Fitch Affirms Owens Corning's IDR at 'BBB-'; Outlook Stable
KEY RATING DRIVERS
OC's ratings reflect the company's leading market position in all of its major businesses, strong brand recognition, and product, end-market and geographic diversity. Risks include the cyclicality of the company's end-markets.
The Stable Outlook reflects Fitch's expectation that overall demand for OC's products will grow modestly during the remainder of 2015 and into 2016 as construction activity in the U.S. maintains its moderate recovery. The ratings and Stable Outlook also incorporate OC's improving credit metrics and solid liquidity position.
LEADING MARKET POSITION
OC maintains a strong market position in all of its core businesses. According to company estimates, OC's roofing business is the second largest producer of asphalt roofing shingles in the United States. The company also indicated that it is the largest producer of residential, commercial and industrial insulation and the second-largest producer of extruded polystyrene foam insulation. The company's Owens Corning PINK FIBERGLAS insulation is a well-recognized brand name. OC's composites segment is also a world leader in the production of glass fiber reinforcement materials.
IMPROVING CREDIT METRICS
The company's credit metrics have improved over the past twelve months and are currently solid relative to the 'BBB-' rating level. Leverage as measured by Fitch-calculated debt to EBITDA was 2.4x for the latest-12-months (LTM) period ending Sept. 30, 2015 compared with 2.7x at the end of 2014 and 3.0x from a year ago period. EBITDA to interest was 7.9x for the Sept. 30, 2015 LTM period compared with 6.5x during 2014 and 6.5x for the Sept. 30, 2014 LTM period. Fitch expects debt to EBITDA will settle between 2.0x - 2.5x and EBITDA to interest coverage will remain above 7.0x by the end of 2015 and during 2016.
SOLID LIQUIDITY POSITION
OC has strong liquidity and is able to meet its financial obligations. As of Sept. 30, 2015, company had $62 million of unrestricted cash and $791 million of borrowing availability under its $800 million unsecured revolving credit facility. OC also had available capacity of $146 million under its $250 million accounts receivable securitization facility. Fitch expects the company will have continued access to these facilities as OC has sufficient room under the financial covenants required under its credit agreements. The company has no major debt maturities until December 2016, when $158 million of senior notes become due.
FREE CASH FLOW AND CAPITAL ALLOCATION STRATEGY
OC has generated minimal free cash flow (FCF: Cash flow from operations less capital expenditures and dividends) during the past few years. The company reported $22 million of FCF (0.4% of revenues) in 2014 compared with $65 million (1.2%) during 2013. OC generated negative FCF during 2011 and 2012. OC started paying dividends during 2014. For the LTM period ending Sept. 30, 2015, the company generated $324 million of FCF (6%), driven in part by positive working capital, which added $127 million to FCF during the period. Fitch expects OC will generate FCF margins of 2.0%-3.0% during the next few years.
The company is committed to an investment grade rating and maintaining investment grade financial strength is a pillar of its strategy. Management has demonstrated this commitment during this past U.S. economic and construction downturn by putting great emphasis on liquidity and maintaining discipline in deploying its cash. Fitch expects management will remain disciplined in prioritizing the use of its cash and FCF by continuing to invest in its business, finance acquisition opportunities and prudently return capital to its shareholders.
In February 2014, the company initiated a quarterly dividend of 16 cents per share. This equates to about $76 million of annual dividend payments. In March 2015, OC increased the quarterly dividend to 17 cents per share, payable in April 2015.
OC repurchased $120 million of its stock in 2010, $138 million in 2011, $113 million in 2012, $63 million in 2013 and $44 million in 2014. For the first nine months of 2015, the company repurchased $86 million of its stock. At Sept. 30, 2015 OC had 5.6 million shares remaining under its repurchase programs.
Fitch expects the company will continue with moderate annual share repurchases, financed primarily with FCF. Share repurchases will likely be moderated depending on the level of investment opportunities (internal growth or acquisition opportunities available to OC) and the macroeconomic outlook.
PRODUCT, GEOGRAPHIC AND END MARKET DIVERSITY
OC operates in three product groups: Composites (36% of 2014 sales), Insulation (32%) and Roofing (32%). OC markets its products primarily to the construction industry, with approximately 17% of the company's 2014 net sales directed toward new residential construction, 23% derived from new non-residential construction, 33% from the repair and remodel segment (commercial and residential) and 27% from its international operations. The company's activities in the U.S. are also diversified with manufacturing capacity across the country.
