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Tuesday, September 26, 2006

Insider Buying At Eagle Materials (EXP) & Selling At Illinois Tool (ITW)

By Yaser Anwar, CSC of Equity Investment Ideas

Insider BUYING

Eagle Materials (EXP) Date of Transaction- 9/19/06 Average Price- $35.2

The market reacted quite positively to this move, climbing more than 15% since then. So what does it bode for the stock? Laurence Hirsch of EXP has made a huge bet that commercial property seems to be on a different level than the housing market. How big a bet? $14+ million, equivalent to approximately 400K on his personal account. Prior to EXP, Mr. Hirsch had been the CEO of Centex (CTX), the homebuilder that spun off EXP in 2004.

EXP is the 2nd largest producer of gypsum wallboard, also known as drywall, after USG Corp (USG), where Warren Buffetts Berkshire Hathaway raised its stake to 17.3% just last month.

The US Geological Survey (USGS) reported that crushed stone production in the first quarter of 2006 was 324 million metric tons, up 5.8% from the year-earlier level of 306 million metric tons. According to USGS data, the rise was due to favorable weather conditions and increased activity in commercial, private and public construction.

Aside from wallboard, which generates some 50% of sales and the bulk of its revenue, EXP also makes cement, ready-mix concrete, recycled paperboard, and aggregates. It sells primarily to residential, commercial, and industrial construction customers located near its plants in the western and southwestern US

Trouble is, rough estimates from analysts and materials suppliers suggest that between 40% and 50% of wallboard demand comes from new residential construction. Less that mediocre forecasts from homebuilders such as Toll Brothers (TOL) and D.R. Horton (DHI) together with disappointing new-home sales data leaves little doubt that the residential market is slowing. What Hirsch is banking on is that this slack will be taken up by the commercial construction and home remodeling markets, which remain robust.

On the other hand, prices of commercial property have always been more volatile than those of housing, partly because the supply lags are longer. Developers plan new buildings when prices rise, but it often takes years to get planning permission and to construct a building, by which time demand may have fallen.

Booms and busts in commercial property caused widespread banking problems in the early 1990s, when property prices fell by 50% in America and Britain and by 70% to 80% in Japan and Sweden. The bursting of a huge property bubble was also a prime cause of Thailands financial crisis in 1997-98.

Will history repeat itself? At least Mr. Hirsch does not think so and with about 47 million square feet of new office space expected to be completed this year, up 30% from 2005, and completions projected to increase 37% to 65 million square feet next year, he has good reason to believe EXP is well placed to cope with a residential market that is turning sour.

The 1st Q results were pretty good. They saw an increase of 26.9% to $259.97 million in revenues translating into a rise of 69.3% to $59.09 million of earnings, or $1.16 a share compared with 64 cents a year earlier. EXP expects to earn $1.30 a share to $1.40 a share in the 2nd Q and $4.40 a share to $4.70 a share for the full year.

With the stock at $36.69 on a Fwd. PE of 7.72 and an extremely low PEG of 0.21, Hirsch may have a point in thinking EXP is cheap.

Illinois Tool Works (ITW) Date of Transaction- 9/18/06 Average Price- $43.51

A few days after ITW cut its 3rd Q and full year profit expectations CEO David Speer sold 30K worth of ITW at $43.52 to raise $1.306 million while key director Harold Smith dumped 120K shares at $43.50 each, pocketing $5.22 million.

ITW lowered its third quarter guidance for net income to between 78 cents and 80 cents a share from the previous range of 78 cents to 82 cents and for the year to between $3.03 and $3.07 a share, citing the slowdown in the U.S. home construction market and production cuts at North American automakers. The upper end of the earlier forecast was for $3.11 a share.

ITW is beginning to miss its profit targets is hardly surprising given the size and dispirit nature of the group.

ITW recently announced that it was paying $292 million cash, a 27% premium to the share price, for Click Commerce, which helps companies get up to speed in using radio frequency identification technology (RFID).

While I expect contributions from acquisitions, combined with favorable conditions in many of ITW's end markets to continue over the next 12 months, in my opinion that is largely reflected in the price of the stock.

According to S&P analyst, Anthony Fiore, the industry encompasses a wide range of industrial firms that supply the equipment that other companies need to run their manufacturing operations.

Longer term, S&P believes that the Asian-driven industrial overcapacity could trigger a deflationary cycle, and with corporate profit margins likely to get squeezed in that environment, this could also cause manufacturers to cut back on production, employment levels, and spending on new machinery and equipment.

Even though the sale of shares may not be significant enough, investors might want to consider following Speer and Smith out the door.

Sources: S&P Analyst Report, SEC Filings & IM

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