Is Jim Cramer Right in Calling This a Terrific Stock?

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Company Description

Sherwin-Williams (NYSE: SHW) is an efficient and innovative producer and seller of paints and coatings used by professionals, do-it-yourselfers, and general industry. The company sells paint, floor coverings, wall coverings, and other related materials through an extensive network of paint stores.

The company has organized its divisions along regional lines in order to maximize marketing, distribution, and capacity strengths.

The highest earning segment of the company is its chain of paint stores within the U.S. where the company’s paint is sold exclusively.

The consumer segment sells paints and coatings, under various brand names (Dutch Boy, Pratt and Lambert, and Martin-Senour are prominent ones) and under private label to the industrial maintenance markets through mass-market chain stores, home centers, independent paint dealers and distributors.

The Automotive Finishes sells a variety of motor vehicle finish, refinish and touch-up products primarily through its network of approximately 200 company operated automotive branches primarily in North America (Sherwin-Williams branded automotive finishes products), which involves several license names, technologies, and trade-names worldwide.

The International Coatings segment distributes a variety of paint and coatings products worldwide. Sherwin-Williams branded products as well as other products (including Dutch Boy, Pratt and Lambert, and Kem-Tone) are mainly sold in South America (Brazil and Chile) where the company also operates stores.

The following chart shows the contribution of different segments towards the overall sales:

<img src="/media/images/user_15211/capture3_1_large.PNG" />

 

Multiple catalysts on the horizon

Jim Cramer believes that Sherwin is a terrific stock. I am also bullish on the stock given that multiple growth catalysts are on the horizon:

1)      Sherwin’s stock moves very closely to the paint’s raw material prices. This means that an increase in the cost of paint’s raw materials normally lead to a capital appreciation in Sherwin’s stock price. Propylene and TiO2 are two important raw materials of paint. The following chart shows the price trend of propylene:

<img src="/media/images/user_15211/capture1_3_large.PNG" />

Source: propylene prices

The chart shows that the price of this raw material is declining. This seems to give bearish signals to the market. However, many experts believe that though a rise in paint’s raw material cost leads to an increase in the company’s revenues (and therefore its stock price), a decline in the raw material costs may not lead to a substantial decline in the company’s revenues as paint producers, typically, are able to hold onto the increases on the way down. I am not stating that there will not be a little give-back, but instead, I believe, most markets should be able to retain price. Also, a moderation in the raw material costs is expected in the future. A decline in the costs, with a lesser decline in the paint prices mean a straightaway margin expansion for Sherwin.

2)      Sales volume is also expected to increase. Gallons of architectural paint are expected to increase by 2-3% this year to near 630 million gallons. When the economy is not in a recession, around 730 million gallons of paint are sold annually.

3)      This point can be related to the previous one. Continued strengthening in the housing environment is also expected to drive pent-up demand and improve volume growth.

4)      Sherwin has announced its decision to acquire Comex, a Mexican paint company with operations in both Mexico and North America. This deal is expected to bring cost synergies of more than $70 million according to JP Morgan. JPM also believes that acquisition of Comex is expected to add $1/share to Sherwin’s earnings by 2015.

5)      The shale gas boom has led to a sharp decline in the price of ethane. Ethane is one of the main raw materials in the chemical industry. Where Dow Chemical (NYSE: DOW) has benefited the most (in the chemical industry) from this opportunity, Sherwin is also  a considered to be a major beneficiary.

Peer Analysis

Before analyzing valuations, there are a couple of points that the readers should know:

1)      As already mentioned, propylene is one of the key raw materials in the Paints and Coating Industry. Sherwin’s competitors just like Sherwin are highly exposed to changes in the raw material prices. The Valspar Corporation (NYSE: VAL)PPG Industries (NYSE: PPG) and RPM International (NYSE: RPM) are those coatings companies, which have the highest exposures to propylene-based inputs and therefore, they might benefit a lot from the moderation in the raw material costs.

2)      FX risk has also hampered Sherwin’s earnings over the years. However, given its increased focus in North America, the effects from the currency movements are muted as compared to its more globalized peers like Valspar and PPG.

Valuations and Bottom-Line

Sherwin trades at a 19.1x P/E multiple and a 12.4x EV/EBITDA multiple based on the 2013 forecast. The current valuation already reflects most of the investor confidence in a rapid rate of earnings growth resting on a housing recovery and margin expansion. Its competitor Valspar trades at a 15.9x earnings multiple for 2013 and PPG trades at a multiple of 15.7x for 2013. On an EV/EBITDA basis, Valspar trades at a 9.5x multiple based on the 2013 estimate and PPG trades at an 8.9x multiple. Sherwin’s 2013 multiples are above the valuation multiples of historical Paint & Coatings transactions of 10-12x EBITDA including the acquisition of ICI/Glidden by Akzo Nobel, Sigma Kalon by PPG, and the purchase of Rohm and Haas by Dow Chemical.

Sherwin seems an attractive buy on cheap valuations, improving end markets and moderating raw material prices. 


AnalystX has no positions in the stocks mentioned above. The Motley Fool owns shares of JPMorgan Chase & Co. Motley Fool newsletter services recommend Sherwin-Williams. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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