CHICAGO--(BUSINESS WIRE)--Fitch Ratings has upgraded the ratings of USG Corporation (NYSE: USG), including the company's Issuer Default Rating (IDR), to 'B+' from 'B'. The Rating Outlook is Stable. A complete list of rating actions is provided at the end of this release.
KEY RATING DRIVERS
The rating upgrade reflects the continued improvement in USG's financial results and credit metrics during 2014 and the expectation that these credit metrics are either maintained or further enhanced in 2015 as the overall U.S. construction sector continues its modest recovery.
The rating for USG also reflects the company's leading market position in all of its core businesses, strong brand recognition, its large manufacturing network and sizeable gypsum reserves. Risks include the cyclicality of the company's end-markets, excess capacity currently in place in the U.S. wallboard industry, volatility of wallboard pricing and shipments and, although improving, the company's still high leverage position.
The Stable Outlook reflects Fitch's expectation that demand for USG's products will continue to grow during the remainder of 2014 and into 2015 as the housing market maintains its moderate recovery and commercial construction activity improves from cyclical lows. The Stable Outlook also incorporates USG's solid liquidity position.
IMPROVING FINANCIAL RESULTS AND CREDIT METRICS
Revenues for the first nine months of 2014 increased 4.3% to $2.77 billion compared with $2.65 billion during the same period last year. More importantly, operating profit (excluding restructuring and impairment charges and litigation charges) advanced 31.3% to $264 million (9.5% of sales) during the first three quarters of 2014 compared with $201 million (7.6%) during the same period last year, reflecting the company's strong operating leverage. For all of 2014, Fitch expects mid-single digit revenue growth and a 150-200 basis point improvement in operating profit margins.
USG's Fitch-calculated leverage has improved significantly to 4.4x for the latest 12 month (LTM) period ending Sept. 30, 2014, compared with 5.4x at the end of 2013, 8.75x at year-end 2012 and 35.4x at the end of 2011. Fitch expects further improvement in leverage, with debt to EBITDA projected to be around 4.3x by year-end 2014 and below 4.0x at the conclusion of 2015. Interest coverage also increased to 2.7x for the Sept. 30, 2014 LTM period from 2.1x in 2013, 1.3x in 2012 and 0.3x in 2011. Fitch expects the interest coverage ratio will settle at around 2.9x at the end of 2014 and above 3.0x at year-end 2015.
WALLBOARD PRICING STRATEGY HOLDING UP BUT PRICE INFLATION MODERATING
At the end of 2011, major wallboard manufacturers announced that they were eliminating the practice of job quotes. In the past, job quotes provided pricing protection for customers, particularly for large projects. However, this practice limited the realization of price increases implemented by manufacturers.
During the past three years, major manufacturers announced an annual one-time price increase effective at the beginning of 2012, 2013 and 2014. The pricing increases were realized in 2012 and 2013 and are holding up so far in 2014. USG's average U.S. wallboard price grew about 18% in 2012, 17% in 2013 and 8% during the 2014 year-to-date period.
During the third quarter of 2014, USG reached an agreement in principle to settle all claims made in the direct and indirect purchaser class action lawsuits pending in the U.S. District Court for the Eastern District of Pennsylvania alleging that since at least September 2011, U.S. wallboard manufacturers conspired to fix and raise the price of gypsum wallboard sold in the U.S. and to effectuate the alleged conspiracy by ending the practice of providing job quotes on wallboard. Pursuant to the agreement in principle, which is subject to finalization of a settlement agreement and court agreement, USG will make a payment of $48 million. USG strongly denies any wrong-doing for the claims made in the lawsuits, but settled to avoid the expense, distraction and risk of further litigation. The company expects to make the cash payment within the next 12 months. Management indicated that this settlement does not alter its pricing strategy. Fitch is not aware of other manufacturers entering into similar settlement agreements with the plaintiffs.
STRONG MARKET POSITION
USG maintains a strong market position in all of its core businesses. According to the company, it has the #1 market position in the wallboard industry in North America. Its Ceilings business has the #2 market position worldwide. USG's Distribution segment also has the #1 market position in the U.S. specialty distribution business. These leadership positions provide the company with economies of scale as well as a solid platform to launch new product offerings.
USG BORAL BUILDING PRODUCTS
On Feb. 27, 2014, USG formed a 50/50 joint venture (JV), USG Boral Building Products (UBBP), with Boral Limited. The JV will leverage the two companies' brands, complementary geographic footprints and technological expertise. The JV is valued at $1.6 billion, with Boral contributing its Gypsum division, valued at $1.35 billion and includes its plasterboard operations in Australia and Asia, to the JV and USG contributing assets valued at $250 million, which include its Asian and Middle Eastern businesses, as well as exclusive access to USG's technologies in the JV's territory. In addition, USG will pay Boral cash payments of up to $575 million, of which $513 million was paid at closing ($500 million base price and $13 million of working capital adjustments), and, subject to achieving earnings targets, $25 million on the third anniversary and $50 million on the fifth anniversary.
