What Did Sherwin's Investor Day Tell Us?

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Sherwin-Williams' (NYSE: SHW) recent investor day has sent bullish signals to the market. The optimism is to be seen not only in the company’s story but also in the overall industry. Given the recent news on sluggish improvement in non-residential construction markets (shown by the Architectural Billing Index), many had turned bearish on this industry.

However, Sherwin’s investor day left us with four key takeaways. The strength in the industry will be driven by:

1.) Increasing volumes

2.) Moderating raw material prices

3.) Growth effects of newly acquired businesses

4.) Effects of industry consolidation

Volume momentum is boosted by a strong cyclical architectural paint rebound. There is no doubt that the progress in non-res markets has been below par, but current US paint volumes are still near trough levels. And as they cyclically recover over the next three years, the coating space should see outsized earnings growth.

Raw material cost pressure has eased and could start to reverse (if the Street is right on the TiO2 outlook). For those who don’t know, Titanium oxide, or TiO2, is one of the most essential ingredients in paint making. Prices of TiO2 have started a decline toward record levels.

All three major coating companies have made major strategic moves in the last year: a.) Sherwin is in the process of acquiring COMEX; b.) Valspar (NYSE: VAL) acquired ACE Hardware business, launched paint lines at B&Q in Europe, and took over a paint line in Lowe’s; c.) PPG Industries (NYSE: PPG) has acquired the North American Glidden brand business from Akzo.

Investment thesis

Looking forward, the earnings trajectory for Sherwin is positive given the company’s outsized leverage to a U.S. housing recovery. The COMEX acquisition, when completed, should further cement Sherwin’s footprint in two key architectural coatings markets (Latin America and North America). The environment for Sherwin’s stock should continue to be favorable in Q2 on easing raw-material prices (both TiO2 and propylene) as well as some possible pent-up demand from a cold winter in the Northern portions of the United States.

Valspar – growing from acquisitions

Valspar remains on track to achieve $400 million in incremental revenue by 2015 from new business wins, predominantly from B&Q, Lowe’s (Valspar Pro) and the Ace acquisition. The potential contribution of these businesses can already be seen in Q1, as it was largely Valspar Pro and Ace which boosted sales in the company’s paint segment.

While Ace is initially dilutive, toward the end of the year, the company should see improvements in contribution as the Valspar brand (higher price point and margin) starts to shift the mix favorably.

The company announced $18 million to $23 million in cost-reduction charges and ~$30 million of efficiency improvement CAPex for both its North America and Australia asset base. In total, this spend should result in ~$0.10 of incremental EPS in 2015. Additional upside on more cost take-outs (i.e. paint manufacturing facility rationalizations) is probable as well.

A story quite similar to Valspar

A story quite similar to Valspar is that of PPG Industries. The giant coatings producer and the number-two global producer of paints and coatings generated annual revenue of ~$15 billion in 2012.

PPG makes a large chunk of its sales from paint and coatings. However, the end market of paints in this case is not only houses. It is also used in the automotive and aerospace industries. And we all know that both of these industries are booming right now. Auto sales (SAAR) for May reached a five-year high level. Similarly, companies like Boeing believe that the demand for commercial aircraft (small and fuel-efficient) is rising day by day. The company also gets revenue from large flat glass and optical material, which helps it to diversify its revenue base.

Final word

Increasing volumes, declining raw material prices, new acquisitions in this space and consequent industry consolidation mean that the paint and coatings industry is poised to fly higher despite sluggishness in non-res construction markets. 

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Zain Abbas has no position in any stocks mentioned. The Motley Fool recommends 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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