A Pretty Painted Picture

By Will Ashworth | September 08, 2009 AAA

Peter Lynch believed you could learn a lot simply walking around a mall, checking out the action and keeping an eye open to opportunities. With that theory in mind, a quick stroll around a local shopping center presented the following revelation. It turns out Behr is owned by Masco Corporation (NYSE:MAS), a Michigan-based company that also happens to own KraftMaid cabinets, often seen on ABC's Extreme Makeover: Home Edition. That's enough for me; let the research begin.

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A Real Estate Slump
New home sales have been drastically hurt by this recession. Only now are stock prices of homebuilders recovering. With the precipitous drop in new home sales came an equally large decline in the revenues and profits of companies serving the industry.

Masco is no different. However, bucking the trend is Masco's paint business (part of Masco's Decorative Architectural Products segment) with second quarter sales that were up 6%, despite the company's overall sales being down 23%, to $2.04 billion. Even better, the segment's operating profit grew 30.3% year-over-year, to $116 million, compared to a 41.2% decline in overall operating profits to $147 million. In the last five years, the paint division's operating profit margin hasn't been less than 18.4%. In the latest quarter, it was 23.0%, 430 basis points higher year-over-year. Behr should trade on its own as Sherwin-Williams (NYSE:SHW) does - it'd fetch a premium price.

Top Paint Brands
Paint Brand Parent Company 2008 Operating Margin
Behr Masco (NYSE:MAS) 18.4%
Olympic PPG Industries (NYSE:PPG) 16.6%
Sherwin-Williams Sherwin Williams (NYSE:SHW) 13.4%
Benjamin Moore Berkshire Hathaway (NYSE:BRK.A) 11.9%
Valspar Valspar (NYSE:VAL) 8.4%

A Painted Picture
The table above lists some of the top brands in the paint war and their respective 2008 operating margins. Behr is at the top of the class with PPG's Olympic, and Pittsburgh Paints next in line at 16.6%. The tough part is, every company reports segments differently. For instance, Benjamin Moore's operating margin is part of "Other Manufacturing" in Berkshire Hathaway's 2008 10-K. Four other companies are a part of this group, which includes Johns Manville, an insulation and roofing business. It's likely that Benjamin Moore's operating margin is actually higher than the rest of the businesses in the group. I'd add a couple percentage points to its operating margin, putting it right alongside Sherwin-Williams. The other number that needs some adjusting is Valspar. Its operating margin is 8.4%. However, this number is actually its 2008 EBIT margin.

Which Stock Should You Buy
That's a tough decision to make. Behr, on its own, would be the obvious choice. However, the rest of the Masco business isn't fairing nearly as well. Masco's business has been deteriorating since 2006, long before the recession hit. If you really want to own a paint company, but aren't sure which is the best, go with Berkshire Hathaway - 'cause you can't go wrong with Warren Buffett. This brings us to PPG and Sherwin-Williams. PPG's paint division probably contributes no more than 75% of the revenues of the Performance Coatings segment, of which it is a part. In 2008, it was $4.7 billion. This means the paint division represents approximately 22% of the overall sales of PPG. Not only are Sherwin-Williams' paint revenues the largest of the five, they also represent the highest percentage of overall sales of the group. You could say that paint means more to Sherwin-Williams.

The Bottom Line
I really like the Behr business, but given Masco's other parts, Sherwin-Williams is the safer bet. Although its second quarter saw a sales decline of 12.7%, its earnings per share (year-over-year) was only off by 10 cents to $1.35. For the full year, it expects an 11-12% drop in sales and earnings per share - between $3.30-3.80. At today's prices, that's a forward P/E of roughly 16.8. Wait to see if we have a correction, so you can buy it below $50. That would give you a greater margin of safety. (To learn more, see Take On Risk With A Margin Of Safety.)

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