Here and there, investors are already seeing certain stocks recovering on the expectation of improving commercial construction activity. To a certain extent, American Reprographics (NYSE:ARC) has been one of them, as the stock has rebounded significantly (on a percentage basis) from its lows in the fall of 2011. That said, there looks to be plenty of opportunity left in these shares if recent signs and portents really do mean that better commercial building activity is on the way.
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The Basics
American Reprographics is the largest company in the reprographic services industry, with somewhere in the neighborhood of 15% market share. In fact, because there are so few competitors of any size (ARC is about 10 times the size of its largest competitor), it's actually a little difficult to calculate how much share they have - particularly since the multi-year downturn in commercial building activity has pushed many small companies out of business entirely.

For those who've let their subscriptions to Reprographics Daily expire, reprographics is the business of producing and reproducing documents related to construction - blueprints, mostly. When large commercial buildings are planned, drawn up and built, numerous copies of blueprints are needed, as the building process is farmed out to what amount to specialty teams. Moreover, if there are any changes in the plans (as there usually are), new plans are printed up and distributed.

Not surprisingly, commercial construction is a huge part of ARC's business - a little more than three-quarters, in fact. With one of the worst commercial real estate building markets in decades, ARC has seen steady erosion in revenue and free cash flow over the past few years.

SEE: Find Fortune In Commercial Real Estate

Experience, Scale and Flexibility
That said, ARC is still standing and is in fact still cash flow positive. At least some of this has to be credited to management and the company's diversified business mix. For starters, the company operates a nationwide hub-and-spoke structure, but has closed branches in response to the deteriorating conditions in many markets.

At the same time, ARC has gotten more active in digital technologies and outsourced operations. About one-quarter of the company's revenue comes from "facilities management services" where ARC helps and supports clients who want to handle their reprographic needs in-house. Not only do these services offer good margins, but it helps the company keep business it would otherwise lose to companies like Xerox (NYSE:XRX), Canon (NYSE:CAJ) or Ricoh (OTCBB:RICOY).

Is the Recovery Coming?
ARC management was relatively cautious when they realized fourth quarter earnings, but there are signs of optimism in the commercial building space. For starters, the American Institute of Architects' Architecture Billings Index (ABI), a popular leading indicator of building activity, has been getting better. Not only has that index been positive for four straight months now, but new project inquiries are at five-year highs.

Moreover, a variety of companies including Johnson Controls (NYSE:JCI), Honeywell (NYSE:HON) and RPM (NYSE:RPM) have been seeing relatively encouraging trends in commercial activity. Plenty can still go wrong and it is hardly a robust market, but it does look like the worst is over.

The Bottom Line
The difficulty with American Reprographics is that there is no blueprint for the recovery from one of the worst markets in living memory. Is building going to suddenly accelerate in a year or two, or will there be a more gradual improvement?

At this point, I'm modeling "gradual." I look for roughly 2% revenue growth in 2012, accelerating to 4% and then 8%, before settling back down to mid-single-digit growth. At the same time, I do believe free cash flow conversion has bottomed and incremental revenue growth should boost cash flow.

If American Reprographics can achieve $70 million in free cash flow in 2016 (well below the $118 million in 2008), I believe fair value on these shares is north of $9. The company's hefty debt load is a worry if the commercial building market stays down, but this looks like an interesting (albeit risky) building recovery play.

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

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