During my time as an investor, I have been greatly influenced by individuals such as Warren Buffett, Philip Fisher, Benjamin Graham, Peter Lynch and others. And one of the things I’ve learned from them is that, sometimes, the best investment prospects are the most ‘boring’ opportunities that exist. And while the definition of ‘boring’ can be subjective, few would argue that a company that engages in the construction and sale of fiberglass, insulation and other products would be considered ‘boring’ by many. This business in question is Owens Corning (NYSE:OC). And since I rated the company a ‘strong buy’ in July 2022, the stock has generated gains of 59.9% at a time when the S&P 500 has returned a more modest 13.9%.
The market tends to look at how cheap ‘boring’ companies can be. And it’s in that freedom we have the opportunity to get some real bargains. But after seeing such a significant increase in its share price since that article was published, a fair question would be whether the stock still has further upside from here or not. I would argue that, based on recent financial performance that has shown some weakness across the board, and because the company is no longer as affordable as it once was, it likely deserves a cut. But even so, this positions the company as a solid ‘buy’ candidate at this time.
Time for a landing
At the time I rated Owens Corning a ‘strong buy’, the company was doing well to grow its top and bottom lines. That, combined with how cheap the stock was, led me to the best rating I can assign to a company. Fast forward to today, and we’re starting to see some weaknesses emerge. Consider, for example, how the business has operated over time the first nine months of fiscal year 2023. Revenue for that time amounted to $7.37 billion. This represents a 13.8% decrease compared to the $7.48 billion the company generated a year ago.
Management attributed the decline to lower sales volumes for both the firm’s Insulation and Composites riders. However, these were somewhat offset by the higher prices the company charged its customers during this inflationary cycle. Interestingly, when you dig a little deeper, you see that not all of the company’s operations were the same. The insulation segment, for example, reported a roughly 1% year-over-year decline in revenue. The major decline, therefore, came from the Compositions segment. Sales fell 14.4% from $2.07 billion to $1.77 billion. For the first nine months of fiscal 2023, the segment suffered a 13% hit accompanied by lower volumes. You would think that the drop in volume would have been greater since the company stated very clearly that price helped offset the declines to some extent. However, the company suffered from foreign currency fluctuations, the impact of certain asset sales and asset purchases and other factors.
With the decline in revenues came a decline in profits. Net income fell from $1.12 billion to $1.07 billion. Operating cash flow also took a hit, falling from $1.09 billion to $1.02 billion. If we adjust for changes in working capital, we also have a decline, this time from $1.42 billion to $1.41 billion. EBITDA also retreated, falling from $1.81 billion to just under $1.80 billion. When it comes to the most recent quarter, we are starting to see an improvement. Although revenue is down year-over-year, as can be seen in the chart above, and net profits have followed suit, the company’s other profitability metrics have shown year-over-year improvement.
Clearly, what we have here is a company that is experiencing some weakness. But it is encouraging to see some bottom line improvement in the last quarter. However, when we dig even deeper, we find that the picture is even stronger for the last quarter. And that’s because, in the third quarter of last year, the company booked a $130 million profit on its equity investments. This is why there is a disparity between earnings and cash flows. In addition, however, the company was able to keep other costs in line. Marketing and administrative costs increased modestly relative to revenues. However, the business reported an increase in gross profit margin from 27.4% to 29.3%.
While that may not seem like much, this disparity, when applied to revenue generated in the third quarter alone, translates into an additional $47.1 million in pre-tax earnings for the business. And according to management, this improvement is attributed to the benefit of higher selling prices as well as lower costs such as lower shipping costs and lower input costs. What this shows is that, even though inflationary pressures have eased on the company from the supply side, it has been able to capture more profits by not cutting its prices along with the cost cutting it has experienced.
Unfortunately, we don’t know what to expect when it comes to the rest of the fiscal year. But if we simply annualize the financial numbers, we would predict net earnings of $1.18 billion, adjusted cash flow of $1.76 billion and EBITDA of $2.23 billion. This would mean only a marginal deterioration compared to what the company saw in 2022. As you can see in the chart above, using two of the three metrics for valuing the company, the rounded price of the business from a multiple perspective is the same from 2022 to 2023. And even the one that isn’t, the price multiple of earnings, isn’t materially different.
In the next chart above, I decided to show how the stock was valued when I last wrote about the company. At that time, the next numbers would be for fiscal 2022. As you can see, while Owens Corning’s stock remains incredibly cheap on an absolute basis, it’s quite a bit more expensive than when I wrote about the company last July. Now, in the table below, I decided to compare the company with five similar firms. And what I found here is that, using any valuation method, it ended up being the cheapest of the bunch.
|company||Price / Earnings||Price / Operating Cash Flow||EV / EBITDA|
|Lennox International (Iii)||26.6||25.6||19.1|
|Advanced drainage systems (WMS)||20.1||13.2||11.9|
|Fortune Brand Innovations (FBI)||19.5||7.6||12.5|
|AO Smith (FOR HER)||37.8||18.5||27.3|
At this time, I still remain a big fan of Owens Corning. The company looks incredibly cheap on an absolute basis and is definitely attractive compared to similar companies. It’s not as cheap as it used to be. But even with that change, it was tempting for me to keep the company rated as a ‘strong buy’. The only reason I’ve decided to downgrade it to a solid ‘buy’ is because, while the stock is cheap, it has experienced some weakness this year after all. Ideally, I’d like to see growth on this front instead. It wouldn’t take me long to upgrade the stock again. If the fourth quarter, for example, comes in the same way as the third quarter, and if the stock is still priced around where it is today, I will likely upgrade the stock once again. But for now, a ‘buy’ seems to make more sense to me.