Specialty chemicals is a tough sector, and just about anything tied to construction (particularly commercial construction) is even worse. And yet, while RPM International (NYSE:RPM) has seen plenty of ups and downs over the years, the company's growth-by-acquisition strategy has continued to generate solid cash flow and decent returns on capital. While I still don't see these shares as a bargain today, an ongoing revival in the residential market does seem to be tiding the company over until commercial construction improves.

Strong Consumer Trends Drive Fiscal Q3 Results
This was a somewhat challenging quarter for RPM, and one that wasn't made any better or easier by some charges and one-time items that blurred the true picture of the underlying business.

Revenue rose about 9% as reported, though this figure was significantly inflated by M&A activity. On an organic basis, revenue was up 2%, which actually isn't that bad relative to spending trends in the residential and commercial construction markets. Sales growth was led by the consumer sector, with over 14% reported growth and just over 2% organic growth. Consumer sector volume was positive despite a challenging year-ago comp (up 9.5%).

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On the industrial side, weakness in Europe and the U.S. roofing market weighed on results. Reported revenue did rise more than 6%, but organic revenue was up only very slightly.

Margins were mixed. Gross margin improved 150bp, and it sounds as though the Consumer segment saw particularly good margins as input costs ease. This ought to be encouraging for companies like PPG (NYSE:PPG), Sherwin Williams (NYSE:SHW), and Valspar (NYSE:VAL), but the business mix and calendar timing don't line up exactly.

Looking at operations, severance costs and inventory writedowns led to significant increases in non-cash expenses. Pro-forma operating income was down 3%, which wasn't great, but the company did do relatively well relative to sell-side expectations.

Weakness Here, Strength There” Is Business As Usual
Given the mix of RPM's businesses between consumer/commercial and maintenance/new build, there won't be that many periods where everything is strong at the same time. In this quarter for instance, remodeling activity seems to have been a big help to the Consumer business, while aforementioned weakness in Europe and U.S. roofing weighed on the Industrial business.

Although I don't see that changing, the company's M&A decisions could alter the balance down the road. The company recently bought HiChem in Australia and Viapol in Brazil, and I would expect additional deals in the future aimed at increasing the company's exposure to the Asian and Latin American markets. While RPM may look to acquire businesses with good niche market share, I would expect these deals to be motivated just as much by the opportunities to leverage them for broader distribution of the company's existing brands and products.

The Bottom Line
I know that part of the bullish thesis on RPM is that companies like RPM, PPG, Sherwin Williams, and Valspar are poised to benefit from lower input costs as commodities like titanium dioxide and various basic chemicals have all settled down. I'm not so optimistic. First, natural gas prices are trending up again. Second, I'm not sure that lower input prices are going to lead to a return to gross margins in the mid-40%'s. Frankly, I'm concerned that RPM's rivals will use lower costs as a lever to lower prices and grab share. Likewise, if margins do start to expand, I expect customers like Home Depot (NYSE:HD) and Walmart (NYSE:WMT) to push hard on prices.

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As is often the case with RPM, it doesn't look like much of a bargain today. I'm willing to forecast mid-single digit free cash flow growth and use a lower-than-normal discount rate (crediting the company for its brand power), but that still doesn't produce an attractive fair value. Likewise, while EV/EBITDA analysis is more favorable (suggesting a fair value of around $26 on calendar 2013 EBITDA), it still isn't suggesting that RPM is underpriced today. So while RPM remains a solid cash-generating dividend-paying company with great brands, I just don't see a huge opportunity in the shares right now, even if the construction markets continue to recover.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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