Armstrong World Industries is becoming an indispensable part of the U.S. commercial construction industry. Wall Street is mostly ignoring its story. The stock is a buy.

Armstrong makes ceiling tiles and specialty wall products used in the construction of offices, schools, and hospitals-and even data centers. Its ceiling tiles can be found in most modern offices. The company controls roughly half the market for ceiling tiles in the U.S.

Its stock, after hitting a multimonth high in early August, has since dropped 15% to Wednesday's close of $157.92. Sector concerns rather than company-specific issues appear to be the issue, specifically the Federal Reserve's interest-rate hike on Wednesday, which is typically a headwind for construction spending.

Armstrong is hardly alone among construction stocks to sell off in recent weeks. The State Street SPDR S&P Homebuilders and iShares US Home Construction exchange-traded funds have both dropped by 11%. Armstrong's stock is now trading at 17 times the next 12 months' earnings, at the lower end of its range in the past few years.

The company can thrive even if the industry does experience some of the setbacks currently weighing on it. Armstrong has strengthened its market position and relationships with architects. Its strong financial position will allow it to further invest in those relationships. This year's acquisition of Eventscape is one example of an accretive tuck-in that has mildly lifted earnings.

Turning to big-picture concerns, it's unlikely that the construction industry will deteriorate much more in the near term. The Fed is exhibiting "a mid-cycle adjustment rather than the beginning of a prolonged tightening cycle," writes Larry Adam, Raymond James' chief investment officer. A mid-cycle interest-rate hike-or two-won't turn into the tightening cycle seen in 2022. The hope is that it's a "one and done" type of increase and that oil prices won't rise much further next year, curbing overall inflation.

That means U.S. commercial construction spending can stabilize. July data showed annualized spending at $122 billion, down 21% from 2023, according to St. Louis Fed data. But the long-term pace of spending shows modest growth, and "office construction is showing meaningful year-over-year improvement from depressed levels, while activity in transportation, healthcare, and education projects continues to strengthen," writes D.A. Davidson analyst Garik Shmois.

That's far from the only reason to expect continued growth from Armstrong. It's proving it can increase sales even in light of cyclical concerns. On its August investor presentation, management guided for 1% year-over-year volume growth in the mineral fiber segment, its legacy business focused on ceiling tiles. And guidance for average unit value, or AUV-the price a customer pays for a unit of products per square foot-was up 6%.

"Mineral Fiber volumes remained positive despite mixed end market demand fundamentals benefiting from AWI's strong commercial execution and growth initiatives," writes Loop Capital Markets analyst Jeffrey Stevenson.

Management's latest outlook calls for high-single-digit organic revenue growth for the company's newer and still smaller Architectural Specialties segment. It's expected to grow 15% in total, inclusive of acquisitions. The business focuses on specialty walls and helps the company sell to data centers, which are famously in high-growth mode thanks to the infrastructure buildout for artificial intelligence.

Armstrong's dominant market position makes it easier to cross-sell its specialty offerings to existing clientele, given that it offers a broad package of products that can complement each other for almost any customer request. This helps the company deepen its relationships with architects and retailers such as Home Depot and Lowe's.

The focus on just two business segments has likely helped Armstrong gain market share over competitors that are more diversified. These include CertainTeed, a residential and nonresidential building products maker that's part of Paris-based diversified industrial Saint-Gobain; USG Corp., a subsidiary of privately held Knauf Group; and Rockfon, owned by Denmark's Rockwool.

Pricing, reflected in AUV, has risen every year in the past 10 except for 2020. Armstrong's ability to take market share makes its revenue less cyclical, or economically sensitive, than other building products companies. The volatility of Armstrong's annual sales growth, judging by the standard deviation of the figure since the company's first full year as a public company in 2007, is less than other U.S. building products companies. Its sales growth has a standard deviation of seven percentage points, compared with Builders FirstSource and Martin Marietta Materials at 46 and 12, respectively. And Armstrong revenue grew every year since 2022, while the other two saw some years of declines.

Pricing power enables Armstrong to stabilize or modestly increase gross margins, with analysts forecasting operating margin expansion of almost two percentage points, to just over 28% by 2028, according to FactSet.

Combined with share repurchases, this is why analysts see almost 13% annual earnings-per-share growth through 2028. With a few hundred million dollars in annual free cash flow, and growing, the company can continue to buy back stock-$800 million was added to the authorized program in July, increasing the total sum to $2.5 billion-and still make small strategic acquisitions.

Armstrong has a track record of growing cash flow far faster than its net debt, some of which is related to financing acquisitions. The stable growth can lift the stock's valuation to something closer to the 23 times it recorded early this year.

The catalysts for a rerating could come in construction numbers due Oct. 1, if they show that annualized spending is stabilizing; continued volume growth in mineral fiber, which would help confirm the former; and better-than-expected earnings.

Besides cyclical risks, Armstrong could make large acquisitions that don't pay off. We don't see this happening, as it has a history of making small acquisitions so as not to overinvest at any given moment.

This is a good moment to buy the stock.

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