This article is a reprint of my 14 August 2008 RealMoney column

I know, I know … the construction industry should not be touched with a 10-foot pole right now. But the depth of conviction investors have in that belief sends my contrarian side looking for names that might buck conventional wisdom. I didn’t have to look far to find one.

Despite a market capitalization under $800 million, NCI Building Systems (NCS) is one of North America’s largest integrated manufacturers and marketers of metal products for the nonresidential construction industry. With 44 manufacturing facilities located in 18 states and Mexico it sells metal coil coating services, metal components and engineered building systems, offering one of the most extensive metal product lines in the building industry.

The metal-coil-coating segment cleans, treats, paints and slits continuous steel coils before the steel is fabricated for end use. The metal-components segment sells metal roof and wall systems, metal partitions, metal trim, doors and other related accessories. The engineered building systems segment manufactures mainframes and Long Bay Systems, and includes value-added engineering and drafting. This last segment is both the largest and the highest-margin business for NCI.

NCI management pursues a four-pronged strategy of (1) developing new markets and products; (2) successfully identifying strategic growth opportunities; (3) controlling operating and administrative costs; and (4) managing working capital and fixed assets. The limited focus seems to be working.

New market opportunities include the shift toward metal roofing systems from conventional tar and gravel systems. Though more expensive to install, metal roofing systems are more durable and require less maintenance. As a result, they are gaining share in commercial-building applications.

For NCI, “strategic opportunities” means just that. The 1998 acquisition of Metal Building Components Inc. doubled its revenue base, making the company the largest domestic manufacturer of nonresidential metal components. The 2006 acquisition of Robertson-Ceco II Corporation resulted in product and geographic diversification, a stronger customer base and a more extensive distribution network.

Control over operating and administrative costs is exemplified by the fact that SG&A expense declined from 18.1% of revenue in the first half of 2007 to 17.7% in the same period this year. Meanwhile, working capital has been reduced, as have expenditures on fixed capital.

The operational discipline is translating into financial success. Sales in the second quarter grew 13.1% from the year-ago period. The $0.76 in earnings per share reported far exceeded the consensus analyst expectation. The company also narrowed its guidance for full-year 2008 earnings per diluted share to $3.19 to $3.44, compared to the prior consensus estimate of $2.90 per share. Estimates for 2009 were subsequently boosted from $2.88 to $3.39.

Over the last 12 months, NCI has generated $114 million in free cash flow (measured as cash from operations less capital expenditures). At 14.6% of market capitalization, the free-cash-flow yield is enticing enough that I don’t really require any growth to justify an investment. I could even tolerate some declines in cash flow, particularly if they were of a temporary nature related to the economic cycle.

Analysts, however, expect the company to grow 13% annually over the next three to five years. I think that estimate is probably too high — at least without tapping external financing. The sustainable earnings growth rate based on ROE is closer to 11%. With a 1.3 price/book multiple (in line with the industry average) and a P/E of just 11.5, I think the valuation is more than reasonable.

I think the shares could trade to a free-cash-flow yield of 10%, which would ultimately justify a $58 share price (45% above the current level), based on the most recent year’s free cash flow. While this may take some time to play out, I think double-digit returns over the next three to five years are quite possible.

Disclosure: At the time of publication, William Trent has no financial position in the companies mentioned in this article. 

In Fast Money’s Web Extra video “Najarian’s Sweet Trade” which home builder rated the opinion, “I’d stay away”?

Lennar (LEN)

In the models I follow, Lennar scores highly for free cash flow. However, it ranks among the worst in terms of earnings quality, price momentum, and return potential.

In his Friday “Game Plan,” Cramer said banks may bottom soon. But he warned of possible “catches,” including:

The catch here, and there always is a catch, is that if HOV and TOL report poor numbers and the U.S. has lost more jobs, Cramer’s predicting next week would be horrible for the financials. American International Group (AIG - Annual Report), Washington Mutual (WM) Wachovia (WB - Annual Report) and Bank of America (BAC) could sink to multiyear lows.

None of the stocks fare especially well in the models I use. HOV doesn’t even make it past the screens, and Toll Brothers scores among the worst for earnings momentum and return potential.

Bank of America scores poorly for earnings quality, earnings momentum and price momentum. The same applies for Wachovia, which also ranks low for free cash flow. Washington Mutual, by contrast, has a high free cash flow ranking but is also among the worst ranked for return potential.

AIG is the only name on the list that is not a net negative in my models. Its poor scores for earnings momentum and price momentum are offset by high marks for earnings quality and free cash flow.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

The geothermal industry is molten! But there are only 2 pure plays trading on U.S. exchanges. Name one.

Though there are just two pure-play choices trading on US exchanges – Ormat Technologies (ORA) and US Geothermal (HTM - Annual Report), there are a dozen combined in Canada, Australia, the UK and New Zealand.

Disclosure: At time of publication, William Trent has no financial position in the companies mentioned in this article.

