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Value Thoughts - Quanex Building Products (NX)

December 28, 2011 | About:
Wax

wax

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Quanex Building Products Corporation (NX) was organized in 1927 as a Michigan corporation under the name Michigan Seamless Tube Company. It reincorporated in Delaware in 1968 under the same name and then changed its name to Quanex Corporation in 1977.

In December 2007, Quanex Building Products Corporation was incorporated in the state of Delaware as a subsidiary of Quanex Corporation to facilitate the separation of Quanex Corporation’s vehicular products and building products businesses.

The separation occurred in April 2008 through the spin-off of Quanex Corporation’s building products business to its shareholders, immediately followed by the merger of Quanex Corporation (consisting principally of the Vehicular Products business and all non-building products related corporate accounts) with a wholly owned subsidiary of Gerdau S.A. (GGB).

The company’s businesses are managed on a decentralized basis and operate in two reportable business segments: Engineered Products and Aluminum Sheet Products. Each business has administrative, operating and marketing functions.

Quanex is a technological leader in the production of aluminum flat-rolled sheet, extruded vinyl profiles, flexible insulating glass (IG) spacer systems, solar panel sealants and metal and wood products that primarily serve the North American residential new construction and remodeling markets.

The company uses low-cost production processes, and engineering and metallurgical expertise, to provide customers with specialized products for their specific window and door applications. Quanex believes these capabilities also provide the company with unique competitive advantages.

The company’s growth strategy is focused on developing its Engineered Products businesses, introducing innovative products and components, and pursuing expansion through organic growth and the acquisition of companies that produce similar products and serve similar building products markets.

The Aluminum Sheet Products segment is comprised of an aluminum mini-mill operation and three stand-alone aluminum sheet cold finishing operations. Aluminum sheet finishing capabilities include reducing reroll (hot-rolled aluminum sheet) coil to specific gauge, annealing, slitting and custom coating.

Customer end-use applications of the finished sheet include residential windows and screens, patio doors, exterior home trim, fascias, roof edgings, soffits, downspouts and gutters. A secondary market includes transportation (truck trailer, RV and mobile home panels).

Basis

Financial information presented herein, is based on the company’s most recent SEC Form 10-K filing for year ending Oct. 31, 2011, as filed with the Securities and Exchange Commission on Dec. 20, 2011.

Short-Term Investment Valuation

On the upside, the stock closed recently at $15.02, with resistance at $21.62, a 44% increase from the recent close. On the downside, first support for the stock is currently at $15.00, a 0.1% decline from the recent close, with Second Support at $14.09, a 6% decline from the recent close.

Should the stock price pass through Second Support, the next support level is $10.01, a 33% decline from its recent close

Our equilibrium number, the midpoint between resistance and support, is $14.55, which is 3.2% below the recent close, making the odds of a successful upside trade about 32 to 1 against.

Earnings Growth Valuation

Earnings growth valuations are based on the spread between year-over-year earnings growth and the current P/E.

In the case of Quanex Building Products Corporation, the company had year-over-year earnings growth of (8%), ending fiscal year 2011 with earnings of $1.32 per share.

With a trailing-12 month P/E currently at 12, the spread between earnings growth and the P/E is 1, meaning that for an investor focusing strictly on earnings growth, the stock should be trading at $14.33, a $0.69 decline from the recent close.

Fundamental Investment Valuation

Liquidity: The company ended fiscal year 2011 with cash on hand of $2.39 per share, a 52% year-over-year decline, a current ratio of 2.3, a 21% year over year decline, a quick ratio of 1.6, a 31% year-over-year decline, a cash ratio of 0.9, a 48% year-over-year decline, and a cash conversion cycle of 30 days, a 15% year-over-year decline.

In addition, goodwill and intangibles comprised 27% of total assets, lowering book value from $11.66, to $7.46 per share.

Profitability: Fiscal 2-11 found the company with a gross margin of 16%, a 7% year-over-year decrease, an operating margin of 6%, a 25% year-over-year decrease, and net operating profit after taxes (NOPAT) of 5.4%, a 14% year over year decline.

The company also ended fiscal 2011 with an effective tax rate of 41%, a 7% year-over-year increase. In addition the company posted a return on invested capital (ROIC) of 19%, a 16% decline from fiscal 2010.

Debt: The company ended fiscal 2011 with debt of $0.05 per share, a 9% year over year decline, and paid an average interest rate of 23.5%, a 12% year over year increase. For fiscal 2011, the company had a debt to cash ratio of 0.02 and a debt to equity ratio of 0.001.

Operational Performance: For fiscal 2011, the company turned its inventory over 13 times, a 13% year-over-year decline. In addition, the company’s accounts receivable were outstanding 35 days on average and its accounts payable were outstanding 34 days on average.

Cash Flow: The company’s fiscal 2011 operating cash flow was $2.13 per share, a year-over-year increase of 2%. The company also ended fiscal 2011 with free cash flow of $1.30 per share, a year-over-year decline of 16%.

Dividends: For fiscal 2011, the company paid a dividend to stockholders of $0.16 per share, a year-over-year increase of 14%. There is no guarantee that the company will pay a future dividend.

Valuation Estimate: Based on our review of the latest annual financial information for Quanex Building Products Corporation, we think a Reasonable Value Estimate for the company is in the $31-$35 range, with a fiscal 2011 strength of statement of 5.4, a 25% year-ove-year decline.

Long-Term (Five-Year Hold) Investment: With a reasonable value estimate of $31-$35, we would set a buy target at $19, a first sell target at $37, and a close target at $39.

Portfolio Thoughts

Admittedly, we like the business the company is in, and believe going forward the company should be successful. What has us a bit concerned is the 52% year-over-year decrease in cash on hand, the $0.16 per share increase in capital stock repurchases, and the $0.02 per share increase in dividends. Certainly on the surface, these seem insignificant amounts. But taken with an increase in sales yet a decrease in net operating margin, it just makes us wonder what management may be thinking.

Considering our management questions, a recent close for the stock of $15.02, an estimated merger and acquisition payback of 9.1 years (assuming EBITDA remains the same), a year-over-year earnings decline of 8%, free cash flow of $1.30 per share, and our reasonable value estimate of $31-$35, we believe that on a fundamental investment basis the stock is currently UNDER VALUED, and a candidate for future research for the Wax Ink Portfolio.

Wax

Disclaimer

We have no position in Quanex Building Products Corporation at the this time, and no plans to initiate a position in the next five business days. Additionally, we have received no compensation to write about a specific stock, sector, or theme.

About the author:

wax
Wax Ink is a baseline equity research company not licensed or registered with any government agency

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