Playing the Housing Recovery with One Stock
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Heard about the jump in U.S. housing starts in September? Looking for a stock to play the long-awaited recovery in the U.S. housing market?
Sure, you could buy a mortgage servicer like Wells Fargo or a homebuilder like KB Home. You could even buy a pure play like USG Corp. (NYSE: USG), a wallboard manufacturer.
Berkshire has big stakes in Wells Fargo and USG. It also owns Clayton Homes, a major homebuilder; Shaw Industries, the world’s largest carpet manufacturer; and Benjamin Moore, the paint company that recently made news with an executive junket to Bermuda to celebrate its first quarterly sales increase in five years.
Buffett subsequently sacked Denis Abrams, Benjamin Moore's CEO, although the Berkshire chairman insisted it was differences over corporate strategy, not the junket, that cost Abrams his job.
I haven't even mentioned Berkshire subs Acme Brick Co., Johns Manville (insulation), Jordan Furniture, MiTek Inc. (building components), Nebraska Furniture Mart or RC Willey Home Furnishings, nor its bid for the most valuable assets of bankrupt mortgage lender Residential Capital, scheduled to be auctioned off this week.
Of all Berkshire's housing-related investments, USG may provide the best window for the public. Unlike Berkshire's many subsidiaries, it is an independent public company, meaning it discusses its results out in the open each quarter. And unlike Wells Fargo, it is a reasonably uncomplicated play, with more than half its revenue coming from its North American wallboard business. Berkshire owns 17 million shares of USG, roughly a 16 percent stake.
USG reported third-quarter earnings last week one day after the U.S. Commerce Department announced that housing starts jumped 15 percent in September to a seasonally-adjusted annual rate of 872,000, a bigger number than just about anyone had predicted. This brought a new round of market optimism that lifted housing-sensitive shares. Homebuilders KB Home and Lennar Corp. are trading near their 12-month highs, as is USG.
During USG’s conference call the day after the Commerce Department announcement, CEO James Metcalf said he was cautiously optimistic, describing the U.S. housing market as having “turned the corner.” But he also said USG has no plans to increase capacity until it figures out if the recovery is sustainable.
The company reported an increase of 14 percent in wallboard sales in the third quarter, but said growth was slower in its ceilings and commercial distribution businesses. Metcalf said the company will manage wallboard sales through a controlled distribution model for the rest of the year in anticipation of a price increase on Jan. 1.
“We believe the recovery is going to be very regional and lead times may be extended due to challenges of staffing up as we see regional increases in demand,” Metcalf said.
“We want to be confident of a sustained recovery before we start the hiring process, which can take anywhere between three and six months. Availability of credit may also dampen the recovery. Lower availability of working capital for our customers, challenges with contractor receivables and the ability for homeowners to qualify for mortgages may impact the rate of growth next year.
“We believe the commercial recovery will lag residential. McGraw-Hill construction starts overall have been relatively flat in 2012, with some segments showing improvement while others still remain relatively weak. The office segment has improved throughout the year and we will benefit our commercial business in 2013 as we ship products approximately 12-18 months after a commercial start. Other segments like retail are stabilizing but have not yet begun to grow.
“As we look to 2013, we believe we’ll see growth in new residential construction, although commercial and repair & remodel are likely to remain soft. New household formation will drive this increase in demand, even if moderated by the factors that I’ve just covered.”
Given the long lead times he described for staffing up, one analyst asked Metcalf to describe how he figures out the timing. As part of his reply, Metcalf said USG has no plans to increase staffing or manufacturing capacity in 2013:
“If you look at the housing start numbers yesterday, they were very positive. And we’ve had a nice trend here. I think 850 to 900,000 starts is a very solid number. But housing starts are only part of the story. If you look at the gypsum opportunity for demand into 2013, we’re still at some very, very low levels. If you’re looking at an opportunity anywhere between 19.5 and 20 billion feet, those are historically low levels.
“We know our network and we have a very well-run strategic sourcing and planning network of how we run our plants. And we can run our plants with some overtime, we can run our plants, if we do have to add a shift, it isn’t adding capacity, and we are going to be extremely careful and quite frankly, as the CEO, I need to be convinced that any type of recovery is sustainable.
“We have a long lag of bringing people back. We’re in outlying areas and people have left the jobs. It’s anywhere three, four to six months to bring people back, so we have to be extremely confident that this isn’t a false positive.
"We’re being very, very conservative. So adding plants back is not in the plan for us in 2013. Do not see it happening. And adding a shift or staff, we have to be extremely confident in that region that it’s sustainable because it is very expensive to hire people and quite frankly the last thing I (want) to do is get rid of people. So we’re going to run our network very, very tight. That’s why it’s important we stay in touch with our customers on their demand.
“And quite frankly, with our organization, we have the widest sales organization, and, I believe, the best sales organization in the field that calls on the customers every day. So we are in touch with individual demand ups and downs. So we’re still cautiously optimistic. The housing start number was good, but that’s only part of the story. R&R’s still weak, commercial’s still weak and the overall demand is going to be up, but not at any historical levels.”
Even though USG’s quarterly revenues and earnings per share missed analyst estimates, the stock continued its recovery as the market anticipates better days in the housing business. USG shares were up 16 percent last week to $24.48, just 60 cents off its 12-month high. It remains a long way from its pre-crash historical highs, however.
Metcalf said USG's long battle back to break-even is not dependent on a quick turnaround in the housing market. The company is selling its low-growth European operation and opening a quarry and manufacturing plant in India in an effort to get in on Asian growth and reduce the cyclicality of the business. It is also shedding unprofitable business, particularly in L&W Supply Corp., its commercial distribution arm. It no longer makes steel studs, for example, a low-margin product, although it continues to distribute those made by others.
As Metcalf described it, USG expects the housing recovery to be spotty and highly regional. The Commerce Department’s housing starts numbers confirmed the latter, reporting new construction up 20 percent in Western states but down 5 percent in the Northeast.
While USG is the purer play on the housing recovery, Berkshire is the safer one. Measured by the price-to-book ratio, Berkshire shares are trading at the lower end of their historical range despite appreciating more than 16 percent so far in 2012. Berkshire is currently trading at about 120 percent of book, while its long-run average is closer to 150 percent.
Buying Berkshire gets you exposure to Wells Fargo, Clayton Homes, Shaw, Benjamin Moore, USG and those other housing-related businesses, but it also provides the downside protection of an undervalued asset in a generally overvalued stock market.
Obviously, if you buy Berkshire you have to be comfortable with all the other stuff it does, including extensive insurance operations and a rather large railroad. Berkshire is now a well diversified conglomerate. But it offers such broad exposure to housing that Buffett freely opines on that industry's condition based entirely on how his businesses are doing. Plus, at current prices, you're getting the twilight of Buffett's brilliant investing career for free.
ultimatespinach owns shares of Berkshire (the little ones). The Motley Fool owns shares of Berkshire Hathaway. Motley Fool newsletter services recommend Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.