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On May 17, we downgraded our recommendation on manufacturers of metal products for the North American non-residential construction industry, NCI Building Systems Inc. (NCS - Analyst Report) from Neutral to Underperform. The downgrade followed its wider-than-expected loss of the first quarter and its announcement of an expected second quarter loss as well as other concerns like volatility of steel prices, dependence on few steel suppliers, and uncertainty regarding sequestration.

Why the Downgrade?

NCI Building reported loss per share of 19 cents in the first quarter of 2013 due to severe weather conditions, product mix, additional costs for the ramp-up of the Middletown coatings plant, and additional training required for employees.

NCI Building has provided preliminary results for the second quarter of fiscal 2013 (ending Apr 28, 2013). Even though revenues are expected to be up 17% year over year to approximately $293 million, adjusted EBITDA is projected to be in the range of $10 million to $11 million. This is expected to lead to a per share loss for the quarter.

NCI Building recognized additional expense in the first quarter to train skilled manufacturing workers (such as welders) and expects to do the same in the second quarter of fiscal 2013 as well, affecting margins. Furthermore, sequestration uncertainty remains an overhang.

One of the important raw materials for NCI Building is steel and it is considerably influenced by steel prices. The steel industry is cyclical in nature and steel prices remained highly volatile in recent years. The prices may remain volatile in future causing margin headwinds.

For the first quarter of fiscal 2013, steel accounted for 70% of its cost of sales and  a 1% change in the cost of steel  would have led to a pre-tax impact on cost of sales of approximately $1.7 million, had such costs not been passed on to the customers. Given the competitive environment and the costs of other alternative building products, it could restrict the company’s ability to pass on these higher costs. Furthermore, reliance on a few steel suppliers could make NCI Building more vulnerable to supply disruptions.

Other Stocks to Consider

Other stocks to consider in the same industry with a favorable Zacks Rank are Chicago Bridge & Iron Company N.V. (CBI - Analyst Report), James Hardie Industries plc , and PGT, Inc. (PGTI - Snapshot Report) all of which carry a Zacks Rank#2 (Buy).

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