Buffett's USG Bet Hits a Wall
In 2006, Warren Buffett spotted a bargain. Just a few months earlier, USG (USG) had emerged from five years in bankruptcy, and its stock had lost more than half its value, falling from more than $115 to less than $50. The chief executive of Berkshire Hathaway (BRKA) had enriched himself on USG before: He had picked up 15% of the wallboard maker in late 2000 at an average share price of $15. Hoping to score again, Buffett spent some $165 million for 3.5 million additional shares. But lightning didn't strike twice.
Today, USG shares fetch $34 apiece. With Sheetrock production and prices plummeting—homebuilding is in collapse, after all—the company lost $73 million in the past two quarters, and industry analysts expect the losing streak to continue into 2009. Revenue might bottom out at $4.6 billion next year, after declining three years in a row. And if the analysts are right, USG's shares will be worth no more than $40 a year from now. "Frankly," says William Foote, chairman and chief executive since 1996, "we've been caught in a perfect storm."
So where are the angry mobs of shareholders clamoring for new leadership or a new direction? Not at USG's annual meeting, that's for sure. Thirty minutes after Foote welcomed investors to the company's new Chicago headquarters in early May, he adjourned the meeting without having heard a single comment from the audience. Peter Supino, a portfolio manager with Weitz Funds in Omaha, which has a 3% stake in USG, has no complaints. "We think this company is built to last and believe it will make an awful lot of money during the next positive cycle," he says.
Foote, too, takes the long view. Short term, the numbers are bleak. Home starts fell 32% in May from a year earlier, the government reported on June 17. But in a couple of years, Foote believes, the market will bounce back, and when it does, USG—with its dominant market share, high-quality reputation, and well-situated and efficient plants—will be a hot stock once more, he says. To get ready, the company plans to open a new factory in central Pennsylvania later this year and is spending $200 million to build another near Sacramento.
Meantime, Foote is also slashing expenses to minimize losses. Over the past 18 months, he has reduced USG's head count by 1,700, to 14,000, and idled almost a third of the company's drywall-making capacity. Its plant in East Chicago, Ind., for instance, is operating just three days a week. But with such retail customers as Home Depot (HD) and Lowe's (LOW) lowering their own financial forecasts, he may have to cut even deeper before the cycle turns.
Foote has worked through tough times before. In 2001, as USG was fighting off economic recession, the company declared Chapter 11 bankruptcy to shelter itself from a deluge of personal-injury claims related to asbestos that had been in wallboard compound for decades. The filing was USG's second since Foote started at the company as a division head in 1984. That earlier bankruptcy, the result of piling on too much debt to avoid a takeover, occurred in 1993.
A Wild Ride in the Industry
The gut-wrenching lows have been matched by breathtaking highs. As construction boomed in the mid-2000s, USG posted year after year of higher sales and earnings—except in 2005, when it booked a $1.4 billion loss after setting aside funds for asbestos settlements under its bankruptcy reorganization. From 2001 to 2006, sales increased 75%, to peak at $5.8 billion, while net income tripled, to $288 million. But in 2007, as builders put down their nail guns, sales fell 10%, to $5.2 billion, with profit plunging to $76 million, below 2001's level. "This company seems to face challenges not infrequently," Foote observes. "It can be a wild ride at times."
The 57-year-old CEO handles the ups and downs with the emotional detachment of an economics professor. Dressed in shirtsleeves and a tie, he appears casual. He has little time for chitchat, however. Raised in suburban Milwaukee, Foote recalls duck hunting with his father in Canada. But the graduate of Williams College and Harvard Business School talks mostly about economic cycles, costs, and "value propositions."
In his 12 years as boss, Foote has invested heavily to modernize USG's manufacturing. In 2007 alone, the company spent $460 million on capital expenditures, or 9% of sales, a high ratio for any industrial outfit. Today, 70% of USG's capacity is less than nine years old. Its new machines can produce wallboard at 600 feet a minute, two to three times faster than old machines. And, as Foote points out, they require no more personnel. Foote has also been careful to scatter plants across the country, to reduce costs of shipping such heavy materials.
Value of Integration
USG has another edge: It is a fully integrated producer, from gypsum mines and quarries in the U.S. and Mexico to paper mills and its own distribution subsidiary, L&W Supply.
Despite its highly cyclical nature, institutional investors like USG stock. In addition to Berkshire Hathaway, which owns 17.2% of the company, Germany's Knauf International has a 14.9% stake. Third Avenue Management of New York joined in last year, buying a 5.6% interest when shares traded between $35 and nearly $58. Portfolio manager Ian Lapey concedes, "The housing downturn clearly has turned out to be deeper than we would have imagined." But he has no second thoughts about the purchase. "The wallboard business is generally a very good business on a long-term basis," he says.
Foote vows USG won't disappoint shareholders. He does confess to one wish, however—that the calendar had already advanced to 2010. "The future can't come soon enough."