RPM International, Inc. (RPM: Buy, $57 PT) 
Upgrade to Buy; Risk-Reward More Favorable on Pullback
• Has RPM been thrown out with the bathwater? In our opinion, RPM shares now offer a compelling opportunity for relative value, GARP and growth investors alike. Despite RPM’s long-term track record of consistent growth at a premium pace, shares under-performed in 2017 and – from that lower base –have now corrected more than most chemical companies through the recent period of market volatility. While potential for gross margin pressure remains a concern, the recent correction in crude oil could help to take some of the sting out of raw material cost pressure, looking beyond RPM’s fiscal 2018 year-end in May. On balance, we find risk-reward prospects much improved with a ratio of upside potential to residual downside risk of perhaps 4:1. We maintain our price target of $57, which suggests upside potential of 18%, including an above-average dividend yield of 2.6%.
• Relative valuation looks more appealing. As compared to our re-launch on the stock 16 months ago, RPM’s share price is 8% lower (vs. +23% for the S&P500 index), while our forward EPS estimate is 10% higher than it was back then. In this context, risk-reward prospects have shifted materially in our view, with RPM now trading at the lowest multiple of CY18 EBITDA among the four coatings stocks in our coverage and a discount to our broader chemicals coverage universe on the basis of both calendar 2018 and 2019 P/E ratios (15.6x and 14.1x respectively). We judge these discounts to be unwarranted based on...
• Recent sales trends are more encouraging and comps are easier. As shown in Figure 2, RPM’s organic sales growth of 4.2% in F2Q18 was 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 in coming quarters, supported by…
• Several company-specific challenges appear to be fading. RPM’s Kirker nail enamel business accounts for only ~2% of company sales, yet severe earnings pressure made for several unpleasant quarters in F2016-F2017. Our current view is that downside risk is minimal with new management in place following the evaporation of earnings and a substantial impairment charge. Elsewhere in the portfolio... 
• We view takeout potential as above-average in a rapidly consolidating coatings industry. While it is true that the coatings industry is consolidating rapidly, we consider large-scale acquisitions by RPM to be unlikely given RPM’s current financial leverage of 2.5x EBITDA and historical preference for bolt-on deals. For RPM itself, we have assigned in our prior research a probability of takeout in excess of the chemicals sector average based on...
• More favorable FX should support earnings. While RPM derives two-thirds of its sales from the United States, we expect the weaker USD to result in more favorable currency translation across the remainder of the portfolio...
• We rate shares of RPM Buy and maintain our PT of $57. Our target of $57 suggests total upside potential of 18%, including a dividend yield of 2.6%. Shares of RPM now trade at 15.6x our CY 2018 EPS estimate, a 6x or nearly 30% discount to coating peers, and 10% discount to the market on the basis of forward net earnings. As seen in Figure 9, these represent significant discounts to the respective five-year averages, and are well below the valuations realized earlier this decade. Our $57 price target 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 $60, 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 $55 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.
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