There's still not that much joy to be found in the residential building world. While the superstores Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) have seen improvement in same-store sales and companies like Louisiana-Pacific (NYSE:LPX) are well off the lows, the actual building starts numbers still aren't good.
That means investors considering the shares of Quanex Building Products (NYSE:NX) need to have some patience. While this company has built impressive share in markets like window and door components, demand still just isn't that strong. Quanex does seem undervalued on the basis of its potential long-run free cash flow, but with so much of that growth coming in the foggy future the risk here is above average.

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Not Much to Celebrate in Fiscal Second Quarter
Quanex didn't have a terrible fiscal quarter, but there wasn't a lot in the numbers to get excited about either. Revenue fell 4%, and would have fallen more but for the 32% sales growth in the Engineered Products business that was helped in part by an acquisition. Growth in the core windows business was above-market, but that's not such a great thing when the market is still declining.

Margins were also weak this quarter. Reported gross margin fell two points and the company saw its operating loss expand from last year. A strike certainly hurt the numbers, as did charges related to a facility consolidation and ERP program, but the margins weren't just that strong on an adjusted basis. Execution and efficiency issues have been a concern of late, and this quarter suggests management has more work to do.

SEE: Analyzing Operating Margins

Great Share ... When the Market Comes Around
A lot of smaller building material companies have gone out of business in the last five years, as the collapse in new building activity took away their revenue. That has given Quanex the opportunity to build its business and gain share. It looks as though Quanex holds about 70% share in the window market, though the absence of publicly-traded comparables makes it hard to confirm the numbers. Making matters a little more complicated, most of Quanex's customers (including major window and door manufacturers like Andersen, Pella and Jeld-Wen) are also private.

Sooner or later, that share should matter again. PulteGroup (NYSE:PHM) and Toll Brothers (NYSE:TOL) are still not seeing great business conditions today, but sooner or later the long-term demographics of the United States are going to drive higher building activity. The trouble is the difference between "sooner" and "later" - bubbles take markets higher than anybody ever thinks they can go, and likewise crashes take them lower than people are usually willing to estimate, and this recovery could take a long time to materialize.

SEE: Top 5 States For Construction Workers

The Bottom Line
It looks like Quanex is paying the price for business that was pulled forward by tax credits tied to energy-efficient retrofits. As a result, the improvement that retailers like Home Depot are seeing doesn't translate directly to better results or a better outlook for Quanex.

Better housing demand ought to eventually push Quanex's revenue above $1 billion and support better free cash flow margins, but the timing is uncertain at best. If the housing market is on its way back by 2015-2017 and Quanex can start improving margins now, these shares could have a fair value in the high teens. There's a lot of uncertainty in those numbers, though, so Quanex shares are really only suitable for aggressive investors and those with a willingness to let this story develop.

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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.

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