The market has been very rough on my Small Cap Watch List (Track at Marketocracy) this quarter. Obviously including Impac Mortgage (IMH - Annual report) on the list was not a good start, but the housing market isn’t the cause for all the woes – at least not directly. Pretty much everything is down and homebuilder NVR’s (NVR - Annual report)10% decline puts it among the top performers while furniture maker Tempur-Pedic (TPX) has turned in the best performance on the list.

In the bottom camp, however, has been another construction related stock – namely US Concrete (RMIX). Down nearly 20% since the end of June on the heels of a lowered outlook, it is starting to look ugly. The Zacks rank, which tracks earnings momentum, is the second-lowest possible rating. Free cash flow in 2006 was a big goose egg thanks to unusually high capital expenditures and the debt load now exceeds the market capitalization.

Still, the stock is also now trading with a single-digit P/E multiple and 7.6x EV/EBITDA multiple, both of which are reasonable. The market price is barely above book value and the price/sales is a measly 0.35x. The company also has more than $75 million in working capital, which is a double-edged sword. In a slowdown working capital could be reduced and boost cash flow – provided the customers to whom they sell the inventory and from whom they are owed receivables are able to stay in business too. Combining this with the fact that capital expenditures were abnormally high in 2006 suggests that the “normal” free cash flow is closer to the $25 million they realized in both 2004 and 2005.

My spirits rose a bit when I saw the 8-K they filed yesterday, saying:

On July 31, 2007, we entered into new Executive Severance Agreements with several of our officers, including the following “named executive officers” identified in our proxy statement relating to our 2007 annual meeting of stockholders: Michael W. Harlan, Robert D. Hardy and Thomas J. Albanese. The new agreements generally replace other agreements or term sheets previously agreed to between us and the applicable officers. Each Executive Severance Agreement provides for severance payments and other benefits following termination of the applicable officer’s employment under various scenarios, as described below. Each such agreement also contains a confidentiality agreement, requiring the applicable officer to maintain the confidentiality of confidential information we provide him, as well as a non-competition agreement that generally extends for one year after the officer’s employment terminates (subject to extension in the event of a change of control, so that the non-competition agreement will extend to cover the number of months used to determine the severance benefits payable to him (as described below)).

Could all the focus on a potential change in control signal that one may be in the works? It is possible. I think the odds of a private equity buyout are relatively low due to the fact that there is little room for additional leverage and the valuation already appears reasonable rather than cheap. Then again, the low market capitalization would make it an easy bite.

Still, I think that if there is to be a buyout it would probably come from a competitor who would have greater opportunity to cut costs through economies of scale. Yahoo! Finance lists six cement makers with market capitalizations of $2 billion or more -  all of whom would also find US Concrete to be a bite-size addition to their current business.

Here’s hoping.

Zacks Investment Research has provided Stock Market Beat with a complimentary trial subscription to Research Wizard.

Conventional wisdom holds that magazine cover stories are contrarian indicators – by the time a company’s success or failure reaches the cover page of a major publication the story is so well known as to be completely reflected in the stock price. Therefore, all good news is priced in and the stock can only underperform or all bad news is priced in and the stock can only outperform.

While simplistic, the magazine cover indicator now has the support of recent academic research. This research did find that cover story headlines on Business Week, Fortune and Forbes tended to indicate that the mood (bullish or bearish) of the story had run its course in the market.

As a result of this research, I have decided to develop a portfolio of stocks based on using those three magazine’s covers as a contrary indicator. I also track this portfolio on StockPickr. This week’s results:

Business Week
Markets In Turmoil
By rushing into the mortgage business big-time, homebuilders helped fuel the housing crisis. Now they’re hurting—and so is Wall Street

Contrary indicator: Buy Homebuilders. 

Fortune: Going Nuclear

The industry is gearing up to build its first new plants in decades. But are we comfortable with that? Join Fortune’s David Whitford on a road trip into America’s nuclear future.  (more)

Contrary Indicator: Sell TXU, Will Uranium Price Top?

With the end of the first quarter approaching, it is time to adjust the names in my Watch Lists. I will price all the new lists as of the close on Friday, June 29.

Today I present my planned updates to the Small Cap Watch List. There was a fairly high level of turnover to the list. 12 of the 24 names from the previous run made it to the current list, which was also 24 names. Performance-wise, the list created in March has returned an unweighted average return of 2.6% through June 28, with 80% of the stocks in positive territory. All of the money-losers from the previous list fell out of consideration.
So without further ado, the names on the chopping block from the previous list are: PW Eagle (PWEI), Insteel Industries (IIIN), Allied Defense (ADG - Annual Report), Hartmarx (HMX), Parlux (PARL), Hansen Natural (HANS), FirstFed Financial (FED), Young Innovations (YDNT), ITT Educational (ESI), Rent-a-Center (RCII), Valassis (VCI), and Travelzoo (TZOO). The castaways include four of the five money losers from the previous portfolio (HMX, PARL, YDNT and TZOO) as well as the biggest gainer (ESI).
The new list is:

I will continue to track both lists on StockPickr.

