Tickers in this Article: RPM, DOW, DD, KRA, FOE, AKZOY, PCL
If a company can do alright in the midst of a terrible end-user market, it stands to reason that the company should do pretty well when the eventual recovery comes. That could well be the thesis for investors looking at RPM International (NYSE:RPM) these days. While the residential real estate market has been a disaster recently, and the commercial market has not exactly been muscular, the company has continued to produce free cash flow. With a bevy of well-known brands, this should be a company in line to benefit from an eventual real estate and construction rebound.

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The Quarter That Was
Although things might get better someday, that day has not come yet. Sales were up 5% on a pro forma basis, with all of the growth coming from the company's industrial business. Industrial sales climbed about 8%, with more than half of that growth from organic improvement. By comparison, the consumer segment declined about 0.6%, with organic "growth" down more than 1%. For the company's fiscal second quarter, industrial was more than 70% of the company's sale base.

In point of fact, 5% growth actually compares pretty well to the company's historical average revenue growth rate, so investors really do not see the impact of a bad market environment until they get to the profits. Gross profit rose about 1.5% this quarter (and gross margin fell about 150 basis points), while consolidated EBIT increased a bit less than 3%.

The problem here is not that management decided to give themselves big raises or install gold-plated toilets. Rather, the issue is input costs. Companies like Dow (NYSE:DOW), DuPont (NYSE:DD), and BASF have not exactly been dropping prices lately, and RPM really does not have the leverage to push price increases through into the end-user market (particularly in the consumer segment). There's not much for the company to do, then, but eat some of those costs. (For more, see Analzying Operating Margins.)

The Road Ahead
In a lot of respects, RPM is doing a fine job. Consumer segment sales were down a bit more than 1% in a quarter when existing home sales were down roughly one-quarter. Of course there is no one-to-one relationship there, but suffice it to say that people are not going to be spending as much on their houses in an environment where prices keep dropping, unemployment is still high and other financial issues take precedence. On the other hand, it's also true that the company has not done as well as other "industrial specialty chemical" companies like Akzo Nobel (Nasdaq:AKZOY), Ferro (NYSE:FOE) or Kraton (NYSE:KRA), so it's not all praise and smooth sailing.

There are perhaps no more dangerous words in the English language than "how much worse can it get?", but that nevertheless seems like a fair question about RPM's markets. CMBS defaults are still moving higher, but the commercial real estate market seems better in some respects. The residential market, though, is still murky and it is tough to advocate buying housing-related stocks ahead of the turn. If an investor wanted to do so, why not buy Plum Creek (NYSE:PCL) or Rayonier (NYSE:RYN) safe in the knowledge that trees keep growing and these companies can sit on that "inventory" if they have to do so.

The Bottom Line
Assuming only 5% revenue growth and a very modest improvement in free cash flow yield, RPM would seem to be trading at fair value today. A real rebound could make 5% growth a bit conservative, though, and management may be able to improve free cash flow production to a greater degree. Either way, investors should not dismiss this company - it is has been a remarkably consistent free cash flow generator and pays a healthy dividend, and that almost never goes out of style. (For more, see 4 Companies With High Free Cash Flow Yield.)

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