NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded the ratings of USG Corporation, including the company's Issuer Default Rating (IDR), to 'BB' from 'B+'. The Rating Outlook was revised to Stable from Positive. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The upgrade of the IDR to 'BB' reflects the company's improving operating and financial metrics, including the company's deleveraging strategy that is expected to result in debt/EBITDA between 2.5x and 3.0x by the end of 2016.
The rating is further strengthened by management's announcement that it has agreed to sell its distribution business for about $670 million (net cash proceeds of around $650 million) and will use part of the net proceeds to further reduce debt. Fitch projects the company's leverage will settle between 2.0x-2.5x on a pro forma basis following the sale of the distribution business and the expected debt reduction.
The rating for USG also reflects the company's leading market position in its core businesses, strong brand recognition, its large manufacturing network, sizeable gypsum reserves, and modest leverage levels. Risks include the cyclicality of the company's end markets, excess capacity that persists in the U.S. wallboard industry, and the volatility of wallboard shipments and pricing.
The Stable Outlook reflects Fitch's expectation that demand for USG's products will continue to grow in the near to intermediate term as the U.S. construction market maintains its moderate recovery. The Stable Outlook also incorporates USG's strong liquidity position.
SALE OF DISTRIBUTION BUSINESS
USG announced today that the company has signed a definitive agreement to sell its distribution business to ABC Supply Co. for $670 million. USG expects to use the net proceeds to reduce debt after the transaction closes and invest in its advanced manufacturing initiatives. For the latest-12-months (LTM) ending June 30, 2016, Fitch estimates that this business segment had sales of $1.47 billion and EBITDA of roughly $51 million. The company expects to close the transaction during the fourth quarter of 2016.
USG's distribution business consists of L&W Supply Corporation and its subsidiaries, a leading distributor of gypsum wallboard and other building materials in the U.S. L&W's core products are wallboard, ceilings, joint treatment, insulation, exteriors, steel and fasteners. Management estimates that about 70% of L&W's revenues are from non-wallboard products and about 50% are from non-USG products. USG's sales to legacy L&W Supply branches will be governed under a supply agreement and will be stepped down in an orderly manner over the near term.
In 2015, this segment serviced its customers from 142 distribution branches in the U.S. and distributed approximately 7% of all gypsum board in the U.S., including 30% of U.S. Gypsum's (USG's gypsum manufacturing segment) gypsum board production.
Overall, Fitch views this transaction positively as the loss of earnings from this business segment is more than offset by the debt reduction expected from the proceeds of the sale. Management indicated that it intends to use the proceeds to pay down debt and fund investments in its advanced manufacturing initiatives.
The distribution segment has also been slower to recover compared to USG's other businesses. This segment's operating margin during the LTM period was 2.7% compared with 16.4% for the gypsum operations and 19.8% for the ceilings business.
Additionally, the disposition of the distribution business lowers the company's overall exposure to the more volatile new construction market (residential and nonresidential). According to the company, about 65% of this segment's revenues were directed to the new construction market while 35% were to the repair and remodel segment. By comparison, the repair and remodel segment accounted for about 52% of USG's gypsum segment and 71% of its ceilings business. Management indicated that the divestiture of L&W reduces the volatility of USG's earnings by about 20%.
However, the sale of the distribution business also sets back management's goal of diversifying the sources of the company's earnings. That said, it is important to note that the sale of the distribution business eliminates some channel conflict (since USG will no longer own a distribution business that competes with other building products distributors) that will likely provide USG with new distribution points for its products. L&W had also in the past supported USG's strategy and served as a platform for the company's new product launches. Lastly, L&W's large customer base (about 35,000) provided USG with insights regarding this segment's commercial contractor customers, which helped drive USG's innovation efforts.
SUSTAINED IMPROVEMENT IN CREDIT METRICS AND CASH FLOW
USG's operating and credit metrics have shown sustained improvement over the past four years. Fitch-calculated EBITDA margins have increased from below 2% in 2010 to 16.9% for the June 30, 2016 LTM period.
Leverage has also declined significantly from EBITDA growth as well as debt reduction. Debt to EBITDA improved to 3.1x for the LTM period ending June 30, 2016 from 3.8x at year-end 2015, 4.5x at the conclusion of 2014, and 5.4x at the end of 2013. The company has committed to organically reducing debt by repaying its $500 million of senior notes maturing in November 2016. To date, the company has repurchased about $177 million of the notes and will repay the remaining balance at maturity. Excluding the sale of the distribution business, Fitch expects leverage will be between 2.5x and 3.0x at year-end 2016.
