Fitch Affirms USG's IDR at 'B+'; Outlook Revised to Positive

NEW YORK--()--Fitch Ratings has affirmed the ratings for USG Corporation (NYSE: USG), including the company's Issuer Default Rating (IDR) at 'B+'. The Rating Outlook has been revised to Positive from Stable. A complete list of rating actions follows at the end of this release.

KEY RATING DRIVERS

The rating for USG 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 shipments and pricing, and, although improving, the company's still high leverage position.

The Positive Outlook reflects Fitch's expectation that demand will continue to grow during the remainder of 2015 and in 2016 as the moderate recovery in the residential and non-residential construction sectors is maintained. The Positive Outlook also reflects the company's solid liquidity position and Fitch's expectation that USG's credit metrics will continue to improve, driven by modestly healthier financial results and lower overall debt levels next year.

IMPROVING CREDIT METRICS

USG's leverage has improved significantly to 4.3x for the latest-12-months (LTM) ending Sept. 30, 2015 compared with 4.5x at year-end 2014, 5.4x at the end of 2013, 8.75x at the conclusion of 2012 and 35.4x at the year-end 2011. Fitch expects further improvement in leverage, with debt to EBITDA projected to be around 4.2x by year-end 2015 and will be between 3.0x - 4.0x at the conclusion of 2016.

Interest coverage also increased to 3.1x for the Sept. 30, 2015 LTM period from 2.3x in 2014, 2.1x in 2013, 1.3x in 2012 and 0.3x in 2011. Fitch expects the interest coverage ratio will settle at around 3.2x at the end of 2015 and above 3.5x at year-end 2016.

Management has indicated its commitment to achieving investment grade credit metrics, including debt to EBITDA of 1.5x - 2.0x at the mid-cycle. The company intends to lower its absolute debt levels, and could accomplish this with the repayment of $500 million of senior notes maturing in November 2016. The Positive Outlook reflects Fitch's expectation that the company will reduce overall debt next year, leading to debt to EBITDA levels comfortably in the 3.0x - 4.0x range.

SOLID LIQUIDITY POSITION

The company has a solid liquidity position and is able to meet its financial obligations, including $500 million of senior notes maturing in November 2016. As of Sept. 30, 2015, USG had $785 million of liquidity comprised of $333 million of cash, $89 million of short-term marketable securities, $28 million of long-term marketable securities and $335 million of borrowing availability under its credit facility.

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 2015 and will remain above $600 million during 2016.

INCREASING FREE CASH FLOW GENERATION

For the LTM period ending Sept. 30, 2015, USG generated $129 million (3.4% of revenues) of free cash flow (FCF). By comparison, USG reported FCF of $40 million (1.1%) during 2014, negative $46 million during 2013 and positive $8 million during 2012. Fitch expects the company will generate FCF of about 2.5% - 3.5% of revenues during 2015 and 6.0% - 7.0% of revenues during the next few years.

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. USG's Ceilings business has the #2 market position worldwide and its Distribution segment has the #1 market position in the U.S. specialty distribution business. The company's USG Boral Building Products international joint venture also has the #1 or #2 position in most of its markets in Asia, Australasia and the Middle East. These leadership positions provide the company with economies of scale as well as a solid platform to launch new product offerings.

CYCLICALITY OF END MARKETS

USG markets its products primarily to the construction industry, with approximately 25% of the company's 2014 net sales directed toward new residential construction, 24% derived from new non-residential construction, 49% from the repair and remodel segment (commercial and residential) and 2% from other industrial products.

While the overall construction industry is inherently cyclical, typically, residential construction and commercial construction have differing cycles. Additionally, the repair and remodel sector (both residential and commercial) has generally exhibited less volatile characteristics compared with the new construction market. However, during the last U.S. economic and construction downturn, there were periods when all of these end markets were simultaneously in decline.

During this period, USG's sales fell 10.5% during 2007, declined 11.4% during 2008, contracted 29.8% during 2009 and decreased 9.2% during 2010. USG's EBITDA margins fell more than 12 percentage points to 7.4% during 2007 and EBITDA margins ranged from 0.4% to 2.0% during the subsequent periods.

The company's sales remain 34.5% below the peak revenues reported during 2006 while EBITDA margins are 630 bps below the high reported during 2006. Nonetheless, USG has lowered its breakeven point, with its U.S. Gypsum operations reporting operating profit (excluding non-recurring charges) of $226 million on 924,900 housing starts during 2013 compared with an operating loss (excluding non-recurring charges) of $218 million on 905,500 housing starts in 2008. This segment reported operating profit (excluding non-recurring charges) of $270 million during 2014 on 1 million housing starts.

U.S. CONSTRUCTION MARKET OUTLOOK

Fitch expects continued growth in overall U.S. construction spending through 2016, particularly for the private residential and commercial construction markets.

Housing activity has ratcheted up more sharply in 2015 with the support of a steadily growing, relatively robust economy throughout the year. Single-family starts are now forecast to rise about 11.4% to 722,000 as multifamily volume expands about 11% to 394,000. Total starts would be just in excess of 1.1 million. New home sales are projected to increase 20% to 523,000. Existing home volume is expected to approximate 5.280 million, up 6.9%. Fitch expects further improvement next year, with housing starts forecast to grow about 11%, while new and existing home sales advance 18% and 4%, respectively.

Home improvement spending is expanding at a steady pace and Fitch expects this to continue. Fitch estimates that home improvement spending increased about 4% in 2014 and will grow approximately 4.5% in 2015 and 2016.

