Paint Stocks Glossing Over Housing Mess

By Matt Cavallaro | October 03, 2011 AAA

As if it wasn't clear enough, recent housing data continues to paint a mostly bleak picture. New home sales ticked in at a nine-month low during August as median and average selling prices dropped sharply. Surprisingly, existing home sales improved last month, yet housing starts fell 5%, cancellations remain very high and tight credit is marginalizing potential buyers. Can paint stocks like The Valspar Corporation (NYSE:VAL) and Sherwin-Williams Company (NYSE:SHW) shine without a sustained housing rebound?

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Paint Stocks in a Bad Housing Market
Even with mortgage rates hovering around near record lows, investors shouldn't expect housing to provide a stimulus to equity markets anytime soon. Consumer confidence remains very soft, and an impending change to conforming loan limits beginning in October will be just another headwind working against a recovery.

The big problem is foreclosures; default notices surged a staggering 33%, sequentially, during August. That's the biggest increase since August 2007. The housing mess - persistent oversupply due in large part to a dogged glut of foreclosures - isn't going anywhere.

Strangely enough, paint producer stocks really aren't reflecting the undeniable problems in the housing market. Over the past month, shares of Valspar, Sherwin-Williams and diversified paint producer PPG Industries Inc. (NYSE:PPG) were are all roughly flat. Considering all of the bad news coming out of the housing market, there appears to be a disconnect. Only H.B. Fuller Company (NYSE:FUL) and chemical and paint manufacturer RPM International Inc. (NYSE:RPM) are deep in the red this month. The paint segment was underperforming before September, with all of the major stocks down 6% or more year to date. So, what has happened within the past month that would be positive catalysts for the group? It was understandable for paint stocks to rally ahead of, say, implementation of the $8,000 first time home buyer tax credit that ended last year. The housing backdrop simply has more shades of red than green right now.

Inflation Eating Away at the Paint?
Investors will be waiting for the paint on the walls to dry if they are looking for a housing market turnaround. More importantly, costs have been steadily rising. Paint producers have been forced to raise prices to offset higher raw material costs. Last quarter, higher charged prices helped Sherwin-Williams record a 10% increase in revenues. However, profits dipped 1% as the cost of goods sold rose 14%.

Likewise, H.B. Fuller saw unit volume sales sink during the third quarter because of higher price points needed to maintain margins amid elevated costs. That means H.B. had to charge higher prices to make a similar amount of money because material costs increased. Even though the Minnesota-based paints, adhesives and sealants producer generated earning in-line with estimates at $23.2 million, H.B. Fuller guided down the top range of its earnings forecast due to higher-than-expected costs and a difficult demand environment.

The Bottom Line
Margin pressures are a major concern for paint retailers, including Benjamin Moore Paints which is owned by Berkshire Hathaway Inc. (NYSE:BRK.A). Paint companies will have to continue to aggressively manage costs and pricing. On the bright side, several companies in the group pay attractive dividends, particularly RPM International which yields an outstanding 4.6%. In all likelihood, these yields may only get better as paint stocks better reflect the glaring streaks in the housing market. (For additional reading, take a look at 4 Key Factors That Drive The Real Estate Market.)

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