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Gypsum Sales Chalk Up Improvements

Makers of gypsum wallboard have seen a pickup in business in recent quarters thanks to improving construction markets as well as a more aggressive pricing strategy among manufacturers.

The momentum should continue into the next couple of years, analysts estimate, as a rise in both residential and nonresidential construction continues ratcheting up demand for wallboard, a key material in just about any building.

The two biggest publicly traded wallboard suppliers — Eagle Materials (EXP) and USG (USG) — have both seen sales and earnings increase the last couple of years following a long downturn that began in 2008, when the housing industry got knocked for a loop by the financial crisis and recession.

Continental Building Products (CBPX), which went public in February, has delivered robust revenue gains in recent quarters.

Analysts reckon the wallboard industry will continue growing, despite recent data pointing to continued hiccups in the U.S. housing market's recovery.

Sales of new homes, a key wallboard market, fell 14.5% in March, the Commerce Department reported Wednesday. It was the second straight monthly decline and the lowest rate since July.

A week earlier, the Commerce Department said the rate at which builders started work on new homes in March increased a healthy 2.8% over February. But applications for permits — a measure of future activity, not to mention drywall demand — slowed 2.4%.

That kind of mixed reading has kept analysts cautious in their assessment of the housing market's impact on demand for wallboard.

"Our position is that there will be a shallow recovery in housing, with bumps along the way," said Kathryn Thompson, director of research at Thompson Research Group. "There's not going to be a straight line up for the construction markets or the wallboard market. There will be some peaks and valleys.

Todd Vencil, analyst at Sterne Agee, said the housing industry last year saw less than 1 million new starts.

"That's still at a trough," he said. "We are coming out of an historic monster recession, so we are looking at several years yet of slow grinding recovery.

The market for commercial construction is similarly mixed. While there are bright spots — including rising demand for industrial facilities and certain types of office properties — overall market growth has been sluggish.

While progress is back and forth, there's no question that gypsum wallboard suppliers are in a lot better shape now than a few years ago. Shipments, revenue and profits are all on the rise.

"The positive changes in volume began in the latter part of 2012, driven by the housing rebound for both single and multi-family homes," Thompson said. "Now they are getting the benefit of nonresidential construction as well.

The gypsum industry has also benefited from a change in pricing strategy spearheaded by Eagle Materials in 2011.

During the fall of that year, the company announced it would raise prices 35% on Jan. 1, 2012, then not raise them again for the rest of the year.

The bold move completely flipped the script on how prices had traditionally been set.

Previously, wallboard suppliers made numerous price adjustments during the course of a year based on a constellation of factors, like how busy their plants were and how much customers were willing to pay for a particular job.

"It was very ad hoc," Vencil said.

Eagle instituted its one-time change for the entire year, hoping to bring more stability to the process and to transfer more risk from the suppliers to the distributors.

The change might not have made much difference if other suppliers didn't follow suit. But they did.

"As it happened, within a couple of months all the other competitors announced price increases on basically the same terms," Vencil said. "The other competitors thought it was a good idea.

Prices have been rising steadily ever since.

In 2013, USG's realized selling price for its Sheetrock brand of wallboard climbed 17% from a year earlier. Eagle's average gypsum wallboard net sales price rose 19% during its fiscal third quarter, which ended in December. Continental Building saw a 13.8% increase in the average wallboard mill net price during its 2013 fourth quarter.

1. Business

Gypsum wallboard, also called drywall or plasterboard, is cut into panels and used to create walls. It has a paper facing, a high moisture content and is more fire-resistant than materials such as plywood and fiberboard.

Wallboard producers sell to large home improvement retailers such as Home Depot (HD) and Lowe's (LOW). They also sell to smaller independent retailers, wholesale distributors and construction companies.

The big players don't depend on gypsum wallboard for all of their business. In fiscal year 2013, Eagle Materials got 39% of its revenue from gypsum wallboard and an equal percentage from its cement business. The rest came from recycled paperboard and concrete/aggregates.

USGgot about 53% of its 2013 revenue from its gypsum unit. The rest came from other construction materials as well as ceiling and tile products. Its biggest customer is Home Depot, which accounted for about 15% of overall revenue last year.

Continental Building is much more of a pure play, with about 95% of its business coming from wallboard.

One thing they share in common: all wallboard suppliers have recently been on a roll.

Eagle has run off nine straight quarters of double-digit sales and EPS growth after reporting lower sales four straight years from fiscal 2008 through 2011.

Last year USG logged its first annual profit since 2007, while revenue rose 11%. The company shipped 5.14 billion square feet of Sheetrock in 2013, up 9% from the previous year.

Continental Building, formerly Lafarge Gypsum, grew its annual sales 29% last year and 24% in 2012.

2. Market/Climate

Suppliers of gypsum wallboard in the U.S. belong to a pretty exclusive club. There are only eight of them.

The three biggest are USG, privately held National Gypsum, and Georgia Pacific, which is owned by Koch Industries. Those three accounted for an estimated 60% of wallboard sales in the U.S. last year, according to a regulatory filing from Eagle Materials.

Around 20.5 billion square feet of gypsum wallboard was shipped in the U.S. last year, analyst Vencil says. That is equal to 735 square miles — more than enough to cover the combined areas of Los Angeles and Chicago. It was up from a low of 17.2 billion in 2011, but still well shy of the 36.2 billion shipped as recently as 2005.

Much of the recent growth has been driven by the repair and remodeling market, Vencil says. One gypsum supplier he met with recently said about half of its current business comes from the repair/remodel market. Another 35% came from non-residential construction and 15% from new residential construction.

"In a normal market the percentage would be about 40% new residential," Vencil said. "New residential construction has come back somewhat, but it still has a long way to go.

Meanwhile, wallboard demand for non-residential construction will be driven by the industrial sector, Thompson says.

"The energy sector is a very big part of that right now, so you will see demand for warehouses," she said. "There will be also be some new office buildings and retail. But it will be more driven by growth in industrial.

3. Technology

The biggest technological trend in the gypsum wallboard industry in recent years has been the adoption of synthetic gypsum, made from byproducts of energy generation or industrial waste.

Although synthetic gypsum has been around for a couple of decades, production "really picked up in the mid-2000s," Vencil says.

That's mainly because a lot of synthetic gypsum comes from flue gas at coal-fired plants, stripped out by emissions scrubbing equipment. Most of those sources are located in the eastern half of the country, a region where natural gypsum minerals are in short supply. For these companies, it is more cost efficient to make synthetic gypsum than to ship minerals in from the western U.S.

Continental manufactures only synthetic gypsum drywall. USG says about 35% of the gypsum used in its plants last year was synthetic, with production at six of its 19 plants entirely based on the synthetic material.

Another recent trend has been a rise in demand for lightweight wallboard. Pioneered a few years ago by USG with its Sheetrock UltraLight panels, the panels weigh less and are easier to work with and transport than standard wallboard.

Still, gypsum wallboard is a pretty old product — dating to the 19th Century. Producers are always looking for new ways to improve it, says Stephen Meima, deputy executive director of the Gypsum Association, an industry trade group.

"Our members are continually innovating on the manufacturing side and on the product side," he said.

Much of the current innovation focuses on green and sustainable wallboard products, he says, as well as software tools that help architects and designers analyze the life cycle costs of wallboard.