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Morningstar | Improving U.S. housing market and composites demand should drive better margins for Owens Corning.

Owens Corning, a leading manufacturer of fiberglass insulation, roofing shingles and components, and glass fiber composites, took a beating as a perfect storm of the steepest housing contraction in U.S. history and the mistimed emergence of Chinese glass fiber capacity hit in the late 2000s. However, the firm is well on the path of recovery, as operating margins have improved from 2.9% in 2012 to 12.8% in 2017.Although tough competition and Owens Corning’s high capital intensity and fixed costs make it difficult for the firm to generate sustainable excess returns over the business cycle, we see an opportunity for the company to earn economic profits over the coming decade as the U.S. residential construction activity strengthens and growing demand for glass fiber composites is met with limited capacity additions, which should support better pricing.We think Owens Corning’s most profitable roofing business has the strongest competitive advantages, and we think the segment can maintain operating margins in the high teens to low 20s over the next decade, thanks to favorable new construction and replacement activity, as well as a growing mix of high-margin roofing components sales. The insulation business, which has a less flexible operating model than roofing and is more dependent on capacity utilization, averaged 15% operating margins between 1985 and 2008, but margins fell off a cliff during the housing recovery and have yet to exceed 10% over a full year. We remain bullish on the long-term outlook for new residential construction, and we think increased housing starts, paired with stricter building codes (which require more insulation), will result in better capacity utilization and allow the insulation business to achieve double-digit operating margins. In recent years, Chinese glass fiber composite capacity additions have slowed, leading to capacity utilization rates at or above 90%. We expect that growing end-market demand and Owens Corning’s continued product innovation will support better pricing, while the company’s investments in a low-cost manufacturing network and partnerships with Chinese manufacturers will lower its cost structure.