KJ, I haven't gotten to the stocks you mentioned yet. I'm starting with the larger companies. I think that the industry leaders would be the first beneficiaries of a market trend.
RGC is the country's largest gypsum manufacturer. The fundamentals are solid. Why isn't this stock blasting off ?
Recent articles from the Street.com and WSJ:
<Hitting a Dry Wall: Maybe you saw the recent
story in the Wall Street Journal: There's a huge
shortage of gypsum board (known to most of us as
drywall, wallboard or sheetrock). How huge is it?
It's so big that housing projects are getting
delayed. It's so big that contractors have had to lay
off workers. Why, the drywall shortage is so big
that some contractors are being forced to go to
Home Depot (HD:NYSE)!
Yet that's not necessarily any reason to buy the
stocks of drywall makers. The biggest and purest
play, among public companies, is USG
(USG:NYSE), which was better known as U.S.
Gypsum before it emerged from bankruptcy a few
years ago. This is a company that analysts love
because it has new leadership, has pared itself
down and is a leader in an oligopolistic industry.
So, what's not to like? Plenty, according to one
money manager, who has been covering the
housing and building industry for more than a
dozen years (but who declined to be quoted by
name.) His concern is that the company is on the
brink of adding new capacity just as mortgage
rates have started to rise -- up 100 basis points
since their low last fall -- and housing starts and
building permits are at or near records. "Whenever
you get a backup in rates, you get a surge at the
end (of demand) as fence sitters say, 'I better do
this now if I want to buy my house.'
"Regardless of what happens to rates, unless they
come back down at least 50 basis points from here
you'll have a decline in housing starts from here.
Things are so good they can't stay good forever."
A USG spokesman said that the extra capacity is
being added over three to five years, while older
lines are being shut. He adds that USG believes
this will be another booming year for housing, with
the shortage actually getting worse. Even if it
doesn't, the spokesman says almost 40% of
drywall demand comes from remodeling.
Besides, with USG currently trading at around 7.7
times trailing earnings, he figures the worst case
has already been factored in. "And we're trading at
discounts far below where we have historically
through all of the industry's ups and downs."
Maybe, and maybe these concerns are too
premature. But remember that housing booms can
quickly turn to busts, which is just what happened
to USG last time around. >
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Interior Struggle:
A Dearth of Drywall
Leaves Contractors
With Their Studs Bare
---
A World-Trade Wallflower,
Material Is Rare Example
Of a Scarce Commodity
---
Paying Retail at Home Depot
By Wall Street Journal staff reporters Carlos Tejada in Dallas, James R. Hagerty in Atlanta and Carl Quintanilla in Chicago
03/15/99
The Wall Street Journal
Page A1
(Copyright (c) 1999, Dow Jones & Company, Inc.)
Eight years of nearly inflation-free expansion have diminished the old boom-and-bust fears. So what's going on in the drywall industry seems like an economic flashback: The paper-covered plasterboard used in nearly all interior construction is in short supply, and prices are surging.
Kaufman & Broad Home Corp., Los Angeles, one of the nation's biggest home builders, says its drywall costs have shot up 25% over the past 15 months.
The shortage is causing expensive delays for some residential and commercial construction projects, especially in the Southeast and around Houston. Bob Pasarela, an owner of Pasarela Drywall Inc. in Hudson, Fla., says he has "at least 25 houses ready for drywall that I can't get boarded."
And the delays are expected to spread as the spring and summer building season heats up. U.S. drywall factories already are running at their capacity of about 27 billion square feet of board a year.
Some big builders and drywall installers are so desperate for the stuff that they are willing to pay retail, tiptoeing into Home Depot stores, among the do-it-yourselfers. But they are finding many of the Home Depot Inc. outlets are rationing drywall -- a few dozen boards per customer -- to get through the shortage. "I wish we could take care of everybody," says Rod Johnson, a Home Depot merchandising manager in Tampa, Fla.
It isn't clear yet whether the shortage will grow serious enough to stall overall construction growth, which has been a surprisingly strong contributor to economic expansion. And, in any case, new drywall factories scheduled to open are expected to increase the supply by late in the year.
