F2Q EPS Beat on Tax; EBIT in Line as Margin Offsets Sales Upside
• RPM posted decent operational results for F2Q18. EPS of $0.70A exceeded our $0.59E and consensus of the same. Relative to our model, the entire upside of $0.11 was driven by a lower than expected tax rate of 12% vs. the 26% that we had anticipated. Operationally, the results were in line as $132mn in EBIT was spot in line with forecast. Total sales grew 10.5%, ahead of the 8.0% we had penciled in and the 7.5% reported in F1Q18. The top line was driven by organic sales growth of 4.2% vs. the +3.6% that we had modeled as well as a strengthening FX tailwind and over 4.5% from acquisitions. On a segment basis, Specialty EBIT was a modest beat, while Industrial and Consumer missed our mark. Lower corporate expense was an additional $0.05/share tailwind vs. our estimate as the company flags $11.1mn in lower pension, healthcare, acquisition and professional fees y-y. RPM has an ongoing cost cutting program, which is likely the primary driver of this lower corporate expense.
• F2018 EPS guidance raised by $0.15 largely due to tax. RPM increased its F2018 EPS guidance range to $3.00-3.15 from $2.85-2.95 as the company anticipates $0.10/share of tailwind in 2HF2018 due to a lower tax rate. This tax boost is a bit higher than the $0.05/share that we anticipated heading into the quarter. Given F2Q results, the guidance now implies 2HF2018 EPS of $1.45-1.55 vs. our $1.45. Adjusting our $1.45/share estimate by the additional tax boost of $0.05 would bring our estimate for F2H performance in line with the new guidance.
• Industrial sales show solid traction. In EPS terms, results for the Industrial segment were a $0.01 miss vs. our forecast as higher raw material costs outweighed the benefits of a stronger top line. Organic sales growth of 5.4% on the quarter came in ahead of the 4.3% we expected, with M&A and FX contributions an additional 300bp tailwind vs. what we had penciled in. However, EBIT margin of 10.0% was weaker than our 10.8% estimate. That said, EBIT margin now reflects only 20bps of y-y compression vs. the 100bps witnessed in the segment in F1Q18. We are encouraged by the stronger top line results, as the business performance appears reflect more positive manufacturing and industrial macroeconomic data. With the ongoing rally in oil prices and positive PMI trajectory, we would expect this trend to continue.
• Consumer earnings continue to languish. Revenue of $415mn was a modest beat vs. our $408mn as organic sales growth of 3% was better than our 1.5% estimate and a strong improvement from the -1.2% contraction in F1Q18. Better results in caulks and sealants as well as a modest rebound in international markets are cited as reasons for strength. However, margin continues to disappoint, driving a $0.05/share miss in EPS terms for the segment on the quarter. Operating margin of 10.9% was 240bps weaker than we had expected and represents 190bps of y-y contraction vs. the 50bps of contraction seen in F1Q18. RPM cited higher raw materials and a weaker product mix as drivers of margin erosion.
• Specialty business delivers modest upside. EBIT of $34mn came in $2mn ahead of our estimate of $32mn as margins of 17.4% beat our 15.9%. Organic sales growth of 2.8% was a bit disappointing vs. the 6% we had penciled in as benefits from restoration and flood remediation product sales due to Hurricane Harvey lagged our expectation. Encouragingly, the company noted it was able to mitigate the negative impact of patent expiration in edible coatings by retaining most of its larger customers. We would normally question the price concessions needed to retain such business, however the margin upside for the segment on the quarter is perhaps at odds with that notion.
• We rate shares of RPM Hold. Our price target of $57 suggests total upside potential of 9%, including a dividend yield of 2.4%. 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 $57, 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 $584 per RPM share. Using our updated CY18 estimate as a base, our analysis reflects an applied premium of nil to the S&P500 index multiple based on consensus estimates of forward earnings.
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