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Valspar's Future Looks Bright

|Includes: The Sherwin-Williams Company (SHW)

Valspar Corporation, symbol VAL, is the world's 5th largest manufacturer and distributor of coatings and paints with FY 2013 revenue of $4.1 billion and a market cap of $6.1 billion. Its major segments in the coating division include packaging, general industrial, coil, and wood. Its main segments in the paints division are consumer paints and auto. Its customers include some market leaders; including Deere, Caterpillar, Whirlpool, Ball, and Lowe's.

Last FY, Valspar had an EPS of $3.29 on net income of $289 million. The company generated $398 million in cash from operations. Almost half, 56% of company sales, came from the US. Coatings accounted for $2.2 billion of sales, paints $1.7 billion, and other 0.2 billion. (Figures from company presentation)

I compare Valspar with 3 other major American companies in this space; Sherwin-Williams, RPM International, and PPG industries. Valspar has a current PE of 23.36. Its competitors have PEs of 26.33, 27.89, and 8.4, respectively. Valspar has a current EV/EBITDA multiple of 12.24. Its competitors multiples are 15.5, 11.82, and 11.97, respectively. (Multiples taken from Yahoo Finance on Feb. 17, 2014)

Investment Thesis

The company made 2 acquisitions in 2013 that make me optimistic about 2014. They acquired the paint manufacturing business and entered into a strategic partnership with privately held Ace Hardware. They also acquired Italian based industrial coatings manufacturer Inver Group. These acquisitions did not begin to be recorded in company financials until Q4.

According to the company, paints saw a 30% growth in North American sales in Q4, half due to Ace. Additionally, Inver increased total company sales by 3% in Q4.

Positives for the year ahead are full year revenues from both Ace and Inver. Valspar also broadened its partnership with Lowes in 2013 and began offering professional grade paint. These expansions with both Ace and Lowes will expose Valspar to the recovering US housing market. Some estimates have US housing starts increasing 20% in 2014. The company's wood coating segment will also benefit from an US housing recovery.

Headwinds for the company include Australia and China. The Chinese housing market may continue to struggle as the Chinese government looks to curb credit-fueled growth in the face of decreased exports. One positive, Valspar's management is focusing on affordable housing products which may be one area where the Chinese government does not rein in spending.

The Australian housing market is also expected to be stagnant this year. However, Valspar is gaining market share in Australian home improvement store Masters. Australian currency may also be a headwind if the Australian dollar remains weak against the US dollar. Foreign currency related charges totaled $26 million in FY 2013.

Valuation

I arrived at my price target by looking at sales per square feet. From 2010-2012, sales per square feet were growing at about 14% CAGR. Last year's acquisitions resulted in an increase of 1 million square feet and a 10% decrease in sales per square feet. With full year sales from Ace, Inver, and Lowes professional line, as well as these markets maturing, I believe that Valspar can get back to 2012 sales per square feet numbers.

This would result in the company increasing revenue by 11.6% in FY 2014. New business with Inver, Ace, and Lowes can contribute 8 - 9 % of the growth. The remaining increase can come from coatings as the global coatings market generally increases with global GDP which the IMF expects to be around 3.5% this year.

I estimate revenue to be about $4.85 billion in FY 2014. I used a 33% gross operating margin and a 21.7% operating expense margin to arrive at an operating margin of 11.3% or about $517 million. I subtracted the max interest expense and other expense since 2009 to arrive at about $446 million income before taxes. I calculated taxes using a 31.21% rate and arrived at my net income of about $307 million. I used a shares outstanding number of 85.4 million to arrive at my estimated 2014 EPS of $3.59.

Using this EPS and shares outstanding I arrived at my target price of $84.10. This is an 11.79% increase over the closing price on February 14, 2014 of $75.23.

In full disclosure, the company reiterated its forecasts of 7 - 9 % growth and an estimated EPS of $3.95 - $4.15 at its latest quarterly conference call.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.