But beyond these uncertainties, the crunch is noteworthy because it is so unusual -- labor, really, is the only other thing in serious short supply -- and it represents a throwback to previous economic cycles. Of course, the U.S. has seen temporary and local shortages of products such as cement and insulation over the past year, but nothing as disruptive as the drywall shortage. The peculiar factors that led to it help explain what isn't happening -- why the rest of the U.S. economy remains so amazingly immune to scarcity and inflationary pressures.
This late in an expansion, a whole bunch of major commodities typically would be scarce, sending prices upward and signaling the Federal Reserve Board to slow things down with tighter monetary policy. Instead, many basic industries-steel, agriculture, oil and gas -- are suffering from overcapacity.
"Almost every other industry thought that demand would be there" to fill all the capacity added in recent years, "and it isn't," says Norbert Ore of the National Association of Purchasing Management.
Where have the shortages gone? Hyper-efficient global capital markets can spot a developing shortage, or profit opportunity, and add to production capacity with great speed these days. And booming world trade matches goods with customers, turning local supply-and-demand mismatches into regional and global equilibrium.
Still, says Diane Swonk, an economist at Bank One Corp. in Chicago, the U.S. economy might have boiled over last year but for trouble in Asia that curbed demand for many products. That kept prices down and supplies more than adequate. Indeed, Asian steel has flooded the American market, depressing prices. And some heavy equipment built for Asian industry couldn't be sold there and languishes in U.S. warehouses.
But drywall never joined the global economy. European and Asian builders rely on the stuff much less than their American counterparts. And because it is very heavy, brittle and of relatively low value, shipping it long distances makes little sense. That explains why oversupply in one region can't easily cover a shortage elsewhere.
Moreover, Asian economic troubles actually helped stimulate demand for drywall in the U.S. As overseas investors fled to the safety of U.S. Treasury securities, they helped push down interest rates here, making mortgages more affordable and increasing demand for housing. "It's weird," Ms. Swonk says. "You can attribute the shortage of drywall to problems abroad, while other commodities, like steel, are in abundance due to problems abroad."
Drywall, also known as wallboard and by the USG Corp. brand name Sheetrock, was born around 1900 when Augustine Sackett, who made packing cases with layers of straw paper and tar, tried layering plaster and paper to form a board. USG's predecessor, U.S. Gypsum Co., bought Sackett Plaster Board Co., of New Jersey, for $850,000 in 1909. It gradually reduced the number of layers the board contained and developed enclosed, squared-off edges that didn't crumble. With a little joint compound and tape, a wall of drywall could be made smooth, even and ready to be painted.
In the post-World War II building boom, drywall pushed aside the inexact and labor-intensive art of forming walls by applying wet plaster to a lath, or base. Drywall was nailed directly to 2-by-4 studs, the vertical struts that make up a wall's skeleton. With today's nail guns, walls go up in minutes, not days, and craftsmen can soak stiff drywall to make it conform to curved contours.
Gypsum, the product's primary ingredient, is the fifth-most-common mineral on earth, making it literally dirt cheap. But the drywall business faced a big problem. Manufacturing plants were hugely expensive, and demand for drywall and all building products moved violently up and down during economic cycles. Rhyne Simpson Jr., president and chief executive officer of Continental Gypsum Co., Port Newark, N.J., recalls watching wholesale prices plunge in a year's time in the mid-1960s to about $24 for 1,000 square feet of board from $48.
Such ups and downs continued through the 1980s. And, along with the paper and chemical businesses, drywall makers seemed to develop a knack for building expensive new plants just as recessions were about to begin. The industry added about two billion square feet of capacity, an increase of roughly 12%, between 1978 and 1982, even as sales were plunging 20%. In 1982, saddled with 19.1 billion square feet of capacity, the industry shipped just 13.1 billion square feet of drywall.
By 1988, the industry was heading into another sickening cycle. The Port Authority of New York and New Jersey had helped finance a new drywall plant next to Newark's airport that opened in late 1987. "It ran a few months" before being mothballed for more than five years, says Continental Gypsum's Mr. Simpson, whose company now leases the plant.
