Homebuilders are down big this year - does that mean opportunity with stocks like OC?

November 22, 2018

Homebuilders are down big this year – does that mean opportunity with stocks like OC?

Happy Thanksgiving! The holiday is a good opportunity, while the market takes a break from its wild day to day swings of the past six weeks or so, to sit back and think about where there might be some interesting opportunities to be had in the weeks, months, and possibly even years ahead. Despite the angst and worry that has dominated market headlines, centered primarily around continuing trade tension and interest rate fears, the fact remains that the economy for the most part continues to be quite healthy. Despite the general healthy state of the economy, one of the biggest underperforming sectors in the market throughout the year has been homebuilders, including building products companies. As measured by the S&P Homebuilders SPDR ETF (XHB), this segment is down more than 22% year-to-date, and a little over 27% after reaching its high in late January. I believe that decline has been driven by date like existing home sales, which had suffered through six straight months of declining numbers until October, when the number picked up about 1.4%, and housing starts, which remain lower than they were a year ago, but also started to pick up last month.

Homebuilding is a highly cyclical and often moves in fits and starts. The frustrating thing for investors is that this industry’s cyclicality doesn’t always move in concert with the economy. Analysts generally point to rising mortgage rates, driven by increasing interest rates, and home price increases that have outpaced disposable income, as primary reasons for the decline. In a troubled sector, and in an uncertain economic environment where investors seem to be growing more and more concerned that we are finally reaching a tipping point for an economy that has experienced an unprecedented period of expansion since 2009, it might seem like stocks like Owens Corning (OC) might be stocks to stay away from. I’m less certain; the stock is down nearly 45% year to date, and even more than that after hitting an all-time high in late January at around $97 per share. This is a company with a generally positive fundamental profile (albeit with room for improvement) and a value proposition that is becoming more and more interesting the longer market uncertainty persists.

One of the interesting elements of an extended bull market – and even with the uncertainty that has dominated the market over the last month and a half, that is still the state of the market’s long-term trend – is that the longer it lasts, the more that investors seem to gravitate to large cap stocks as well as small caps, but tend to disregard stocks in between. OC is an example of a mid-cap stock that might not get a lot of attention from talking heads or investors in generally, because it may not seem as well-known as the biggest boys in its industry, or as sexy as its smaller, up-and-coming competing brethren. That is actually another one of the reasons that I think this could be a stock to keep an eye on, because at some point market tendencies will swing away from large and small caps, and start gravitating to a lot of solid, well-run mid caps that have the ability to survive and prosper in multiple economic environments. I’ve seen a lot of reports that suggest OC could be well-positioned for the years ahead, as homeowners and buyers start to shift away from trying to buy new homes and instead focus on buying older homes and improving them, or simply upgrading the home they’re in.



Fundamental and Value Profile

Owens Corning is engaged in the business of composite and building materials systems, delivering a range of products and services. The Company’s products range from glass fiber used to reinforce composite materials for transportation, electronics, marine, infrastructure, wind-energy and other markets to insulation and roofing for residential, commercial and industrial applications. The Company’s segments include Composites, Insulation and Roofing. The Composites segment sells glass fiber and/or glass mat directly to a small number of shingle manufacturers. Its insulating products include thermal and acoustical batts, loosefill insulation, foam sheathing and accessories, and these are sold under brand names, such as Owens Corning PINK FIBERGLAS Insulation. The primary products in the Roofing segment are laminate and strip asphalt roofing shingles. Its other products include oxidized asphalt, roofing components and synthetic packaging materials. OC has a current market cap of $5.5 billion.

  • Earnings and Sales Growth: Over the past year, earnings increased a little more than 23%, while sales improved about 6.75%. Growing earnings faster than sales is hard to do, and generally isn’t sustainable in the long term, but it is also a positive mark of management’s ability to maximize its business operations. In the last quarter, earnings increased nearly 32%, while sales were mostly flat to slightly lower, at -.3%. The company operates with a margin profile that improved from 5.3% in the past twelve months to 8.85% over the last quarter.
  • Free Cash Flow: OC’s Free Cash Flow is adequate, if somewhat modest, at about $326 million. This actually represents a decrease of more than 50% since the beginning of the year, and is a reflection of some of the larger trends in the homebuilding industry that I believe has driven the industry into its bear market territory. This is an area that I would pay attention, with an eye on an improvement in Free Cash Flow to drive an actual investment decision.
  • Debt to Equity: OC has a debt/equity ratio of .87, which is a conservative number. Their balance sheet indicates about $136 million in cash against $3.6 billion in long-term debt. While their balance sheet indicates their operating profits are adequate to service their debt, this is an indication that liquidity could be an issue. Along with improving Free Cash Flow, I would prefer to see this number start improving.
  • Dividend: OC pays a dividend of $.84 per share, which translates to an annual yield of about 1.65% at the stock’s current price.
  • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for OC is $38.47 per share. At the stock’s current price, that translates to a Price/Book Ratio of 1.31. The stock’s historical Price/Book ratio by comparison is 1.83 and puts the top end of the stock’s long-term price target at around $70.50 per share. That is significantly below the stock’s all-time high around $97, but still almost 40% above the stock’s current price. The stock Price/Cash Flow is only a little more conservative, trading at about 34% its historical average, and which offers a target price around $67 per share. This is a workable range that I think makes this stock worth paying attention to, even under current market conditions.



Technical Profile

Here’s a look at the stock’s latest technical chart.

 

  • Current Price Action/Trends and Pivots: OC’s downward slide since January is easy to see, and is emphasized by the red trend line I’ve used to measure the Fibonacci retracement levels shown on the right side of the chart. The stock is currently rallying off of a trend low point around $43, but is nearing short-term resistance around $55. The stock would need to break above the 38.2% retracement line shown in the $63 price range to constitute an actual trend reversal at this stage. If the stock breaks down below its trend low point at $43, I expect its next support range to be in the $39 based on prior pivots the stock traded at in late 2015 and early 2016.
  • Near-term Keys: If you don’t mind being aggressive, and little bit speculative, there could be an opportunity to buy the stock or work with call options if the stock can break above $51. In that case, be ready to take profits quickly once the stock reaches the $55 level. A bearish trade using put options or shorting the stock isn’t really a very practical trade unless the stock does actually break below its trend low and reaches $42.50. I believe the best opportunity lies in the stock’s long-term value proposition, but since I also expect this industry to remain under pressure under current market conditions, I would prefer to wait to see a couple of OC’s fundamentals start to improve, particularly Free Cash Flow and liquidity from available cash and liquid assets.