Commercial construction spending has been robust, expanding 12.2% during the first nine months of 2015. This follows 11.3% improvement during 2014. Fitch expects spending in this sector will advance 8.5% this year and 7.0% next year as property fundamentals in the commercial sector remain healthy.

IMPROVING WALLBOARD SHIPMENTS AND STABLE PRICES

Shipments and market prices for the company's building products historically have been volatile and cyclical. Currently, there is significant excess wallboard production capacity in the U.S.

Industry wallboard shipments in the U.S., as reported by the Gypsum Association, grew about 4% to 16.4 billion sq. ft. during the first nine months of 2015 compared with 15.7 billion sq. ft. during the first nine months of 2014. Shipments for the full year 2014 increased roughly 4.3% to 21.8 billion sq. ft. compared with 20.9 billion sq. ft. during 2013. USG estimates industry capacity utilization rates improved further this year but remained low, averaging approximately 67% during the first nine months of 2015 compared with 63% during first nine months of 2014. Industry capacity utilization averaged about 66% during 2014.

U.S. wallboard manufacturers have been successful with their pricing strategy during 2012 - 2014. Industry participants realized meaningful pricing improvement after eliminating the practice of job quotes and implementing a one-time price increase effective at the beginning of each year. USG's average U.S. wallboard price grew about 18% in 2012 and 17% in 2013. Fitch estimates that wallboard prices improved high single-digits during 2014. (Starting in the 4Q'14, USG stopped providing pricing and volume information for its wallboard products.)

Fitch projects wallboard shipments will increase low to mid-single digits during 2015. This sector should continue to benefit from higher new home construction activity, as well as moderate improvement in the repair and remodel, and commercial construction sectors. Fitch estimates about a third of industry shipments are directed to the new home construction market.

Several manufacturers have announced wallboard price increases of as high as 20%, effective Jan. 1, 2015. However, companies that publicly provide financial information have only realized low-single digit pricing improvement so far this year. Demand has been rather weak so far this year relative to industry expectations, making it difficult for manufacturers to fully realize the announced price increases.

Heading into 2016, several manufacturers have announced pricing increases effective during the fourth quarter of 2015 and the beginning of 2016. However, most of these pricing increases have been postponed and are likely to be implemented during the latter part of first-quarter 2016/early second-quarter 2016 as manufacturers monitor demand. If industry shipments are meaningfully greater during 2016 compared with 2015, Fitch believes that manufacturers may have the opportunity to be more successful in realizing moderately higher prices next year.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

--U.S. construction spending increases 7.7% during 2015 and 7.1% during 2016;

--Sales improve low single-digits during 2015 and mid-single-digits in 2016;

--EBITDA margins between 13.0% - 14.0% during 2015 and 2016;

--FCF margin of 2.5% - 3.5% during 2015 and 6.0% - 7.0% in the next few years;

--Some debt reduction during 2016;

--Debt to EBITDA of 4.2x at the end of 2015 and between 3.0x - 4.0x at year-end 2016;

--EBITDA to interest above 3.0x during the next few years.

RATING SENSITIVITIES

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.

The company's IDR may be upgraded to 'BB-' in the next 6 - 12 months if the company shows further improvement in its financial results and reduces its total debt, 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 (cash, investments and revolver availability).

On the other hand, the Outlook could be revised to Stable if the company's credit metrics do not improve much from current levels, including debt to EBITDA consistently above 4.0x and interest coverage sustained in the 3.0x-3.5x range.

A negative rating action may be considered if there is a sustained erosion of profits and cash flows either due to weak residential and commercial construction activity, meaningful and continued loss of market share, and/or continued materials and energy cost pressures resulting in margin contraction, including EBITDA margins of less than 10%, debt to EBITDA consistently above 8x, and total liquidity falling below $300 million.

FULL LIST OF RATING ACTIONS

Fitch has affirmed the following ratings:

USG Corporation

--Long-term IDR at 'B+';

--Secured bank credit facility at 'BB+/RR1';

--Senior unsecured guaranteed notes at 'BB/RR2';

--Senior unsecured notes at 'B+/RR4'.

The Rating Outlook is Positive.

Fitch's Recovery Rating (RR) of 'RR1' for USG's $450 million secured revolving credit facility indicates outstanding recovery prospects for holders of this debt issue. Fitch's 'RR2' for USG's unsecured guaranteed notes indicates superior recovery prospects. ($950 million of unsecured notes are guaranteed on a senior unsecured basis by certain of USG's domestic subsidiaries.) Fitch's 'RR4' for USG's senior unsecured notes that are not guaranteed by the company's subsidiaries indicates average recovery prospects for holders of these debt issues. Fitch applied a going concern valuation analysis for these RRs. Fitch used a mid-cycle EBITDA of $350 million, which is equivalent to the average EBITDA reported by the company during the 2002-2014 periods, excluding the high point reported in 2006 and the low point reported in 2008.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 12 Jun 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=867275

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=994413

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=994413

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings, Inc.
Primary Analyst
Robert Rulla, CPA
Director
+1-312-606-2311
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Robert Curran
Managing Director
+1-212-908-0515
or
Committee Chairperson
Michael Paladino
Managing Director
+1-212-908-9113
or
Media Relations
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings, Inc.
Primary Analyst
Robert Rulla, CPA
Director
+1-312-606-2311
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Robert Curran
Managing Director
+1-212-908-0515
or
Committee Chairperson
Michael Paladino
Managing Director
+1-212-908-9113
or
Media Relations
Sandro Scenga, +1-212-908-0278
sandro.scenga@fitchratings.com