Comparing America's 3 Largest Specialty Chemicals Companies

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Includes: PPG, SHW, SIAL
by: Joseph Cafariello

Summary

The Specialty Chemicals industry is expected to outperform the S&P broader market substantially this and next quarters, significantly this and next years, and meaningfully beyond.

Mean and high targets for the 3 largest U.S. Specialty Chemicals companies – PPG Industries Inc., Sherwin-Williams Company, Sigma-Aldrich Corporation - range from 12% below to 26% above current prices.

Find out which among PPG, Sherwin and Sigma offers the best stock performance and investment value.

* All data are as of the close of Friday, January 16, 2015. Emphasis is on company fundamentals and financial data rather than commentary.

A look into the Specialty Chemicals industry could be telling us something very important about the future. Things could be picking up real soon.

The companies in this space produce many of the basic materials that other companies use, especially manufacturers and builders. While the economic recovery may still be a little wobbly, the projected pick-up in earnings for the Specialty Chemicals industry seems to be indicating that overall manufacturing and production down the line is expected to pick up as well.

For instance, the third largest U.S. company in the space - Sigma-Aldrich Corporation (NASDAQ: SIAL), which produces various biochemicals and equipment useful to pharmaceuticals producers - is in the process of being acquired by one of the largest drug manufacturers, Merck (NYSE: MRK), in a move to secure its supply line in anticipation of growing demand for its drugs in the future.

For their own part, the largest two U.S. companies in the Specialty Chemicals industry - PPG Industries Inc. (NYSE: PPG) and The Sherwin-Williams Company (NYSE: SHW) - are both expected to beat the broader market's earnings at some 1.45 to 3.16 times their average growth rate over the next five years.

Hence, investors who can't quite decide which manufacturers to dive into at the moment might simply opt to go to the root of manufacturing and pick up the materials producers which manufacturers from multiple industries turn to. If you can't decide which branch of the tree you like the best, go with the trunk.

Just what types of materials do America's top three Specialty Chemicals companies produce?

• PPG Industries, Inc., headquartered in Pittsburgh, Pennsylvania, manufactures and distributes coatings, optical and specialty materials, and glass products. It offers coatings products for automotive and commercial transport/fleet repair and refurbishing; light industrial coatings and specialty coatings for signs; sealants, coatings, maintenance cleaners, transparencies and transparent armor for commercial and military aircraft; as well as coatings and finishes for the protection of metals and structures used by metal fabricators, heavy duty maintenance contractors, ship builders, bridge builders, and railroads. It also provides packaging coatings to aerosol, food, and beverage container manufacturers; optical products such as lenses, optical lens materials, and sun lenses; silicas to tire and battery manufacturers; and flat glass and continuous-strand fiber glass products for commercial and residential construction markets, and for the wind energy, energy infrastructure, transportation, and electronics industries.

• The Sherwin-Williams Company, headquartered in Cleveland, Ohio, provides paints, coatings, and related products to professional, industrial, commercial, and retail customers, including architectural paint and coatings, protective and marine products, automotive finishes and refinish products, original equipment manufacturer product finishes, and related items.

• Sigma-Aldrich Corporation, headquartered in St. Louis, Missouri, produces various chemicals, biochemicals, and equipment used in scientific research, genomic and proteomic research, biotechnology, pharmaceutical development, and diagnosis of disease. Its products serve as key components in pharmaceutical, diagnostics, and high technology manufacturing.

For being at the root of many manufacturing and production trees, the companies in the Specialty Chemicals industry are generally considered defensives, as they tend to ride out economic storms a little better than the finished product manufacturers themselves, as graphed below.

During the market meltdown from mid-2007 to early-2009, where the broader market S&P 500 index [black] fell 56% and the SPDR Materials Sector ETF (NYSE: XLB), of which all three of our highlighted stocks are components, fell 57%, both Sherwin [purple] and Sigma [orange] beat both benchmarks rather handily, falling just 35% and 27% respectively, while PPG [beige] fell 63%.

Source: BigCharts.com

Yet despite their generally defensive posture, they can still deliver some impressive upside during bull runs, given their position at the base of a multitude of manufacturing trees, as graphed below.

Since the beginning of the economic recovery in March of 2009, where the S&P has risen 207% and XLB has risen 165%, Sigma has gained 330%, Sherwin has soared 500%, while PPG has skyrocketed 680%.

