Two Keys to Watch
• Keys for the future: gross margin gap and organic volume trajectory in Consumer. We exited RPM’s F1Q18 conference call feeling rather balanced on F1Q results as well as the stock. Earnings came in a touch better than expected, but our expectations were modest given the recent trajectory of organic sales growth (+1-2%), coupled with a backdrop of elevating raw material costs. Consistent with our view, it appears as though the growth pendulum has swung away from Consumer and towards Industrial. This was verified by continued softness among “big box” retailers. However, we found management’s commentary on the choppiness in Industrial to be somewhat disconcerting as well. With macro indicators such as ABI and ISM trending positively in the US, we suspect that mixed trends are perhaps hurricane-related as RPM suggests. In the meantime, we believe management is taking the right steps to initiate price hikes to restore gross margin, which declined 160bps y-y in F1Q18. Traction here will be important for investors’ willingness to engage, in our opinion. The other key in our view will be resumption of organic volume growth in Consumer. On this point, constructive data seems lacking for now, so we remain in “wait and see” mode. With RPM shares having languished YTD, valuation appears reasonable albeit not terribly enticing in our view, so we continue to await a better entry point.
• Our top 10 takeaways: (1) adjusted EPS of $0.86 came in ahead of our $0.84E and consensus of the same; (2) a lower than expected tax rate was responsible for $0.01 of the upside; (3) sales featured a larger M&A contribution, while organic sales growth was largely in line with our estimate; (4) commentary regarding weakness in the Consumer segment suggests ongoing...
• Changes to our model: We maintain our F2018 estimate of $2.85, including $0.59E for F2Q. We now project higher operating earnings in RPM’s Specialty segment, where the company’s Legend Brands unit should continue to benefit from higher sales of restoration-related equipment in the wake of several hurricanes. In offsetting fashion, we adopt a more cautious stance on Consumer growth prospects with organic sales having dipped y-y to start the fiscal year. Likewise, for F2019 we maintain our $3.05E, which would imply EPS growth of 7% from the F2018 base.
• We maintain our rating of Hold. Our price target of $54 suggests total upside potential of 6%, including a dividend yield of 2.3%. Our valuation of RPM is based on an average of our DCF analysis and a relative P/E-based framework. Our DCF analysis suggests a warranted stock price of $55, and includes a weighted-average cost of capital (WACC) estimate of 7.8% and a terminal growth rate of 2.5%. Using our relative P/E framework, we calculate warranted value of $54 per RPM share. Using our updated CY18 estimate as a base, our analysis reflects an applied premium of nil vs. the S&P500 index multiple based on consensus estimates of forward earnings.
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