The Best Way to Play the Housing Recovery

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

US housing starts are at their four year highs. The Fed’s decision to purchase $85 billion of mortgages every month in a low interest rate environment could further bolster the housing recovery. Investing in REITs sounds like a logical choice, but the rising prepayments are negatively affecting their bottom-lines. However, to play the housing recovery, one can invest in construction material providers; but not all of them get a “buy” rating.

Sherwin Williams (NYSE: SHW) is involved in the manufacturing and marketing of paints, coatings, nuts and bolts, and other building materials. Chloride TiO2 is one of the key ingredients in paint manufacturing, accounting for 40% of paint manufacturing costs. Its rising prices have been a cause of concern, but management recently announced that it would able to replace it with a cheap alternative. Its competitors have already begun substituting the ingredient, but Sherwin Williams has followed the “wait-and-watch” approach up until now. The substitution is expected to begin mid-2013, following which we should see an immediate boost in margins.

In November, the company acquired the Mexican paint giant Comex for $2.34 billion. Comex reported $14 billion in annual sales with over 3,300 selling points. This would allow Sherwin Williams to take advantage of the recovering housing sectors of Latin America.

Sherwin Williams’ quarterly net income increased by 30.6%, operating income rose by 31% and net sales increased by 4.6%. With a solid bottom-line and topline growth, the street was impressed by the results. Shares of Sherwin Williams yield 1%, and the management announced dividend payouts will continue. However it would reduce its share repurchases, because of the acquisition related expenditures. Keeping all these triggers in mind, we could expect operating expenses and increasing revenues (on the back of Comex acquisition) in 2013. Though its shares are not undervalued, the mentioned reasons are compelling enough for a buy.

Though Vulcan Material (NYSE: VMC) reported a 340 bps increase in its gross margins, weak sales drove down the revenues. The management expects the housing recovery to continue and raised its 2012 adjusted EBITDA from $435 million to $455 million. However I’m pessimistic about the company, as merely a margin boost can’t cover for weak sales. Though its shares are up by 30% YTD, it’s mainly driven due possible acquisition by Martin Marietta Materials (NYSE: MLM) .

Last year MLM had earlier bid for the company, which was rejected by Vulcan. In 2012, Martin Marietta again bid for the company, but at a higher price, which was again rejected by Vulcan. As the bid expired, MLM was not allowed to bid for the company for 4 months. Now that the 4 month period is over, acquisition rumors are powering the stock.

Shares of Vulcan Materials trade at a ridiculously high forward P/E of 322.5x, with one of the worst (in the industry) P/FCF ratios of 103.5x. Weak financials and bad fundamentals coupled with the absence of positive triggers, shoots all kinds of investment theories straight out of the window.

Masco Corporation (NYSE: MAS) reported a 11% jump in quarterly operating net income with $52 million in gross profit improvements. But its European sales were down by 11% and its revenues were flat. The management announced that lost sales accounted to $15 million and would account to $50 million in each of the next 4 quarters. Besides promises of operating expenditure cuts, there aren’t any positive triggers for the company. Its debt/equity equates to a towering 777%, and its shares trade at a P/E of 28.7x. Its Returns on Equity equate to a negative 56% and its shares carry a ridiculously high P/FCF of 2878x. The absence of positive catalysts, coupled with poor financials and fundamentals, should discourage investors from entering Masco.


PiyushArora has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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