The road has been long, winding, and potholed for USG Corp. (USG), a leading manufacturer and distributor of residential and commercial materials (best known for its ubiquitous Sheetrock wall-siding brand).
In July 2001, the company declared Chapter 11 bankruptcy to manage intractable asbestos litigation costs.
In the prior eight years, USG had been named in more than 250,000 asbestos-related personal injury claims and had paid more than $450 million (before insurance) to resolve asbestos-related litigation.
Five years later, in Feb. 2006, USG announced a reorganization to emerge from Chapter 11. Under the court-approved plan, all present and future asbestos personal injury claims against the company have been permanently channeled to an independent personal injury trust that is responsible for administering and paying claims.
As part of the plan, USG's bank lenders, bondholders, and trade suppliers would be paid in full with interest. Stockholders would retain ownership of the company. To fund the trust, USG will use accumulated cash, new long-term debt, and a $1.8 billion rights offering.
In the recently completed offering, existing USG stockowners received rights to buy new USG stock at $40 per share. The offering was backstopped by Berkshire Hathaway Inc. (BRK.A), meaning Berkshire Hathaway was responsible for purchasing any unbought shares, which it did to the tune of 6.97 million shares (raising its stake to 17.3% of shares outstanding).
Today, litigation is behind USG, and its stock trades around $46, a 44% discount to its rights-adjusted high of $80 set back in April.
What happened? Now that litigation woes are in the rearview mirror, investors are looking ahead to economic reality: USG's business is cyclical. Its fortunes are tethered to the level of new commercial and home construction (which have been terrible), re-sales and home improvements (which have slowed), and raw-material costs (which have ballooned).
However, USG is demonstrating some chutzpah in this tough environment. It recently reported second-quarter profits of $176 million, or $1.97 a share, compared with $110 million, or $1.24 a share, in 2005. What's more, sales rose 22 percent to $1.57 billion, a new record.
Nevertheless, consensus estimates call for EPS to tumble 46 percent in fiscal year 2007; hence, the similar percentage drop in USG's stock.
Could the price drop be too much? I think so. Focusing on near-term problems obscures long-term investability. And long term, USG looks solid, at least based on a rudimentary net-present-value (NPV) calculation (any Warren Buffett investment begs for NPV).
I'm a conservative investor, so my beginning NPV calculation includes 2006 EPS of $7, a 35 percent annual two-year EPS contraction (I think the next two years could be rough), 4 percent annual EPS growth thereafter, and a 10% discount rate (Why 10%? It's a nice round number, it approaches the long-run return of the S&P 500, and it's a number John D. Rockefeller used in his business dealings).
Given the aforementioned inputs, I calculate a net present value of $48 per share, which admittedly, leaves little margin for error. But if I change the variables slightly to an equally reasonable 30% annual EPS contraction over two years and 5% EPS growth thereafter (to more liberally account for the Buffett factor, eventual industry improvement, management know how, and lack of litigation), I calculate a NPV of $67 per share.
Of course, I could plug in any inputs to make the NPV fit my objective, but USG has precedence on its side. Many companies – Halliburton (HAL), Altria (MO), American Express (AXP), and US Smokeless Tobacco (UST), for example – have proven that once the Damocles Sword of litigation is removed, exemplary shareholder gains follow.