Fitch's Recovery Rating (RR) of 'RR1' on USG's $500 million secured revolving credit facility and $300 million unsecured notes indicates outstanding recovery prospects for holders of these debt issues. (The $300 million unsecured notes are guaranteed on a senior unsecured basis by certain of USG's domestic subsidiaries.) Although the senior unsecured notes are effectively subordinate to the company's secured debt, including the $500 million secured revolving credit facility, the recovery prospects for both of these debt classes are similar given USG's strong asset coverage. Fitch's 'RR4' on USG's senior unsecured notes that are not guaranteed by the company's subsidiaries indicates average recovery prospects for holders of these debt issues. Fitch applied a liquidation analysis for these RRs.

The rating for USG is based on the company's leading market position in all of its businesses, strong brand recognition, its large manufacturing network and sizeable gypsum reserves. Risks include the cyclicality of the company's end-markets, excess capacity currently in place in the U.S. wallboard industry, volatility of wallboard pricing and shipments and the company's high leverage. While Fitch expects to see moderate improvement in housing metrics as well as home improvement spending in 2010, these will likely be offset by the continued decline in commercial construction spending. (Roughly 1/3 of the company's sales are directed to the new commercial construction market.)

Within this environment, selling price increases for its gypsum wallboard product may be challenging. Nevertheless, the Stable Outlook reflects USG's solid liquidity with $700 million of cash (on a pro forma basis, inclusive of receipt of the $80 million initial payment from the recent settlement with Lafarge North America) and $175 million of availability under its revolving credit facilities in the U.S. and Canada, which should give the company financial flexibility to deal with weak underlying demand for its products in the intermediate term.

USG markets its products primarily to the construction industry, with approximately 27% of the company's 2008 net sales directed toward new residential construction, 35% derived from new non-residential construction, 36% from the repair and remodel segment (commercial and residential) and 2% from other industrial products. In the past, earnings stability in the building materials segment has been driven by end-market diversification - historically, weakness in residential demand has been largely offset by commercial/industrial strength and/or repair and remodel spending. This has not been the case in 2009, wherein most of USG's end-markets are in decline simultaneously although at different stages of correction. Recent statistical and anecdotal information point to a bottom for U.S. housing, though early-stage recovery will be more muted than average. Fitch projects total housing starts to fall 41.4% in 2009 and increase 15.1% in 2010 to 610,000 homes. During the first 12-15 months from this bottom, the recovery may appear jaw-toothed as substantial foreclosures now in the pipeline present as distressed sales, and as meaningful new foreclosures arise from Alt-A and option adjustable-rate mortgage resets. Home improvement spending is projected to fall by 8.3% in 2009 (the third consecutive year of decline) but is anticipated to improve 3.5% next year. A pick-up in home sales, particularly in existing home sales, combined with a strengthening economy should lead to higher spending on home renovations in 2010. Commercial construction started to weaken earlier in 2009, and the rate of decline is expected to intensify next year. Fitch currently projects private non-residential construction spending (as measured by the Census Bureau) to decline 10% in 2009 and 14.5% in 2010.

Shipments and market prices for the company's building products (particularly wallboard) historically have been volatile and cyclical. USG's latest 12 months (LTM) wallboard volume is down approximately 56.4% from its peak (the second half of 2005 through the first half of 2006), and pricing has declined 38.8% from a high of $188.37 per thousand square feet during third-quarter 2006 (3Q'06) to $115.33 during the 3Q'09. Industry capacity utilization rates were in the low 50% range during the third quarter of 2009 and are likely to stay low as demand remains weak across most end-markets. During the second half of 2008 and early in 2009, certain gypsum wallboard manufacturers reported higher sequential pricing despite lower volume trends and dropping capacity utilization rates. That trend reversed during 2Q'09 as manufacturers reported lower wallboard prices compared to 1Q'09. During the third quarter, wallboard manufacturers once again reported lower sequential prices compared to the previous quarter. USG reported 0.8% year-over-year growth in wallboard pricing during the third quarter following a 10% increase during the second quarter and a 16.3% improvement during 1Q'09. However, the company reported a 4.5% drop in average wallboard price on a sequential basis during the third quarter compared to the second quarter. This is the second consecutive quarter that the company has reported lower pricing on a quarter-over-quarter basis after reporting sequential pricing increases for four consecutive quarters. Fitch expects this trend to continue during the fourth quarter as demand continues to be sluggish and input costs remain stable.

USG's ratio of debt to earnings before interest, taxes, depreciation and amortization (EBITDA) as calculated by Fitch remains very high at 25.8x, although this ratio has improved sequentially each quarter this year despite lower revenues. (The company's debt to EBITDA was 33.3x for the LTM from Sept. 30, 2008.) Through the first nine months of the year, revenues are down 30.7% due primarily to 35% lower wallboard volumes, offset in part by a 9.2% increase in average wallboard prices. Since 2007, USG has implemented restructuring initiatives related to workforce reductions and plant shutdowns/closures. The benefits of these cost reduction initiatives are already evident. Through the first nine months of 2009, the company recorded an operating loss (before restructuring charges and impairments) of $82 million compared to a loss of $101 million during the same period last year despite sales being $1.1 billion lower this period. The benefits of these initiatives are likely to be more apparent when demand picks up. Fitch expects operating margins to continue to improve next year, although they are likely to stay in negative territory. Given the weak margins, the company will be challenged to generate free cash flow in 2010.

The company currently has solid liquidity, with $621 million of cash and $175 million of availability under its revolving credit facilities in the U.S. and Canada as of Sept. 30, 2009. USG has no major debt maturities until August 2014, when $300 million of senior notes mature. Most recently, the company announced that it entered into an agreement with Lafarge North America resolving certain disputes between the parties that had been the subject of a lawsuit. (In 2003, USG filed a lawsuit alleging that Lafarge misappropriated its trade secrets and other information through hiring certain USG employees and that Lafarge infringed on one of its patents regarding a method for producing gypsum wallboard.) Under the terms of the agreement, USG will receive $105 million and will grant a fully paid-up license for the use of certain USG technologies. The company will receive $80 million this week and will collect the remaining $25 million in December 2010. This settlement further strengthens the company's liquidity position, with its cash balance rising to about $700 million on a pro-forma basis.

The company had upgraded its manufacturing base (replacing older, higher cost plants with new, low-cost facilities) during the past few years. Capital expenditures (capex) totaled $460 million in 2007 and $238 million in 2008. This year, USG is on track to spend $50 million on capex. Management feels that it can spend at this level again next year, given that about 50% of the company's wallboard capacity is eight years old or newer.

USG is the largest producer of gypsum wallboard in the U.S., eastern Canada and Mexico. In the U.S., its largest market, it is estimated that USG has a market share of roughly 26%. Its Canadian operation, CGC Inc., is the largest manufacturer of gypsum wallboard in eastern Canada and USG Mexico is also the largest manufacturer in Mexico. The company's products include well recognized brand names such as SHEETROCK, DUROCK, and FIBEROCK. USG's building products distribution business, marketed as L&W Supply, is the only specialty gypsum dealer with a national presence. In 2008, it is estimated that L&W Supply distributed approximately 12% of all gypsum wallboard in the U.S., including 36% of U.S. Gypsum's wallboard production. USG is also the world's largest manufacturer of ceiling grids and the second-largest manufacturer/marketer of acoustical ceiling tiles.

Established in 1902, USG Corporation is a vertically integrated manufacturer and distributor of building materials that are used in new residential, new commercial and repair & remodel construction, as well as certain industrial products.