USG is a Fat Pitch

USG Corporation (USG) threw a nice slow, almost perfect pitch right over my plate this week. I have been watching and studying this stock for the past two weeks. With Warren Buffett acting as my virtual coach, I knew it was time to swing when I heard that he added more shares of USG to his Berkshire Hathaway holdings. Apparently, Buffett was buying shares between August 2nd through August 9th at prices ranging from $45.46 to $45.98.  When the stock jump to over $47, I put in an order for $46.51 and it was filled today in both my private account and my public Fat Pitch Financials portfolio.

USG is the maker of Sheetrock. I did not realize Sheetrock was the brand name of USG’s gypsum wallboard, also known as drywall. It looks like the Sheetrock brand however is going the way of Xerox and maybe even Google, but I’m not too worried about that.  USG’s moat is really their economies of scale and low cost producer status.

USG Corporation’s shares have taken a beating and are selling for a discount right now as a result of three main factors.  First, their legal liability from asbestos cases had almost destroyed this company.  As a result of their legal problems, USG filed for Chapter 11 bankruptcy protection. I believe the stigma associated with bankruptcy and the associated complicated contingency funds is also holding the stock price down.  Finally, the recent rapid increase in real estate inventories and the start of a real estate slow down are also keeping away many short term investors.

Based on a rough discounted cash flows model, I’m estimating that USG has an intrinsic value between $85 and $100 per share.  Given that potential margin of safety that this investment currently provides, I feel confident in having taken a swing at this fat pitch. I’ll get into more details regarding this stock purchase over the coming week.

16 thoughts on “USG is a Fat Pitch

  • August 16, 2006 at 9:24 am

    Wow!!!! It is hard to believe that you could be so uninformed regarging USG. The chapter 11 status became a non event for the stock. In fact, since filing for ch.11 in 2001 the stock has gone from about 4 dollars per share to about 120 per share all while in bankruptcy. The recent dramatic decline in the stock is a result of the rights offering which gave shareholders the right to buy an additional share at $40 per share for every share they own. Obviously this had a dilutive effect on the stock. It is remarkable that anyone would put out research on USG without mentioning the most important events…………..

  • August 16, 2006 at 9:50 am

    I understand that the Chaper 11 status is over. However, I still believe the stigma associated with it persists for some time after the event.

    I agree with you that I should have detailed the rights offering. I simply ran out of time last night to detail everything I wanted to regarding my decision to invest in USG. That is why I mentioned at the end of my post that I will be following up with more details. I decided to post a short entry regarding USG yesterday in order to memorialize my purchase. I would like to have shared all my research at that time as well, but my family needed my attention.

  • August 16, 2006 at 12:36 pm

    The recent decline (from about $90 to today’s $47) was not just from the dilution of shares. If USG was priced @ $80 per share before the rights offering, it should trade at ((80+40)/2) = $60 per share. Currently, it is over 20% below that price. This could be from institutional selling before the offering (because they didn’t want to cough up the $40/share and they also didn’t want to be diluted) or just negativity surrounding USG. As time has gone on, cycles in the industry have lasted longer and it’s hard to say USG is at “peak” earnings. Even if that is the case, USG is cheap. I believe George’s estimate of $85-100 is on the conservative side.

  • August 16, 2006 at 1:49 pm

    Though my estimate of FV isn’t very near the $80 level, USG looks like it could offer some interesting possibilities.

    One alternative is that the company gets some asbestos legislative relief (2006 FAIR.) In this case I’m assuming something around $480 mm cash earings with a 12 multiple or around $64 a share as fair. Plus I would guess that since USG would save on kicking in more $ for the asbestos payout, some special dividend is a possibility.

    My other thought is that if there is no legislative relief, I’ll assume $360 mm cash earnings with a 12 multiple or a fair $48 a share with no special dividend.

    Could this be a “heads – I win, tails – I don’t lose” opportunity?

  • August 17, 2006 at 11:21 pm

    USG was one of my first stocks that I purchased when I got into investing… still kicking myself for not holding onto it. At least it was a 5-bagger, instead of the 20-bagger it could have been for me.

    I’ve recently started to make own assessment of its fundamentals again, that’s how I found this article. Thanks for sharing your views on the valuation. Question: Did your discounted cash flow model take into account the dilutive effect?

  • August 18, 2006 at 12:39 am

    My quick and dirty discounted cash flow model used 58 million shares. Yikes, I should have used 89.8 million shares. Thanks for asking the question. Thankfully, it still looks like these shares are trading at a discount even when factoring in the rights offering.

  • August 22, 2006 at 3:18 pm

    I thought the same thing about USG but thought their share price should be about $55-65 per share. But if you like USG, what do you think about Solutia (SOLUQ.OB) This is a company that is emerging from bankruptcy through a rights offering from their parent company, Monsanto. The company’s re-org plan says that after the offering, unsecured creditors could control 22.7% of the stock, Monsanto will own up to 49% and the new company will have a market value of between $2-2.3 billion. Current stock holders will therefore control the remaining 27.3% of the company’s book value which would be $546 million. The company has a current market cap of $47.1 million. That’s a company selling at less than 10% of its book value after the offering. Also, the company sales and gross profits have climbed each of the last 4 quarters, they have a leadership position in their markets, are pooring money into R&D and expanding plants and the money from the rights offerings is to fund environmental cleanup that drove them into bankruptcy. This seems like a no-brainer which of coarse scares me to think I am missing something?

  • August 24, 2006 at 10:57 pm

    SOLUQ common is canceled and new stock in the reorganized company is issued to unsecured creditors and Monsanto. From the latest 10q…

    “The Plan does not provide for distributions to the holders of Solutia’s existing equity. Under the Plan, Solutia’s existing shares of common stock, as well as options and warrants to purchase its common stock, would be cancelled and holders of Solutia’s common stock, including options and warrants to purchase Solutia’s common stock, would receive no consideration for that stock or those options and warrants.”

  • August 24, 2006 at 11:58 pm

    Thanks for clearing that up Rogermunibond. I hadn’t gotten a chance yet to look into Solutia. The newly issued stock might be interesting but it looks like SOLUQ is not worth any effort.

  • August 30, 2006 at 4:25 pm

    Interesting to read that you use DCF – congrats on the new baby too!

  • March 3, 2007 at 1:34 pm

    As a cyclical business, USG has generated peak earnings last year. It took 6 years to eclipsed 1999 operating earnings ( asbestos excluded ). Thus, cycle seems to be very long. I find difficult to modeled the right assumptions about margin pressure & drop in volumes (Threats) versus low cost advantage (Strenght) and market share gain (Opportunity) in this slowing period.

    I would be very pleased to know your views on these concerns.

    Thank you

  • October 5, 2007 at 12:29 pm

    USG is past the asbestos deal too so they’re stock’s now in the clear to start gaining value.

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