By Matt Doiron
Paint and finish company Sherwin-Williams (SHW) is up about 75% over the last year. While some of Sherwin-Williams' business units tend to be exposed to the broader economy, in general it does not track the S&P very closely with a beta of 0.6. In fact, its recent performance is hardly anomalous: the stock has nearly doubled over the last five years while the S&P 500 index (SPY) is just clawing its way back to that point.
The rise in the stock price has been warranted. Sherwin-Williams' Q2 revenue was up 9% over the second quarter of 2011, and its earnings per share rose 31% as the company turned in higher gross margins. The first quarter of the year showed similar performance, and so Sherwin-Williams is showing good growth so far in 2012. The Paint Stores group, which is responsible for about 75% of the company's income, grew its revenue by 15% in the second quarter. Wall Street analysts expect this growth to continue; while Sherwin-Williams's trailing price-to-earnings ratio is 27, too high to be considered a value stock, sell-side earnings estimates imply a forward P/E of 18. These analysts, at least when it gets close to reporting time, tend to be very accurate as in each of the last four quarters Sherwin-Williams has beaten earnings estimates, and three of these four times has done so by less than 2%.
Sherwin-Williams has some popularity among hedge fund investors. Billionaire Ken Griffin's Citadel Investment Group doubled its stake in the first quarter of 2012 and reported holding 1.3 million shares at the end of March. Robert Caruso's Select Equity Group has been reducing its stake since last summer but reported 1.9 million shares in its portfolio, remaining ahead of Citadel as the largest hedge fund holder of the stock. Viking Global, a value hedge fund managed by Tiger Cub Andreas Halvorsen, has also been selling out of its position but still owned 940,000 shares according to its 13F (see more stock picks from Viking Global).
Most of the recent insider selling at Sherwin-Williams has been insiders exercising their stock options, but there have been two exceptions. The President of the Paint Stores group sold 3,700 shares in May (at a price of about $125) and a member of the Board of Directors sold 1,000 shares last week at an average price of $133.20. While there are many reasons why insiders might be selling their own shares, and it might be reasonable to take some profits after a large gain in the stock price, investors should keep this information in mind.
PPG Industries (PPG) and du Pont (DD) have business units, which make protective coatings and so to some degree these companies compete with that part of Sherwin-Williams' business, though they are technically in the chemicals industry. Both stocks pay higher dividend yields and both have lower P/E multiples than Sherwin-Williams; du Pont's trailing P/E is 13 and PPG's is 19 versus Sherwin-Williams's 27. Since the protective coatings business is more cyclical than paints, and these companies have other business operations that also tend to be cyclical, they are more exposed to the broader market. Two peer companies in the building materials industry are Fastenal (FAST), which provides items such as nuts, bolts, and screws, and Vulcan Materials (VMC), which provides construction aggregates such as asphalt and concrete. These peers trade at considerably higher valuations, with forward P/E ratios of 26 and 166 respectively. Both of them have also outperformed the S&P 500 over the last year. We think that Sherwin-Williams may have outpaced its fundamentals, but if there is a pullback in the near future it could fall to a level where it is a buying opportunity.