CYCLICALITY OF THE CONSTRUCTION MARKET
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, OC's sales fell 23% during 2007, expanded 17.5% in 2008 (due primarily to acquisitions), declined 17.9% in 2009 and rebounded 4% in 2010 and 6.8% in 2011. OC's Fitch-calculated EBIT margins fell 110 bps in 2007 and 190 bps in 2008 before rebounding 210 bps in 2009, 90 bps in 2010 and 50 bps in 2011. The increase in EBIT margins during 2009 was due to higher roofing margins resulting from stable selling prices and from deflation of asphalt prices (a key input for the roofing segment) during the year.
While the company's credit metrics weakened somewhat during this period, these metrics remained within a relatively narrow band. Between 2007 and 2011, OC's debt to EBITDA ranged between 2.25x and 3.60x while interest coverage was 5.0x or higher.
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 likely grow approximately 4.5% in 2015 and 2016.
Commercial construction spending has been robust, expanding 12.1% during the first eight 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.
VOLATILITY OF OC's ROOFING BUSINESS
OC's roofing business has been rather volatile over the past five years. During 3Q'15, roofing sales increased 5.9% and EBIT margins grew 830 bps to 20.5% as volumes grew and pricing remained relatively stable while asphalt prices fell year-over-year (asphalt deflation contributed $27 million of benefit or 540 bps). Through the first nine months of 2015, sales are down 0.7% while EBIT margins improved 100 bps compared with the same period last year. In 2014, sales fell 11.1% and EBIT margins were 630 bps lower compared with 2013. During 2013, sales were 2% less compared with 2012 but EBIT margins increased 320 bps year-over-year. Roofing sales fell 7% in 2012 and EBIT margins declined 340 bps.
While roofing demand is primarily driven by re-roof activity (about 75% of demand, on average), new construction (18% of demand) and storm-related activities (about 7% of market demand) have been quite variable during the past 10 years.
The structure of the industry has changed the past decade, becoming more concentrated, with four competitors accounting for roughly 90% of the asphalt shingle market. This compares with nine major competitors dominating the market during the 1990s. While the industry has generally demonstrated pricing discipline during the past 5 - 6 years, discounting was evident in 2012 and 2014 as shipments of roofing shingles declined during these periods. Manufacturers may continue to use pricing as a lever to gain market share as demand remains relatively weak. Nevertheless, the combined operations of the company have been relatively stable, with reported consolidated EBITDA margins between 10.5% and 14.5% over the past 10 years.
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-digit during 2015 and mid-single-digit in 2016;
--EBITDA margins of around 15% - 16% during 2015 and 2016;
--FCF margin of 2.0% - 3.0% during the next few years;
--Debt to EBITDA between 2.0x-2.5x and EBITDA to interest coverage above 7.0x during 2015 and 2016;
--No meaningful share repurchases with buybacks to primarily offset dilution from stock awards. Fitch expects the company may do moderate annual share repurchases, financed mainly with FCF.
Future ratings and Outlooks will be influenced by broad construction market trends, as well as company specific activity, including FCF trends and uses.
Positive rating actions may be considered if the company shows continuous progress and stability in its overall operating results, leading to sustained improvement in credit metrics (particularly debt to EBITDA levels approaching 2x and interest coverage above 7x), and maintains a robust liquidity profile (at least $500 million with a combination of cash and revolving credit availability).
Negative rating actions could occur 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 sustained materials and energy cost pressures resulting in margin contraction, leading to weaker than expected financial results and credit metrics (including EBITDA margins below 12%, debt to EBITDA consistently and meaningfully above 3.0x and interest coverage falling below 5.0x for an extended period). Additionally, Fitch may consider negative rating actions if the company completes a large debt-financed acquisition or undertakes a meaningful share repurchase program funded by debt, resulting in consistent debt to EBITDA levels meaningfully above 3.0x.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--IDR at 'BBB-';
--Senior unsecured debt at 'BBB-';
--Unsecured revolving credit facility at 'BBB-'.
The Rating Outlook is Stable.