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Morningstar | Owens Corning's Insulation Business Carried the Firm's 2018 Results; 2019 Outlook Subdued

Despite beating Wall Street's fourth-quarter revenue and EPS expectations, shares of no-moat-rated Owens Corning fell about 5% on Feb. 20, likely due to a 2019 outlook that was less optimistic than the market had been hoping for. Owens Corning's reported fourth-quarter revenue increased over 7% year over year to $1.7 billion, which was about 2% above the consensus estimate, and the firm's adjusted EPS increased 24% to $1.38 versus Wall Street's expectation of $1.27.

Owens Corning's fourth-quarter and full-year performance relied heavily on the strength of its insulation business, which itself was supported by the segment's two recent acquisitions, Pittsburgh Corning and Paroc. Based on our calculations, excluding the contribution from acquisitions, Owens Corning's consolidated fourth-quarter revenue declined about 0.5% (versus 7% reported) and its full-year revenue grew a meager 1% (versus 11% reported). In addition, insulation was the only segment that managed to expand its operating margin each quarter in 2018 thanks to strong price realization and the Paroc acquisition. The insulation segment's full-year operating margin expanded 190 basis points year over year to 10.7%, while composites segment operating margin contracted 180 basis points to 12.3% and roofing segment operating margin fell 360 basis points to 17.4%.

While management offered broad views on key end markets in 2019, they discontinued the practice of providing full-year EBIT targets for the composites and insulation segments. If management's outlook plays out like they expect, we think revenue growth and margin expansion could be muted in 2019. As such, we expect to temper our near-term growth and profitability assumptions, which we anticipate will modestly lower our fair value estimate. Still, our longer-term outlook remains unchanged. Like management, we too don't believe housing has peaked, and we like the insulation segment's longer-term growth and margin improvement prospects.

In 2019, management expects better residential insulation pricing will offset the unfavorable effect of lower volume and the shutdown of a production line in California. However, the firm expects Owens Corning's technical and nonresidential insulation products to contribute earnings growth in 2019. Moving to the composites segment, the company expects the business to grow in line with global industrial production that could be negatively affected by a more uncertain economic environment. Management also expects inflation to be a headwind for the composites segment in 2019. Finally, management expects flat demand for roofing shingles in the United States but believes the business can take market share in 2019.