Chicago-based USG, the nation's No. 1 producer, was fighting off a hostile takeover attempt. To remain independent, it paid out a $1.9 billion dividend to shareholders in 1988 and boosted its debt to more than $2.5 billion. By 1992, USG, National Gypsum Co., Charlotte, N.C., and a third, smaller competitor were all operating under bankruptcy-court supervision.
Investors didn't even want to hear the word drywall, and as the economy began its current expansion in 1991, the industry wasn't in a position to finance new plants. "When you're in Chapter 11, you're going to have a hard time convincing the judge to let you go out and spend $70 million or so on a new plant," says Jerry Walker, executive director of the Gypsum Association, a trade group based in Washington, D.C.
So, for the past 10 years, Mr. Walker says, there hasn't been a single new drywall plant opened in the U.S. That might seem like long-overdue self-discipline on the industry's part. But during that time, fundamental shifts in demand for housing occurred, and the industry -- for once -- vastly underestimated demand for its product.
New-home construction increased steadily through the 1990s to 1.62 million starts last year. And though that isn't a record, the average size of new homes was increasing, too, to 2,150 square feet in 1997 from 1,905 in 1987, requiring more drywall per house. At the same time, sales of existing homes-buyers often renovate or expand right after a purchase-boomed to 4.8 million last year and have averaged a brisk 3.8 million a year in the past decade. And stock-market wealth encouraged more families to buy a second home.
"Per-capita consumption of housing is going up," says Ms. Swonk, the Bank One economist. And renovation is less vulnerable to economic downturns.
In commercial construction, even as relatively few new office buildings were erected in the 1990s, because of 1980s overbuilding, renovation of old structures and office tenants moving around and reconfiguring existing space has increased demand for drywall.
By 1995, it was clear the drywall industry was about to run out of capacity. USG, now out of bankruptcy proceedings, had only enough money to do some modest modernizing of existing plants. That boosted its capacity about 7%, to 8.8 billion square feet. Other makers did likewise. By 1996, nearly all U.S. plants were running flat out, and drywall was being imported from Canada to meet demand. New plants take about three years from planning to full production, so the market would only get tighter.
USG raised prices four times last year and twice already this year, including a January boost of between 7.4% and 11% and a March increase of 10%. Wholesale prices hit $150 for 1,000 square feet of drywall. USG profit more than doubled last year to $332 million, or $6.61 a diluted share, from $148 million, or $3.03 a share, in 1997. Sales increased 9% to $3.13 billion.
In Tampa, Circle Industries USA, a drywall subcontractor, now is scrambling to find more than two million square feet of board to finish a Marriott hotel and convention center. Jerry Marchelletta, Circle's president, says shipments of drywall are running about four weeks behind schedule, and the company will be able to meet its deadline only with a last-minute blitz of work once enough supplies arrive. He keeps reassuring the general contractor that the drywalling "will get done."
Standing in reddish mud at an Atlanta home site, construction supervisor Mike Vonier says he isn't sure when he will get his next shipment of drywall. As a small operator, he is nowhere near the top of suppliers' lists and has suffered construction delays of as long as a month. "The longer it takes, the more interest we have to pay on the construction loan," he laments. "It has been a nightmare for us."
Christin Cupp, an executive at a bigger home builder, Beazer Homes USA Inc., says the Tampa shortage is so severe that "you start to beg." Though Beazer, based in Atlanta, normally buys in bulk from distributors, Ms. Cupp recently resorted to shopping for drywall at Home Depot, only to learn that customers were limited to 20 boards apiece -- too few to make it worth her while.
Emerald Builders in Houston has 79 houses waiting for drywall it can't get, and with the company starting 15 new homes a week, that number could rise. And, the peak construction season hasn't really begun. "I don't know what to do about June," says Craig Dudley, Emerald's vice president.
In the second half of the year, USG expects a new $110 million plant in Alabama to start up, and a big expansion at its East Chicago, Ill., plant will open, too. Other companies, including Georgia-Pacific Corp. and Lafarge Corp., have new plants opening late this year and early in 2000.
By 2002 the industry should have boosted its capacity by about 30% to about 36 billion square feet of board, says Mr. Walker of the Gypsum Association. Just in time for the next recession? "Don't say that," he says.
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