On an annualized basis, where the S&P has averaged 35.49% and XLB has averaged 28.29%, Sigma has averaged 56.57%, Sherwin has averaged 85.71%, and PPG has averaged 116.57% per year!

Investors should be aware that Merck's acquisition of Sigma is expected to be completed by mid-2015 for $140 per share, some 1.83% higher than Friday's closing price of $137.48. That sharp move higher in the graph below represents the reaction to the buy-out announced September 22nd.

Looking at future earnings growth, the Specialty Chemicals industry as a whole is expected to outgrow the broader market rather robustly going forward as tabled below, where green indicates outperformance while yellow denotes underperformance.

Over the next two quarters, the industry is seen growing its earnings at some 3.04 to 4.62 times the market's average growth rate, before slowing to a more sustainable but still enviable 1.85 times over the next five years.

Zooming-in a little closer, the three largest U.S. companies in the space are expected to split perform, as tabled below.

PPG and Sherwin, for instance, are expected to swap leadership roles, as PPG outgrows all over the near term, to be overtaken by Sherwin over the longer term.

Sigma, however, doesn't seem to offer very much earnings growth potential. After its upcoming take-over, if it were to operate as a semi-autonomous division of Merck, it may not prove to be a very worthwhile holding relative to its competitors.

Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?

Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.

A) Financial Comparisons

• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.

• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.

In the most recently reported quarter, Sherwin delivered the greatest revenue and earnings growth year-over-year, where PPG and Sigma split the worst growth between them, which were negative denoting shrinkage.

• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.

Of our three contestants, Sigma operated with the widest profit and operating margins by a commendable degree, whereas Sherwin contended with the narrowest.

• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.

For their managerial performance, Sherwin's management team delivered the greatest returns on equity where Sigma's team delivered the least.

Since PPG's return on assets is not available, the metric does not factor into the comparison.

• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.

Of the three companies here compared, PPG provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Sigma's DEPS over current stock price is lowest.

• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.

Among our three combatants, PPG's stock is the cheapest relative to forward earnings, company book value and 5-year PEG. At the overpriced end of the scale, Sigma's is the most overvalued relative to earnings and PEG, while Sherwin's is relative to company book.

B) Estimates and Analyst Recommendations

Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.

• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.

Of our three specimens, Sherwin offers the highest percentage of earnings over current stock price for the current quarter, while PPG offers it for all remaining time periods. At the low end of the scale, Sherwin offers the lowest percentage for the next quarter, while Sigma offers it for all remaining periods.

• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.

For earnings growth, PPG offers the greatest growth in the current and next quarters as well as in the current reporting year (Q1-Q4 2014), while Sherwin offers it in the next reporting year (2015) and over the next five years. At the low end of the spectrum, Sigma offers the least growth in all periods.

• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.

For their high, mean and low price targets over the coming 12 months, analysts believe PPG's stock offers the greatest upside potential and least downside risk, while Sigma's offers the least upside and greatest downside.

• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.

Of our three contenders, PPG is best recommended with 8 strong buys and 7 buys representing a combined 78.95% of its 19 analysts, followed by Sherwin with 3 strong buy and 7 buy ratings representing 45.46% of its 22 analysts, and lastly by Sigma with 1 strong buy and 0 buy recommendations representing 8.33% of its 12 analysts.

C) Rankings

Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.

In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.

The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.

And the winner is… PPG by a combustive victory, outperforming in 19 metrics and underperforming in 2 for a net score of +17, with Sherwin rendered non-reactive, outperforming in 6 metrics and underperforming in 6 for a net score of 0, leaving Sigma in a state of decomposition, outperforming in 4 metrics and underperforming in 21 for a net score of -17.

Where the Specialty Chemicals industry is expected to outperform the S&P broader market substantially this and next quarters, significantly this and next years, and meaningfully beyond, the three largest U.S. companies in the space are expected to split perform in earnings growth, with PPG and Sherwin taking turns in the leadership position, while Sigma seems too preoccupied with its upcoming marriage to Merck to be of any use at its job.

After taking all company fundamentals into account, PPG Industries concocts the most potent financial potion, given its lowest stock price ratios, highest cash, revenue and EBITDA over market cap, highest diluted earnings over current stock price, highest future earnings over current stock price overall, highest future earnings growth over all, highest dividend yield, best price targets, and most analyst strong buy and buy recommendations - decisively winning the Specialty Chemicals industry competition.