Volatile market conditions create winners and losers, and Owens Corning's (OC 2.10%) latest move will put it in one of those two camps. Does it make sense to take on debt to buy a company in a declining market? That's the question facing Owens Corning investors as they digest the agreement to acquire residential door company Masonite International (DOOR -0.11%). I think the answer is "yes," and it's based on the company's history of cash generation.
Introducing Owens Corning
You don't have to buy technology stocks to enjoy soaring returns, and Owens Corning is far from a high-tech company. The building and construction materials company operates three segments with a heavy focus on the residential housing market.
The roofing segment makes laminate and strip asphalt roofing shingles. Its demand is driven by residential repair and remodeling work, but it is also exposed to new housing construction and has highly variable sales caused by storms and extreme weather events.
The insulation segment helps improve building efficiency and heating/cooling in the home; its demand tends to follow housing starts and conditions in the housing market. Finally, the composites business has a mix of end markets including building and construction (keeping in the theme of housing exposure), and also reinforcements for wind energy, industrial, consumer products, and infrastructure.
The Masonite deal
Given Owens Corning's heavy exposure to the U.S. housing market -- 51% of its sales in 2022 went to the U.S. residential market in 2022, with the U.S. commercial and industrial market contributing a further 19% -- the agreement to acquire door company Masonite makes sense as it should enable Owens Corning to generate cost savings from merging the two companies.
Image source: Getty Images.
For reference, Masonite generates 80% of its sales from the North American residential market, and Owens Corning expects to generate $125 million in cost synergies from the deal via sourcing/supply chain initiatives and shared selling, general, and administrative costs. Moreover, now customers can buy their roofing, insulation, and doors from one source.
In addition, management is undertaking a strategic review of its glass reinforcements business (as discussed above in the composites section), so don't be surprised if it's sold to increase the company's focus on the housing market.
The details of the deal:
- A $3.9 billion acquisition, at a 38% premium to the share price before the announcement, with Owens Corning taking on $3 billion in debt financing.
- The debt will take Owens Corning to a net debt-to-earnings before interest, taxation, depreciation, and amortization (EBITDA) multiple of 2 to 3 times EBITDA, dropping to around 2 times at the end of 2024.
- The deal values Masonite at an enterprise value (market cap plus net debt) of 8.6 times adjusted EBITDA, or around 6.8 times adjusted EBITDA, including the assumed $125 million in synergies.
Three reasons the deal makes sense
I think it's an attractive deal. First, Owens Corning and, to a lesser extent, Masonite both have good track records of generating free cash flow (FCF), and FCF will be used to pay down debt.
OC Free Cash Flow data by YCharts
Second, while the U.S. housing market continues to face challenges due to the interest rate hikes over the last couple of years, it may start to bottom in 2024. To be clear, housing market forecasters like the Joint Center for Housing Studies at Harvard University forecast U.S. remodeling spending to decline from $481 billion in 2023 to $450 billion in 2024. However, they are also predicting that an inflection point in four-quarter trailing spending will occur in the third quarter of 2024. If that continues, then year-over-year remodeling spending could turn positive in 2025. In addition, recall that the deal will be completed in mid-2024, and it will take a while before the businesses are fully integrated.
Third, while the housing remodeling market is currently weak, this is often the best time to do such deals. Owens Corning's management understands that its end markets are interest rate sensitive and, therefore, cyclical -- and companies with good financial standing and cash flow generation often use such conditions to make strategic acquisitions in markets they are convinced will recover.
Image source: Getty Images.
A stock to buy?
The deal increases Owens Corning's exposure to the U.S. housing market, and the possible sale of its glass reinforcement business will do so even more. Still, suppose you are bullish on the housing market's long-term growth prospects and are willing to tolerate some near-term risk due to its current weakness. In that case, this looks like a good deal, particularly as the company's excellent cash flow generation enables it to take on leverage to buy a strategic asset.
