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Why Owens Corning Soared 19.1% in January

Lee Samaha, The Motley Fool

What happened

Shares of roofing, insulation and composites materials company Owens Corning (NYSE: OC) rose 19.1% in January, according to data provided by S&P Global Market Intelligence.

The move can be put down to an improvement in sentiment toward the homebuilding products sector. After all, Beacon Roofing Supply (NASDAQ: BECN) gained 15%, while other housing stocks in the sector, such as ceilings company Armstrong World Industries (NYSE: AWI) and plumbing products company Masco (NYSE: MAS), also went up by double digits in the month.

There was a sense that the sector had been oversold on fears of rising interest rates choking off housing demand. Of course, these fears are founded in reality -- after all, Stanley Black & Decker (NYSE: SWK) management has already noted a slowdown in interest rate-sensitive sectors like housing in response to rising rates.

Asphalt roofing shingles.

Image source: Getty Images.

It's not so much that growth the home-improvement market will turn negative, rather that its growth is likely to be slower than previous expectations -- indeed, Owens Corning talked of lower-than-expected volumes across its three segments and reduced its full-year earnings guidance on its third-quarter earnings call in October.

When the market realized slower growth was coming, it sold off the sector aggressively in the last quarter of 2018, and January's positive reaction is probably down to investors hunting for value.

So what

The debate of the direction of the home-improvement market is probably best summarized in Harvard University's latest Leading Indicator of Remodeling Activity (LIRA) report. It discusses rising rates, slowing house price growth, and weak home sales activity as "deflating owner's interest" in making renovations. Moreover, signs of slowing in the housing market (homebuilding, remodeling permits, etc.) mean that "gains in renovation and repair spending to owner-occupied homes in the U.S. will shrink from 7.5 percent in 2018 to 5.1 percent in 2019," according to the report. 

This will obviously feed through into lower repair and remodeling demand for roofing and insulation -- not good news for Owens Corning or Beacon Roofing Supply. However, the question is whether investor expectations have now been reset and the bar has been lowered for these companies.

For example, if Owens Corning merely hits its already lowered guidance for adjusted earnings before interest and tax (EBIT) of $855 million, then its trailing enterprise value (market cap plus net debt)-to-EBIT multiple will be just 10.9 times.

That's a notably lower multiple than Owens Corning traded in the last period, when house prices were actually declining to 2012 levels.

OC EV to EBIT (TTM) Chart

OC EV to EBIT (TTM). Data by YCharts.

Now what

Investors will be hoping Owens Corning can hit its guidance, and will be looking for signs of stability in the housing market. The LIRA is still indicating growth in remodeling activity, and there's always the imponderable of the impact of storms and other weather-related events on roofing demand for Owens Corning and Beacon Roofing Supply.

If Owens Corning can meet its guidance and give a 2019 outlook for double-digit earnings growth that analysts expect and the remodeling market grows as anticipated, then the stock can appreciate significantly.

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Lee Samaha has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.