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On Jan 2, we upgraded our recommendation on Beacon Roofing Supply, Inc. (BECN - Analyst Report), one of the three largest roofing material distributors in the U.S. and Canada, to Neutral. While the company is likely to face challenges such as pricing pressure and general market softness, it will benefit from continued focus on acquisition and its strong balance sheet position.

Why the Upgrade?

On Nov 26, Beacon Roofing reported adjusted earnings of 56 cents per share for the fourth quarter of fiscal 2013 (ended Sep 30, 2013), down 7% year over year. The results fell short of the Zacks Consensus Estimate of 62 cents. Despite record revenues and continued cost control, lower gross margins led to the year-over-year decline.

Revenues in the quarter increased 14% year over year to a record $683 million but missed the Zacks Consensus Estimate of $689 million.

The company reported cash and cash equivalents of $47 million as of Sep 30, 2013, up from $40 million as of Sep 30, 2012. Total leverage ratio was low at 1.6x compared to 1.5x at the end of 2012. Additionally, interest coverage ratio of Beacon Roofing was 15.9x compared with 15.8x at the end of 2012. These metrics demonstrate its balance sheet strength, which will benefit its growth strategy.

Beacon Roofing, a Zacks Rank #3 (Hold) stock, remains committed to growth in core industry trends. The company opened seven new branches in the fourth quarter and is on track to open another 15 to 20 branches in fiscal 2014.

For fiscal 2014, the company expects full-year earnings per share to be at the lower end of the current published range of $1.80–$1.70 owing to lower demand and a competitive environment.

In addition, the Architecture Billings Index fell to 49.8 in Nov 2013 from 51.6 a month earlier. A score below 50 indicates contraction. The building and construction market continues to suffer due to the uncertainty in demand for commercial, industrial and institutional buildings. This in turn will affect Beacon Roofing’s sales.

Moreover, higher construction costs, labor shortage, lack of funds for real estate projects and the adverse effects of sequestration are likely to remain headwinds for the company.

Other Stocks to Consider

Better-ranked stocks in the same industry include James Hardie Industries plc and CaesarStone Sdot-Yam Ltd. (CSTE) and Lumber Liquidators Holdings, Inc. (LL - Snapshot Report). While James Hardie Industries and CaesarStone Sdot-Yam have a Zacks Rank #1 (Strong Buy), Lumber Liquidators Holdings carries a Zacks Rank #2 (Buy).

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