How the Japanese Earthquake Could Favor United States Gypsum

If you’re making a list of stocks that have seen the highest highs and the lowest lows, United States Gypsum (USG) – the largest gypsum products manufacturer in North America – should be on it. The company declared bankruptcy in June 2001, its second in 10 years, to stem a tide of asbestos litigation for sales dating back over 60 years.[i] Falling to $3.65 a share on June 25, 2001, the day of the Chapter 11 filing,[ii] the company engineered a rare recovery from bankruptcy that preserved common shareholder equity. Buoyed by the red-hot construction market and price rises for its gypsum wallboard products from shortages generated by Hurricane Katrina reconstruction, the stock hit $121.70 by the second quarter of 2006.[iii] But as housing hemorrhaged the shares declined to a 2009 low of $4.16. Though reaching back to $25.59 in April 2010, now they’re in the $15-$17 range.

Pre-earthquake: A well-managed company hoping for a cyclical recovery

Without the earthquake in the picture, USG is essentially a cyclical value play. Common sense says that the U.S. housing and construction industries will eventually recover, boosting demand for USG’s gypsum products. The thesis is strengthened by the historical quality of USG’s management, having successfully guided the company’s recovery from Chapter 11.

But some of the metrics are dismal enough to make even the heartiest investors queasy. In 2010, the company sold 4.2 million square feet of wallboard, less than half the volume for the average year between 1999 and 2008,[iv] and management realizes that a real recovery would involve doubling or tripling these quantities.[v] Concepts of investor diversification in the post-financial crisis world don’t favor the shares either – investment houses with mortgage portfolios and retail investors who own a home alike may be reluctant to invest in a stock tied to housing to avoid overexposure to the sector.

The Tohoku earthquake factor

Basic demographic analysis shows the potential for the Tohoku earthquake and resulting tsunami to impact the world market for gypsum construction materials. Here are some key factors that relate to Japan’s wallboard consumption and the earthquake:

• Like in the U.S. and Australia, Japanese construction is gypsum-intense due to processes that favor the use of wallboard partitions, in contrast to lower demand for gypsum products in Western Europe, where masonry partitions are preferred.[vi]

• Japanese gypsum mine production in both 2008 and 2009 was 5.8 million metric tons.[vii] In both 2005 (when Katrina occurred) and 2006, U.S. mine production was 21.2 million metric tons (by 2009 it had fallen to 9.4 million), making the comparable U.S. figure 3.7 times higher.[viii]

• The Japanese population was reported as 125.8 million in October 2010,[ix] while the U.S. population was 288.4 million in 2005, when Katrina occurred, making the U.S. number 2.3 times higher.[x]

• Early reports say that rebuilding spending in Japan will far exceed that of Katrina, with a World Bank estimate putting the damage at $122 to $235 billion, in contrast to $81.2 billion for Katrina.[xi] Japanese government estimates are reported as running as high as $308 billion.[xii]

These factors show that U.S. gypsum production per capita during Katrina reconstruction was greater than Japan’s at present since while the U.S. population was about 2.3 times that of Japan’s today, U.S. gypsum production at the same time was 3.7 times Japan’s. This suggests that Japan is fundamentally more reliant on external sources for gypsum products than the U.S., and therefore more vulnerable than the U.S. to gypsum supply shortages during a massive reconstruction effort.

Moreover, the damage incurred by the earthquake appears to be a multiple of that caused by Katrina, and it’s hard to imagine with this magnitude of damage to infrastructure that Japan could ramp up (or even maintain its usual) wallboard production levels soon enough to avoid shortages. Thus, Japan could eventually experience a greater squeeze in gypsum product supply from the earthquake than the U.S. did from the hurricane.

Finally, many Katrina victims are now suffering the consequences of defective Chinese drywall imported during the rebuilding shortages,[xiii] which may also weigh in favor of North American suppliers.

Conclusion: the earthquake favors USG’s business

So far, the market has not recognized the potential for the earthquake to help USG, with the company’s shares in basically the same place ($16.06 at March 22 market close) as the last close before the earthquake ($16.40 on March 10). This is not surprising since demand for construction products cannot be expected to rise until the damage has been assessed and rebuilding plans laid – right now the response is naturally concentrated on providing victims with basic needs and controlling the nuclear energy situation. Also, additional demand from the earthquake cannot be expected solve USG’s problems over the long term if the weak U.S. housing market drags on, and there’s no guarantee that it won’t.

But for investors who are ready to bet on a cyclical housing recovery, USG’s shares hold the additional prospect of gain from the earthquake, mitigating some of the risk.

Disclaimer: The information provided in this post does not constitute professional investment advice, and should only be used in consonance with all available information, including the opinion of a professional adviser, to make an investment decision.

Notes:

[i] See Reference for Business, "USG Corporation - Company Profile, Information, Business Description, History, Background Information on USG Corporation," here.

[ii] See June 25, 2001 Reuters report, "U.S. Gypsum Files Chapter 11," posted on Mesothelioma Empowerment, here.

[iii] See Edgar-Online, here.

[iv] See "United States Gypsum Company Wallbopard Realized Price & Shipments" (chart) on USG’s Investor Relations web site, here.

[v] See Seeking Alpha, January 26, 2011, "USG's CEO Discusses Q4 2010 Results - Earnings Call Transcript," here.

[vi] See Lafarge’s (LFRGY.PK) corporate web site, here.

[vii] See the U.S. Geological Survey’s web site, here.

[viii] See the U.S. Geological Survey’s web site, here.

[ix] See Foxnews.com, "Japan population shrinks by record in 2010," January 1, 2011, here.

[x] See the U.S. Census Bureau’s web site, here.

[xi] See washingtonpost.com, "World Bank estimates Japan damage up to $235 billion; smoke rises from nuclear plant," March 21, 2011, here. See also Bloomberg, "3M (MMM) Says Japan Disaster Recovery May Exceed Katrina Spending," (symbol added to title) March 17, 2011, here.

[xii] See "Japan Sees Quake Damage Reaching Up to $300 Billion, cnbc.com, March 22, 2011, here.

[xiii] See Cleveland.com, "Tainted Chinese drywall emits sulfur, creates a second Katrina disaster for rebuilt homeowners," April 12, 2009, here.

Disclosure: I am long USG. I do not hold positions in Lafarge (LF) or 3M (MMM) (mentioned in sources).