Mid Cap Watch List (Track at Marketocracy) and Large Cap Watch List (Track at Marketocracy) member NVR, Inc. (NVR - Annual report) reported earnings:

NVR, Inc. (Amex: NVR), one of the nation’s largest homebuilding and mortgage banking companies, announced that diluted earnings per share for its first quarter ended March 31, 2007 decreased 33% and net income decreased 36% when compared to the 2006 first quarter. Net income for the 2007 first quarter was $84,821,000, $12.96 per diluted share, compared to net income of $132,560,000, $19.48 per diluted share, for the same period of 2006. Consolidated revenues for the first three months of 2007 totaled $1,093,189,000, a 9% decrease from $1,204,655,000 for the comparable 2006 quarter.

Sounds terrible, but the consensus estimates were much worse: $8.81 per share on $921 million of revenue. The stock is up significantly on the news.

Serving one of the markets worst-hit early on by the housing slowdown, it is possible NVR will also see a recovery ahead of other homebuilders:

New orders in the first quarter of 2007 increased 8% to 3,917 units, when compared to 3,633 units in the first quarter of 2006. New orders in the Mid Atlantic and Mid East regions increased 18% and 11%, respectively, when compared to the first quarter of 2006. The Mid Atlantic region experienced an improvement in market conditions at the start of the quarter, however, market conditions slowed noticeably as the quarter progressed. The cancellation rate in the first quarter of 2007 was 16% compared to 17% in the first quarter of 2006 and 20% in the fourth quarter of 2006. The Washington DC cancellation rate in the quarter was 22% compared to 26% in the first quarter of 2006 and 34% in the fourth quarter of 2006.

At any rate, the company appears to be in little jeopardy of facing a crisis. Cash on hand of $555 million is sufficient to cover liabilities due over the next year even if the company doesn’t take in another dime of cash flow.

However, with earnings expected to plummet to $32 per share next year the multiple looks a little lofty – and the timing a little early – for us to get too excited about it.

With the end of the first quarter approaching, it is time to adjust the names in our Watch Lists. We will price all the new lists as of the close on Friday, March 30. Today we present our planned updates to the Large Cap Watch List (Track at Marketocracy).

Though less than the Small Cap Watch List and Mid Cap Watch List (Track at Marketocracy), there was still relatively high turnover in this list. 14 of the original 33 names made the cut for the new list (which was trimmed to just 26 names.) Part of the reason for the turnover was to reduce overlap between the lists. One third of the Mid Cap Watch List (Track at Marketocracy) names appear on each of the Small Cap and Large Cap Watch List (Track at Marketocracy)s, but there is no longer any overlap between small and large.
So without further ado, the names on the chopping block from the previous list are:

3M (MMM); Continental (CTTAY.PK); Mitsui (MITSY); Anheuser-Busch (BUD); ConocoPhillips (COP); Helix Energy (HELX); IndyMac Bancorp (NDE - Annual Report); Barr Pharmaceutical (BRL - Annual Report); Quest Diagnostics (DGX); Public Storage (PSA); ITT Educational Services (ESI); Equifax (EFX); Rent-a-Center (RCII); Kroger (KR); Ricoh (RICOY); First Data Corp. (FDC); Expeditors International (EXPD); and Keyspan (KSE).

The new list is:

With the end of the first quarter approaching, it is time to adjust the names in our Watch Lists. We will price all the new lists as of the close on Friday, March 30. Today we present our planned updates to the Mid Cap Watch List (Track at Marketocracy).

As with the Small Cap Watch List (Track at Marketocracy), we were surprised at the amount of turnover in our screens. Only 7 of the original 29 names made the cut for the new list (which comes in at only 24 names.) Part of the reason for the turnover was to reduce the overlap between the Small Cap and Mid Cap Watch List (Track at Marketocracy)s. Now there is only one-third overlapping names rather than two thirds. Furthermore, given the level of outperformance we saw in the first quarter (actually just two months) and the fact that much of those gains were achieved early, perhaps the turnover is warranted.

So without further ado, the names on the chopping block from the previous list are:

Silgan Holdings (SLGN - Annual Report); Middleby (MIDD); Olin (OLN); Vector Group (VGR); Sanderson Farms (SAFM); Tesoro (TSO); Downey Financial (DSL); Waddell & Reed (WDR); Gamco (GBL); Apria Healthcare (AHG); Quest Diagnostics (DGX); ITT Educational Services (ESI); Equifax (EFX); Delhaize Group (DEG); Papa John’s (PZZA); Rent-a-Center (RCII); Cato Corp (CTR); Dassault Systemes (DASTY); Ingram Micro (IM); Energy East (EAS); South Jersey Industries (SJI - Annual Report); and American States Water (AWR).

The new list is: