With a headline on a major internet news site proclaiming Tuesday morning that 30% of all mortgages in the U.S. are underwater, the problem for Louisiana-Pacific (NYSE:LPX) is pretty obvious. True, building and remodeling activity has not ceased entirely, but there's a lot of bubble-built capacity out there, and not nearly enough activity to let a leading building materials company like Louisiana-Pacific profit. It's not hard to build a model that suggests LPX is significantly undervalued, but with so much of the recovery baked into those years far ahead, the uncertainty is sky-high.

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Some Good, Some Bad In the Third Quarter
To be sure, it's not as though activity has ground to a halt. LPX actually reported 9% sales growth for the quarter, with basically flat results in Oriented Strand Board (OSB), 7% growth in siding and 44% growth in engineered wood products. For the most part, a familiar theme still rings true - volume growth is there, but pricing is weak.

Despite sales growth, LPX continues to see profit erosion. Gross margin slid more than two full points from last year, while the adjusted earnings before interest, taxes, depreciation and amortization slipped to a loss from a small year-ago profit. Only one of the three segments was profitable on an operating basis (the siding business), and the margins were actually quite encouraging in this one business.

OSB DOA Without More Building
Although housing starts were up about 6% in the third quarter, that growth needs to be seen in the context of "very terrible to slightly less terrible." Builders like Pulte (NYSE:PHM) and DR Horton (NYSE:DHI) are hardly ringing the bell on a housing recovery, and new-build activity is still quite weak. As LPX is the leading OSB producer in the country (with Weyerhaeuser (NYSE:WY) a distant fourth), this hits them precisely where they live. Of the 10 facilities that LPX has, three are presently idled for want of demand.

Clearly this is no LPX-specific problem. Universal Forest Products (Nasdaq:UFPI) is likewise a well-run company in the building materials space, and is likewise reporting ongoing difficulties in the market. Look, too, at names like USG (NYSE:USG), Builders FirstSource (Nasdaq: BLDR), Mohawk (NYSE:MHK) or Masco (NYSE:MAS) - there is some business in remodeling and renovating and some new-build demand, but the markets are just flat-out depressed.

Survive, Then Grow
Is there any reason to be optimistic about a near-term recovery in housing? It can well be true that current build rates are inadequate to house the growing U.S. population. But, it's equally true that just as the housing bubble showed that activity can outstrip demand for years, so, too, can activity "understrip" demand for years at a time. (For additional reading on housing bubbles, read Why Housing Market Bubbles Pop.)

In the meantime, LPX has some existential concerns. The company's debt load is not bad, at all, by the standards of building material companies, but an operating loss is an operating loss. Absent a recovery, the company is eventually going to have to cut deeper into its expense structure, and that will likely impair its recovery when(ever) the rebound comes.

A Better Place to Wait?
I do not doubt that housing will recover someday, and that stocks like LPX, USG and Simpson Manufacturing (NYSE:SSD) (no relation to the author) will rebound fiercely when that happens. The question, though, is what level those stocks will be at when the recovery happens. Clearly, if LPX slides another 50% and then doubles, you're right back where you started.

With all that in mind, investors who feel the need to keep a toe in the water in this market may want to consider companies like Weyerhaeuser and Plum Creek (NYSE:PCL), that have substantial timberland assets. It's not that these companies are doing great, either, but at least they have the advantage that their assets don't lose value with time (actually, they grow in value as those trees grow).

The Bottom Line
Is Louisiana-Pacific a value today? Well, if you mean is the stock undervalued on the assumption that the company stays solvent until the recovery occurs, and that there will eventually be ongoing growth again in residential building, the answer is probably yes. The question is one of timing and of how much more erosion in market value the company sees before that recovery. Louisiana-Pacific is managing this downturn about as well as it can, but this is a stock for the patient and exceptionally risk-tolerant.

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At the time of writing, Stephen D. Simpson, CFA did not own shares in any of the companies mentioned in this article.

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