The JV is targeted to be self-funding with the ability to borrow in its own right with dividend distribution targeted at 50% of after-tax profit, taking into consideration the growth needs of the JV. Management estimates that USG's share of the JV income will be roughly $35 million-$45 million on an annualized basis in 2014.
This JV has good strategic rationale for USG and is consistent with management's goal of diversifying its earnings stream. The JV with Boral provides USG with an immediate significant presence in high-growth emerging markets and allows the company to leverage its leading technologies with Boral's existing production and distribution network.
STRONG LIQUIDITY POSITION
As of Sept. 30, 2014, USG had $686 million of liquidity comprised of $240 million of cash, $64 million of short-term marketable securities, $36 million of long-term marketable securities and $346 million of borrowing availability under its U.S. and Canadian credit facilities.
On Oct. 22, 2014, the company amended its credit facilities and combined its U.S. and Canadian revolving facilities into a $450 million facility maturing in October 2019. Fitch expects USG's liquidity will remain healthy during the next 12-18 months. Fitch projects USG's overall liquidity will be between $700 million and $800 million at the end of 2014 and will remain at or above these levels during 2015. The company has no major debt maturities until November 2016, when $500 million of senior notes become due.
CYCLICALITY OF END MARKETS
USG markets its products primarily to the construction industry, with 25% of the company's net sales directed toward new residential construction, 24% derived from new nonresidential construction, 49% from the repair and remodel segment (commercial and residential), and 2% from other industrial products.
Fitch's housing estimates for 2014 are as follows: Single-family starts are projected to improve 3% to 636,000 and multifamily volume to grow about 17.5% to 361,000. Total 2014 starts should approximate 1 million. New home sales are forecast to advance about 1.5% to 436,000, while existing home sales volume is expected to decline 6% to 4.785 million, largely due to fewer distressed homes for sale.
Housing activity is likely to ratchet up more sharply in 2015 with the support of a steadily growing economy throughout the year. The unemployment rate should continue to move lower (averaging 5.8% in 2015). Credit standards should moderately but steadily ease throughout next year. Demographics should be more of a positive catalyst. More of those younger adults who have been living at home should find jobs and these 25 to 35 year olds should provide some incremental elevation to the rental and starter home markets. Total housing starts are projected to expand 14% to 1.14 million as single-family starts advance 18% and multifamily volumes gain 7%. New home sales should grow 18%, while existing home sales rise 5%.
Fitch projects home improvement spending will increase 6% in 2014 and grow at a similar pace next year. Spending for discretionary big-ticket remodeling projects should continue to lag the overall growth in the home improvement sector somewhat, as credit availability remains relatively constrained and homeowners remain cautious in their spending. However, there are signs that homeowners are a bit more willing to undertake larger discretionary projects.
The fundamentals of U.S. commercial real estate (CRE) continue to improve at a moderate pace following the recent economic recession. CRE vacancy rates are falling modestly and rents are moderately rising as the economy slowly picks up. Fitch currently expects continued, positive property-level fundamentals across most asset classes and projects private nonresidential construction will grow 8% in 2014 and 6% in 2015.
Future ratings and Outlooks will be influenced by broad economic and construction market trends, as well as company specific activity, including free cash flow trends and liquidity.
Further positive rating actions may be considered in the next 12 months if the company shows more improvement in its financial results and operating metrics, including debt to EBITDA consistently between 3.0x-4.0x and interest coverage sustaining above 4.0x, while maintaining at least $500 million of liquidity.
On the other hand, a negative rating action may be considered if the recovery in the construction market dissipates, leading to financial results approaching Fitch's 2015 stress case forecast, including revenue declines of 20%, EBITDA margins of less than 10%, debt to EBITDA consistently above 8x, and total liquidity falling below $300 million.
Fitch has upgraded the following ratings for USG:
--Long-term IDR to 'B+' from 'B';
--Secured bank credit facility to 'BB+/RR1' from 'BB/RR1';
--Senior unsecured guaranteed notes to 'BB/RR2' from 'BB-/RR2'.
--Senior unsecured notes to 'B+/RR4' from 'B/RR4'.
Fitch's Recovery Rating (RR) of 'RR1' on USG's $450 million secured revolving credit facility indicates outstanding recovery prospects for holders of this debt issue. Fitch's 'RR2' on USG's unsecured guaranteed notes indicates superior recovery prospects. (Currently, $950 million of unsecured notes are guaranteed on a senior unsecured basis by certain of USG's domestic subsidiaries.) Fitch's 'RR4' on USG's senior unsecured notes that are not guaranteed by the company's subsidiaries indicates average recovery prospects for holders of these debt issues.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage