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Recent Announcements Can Seriously Hurt this Stock

April 24, 2014 | About:
Explaining sudden gains and losses sometimes can be a tricky and deceptive task. More than once one fails at the attempt of finding the reasons for a company’s stock performance. The task is all the more difficult when no significant changes in the business model can be identified. Moreover, analysts’ opinions alone, or the speculation over a possible transaction can sink the face value, or send it straight to the sky. Usually, reasons for abnormal performance can be found in the economic environment engulfing the activity of an industry. In the case of Sherwin-Williams (SHW), and the rising face value experience during the last two years, the announced of an important acquisition has been at the bottom of the issue. The possibility of the purchasing of a Mexican competitor, turning the company into the largest paint producer and marketer, explains the greatly improving market performance.

Reaching new heights

For fiscal year 2013, Sherwin-Williams reported a 6.8 percent increment on net sales, while consolidated income before taxes grew 19.7 percent to $1.09 billion, net income increased 19.3 percent to $752.6 million, and diluted net income per common share increased 20.6 percent to $7.26 per share in comparison with 2012. Overall performance also registered a record total revenue, for the Paint Stores Group and Global Finishes Group of $6 billion and $2 billion, respectively. At the same time, the company operating cash exceeded $1 billion, finishing the year at $1.1 billion, an increase of $196 million over 2012.

Although Sherwin-Williams headquarters are located in the USA, operations have spanned across the globe. Today, the company is a global leader in the manufacture, development, distribution and sale of coatings and related products to professional, industrial, commercial and retail customers. However, diverse geographic presence and portfolio offerings may be, 58.9% of total sales are originated by the 3,908 stores of the Paint Stores Group, distributed across the US, Canada, Aruba, Jamaica, Puerto Rico, St. Maarten, Trinidad and Tobago and the Virgin Islands.

Amid all the good characteristics of the business model and the strong performance achieved throughout 2013, the first quarter of 2014 reported some weakness. While revenue rose 9.2%, an increase in costs and expenses resulted in a slight drop in earnings. Nonetheless, management anticipates a sales increase of 8% to 14% and EPS in the range of $2.80 to $3.00 for the second quarter of 2014. At the same time, it announced a sales impact of $125 million to $135 million and EPS loss of approximately $.10 per share in relation to the acquisition of Comex.

Conquered goals improves humor for a higher zenith

Trading at 27.1 times its trailing earnings, Sherwin-Williams carries a 59% premium to the industry average. On the other hand, revenue and net income have shown improvements the last five years in a row. More important gains have been experienced by cash flow levels, backed by a strong debt reduction during the last year, greatly improving debt-to-cash ratio. Operating margin also improved since 2009, after an important decline due to the economic crisis, and continues closing in to pre-crisis levels.

The greatest growth catalyst for Sherwin-Williams is the acquisition of Comex, in line with the company’s philosophy to diversify customer base and expand operations into various geographies. An additional upside to the company is the recovery of the consumer segment. Most important for the smooth integration of the recent transaction, aggressive cost control initiatives, working capital reductions, supply chain optimization and productivity improvement should continue to yield margin benefits. And pricing strategies will help to offset raw material inflation.

Amid the good prospects for continued growth, gurus have mostly dropped the stock, especially those with large positions. Only Joel Greenblatt (Trades, Portfolio) has increased his position, however, his position is far behind the large shareholders. Although further expansion is expected, the stock is comparatively expensive and the recent acquisition is expected to slow performance down. A concomitant face value drop should happen, and investors are recommended to wait for it before purchasing the stock.

Disclosure: Vanina Egea holds no position in any of the mentioned stocks.

About the author:

Vanina Egea
A fundamental analyst at Lone Tree Analytics

Visit Vanina Egea's Website


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