It's quite common to see the market reward companies for recoveries even before the evidence is all in hand. Although RPM International (NYSE:RPM) shares haven't been as strong as those of Fuller HB (NYSE:FUL), Sherwin Williams (NYSE:SHW), or Valspar (NYSE:VAL) over the past year, investors have nevertheless pushed up these shares over the past six months. Ongoing recoveries in the consumer and industrial markets could certainly drive the shares even further, but investors should realize that they're no longer looking at a markedly cheap stock.
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Surprisingly Strong Third Quarter Results
RPM certainly helped its case with strong fiscal third quarter results. Revenue rose more than 15% as reported and nearly 11% on an organic basis, and handily surpassed the sell-side estimates. Interestingly, revenue was strong across both businesses; industrial saw a 12% revenue improvement on 7% volume growth, while consumer revenue rose more than 18%.
Margins also improved for the quarter. Gross margin worsened about 60 basis points from last year, but operating income nearly doubled. As this quarterly illustrates, there's a pretty sharp point in the company's operating overhead and incremental income stacks up quickly once that's achieved.
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Still Some Reasons to Worry
Several months of positive ABI readings are a good reason to feel better about the commercial construction market, as is the fact that about 70% of RPM's business is based in maintenance and repair, and rust never sleeps.
That said, I'm a little nervous about the consumer number. True, Home Depot (NYSE:HD) and Lowe's (NYSE:LOW) are seeing better results and improving traffic, but my concern is that a mild winter pulled forward a lot of home projects. For better or worse, we should all know fairly soon as the next quarter ought to show a weaker consumer number if that's the case. If the next quarter is strong, though, that says some pretty encouraging things about the housing market.
Costs are also a potential boogeyman for this story. Unfortunately, RPM does not provide a lot of granularity on its costs; oil prices are high, titanium dioxide prices are rising, and the Bureau Of Labor Statistics (BLS) reports that "paint material costs" are up by double-digits over last year. Some of this cost inflation is unavoidable, but I do wonder if RPM's management philosophy of letting its units run very independently comes at the cost of purchasing inefficiencies.
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A Good Story, but How Much Will You Pay for It?
Certainly RPM scores well in many respects as a company and an investment. The company is well-diversified across multiple markets and is getting increasingly active overseas and in emerging markets. Moreover, that strong reliance on maintenance and repair, along with strong brands, means that customers come back over and over with repeat purchases.
The Bottom Line
We are still talking about a chemical company, even if it is a branded chemical company. By and large, paying near a double-digit enterprise multiple for a chemical company doesn't work out so well, unless there's a really strong reason to believe in sustained above-trend growth. However, I'm not sure the rebound in commercial or residential housing is going to offer that much incremental growth.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.