC is $60-$70/share, which is attractive relative to the alternatives in the Industrials sector. We expect the residential and nonresidential new construction recoveries to be reasonably simultaneous in coming years, driving higher capacity utilization and pricing for OC and other building products companies.
OC is not a member of an S&P Index, which it was prior to 2000, and recently restarted a dividend. Both are potential positives. After roughly six years in asbestos-related bankruptcy and having its end-markets evaporate in the financial crisis, we think OC has a lot more earnings and cash generation potential in coming years than the current valuation reflects.