USG reported earnings today, along with comparable Eagle Materials (EXP). USG has a roughly 30% share of the wallboard market, with Eagle in the high single digits.

Having beaten on both the top- and bottom-lines for the quarter, USG rallied 13% today, with the stock price increasing on pretty much a straight line; Eagle was flat after a fairly large EPS miss. From a purely operational standpoint, USG’s results were objectively poor but very good contextually. Wallboard volume shipments were down 11% quarter-over-quarter and plant utilization sits just under 70%; until capacity recovers into the mid-80%s, USG won’t have the operating leverage to put up big EPS numbers, and that day is still far off. Still, realized wallboard unit prices increased to $110 from last quarter – and while part of this is due to passing on cost pressures from energy and materials, this is a small positive for the industry as whole.

I say that these results are objectively bad because USG’s core segment is wallboard; and when pricing can barely match cash costs you know the environment is tough, and USG was really saved by its non-wallboard units. But you can’t blame USG’s management for the abysmal market they’re selling into, and if you look at the wallboard results from Eagle – volumes down 15% on a comparable basis, and average realized unit price at $90 – USG is positively shooting the lights out.
Eagle’s CEO Steven Rowley said a couple revealing things relevant to wallboard on their conference call, including the fact that Eagle’s recently instituted price increase is sticking, and they’re planning another round of price increases this summer. He also estimated that Eagle is operating at 65% plant utilization, but said that even with most of the new low-cost capacity already on-line, he sees the potential for industry-wide utilization to fall further… and that isn’t a good thing. Responding to a question on the degree of pain being felt in the wallboard industry where the lower-cost players are eating losses, Rowley said:

We don’t like it which is why we’re going to change the way we’re going to market. We’re going to reduce our presence and get back in the markets where we know we can make some money.

He then added that Eagle is “absolutely” willing to cut capacity, which I’m personally apathetic about. While USG and Eagle have the diverse business lines and profiles to attract the liquidity needed to post continued losses, I think the smaller players – i.e. Temple-Inland (TIN) – might not want to do that. If Temple-Inland comes out on their earnings call at the end of the month and says they’re cutting capacity huge, it will be an enormous net positive for the industry. Otherwise, all the players need to get together in a smoky room and fix price, because some continued incremental cutting isn’t going to shake out the excess capacity and weak hands.

Why do I say this? This is what USG is going up against:

It’s a real catch-22 between the new housing, existing housing, and financial players. USG’s forecast is that housing remains weak into 2009, and that view seems to slowly becoming the consensus. USG has a lot of headwinds between diesel and natural gas costs (hedged, but only out so far before they need to start rolling at higher prices), a terrible residential construction market, and a weakening outlook on the commercial side. Right now, the saving grace is the non-wallboard lines, particularly the ceilings business, which continues to set new records for profits.

The good news is that USG has an excellent management team that plans for the bad parts of cycles, executes on their plans, and generally controls what can be controlled. Right now, they are facing some terrible economics – and the economics tend to win. I’m confident, however, that when the cycle turns, USG will be the best positioned company in the industry. At present, however, my funds are going into the 7% notes from Primus (PRD) after some indecisiveness last week during the slaughter of the preferreds – not because I don’t have confidence in Bill Foote & Co., but because a five-year recovery timeframe would necessitate USG to be over $125/share for it to have a similar return potential.