Regulators wouldn’t let Sherwin-Williams (SHW) buy Mexico’s Comex due to market share concerns. PPG (PPG) is ready to head down the same regulatory path, announcing Monday that it was acquiring the Mexican coatings and paint maker for $2.3 billion.
PPG’s presence in Mexico isn’t nearly as significant as its major competitor and likely won’t run into the same regulatory land mines. With the addition of Comex, PPG becomes a player in the South American architectural coatings business.
The deal raises the tough question: Is PPG stock a better buy than SHW?
Why PPG?
Both stocks trade above $200. According to FinViz, only 44 U.S. stocks (market cap greater than $300 million) have achieved this despite the huge bull run we’v been on the past five years. Trading within five dollars of each other, PPG and SHW are up 10.5% and 13.8% year-to-date, respectively. Despite underperforming in the first half of 2014, PPG has held its own against SHW over the past half decade.
In the last 10 years, PPG has transformed itself from an industrial conglomerate into a coatings powerhouse. In 2004 approximately 56% of its $9.5 billion in annual revenue was from coatings. In 2013, coatings accounted for 85% of PPGs $15.1 billion in revenue. Glass, which is the G in PPG, only accounted for 7% of revenue, down 16 percentage points from a decade earlier. In its Q1 2014 report, glass represented less than 1% of PPG segment income. In fact, both its other segments — industrial coatings and performance coatings — generated operating profits that were almost equal to its glass business’s revenue.
As a result, PPG today is quite similar to Sherwin-Williams. You wouldn’t have said that a decade ago.
From a valuation perspective, I don’t think there’s any question PPG stock is undervalued when compared to SHW. While PPG’s enterprise value is 11.8 times EBITDA, SHWs is 16.5 or 40% greater. Meanwhile, their operating margins are very similar, sitting within 100 basis points of one another. When you consider that their dividend yields are virtually identical, there’s no argument that makes SHW the cheaper stock.
Why SHW?
The big advantage for Sherwin-Williams are its 3,908 paint stores which generate approximately 75% of its overall revenue and give it much greater direct control over its customer base compared to PPG, which has approximately 1,000 stores. Most of those stores were added in 2013 when PPG acquired AkzoNobel’s (AKZOY) North American decorative paints business. With almost four times as many company-owned stores in its network, SHW definitely is able to leave less to chance.
SHW has done a great job growing sales and earnings in recent years, and although it missed out on a great opportunity to grow its South American business with Comex, it still generates 7% of its revenue in Mexico and elsewhere. That means SHW should be able to keep up with PPG in Latin America. Perhaps a less contentious acquisition will come along that it can easily roll up into its business down there. In the meantime, it’s business as usual in Latin America.
PPG vs. SHW: Which is Better Buy?
Between the AkzoNobel acquisition last year, the disposition of its Transitions Optical business April 1, and the Comex acquisition announced Monday, PPG has managed to pivot its business into being an even stronger adversary in the paint and coatings business. Paying for Comex in cash, it will likely add to its debt in order to carry out its $2 billion share repurchase program approved by its board in April.
Once completed, the Comex deal pushes PPG’s coating business to $14 billion, or 93% of its overall revenue. Its Latin America business goes from 5% of revenue to 11% overall further diversifying its geographic footprint. The purchase is immediately accretive with anticipated synergies of 3% or more. Sherwin-Williams wanted Comex — PPG got it.
SHW and PPG are both great companies. However, on a valuation basis, PPG is clearly the better stock.
As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.