Fitch expects the company's leverage will settle between 2.0x-2.5x on a pro forma basis following the sale of the distribution business and the expected additional debt repayment.
USG has generated strong free cash flow (FCF) during the past 18 months. USG reported FCF of $387 million (10% of revenues) during the June 30, 2016 LTM period compared with $237 million (6.3%) during 2015 and $40 million (1.1%) during 2014. Fitch expects the company will generate between 6.5% and 7.5% FCF margins in the next few years.
IS THIS A CYCLICAL UPGRADE?
USG's financial results and credit metrics have benefited from the moderate recovery in overall U.S. construction activity, including the modest recovery in housing. Unlike previous housing recoveries, which tended to be V-shaped, this recovery has been more subdued and will likely extend longer than the typical three to five year upturn. Entering the fifth year of the recovery, Fitch projects total housing starts of 1.2 million, which is below the 1.5 million average housing starts reported between 1959 and 2000.
Fitch believes that the company's risk profile has been enhanced since the last severe construction downturn and should be able to sustain a 'BB' rating category through the cycle.
USG has taken steps to reduce its cost structure. For the LTM period ending June 30, 2016, the company reported EBITDA margin of 16.9% on $3.9 billion of revenues. By comparison, USG reported EBITDA margin 17% on revenues of $5.1 billion during 2005 and 19.8% EBITDA margin on $5.8 billion of revenues in 2006. The company achieved improved profitability despite lower construction activity and meaningfully reduced industry wallboard demand.
The Gypsum Association estimates that U.S. industry shipments of wallboard were 36.2 billion square feet in 2006 and 37.2 billion square feet in 2005. During 2015, industry shipments totalled 22.3 billion square feet. In the case of USG, the company's wallboard shipments totalled 5.44 billion square feet in 2015 compared with 10.8 billion square feet in 2006 and 11.3 billion square feet in 2005.
SOLID LIQUIDITY POSITION
As of June 30, 2016, the company had $479 million of cash, $208 million of short-term marketable securities, and $341 million of availability under the company's revolving credit agreement. The company's debt maturities are well-laddered, with about $389 million of its 6.3% senior notes maturing in November 2016 and $500 million of 7.75% notes maturing in January 2018.
The company expects to retire an additional $600 million of debt by calling notes due 2020 and 2021. USG's $250 million 7.875% notes due 2020 are callable at a price of 103.938 and the company's $350 million 5.875% notes due 2021 are callable starting on Nov. 1, 2016 at a price of 104.406.
Fitch's key assumptions within the rating case for USG include:
--Overall U.S. construction spending increases 7%-8% during 2016 and 2017;
--USG completes the sale of the distribution business;
--The company repays the remaining 2016 notes with cash on hand and reduces debt from the proceeds of the sales of the distribution business;
--Debt/EBITDA settles between 2.0x - 2.5x on a pro forma basis;
--USG generates FCF margins of 6.5%-7.5% during the next few years.
Additional positive rating actions may be considered if the company shows further improvement in credit metrics, including debt to EBITDA consistently below 2.0x, FFO adjusted leverage below 3.5x and interest coverage sustained above 7x and the expectation that the company can maintain metrics close to these levels through the cycle. Fitch will also consider USG's liquidity position in assessing positive rating actions.
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 and weaker metrics, including EBITDA margins of less than 12%, debt/EBITDA consistently above 3.5x, FFO adjusted leverage sustained above 4.5x and interest coverage below 6x.
FULL LIST OF RATING ACTIONS
Fitch has upgraded the following ratings for USG Corporation:
--IDR to 'BB' from 'B+';
--Secured bank credit facility to 'BBB-/RR1' from 'BB+/RR1';
--Senior unsecured guaranteed notes to 'BB+/RR2' from 'BB/RR2';
--Senior unsecured notes to 'BB/RR4' from 'B+/RR4'.
The Rating Outlook is Stable.
Fitch's RR of 'RR1' for USG's $450 million secured revolving credit facility indicates outstanding recovery prospects for holders of this debt issue. Fitch's 'RR4' rating 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.) The 'RR4' for USG's senior unsecured notes that are not guaranteed by the company's subsidiaries indicates average recovery.
Additional information is available on www.fitchratings.com
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation, restructuring charges, and cash distributions from USG's USG Boral joint venture. The equity in earnings from joint ventures is excluded in the calculation of EBITDA.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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