Activist investing and special situations.

Time to Paint the Town Red?

Added on by Lee Ho Fook.
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Be sure to check out our detailed stock analysis (click here).

 Sherwin-Williams (NYSE: SHW) fell a whopping 8% the other day. So is now a good time to reload your portfolio with the paint giant? The most recent pullback was due to Mexico's Competition Commission's decision to block its acquisition of Comex. At the same time, the company reported a 13% increase in profit for the second quarter, year over year, but both revenue and earnings missed consensus. 

After the first major fall in the stock's price over the past few years, the company soared in the months following:

Back in November, Sherwin-Williams announced plans to acquire Mexico's Consorcio Comex. The company has a solid presence in Latin America, and Sherwin-Williams would have paid $2.34 billion for this presence. The Comex acquisition would have helped it double sales in Latin America. The deal was rejected because the combined company would have a paint market share of between 48% and 58%, more than ten times that of its closest competitor. The problem with this is that it could lead to anti-competitive practices.

The paint company as-is

Sherwin-Williams current revenue breakdown is as follows; paint stores (57% of revenue), the consumer segment (14%), and global finishes (21%). Its largest segment, the paint segment also has a favorable mix of professional contractors and do-it-yourselfers. Back in 2012, the company opened 70 stores, putting its total 2012 store count to 3,520. It has plans to add another 70 to 80 stores in 2013. 

As mentioned, Sherwin-Williams managed to grow EPS year over year, but missed estimates on a revenue and earnings basis. This was due in part to rising costs, specifically, cost of sales were up 4.1% year over year, and general and admin expenses were up 3.3%. 

The company maintained its 3rd quarter EPS outlook, expecting to grow sales 6% to 9% year-over-year and post EPS between $2.55 and $2.65. For the full year, Sherwin-Williams is hoping to grow sales in the mid-single digits and post EPS of $7.45 to $7.55. 

Despite the pullback, Sherwin-Williams is still a bit too expensive. The company is trading around 24 times earnings, while its five year range is 11 times to 28 times. 

The comps

On a revenue basis, Sherwin-Williams is in the middle, with revenue of nearly $10 billion. 

The leading revenue generator is PPG Industries (NYSE: PPG), while Valspar (NYSE: VAL)generates revenue below $5 billion. Valspar is expected to see a sales increase of 3% this year and 7% next year. Valspar's long-term goal is to grow EPS annually by 10% or more. To reach these goals the company plans to invest in tech, implement various productivity measures, and focus on acquisitions. 

I like Valspar's exposure to the overseas markets. Nearly 50% of revenue was derived from foreign operations, with 13% from Europe, 12% China, and 6% Latin America. Valspar is also looking to continually reward shareholders. In late 2012, the company upped its quarterly dividend by 15% to $0.23 per share -- now paying a yield around 1.4%. The company's board also approved the repurchase of 15 million shares.

The other major competitor, PPG Industries, posted 2nd quarter EPS of $2.45 compared to $1.92 for the same period last year. The company is more than a paints company, but rather a diversified producer of coatings, chemicals, and glass products. It also gets over 33% of its revenue from emerging markets. 

It's revenue breakdown includes industrial coatings (28% of revenue), performance coatings (31%), architectural coatings (14%), commodity chemicals (11%), specialty materials (8%), and glass (7%).

PPG Industries is hoping that its emerging market presence will lead to further growth. It acquired the coatings business of Colpisa in 2012, making it the only major coatings supplier with a direct automotive OEM coatings manufacturing business in Colombia. It also snatched up European coatings company Dyrup A/S, expanding its European architectural coatings business. 

Bottom line

The recent pullback does put Sherwin-Williams price to sales ratio below 2 times, but its still well above peers:

I still believe that Valspar is the industry's best bet. Yet with Comex, Sherwin-Williams could have overtaken even PPG Industries as the world's leading paint producer. But there appears to be too much uncertainty as to whether it can address the Competition Committee's concerns to get a deal done. As it is, Sherwin-Williams is a good company that's a bit pricey.