An industry that refuses to be walled in

As the supply of wallboard has tightened, prices have risen, creating some compelling investment opportunities, according to Fidelity's Jennifer Fo Cardillo.

• Amid a decline in wallboard capacity and a shortage of synthetic gypsum, Fidelity Portfolio Manager Jennifer Fo Cardillo believes that the leading manufacturers and distributors of this essential construction material are positioned to benefit from a favorable pricing environment.
• "I am enthusiastic about companies leveraged to the production of wallboard due to the constrained supply of gypsum, a key raw material input," says Fo Cardillo, who co-manages Fidelity Advisor^® Stock Selector Small Cap Fund, alongside Shadman Riaz, Patrick Venanzi and Eirene Kontopoulos.
• In helming the core U.S. small-cap equity strategy, the managers emphasize higher-quality companies with an established and durable competitive moat that can compound and help the firm become a larger, more-profitable business over time.
• Fo Cardillo says she focuses on investment themes that are not fully appreciated by the broader market, including firms that stand to benefit from supply-constrained markets and improved industry structures.
• Gypsum is a key input for wallboard production, she explains, yet no real substitute for the material exists. About half of the current wallboard supply comes from synthetic gypsum, with the other half coming from its natural counterpart, she adds.
• Yet, as existing coal plants are retired, the supply of synthetic gypsum—a byproduct of coal production—is expected to decline, according to Fo Cardillo. This dynamic has been pushing up both costs and prices for wallboard.
• For example, she notes that importing or transporting natural gypsum adds between $30 and $100 per ton to the cost of wallboard, compared with a current per-ton industry profit of $40 to $60.
• "What's more, the industry has consolidated, leaving only four main players, which together control 85% of the wallboard market," she says. "I believe these dynamics should support a favorable pricing environment and provide a tailwind to certain stocks within the portfolio."
• Among them is building-products distributor GMS, which derives as much as 45% of its profit from wallboard production, according to Fo Cardillo.
• Another notable position (as of September 30) is wallboard manufacturer Eagle Materials, which she sees as a potential outsized beneficiary of current trends due to the company's standing as a low-cost provider.
• Fo Cardillo also notes that about three-quarters of Eagle's capacity is tied to natural gypsum reserves owned by the company, while the remaining 25% is secured through a long-term agreement that guarantees supply to Eagle.
• "Shares of GMS and Eagle are trading at what we believe are reasonable valuations based on near-term earnings that remain below the midpoint of the typical business cycle," she concludes.