Undervalued Company of the Week – NX

The company of the week this week is Quanex Corp. (NX), a producer of engineered carbon and alloy steel bars, and other various products primarily serving the vehicular products and building products markets.  As we did last week, we will be looking reviewing the company using Warren Buffett’s approach for the Business & Management Review.  We will also use Benjamin Graham’s overall philosophies to guide our Financial & Value Review.

Business & Management Review

1.  Is the business simple and understandable?

     Absolutely.  Quanex manufactures and supplies materials to two markets – vehicular products and building products.  For the vehicular products market, the company produces steel bars that are commonly used in a long list of auto-parts including engine/motor components, gear box components, drive train components, and other various parts.  The building products division provides aluminum flat rolled coiled sheets for use in the production of building/construction products, consumer durables, electrical products, machinery/equipment, and transportation.  Overall, Quanex products have a wide range of use.

2.  Does the business have a consistent operating history?

     Quanex was founded in 1927 and has maintained a steady strategy of “growing by focusing on specialized, manufacturing processes to produce value-added metal products for original equipment manufacturers.”  Though the individual products that Quanex produces may have changed over their 75 years in operation, the basic strategy and business has remained the same.  Over the years, the company’s operating history and success has seemed to oppose the expected results of a manufacturer.  Despite being founded just before the Great Depression, the company managed to grow quickly, and attained sales of over $1 million in 1935.  In addition, the last 20 years have seen manufacturers fall from their golden days, but Quanex has continued to grow stronger.

3.  Does the business have favorable long-term prospects?

     The wide range of applications of Quanex products will lead to strong long-term operations.  In addition, as a component manufacturer, the company is not limited to how the consumer market views their products – meaning if consumers no longer want to buy a certain type of car, Quanex should not be affected.  In addition, we see the cyclicality of Quanex’s business smoothing out over the long-term.  The company’s products are being used in more and more end-user products, which leads to smoother sales. 

4.  Is management rational?

    The current management has done an excellent job over the last five years.  We are very pleased with the direction management intends to pursue.  The Chairman’s Message on their website provides an excellent outlook on their “Game Plan.” It is clear to us that management is rational in their approach, as they are focused on remaining “an inch wide but a mile deep” rather than “a mile wide and an inch deep.”  The company has a focused strategy and approach to its business, and that will reward shareholders in the future.

5.  Is management candid with its shareholders?

     We are very pleased with the investor relations webpage of Quanex Corp.  Readers can gain an insightful look at how management intends to compete going forward, and explanations of past actions.  We are especially pleased with the Direct Stock Purchasing Plan offered by the company, which allows individuals to purchase stock directly with minimal transaction costs.

6.  Does management resist the institutional imperative?

    We believe the company’s performance over the last few years is evidence that management is excelling above and beyond the management at competitors and other firms, and is indeed resisting the institutional imperative.

Financial and Value Review

Upon our review, we find Quanex Corporation to be suitable for the enterprising investor but not the defensive investor following Benjamin Graham’s value investing strategy.  The company’s size, current ratio, and lack of a positive net income for 10 straight years eliminate it from the defensive investor’s portfolio.  With a PE ratio (see Our Methods) of 6.48 and an ROIC of 12.66%, we believe this is an excellent investment opportunity.

We believe the company has potential to reach $57/share in the next few years. 

Neither of us held a position in Quanex Corporation at the time of publication.  Also, please read our disclaimer and Our Methods.

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