Ride The Housing Recovery with These 3 Picks

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

Eagle Materials (NYSE: EXP), James Hardie Industries (NYSE: JHX), and USG (NYSE: USG) are leaders in producing cement and wallboard materials (Eagle Materials), fiber cement siding (James Hardie), and gypsum materials and interior ceiling products (USG). These companies serve a number of industries, including residential and commercial construction, home repair and remodeling, and infrastructure.

Currently, these three companies are emerging from one of the largest slumps in construction and remodeling history. They have improved operations, which are leaner than ever, following a few years of declining sales.  Importantly, these 3 companies have significant pricing power due to their leadership position and/or access to commodities, which should benefit them when inflation hits.

Fly like an eagle

Eagle Materials operates in four major segments: cement (38% of revenue), gypsum wallboard (39%), recycled paperboard (15%), and concrete and aggregates (8%).  The company recently recorded an increase in revenue of $147.6 million, or nearly 30% from the prior year, to $642.6 million. The company should benefit from strong demand in cement and sand from construction, infrastructure improvements, and large oil and gas projects as well as general increase in demand for construction and repair materials.
 
In 2012, Eagle Materials announced its intent to acquire two cement plants and related facilities from Lafarge N.A., boosting its cement production by 60%. The acquisition cost of $446 million for $178 million in annual sales is expensive, but assuming a 15% operating margin (the operating margin of the cement division) this gives a price to operating income of 16.7. Currently, Eagle Materials trades at 26.7 trailing operating income, so this deal should be a positive for shareholders.
 
Expansion

James Hardie's margins have been affected negatively in the past few years due to the rising costs of transportation. Fiber cement is heavy and costly to transport. However, the company is currently reorganizing its U.S. operations by moving to regional manufacturing.  Another negative is that the company raised its sales volume but prices declined in the U.S. and Europe.
 
On the positive side, it is diversifying into color coatings and it recently built a new research & development facility near Chicago. Also, it is currently expanding its Carole Park manufacturing facility in Australia. Overall, fiscal 2014 should be a better year in terms of sales, pricing, and profitability.
 
Finally profitable
 
For the first quarter of its fiscal 2013, USG reported its first net income in the past five years. USG plans to continue to deliver strong results by implementing its plan to win which includes:
  • Lower costs – selling general and administrative expenses declined by 4% in the quarter ended March 31, 2013 while sales rose by 4% compared to the same quarter in 2012.
  • Diversify earnings – the company's Oman quarry is breaking ground and will serve the Middle East and India. It is trying to grow its commercial and insulation product offerings at its L&W supply division.
  • Growing through innovation – the new UltraLight portfolio of wallboard is gaining traction with its ad campaign “The Weight Has Been Lifted”.
USG commands over a 25% share of the wallboard market in the U.S. and it should benefit from recovery in construction, repair, and remodeling. Also, the company has recently centralized its pricing authority, which should improve margins going forward.
 
On the negative side, USG has $400 million of 10% convertible securities that could potentially dilute current shareholders by 35 million new shares. This is somewhat offset by the company's net operating loss carry-forward of $2.1 billion, which could have a positive net cash effect from reduced federal and state taxes of $1 billion in future years.
 
 
<table> <tbody> <tr> <td> </td> <td><strong>EXP</strong></td> <td><strong>JHX*</strong></td> <td><strong>USG</strong></td> </tr> <tr> <td><strong>Current fiscal year sales (est.)</strong></td> <td><strong>$900</strong></td> <td><strong>$1,520</strong></td> <td><strong>$3,500</strong></td> </tr> <tr> <td><strong>Current fiscal year operating margin (est.)</strong></td> <td><strong>23%</strong></td> <td><strong>13%</strong></td> <td><strong>9%</strong></td> </tr> <tr> <td>Last fiscal year sales</td> <td>$643</td> <td>$1,321</td> <td>$3,224</td> </tr> <tr> <td>Last fiscal year operating margin</td> <td>21%</td> <td>11%</td> <td>6%</td> </tr> <tr> <td>Year ago sales</td> <td>$495</td> <td>$1,237</td> <td>$2,910</td> </tr> <tr> <td>Year ago operating margin</td> <td>14%</td> <td>14%</td> <td>negative</td> </tr> <tr> <td>2-years ago sales</td> <td>$462</td> <td>$1,167</td> <td>$2,834</td> </tr> <tr> <td>2-years ago operating margin</td> <td>13%</td> <td>16%</td> <td>negative</td> </tr> <tr> <td>3-years ago sales</td> <td>$468</td> <td>$1,125</td> <td>$3,130</td> </tr> <tr> <td>3-years ago operating margin</td> <td>17%</td> <td>18%</td> <td>negative</td> </tr> </tbody> </table>
Sales and operating margin for the last four fiscal years. Sales are in U.S. $ millions.
 
Some more numbers
 
Currently, Eagle Materials, James Hardie, and USG trade at price-to-sales ratios based on their estimated current fiscal year sales of 4.0, 2.6, and 0.8, respectively. About three years ago, near the peak of the financial and housing crises, the common stocks of Eagle Materials, James Hardie, and USG traded at price to sales of about 1.3, 2.8, and 0.6, respectively.
 
It seems like Eagle Materials is the only stock whose valuation has made significant progress based on the price-to-sales ratio. Given that the housing market is in a recovery mode and the company specific factors discussed above, higher valuation is also warranted for James Hardie and USG, despite their lower operating margins.

Conclusion
 
Eagle Materials, James Hardie, and USG are uniquely positioned to benefit from a recovery of the construction and remodeling industries in the U.S. In addition, Eagle Materials has a strong exposure to the growing energy related construction area, James Hardie is a leader in fiber cement and is currently diversifying into coatings, and USG has strong pricing power and is benefiting from demand for its high-end ceiling materials. Continuing increase in demand bode well for investors in these three companies.
 

The Motley Fool's chief investment officer has selected his No. 1 stock for the next year. Find out which stock it is in the special free report: "The Motley Fool's Top Stock for 2013." Just click here to access the report and find out the name of this under-the-radar company.

 


Delian Naydenov 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!

blog comments powered by Disqus