A Future Winner, But a Current Loser (LPX)
By Stephen Brown

The tripods of the housing market are wobbling precariously: The subprime mortgage lenders who funded the boom are imploding, the financial alchemists who repackaged their loans into tradable securities are unraveling, and the homebuilders who slapped together the two-by-fours are sinking.

What's an investor to do? Take a close look at the sector, of course - or if not the actual participants, at least their suppliers.

Concerning the latter, I'm looking very closely at Louisiana-Pacific (NYSE: LPX), one of the largest producers of oriented strand board (OSB) - a ubiquitous plywood-like sheeting used as roof decking, sidewall sheathing ,and floor underlayment - and residential home-building materials.

Needless to say, Louisiana-Pacific's financial well-being is directly tethered to residential construction, as recent financial performance proves.

In the 2006 fourth quarter, Louisiana-Pacific's revenue tanked 41% to $369.6 million compared to the year-ago period, while earnings turned to a $370 million loss.

For the full year, Louisiana-Pacific reported earnings of $124 million, or $1.17 per share, on revenue of $2.2 billion, which is disappointing compared to earnings of $456 million, or $4.15 per share, on revenue of $2.6 billion in 2005.

Don't expect much improvement in 2007, at least in the first six months: Louisiana-Pacific's revenues are expected to decrease another 15% while 2006 earnings are expected to turn to 2007 losses.

Slow but Unsteady
But that's par for the course. Check out the past 10 years. Louisiana-Pacific has exhibited an unstable pattern of sales and an erratic (but improving) pattern of earnings. From 1997 through 2006, its annual revenue fluctuated between $2 billion and $3 billion. Over the same period, its net earnings varied from a loss of $92 million in 1997 to a profit of $424 million in 2005. The company was profitable only half the time.

So why do I like Louisiana-Pacific? The company has demonstrated persistent cyclical resiliency, having performed more comebacks than The Who. And that's no fluke; management anticipates these rainy days and plans accordingly. Long-term debt as a percentage of capitalization was reduced during the good times, falling from 47% in 2000 to 24% at the end of 2006. Meanwhile the cash stands at $8.00 per share, more than adequate to sustain the $0.60 per share dividend.

As for valuation, my 12-month price target for Louisiana-Pacific is $24 per share, assuming the company holds at 1-times book value. My valuation is further supported by a quick, but conservative, discounted cash flow analysis based on operating cash flow of $1.20 for 2007 that grows 5% into perpetuity, discounted using a 10% rate.

Buy on Good News, Sell on Bad - Really!
As many knowledgeable contrarians know, cyclicals run counter to the value-stock dictum of buying on low P/E ratios. In fact, that's often the worst time to buy a cyclical. The best time being during the dry spells when the P/E ratio is meaningless.

I'm not the only one who thinks along those lines, to be sure. Berkshire-Hathaway (NYSE: BRK.A) snapped up large chunks of USG Corp. (NYSE: USG) during it a recent dry spell, and Carl Icahn is doing the same with WCI Communities (NYSE: WCI).

Rumors circulating in the financial press suggest that more than one value-oriented private-equity shop is sniffing around Louisiana-Pacific. Of course, buying on rumors is often a loser's game, but buying a sound cyclical company during bad times is often the opposite.

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By Stephen P. Brown, Contributor - Investopedia Advisor

Stephen P. Brown is a Chartered Financial Analyst, former equity analyst, investor, and freelance financial writer living in Brighton, Colorado. His work has been published in Barron's, CFA Magazine, Wealth Manager Magazine, and The Denver Post.

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

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