When you sell products into the housing market and the housing market is going through its worst stretch in living memory, the rest of the story goes pretty much the way you would expect. From peak to trough, cabinet and vanity maker American Woodmark (Nasdaq:AMWD) saw sales drop more than 50% and free cash flow plunge into the red.

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That said, American Woodmark hasn't really done any worse than rivals like Masco (NYSE:MAS) or Fortune Brands Home & Security (Nasdaq:FBHS) in terms of market share, and has only had one year of negative free cash flow. With a clean balance sheet and major placement in both Home Depot (NYSE:HD) and Lowe's (NYSE:LOW), this may be a "when, not if" recovery story that could pay off for patient investors.

Closing Out the Year on a Wobbly Note
Most earnings reports since April have been, at best, a mixed bag and that's true here as well. The company's sales performance wasn't bad really. Revenue rose about 10% and did come in a bit ahead of expectations, helped by a 30% rise in new construction sales that offset declines in remodeling.

Margins weren't as strong, though. Gross margin slid about 40 basis points, and seemed to come in weaker than most analysts had hoped. Likewise, operating loss (net of a restructuring charge) was a little better than last year, but still disappointing relative to forecasts.

SEE: A Look At Corporate Profit Margins

Slimmed Down for the Recovery
American Woodmark has done what you would expect a company led by reasonable managers to do during this downturn. Cost cutting has been a main priority for a few years now, with three plants closed back in 2009 and another two closures announced more recently, as well as the sale of one of the facilities closed in 2009. That's a pretty sharp step back in terms of active capacity, but it's what you have to do to make it through these down-cycles - evocative perhaps of the old racing quote that "to finish first, first you have to finish."

This recession/downturn has also led the company to be more conservative and efficient with production costs and cash. Now there's a limit to what can be accomplished with this - it's not possible to eliminate materials costs or freight - but it seems as though the low-hanging fruit has been thoroughly harvested. Likewise, the dividend has been suspended for some time now, saving vital cash.

Eventually, the end markets have to recover. Kitchen remodeling had largely come to a halt during the worst of the housing market and eventually improving home prices will re-incentive homeowners to consider them. Likewise, new housing starts have been showing signs of life (off a very low base).

SEE: Economic Indicators: Housing Starts

The Bottom Line
American Woodmark is a smaller fish in the sea - big enough to be worthwhile for the major superstore retailers and builders, but about half the share size of Fortune Brands and about one-third to one-quarter the size of Masco. In a better time or place, it would be an interesting candidate for a private takeout.

As it stands now, though, the company is still looking at a long road back. I'm quite impressed that free cash flow has been positive (if tiny) for the past two years, and I do believe that the company can translate a gradual recovery into steady fundamental improvement.

If American Woodmark can get back into the ballpark of prior peak sales and free cash flow around 2017, fair value looks extremely enticing (perhaps above $30). Even a more modest turnaround (an additional five to six years to recover the former peak sales level), points to worthwhile undervaluation in these shares. Keep in mind, though, that nothing is certain with the housing recovery and these shares are quite risky as a result.

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

Tickers in this Article: AMWD, MAS, FBHS, HD, LOW

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