Excerpted from Mairs & Powers' first quarter 2012 investor letter:
Valspar (VAL) – a long term holding
One of the keys to our success at Mairs and Power is our long-term approach to investing, and one of the keys to successful long-term investing is the ability to find companies with a sustainable growth rate. Generally, these are going to be companies that have a strong franchise or, as Harvard Business School Professor and well-known author Michael Porter phrased it, "a competitive advantage". It is easy to look at some of the holdings at Mairs and Power and see that they clearly have some sort of advantage over their competition, whether it be a superior franchise, product or cost position. Companies that come to mind include Ecolab, General Mills, and Medtronic, among others. But one of the larger holdings in the Mairs and Power Balanced Fund, and one of our most successful, is Minneapolis-based paint company Valspar Corporation. So how does a company selling a product as mundane as paint fall into the select category of having a durable competitive advantage? There is no question that Valspar has been a long-term success story. The company was founded over 200 years ago in Boston and grew steadily due to the success of innovative products such as "Valspar", the first varnish ever produced that remained clear when exposed to water. The nature and rate of growth changed dramatically in 1970 when it merged with privately-held Minnesota Paints and moved its headquarters to Minneapolis. At the time of the merger, the combined company was largely a domestic consumer paint manufacturer with sales of just over $50 million. Valspar then began a series of mergers over the next forty years that grew sales to over $4 billion, turned it into a dominant player in the industrial coatings business and greatly expanded its global presence.
Which brings us back to our original question: why has Valspar been so successful over such a long period selling a largely commodity-type product? Is this enviable track record the result of a superior product, a well-defined and exceptionally executed acquisition strategy, some other factor or a unique combination of several factors? We would argue it is the latter that accounts for much of the difference. While Valspar may not have any one overwhelming advantage over its competitors, it does compete very effectively in a number of areas. In the Paint segment, which is extremely competitive, Valspar has an advantage through its relationship with Lowes, which positions the company well for the fast-growing do-it-yourself market. In the Coatings segment Valspar is a market leader in several categories due to its technology leadership. In addition, the business is well-entrenched with its customer base because switching costs are high relative to the cost of the product. Finally, and perhaps most importantly, Valspar management has done an outstanding job of acquiring businesses that position the company in attractive markets, both in terms of new product lines as well as promising international markets. So while the "competitive advantage" of the company may not be quite as clear as that of other leading firms, we would argue it is just as significant a factor in Valspar's long history of success.