One Home Improvement Industry Doesn’t Need a Strong Housing Market

by James Brumley | September 10, 2012 9:01 am

Last Thursday, Home Depot (NYSE:HD[1]) was placed on a short list of Dow stocks to shed immediately[2]. There were no glaring red flags suggesting the stock was racing to the edge of a cliff. In fact, Home Depot has been doing pretty well[3], riding the wave of a respectable rebound in the housing market.

As is all too often the case, though, rose-colored glasses seem to have pushed Home Depot shares upward at a pace well beyond the pace of the company’s actual earnings growth.

Said another way, home improvement stores might be doing well, but they’re not doing exceedingly well … nowhere near as well as their stocks would imply. As a result, HD has reached a rather frothy valuation, and expectations were — and are — dangerously high. One stumble in the new-construction market could abruptly trip things up for Home Depot.

Just don’t broaden your definition of “home improvement” too widely. While Lowe’s (NYSE:LOW[4]) shares might be in the same overbought state Home Depot shares are, not every home improvement-oriented stock is running a big risk of another slowdown in the home-construction market. Indeed, some home improvement arenas might actually do well because of a housing market lull.

Boring Can Be Fun, Too

Paint stocks seem like about as much fun as watching paint dry … not very compelling. You know what is compelling, though? Making a truckload of money.

In that light, “boring” paint players like Valspar (NYSE:VAL[5]) and Dependable Dividend Stock[6] PPG Industries (NYSE:PPG[7]) have quietly dazzled the markets with huge returns for the year so far. PPG Industries — maker of the Lucite and Ported brands of paint — has seen its stock soar 34% year-to-date, while Valspar is up 42%. Real America Index[8] component Sherwin-Williams (NYSE:SHW[9]) has really impressed with its leading 59% rally since the end of last year.

For comparison, the S&P 500 is only up 14% year-to-date.

Normally, rallies of that size would be scary … invitations to a wave of profit-taking. And to be fair, shares of Sherwin-Williams, PPG Industries and Valspar all look a little overbought and due for a dip. That’s strictly a short-term impasse, though, and ultimately a buying opportunity into a long-term trend that looks surprisingly well-supported.

See, though it would be wrong to deem that paint industry as recession-proof, it’s about as recession-resistant as any company has a right to hope for.

Don’t believe it? See for yourself.

Clearly Not in the Same Boat

In theory, since Home Depot and Lowe’s sell paint, and since Sherwin-Williams and Valspar are paint manufacturers, and since home improvement stores and paint makers are all targeting the same basic consumer, then the paint makers and home improvement retailers would perform about the same in terms of sales or revenue.

That theory, however, would be (mostly) wrong.

[10]The nearby graphic tells the tale. It compares the per-share earnings trend of home improvement retailers Lowe’s and Home Depot against the bottom line of PPG, Valspar and Sherwin-Williams. Simply put, the housing crisis slammed the home improvement stores’ bottom lines pretty hard, while it didn’t really do too much damage to the paint makers.

No, none of these companies went unscathed in the shadow of the housing meltdown. PPG, for instance, had a rough 2009 when its per-share earnings figure fell from 2008’s $4.47 to $2.94. But it has more than made up for lost time in the meantime. Sherwin-Williams and Valspar are also both well into record-profit territory, while Lowe’s and Home Depot continue to crawl … at best.

What’s going on? The obvious answer is also the most correct one — paint is pretty darn near recession-proof. If new paint isn’t needed to prep new construction, then paint is needed to freshen up the houses people are deciding to stay in rather than leave. It really is the cheapest (and simplest) way to update the look of a home.

One acknowledgement: This isn’t a perfect apples-to-apples comparison. All three paint manufactures have made acquisitions during this timeframe that made it easier to show sustained business activity. And, all three paint companies in question make more than just house paint.

Then again, Home Depot has been adding stores in earnest for the last year or so; Lowe’s has been contending with more than a few store closures. Point being, don’t get consumed by the pennies. This is a broad brushstroke designed to paint a bigger picture.

And that bigger picture is quite clear. As former Valspar CEO Richard Rompala said in an interview way back in 2000, the paint business is about 75% recession-proof. The numbers in the meantime seem to verify it.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

Source URL: https://investorplace.com/2012/09/paint-stocks-dont-need-a-strong-housing-market-shw-val-ppg/

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