RPM International, Inc. (RPM: Hold, $57 PT)
Consumer Keeps Us Sidelined For Now
• We exit RPM’s F2Q call with mixed emotions. First, the good news. Organic sales growth of 4.2% is the strongest result in nearly two years and represents encouraging acceleration from the roughly 1.8% posted in F1Q. We expect this trend to continue supported by a rebound in the global manufacturing economy, a rallying oil price, and hurricane-driven rebuilding. Results also reveal progress on tax management as well as ongoing cost control efforts in SG&A and corporate expense. However, margins remain disappointing overall, and it is not clear to us that this dynamic is likely to reverse anytime soon based on (A) persistent raw material cost pressure; (B) lag effects up to one year for price recovery in Consumer; and (C) arguably, lack of will in that our perception is that RPM is more focused on shelf space and share as opposed to selling price increases and gross margin. To be fair, one could argue that (C) has served RPM well over the years as evidenced by the company’s impeccable 30-year track record of growth. Nevertheless, it’s a tough way to run a railroad during periods of substantial cost inflation as we are currently experiencing across numerous inputs such as acrylic resins (MMA), solvents, TiO2 pigment, silicones and epoxies. In light of expectations for increased advertising spend in coming quarters, we suspect that contribution margins will remain lackluster over the near term. Meanwhile, a less favorable earnings mix (lower Consumer earnings, more tax relief) could limit the opportunity for multiple expansion. On balance, we elect to remain at Hold, although we consider risk-reward a bit more interesting following the pullback of 2.1% on the session vs. +0.4% for the S&P500 index.
• Our top 10 takeaways: (1) EPS of $0.70A exceeded our $0.59E and consensus of the same; (2) the entire $0.11 of the EPS beat was driven by a lower than expected tax rate; (3) RPM expects to see an EPS tailwind of $0.20 per annum from a lower tax rate, since the company’s rate was trending lower even prior to the US Tax Cuts and Jobs Act (we had estimated $0.10 from the latter); (4) corporate expense was down $11mn y-y and contributed $0.05 to EPS as the company’s cost actions take hold; (5) organic growth of 4.2% was stronger than the 3.6% we modeled and a solid improvement from the 1.8% reported in F1Q18 despite the loss of 10 days of sales activity in TX and FL due to storms; (6) US commercial construction, oil & gas related businesses, and caulks and sealant sales drove the improved growth; (7) price traction remains lackluster with management commentary implying...
• We raise estimates further on incremental tax relief. Due to the stronger than expected tax policy tailwinds we are taking our F2018 EPS estimate up by $0.15, which includes a benefit of $0.09 from discrete tax items in F2Q as well as incremental, prospective tax support in the latter half of RPM’s fiscal year. Our EBIT expectations for the remainder of F2018 are fairly consistent with our prior estimates, albeit skewed away from Consumer in favor of Industrial and Specialty. The lower tax rate will also carry through to F2019 where we now project $3.35E, up from $3.20.
• We rate shares of RPM Hold and maintain our PT of $57. Our target of $57 suggests total upside potential of 11%, 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 $59, and includes a weighted-average cost of capital (WACC) estimate of 7.9% and a terminal growth rate of 2.5%. Using our relative P/E framework, we calculate warranted value of $56 per RPM share. Using our updated CY18 estimate as a base, our methodology reflects an applied discount of 5% to the S&P500 index multiple based on consensus estimates of forward earnings.
