Quanex: Assessing If A Bullish Breakout Is Imminent (NYSE:NX)

Intro

Quanex Building Products Corporation (NYSE:NX) is an almost hundred-year-old company that supplies products for the fenestration industry in the U.S. & international markets. The company came across our desk due to its attractive valuation, sound profitability, and bullish technicals to boot.

In fact, if we pull up a long-term chart of Quanex, we see that shares are potentially in the process of breaking out to all-time highs. For a breakout to occur, shares must remain elevated for a sustained period of time. An aggressive move higher on strong buying volume would be a solid indicator that overhead multi-year resistance has been surpassed. However, patience is required to ensure one does not get caught buying at the top of the market.

Q2 Earnings

Bullish trends were abound in the fiscal second quarter (three months ending April 30) where Quanex reported GAAP earnings of $0.66 for the quarter (which easily beat the initial estimate of $0.40 per share). This earnings report was really the catalyst for the present multi-month rally as shares were trading at approximately $21 prior to the announcement. Although Quanex was up against a tough comparable, what we did see was an increase in EBITDA margin, top-line guidance being maintained for the year, and strong cash-flow generation due to good stewardship of working capital.

In the Fenestration segments, Quanex experienced softer demand both in the U.S. & Europe markets. However, strong operational performances in both markets led to EBITDA margin growth overall as management executed well in the areas it could control. The same trend played itself out in the company’s North American Cabinet where we saw lower demand but yet margin expansion due to efficient cost-cutting measures and timely ongoing purchases.

Strong Cash-Flow Generation

Despite the lower earnings print for example compared to the second quarter last year, Quanex generated $35.3 million of operating cash flow, which was a sizable increase over the corresponding $19.8 million in the same period 12 months prior. Therefore, investors would do well in looking at the company’s cash-flow multiples (when doing due diligence on the stock’s valuation) and not solely focus on the income statement where the bottom-line earnings number invariably contains non-cash costs.

For example, generated operating cash flow of $138.3 million over the past twelve months equates to a trailing cash-flow multiple of 6.62 when we divide the $138.3 million number into Quanex’s present market cap of $915.75 million. The company’s free-cash-flow multiple appears to be even more impressive due to capex spend ($34.4 million) not taking up a large percentage of operating cash flow. Suffice it to say, when we divide the trailing free cash flow of $103.9 million into Quanex’s present market cap of $915.75 million, we get a trailing free cash-flow multiple of 8.81.

Free cash flow, bar none, is the most important financial metric in investing, as it gives investors a solid read on the firepower (in terms of cash) that the company has at its disposal to build the business. Free cash flow informs us of how much extra revenue Quanex can generate over and above the costs needed to maintain the business. Suffice it to say, a free cash-flow multiple of under 9 is by no means expensive and in fact demonstrates value (even with Quanex shares trading at all-time highs).

Strong Return On Capital

Generating cash is one thing but the ability to be able to allocate it successfully is a whole other ball-game all together. Therefore, to see how well Quanex is allocating the cash it generates, we use the adjusted “return on capital” formula below to see how much operating profit Quanex is generating only off the capital which is essentially required to run the business. Therefore, we do not include idle cash balances on the current assets side nor short-term obligations on the current liabilities side in the formula

Imputing all of the values from Quanex’s latest financial statements into the formula equates to an adjusted ROC of 24.9% which is another excellent number. Furthermore, although bottom-line earnings are expected to contract this year, the present $2.11 per share estimate has already improved by over 12% over the past month alone as we see below. Suffice it to say, a sustained trend with respect to positive earnings revisions in Quanex is bullish for free-cash-flow generation and return on capital alike going forward.

Conclusion

To sum up, we will know very soon if Quanex Building Products Corporation will break out above long-term resistance to all-time highs. Shares remain cheap, and profitability continues to improve through bullish earnings revisions. The stock though remains a “Hold” until a confirmed breakout is realized. We look forward to continued coverage.