Are These Ancillary Companies Worth a Closer Look?

Awais is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The housing markets are showing signs of recovery. As mortgage is the lifeline of the residential construction industry, the lower interest rates have compelled the sizable middle income groups of the United States to jump into the market for new homes. The commercial construction in the country is also increasing, which has been fueled by the recovering economy.

The recovery in the construction industry is making way for some robust investment opportunities in the country. Along with the major construction companies, we can also expect the sales of ancillary industries to show improvement in the coming period. Three companies which fulfill the criteria of the ancillary companies are Armstrong World Industries (NYSE: AWI), Masco (NYSE: MAS) and Fastenal (NASDAQ: FAST). Let’s discuss which one of them represents the best investment opportunity.

Low volumes and high margins for Armstrong

Armstrong is a manufacturer of ceiling systems and flooring products, and its products are sold to customers worldwide. The company’s building products segment produces soft fibers, metal ceiling systems and suspended mineral fibers, which are used in institutional, commercial and residential buildings. The company’s resilient flooring segments produces vinyl tiles, vinyl sheets as well as laminate flooring products, and its wood flooring segment produces pre-finished wood floors for residential and commercial application.

The management of the company claims that Armstrong has a leading position in the world as far as ceiling systems are concerned. The company has been performing well since the year 2009. Its EBITDA figures have improved by 31% through 2012 because of a surge in earnings from its sale to the North American region.

The company’s earnings from the Asian region were negative in the period because of its China plant construction causing the company to incur huge startup costs. The earnings from the Asian region will also pick up once the construction is complete. The company also has plans to build a Russian facility and increase its profitability in core markets by focusing on innovation, design and environmental leadership. I believe that the company’s earnings progress, despite lower volumes, will definitely help it grow in the future.

Masco’s changing strategies

Masco is another construction support company that manufactures home improvement and building products. The company operates through its cabinet and related products segment, plumbing products segment, installation and other services segment, decorative architectural segment and other specialty products segment. Masco’s plumbing products segment accounts for 38% of the company’s revenue, and it has a leading position in fittings, showerheads, spas and faucets. Its second largest segment by revenue is its decorative architectural products segment as it accounts for 24% of the company’s revenues.

Masco’s income statements have been largely unimpressive lately. The company has shown little growth in its revenues in the past four years, whereas it has been reporting net losses consistently. The EBITDA of the company has, however, increased and this has made the company reduce its net losses significantly.

The company has been changing its strategies for its loss making cabinet segment. This resulted in the disposition of a Danish ready-to-assemble cabinet business and the induction of a new management team. The strategy has worked, and in the first quarter, this segment reported break-even profitability. For its other segments, Masco is planning to implement ERP and supply chain systems and further its cost reduction through the implementation of lean practices.

Fastenal’s cyclicality: A risky undertaking

Fastenal is involved in the wholesale and retail of construction supplies around the world. The company’s main offerings are fasteners, such as bolts, nuts, screws, and other industrial and construction supplies. The company has been reporting sustained growth in its revenues since 2009, and this growth has also been reflected in the company’s net income and EBITDA figures.

The company works by focusing on the local needs of a community by decentralizing its operations. The company’s positive performance has largely been due to its initiatives, such as the introduction of its Pathway-to-Profit and FAST solutions strategy. The company’s Pathway-to-Profit strategy has increased same stores sales and the market share for the company, whereas the FAST solutions strategy of the company has increased the switching costs for Fastenal’s customers. The company has also increased its stores internationally and is working on increasing its in-store staff, so that its managers have more time to visit customers and increase sales.

The company has a strong balance sheet with no debt. The downside to the company is that its performance is super cyclical and the recovery of the industrial sector cannot be properly guaranteed.

The takeaway

The economic recovery has increased the pace of residential and commercial construction in the country. Therefore, companies providing support to the construction companies are bound to grow. From the three companies analyzed, I believe Armstrong represents the best investment opportunity.

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Awais Iqbal has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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