Thursday, February 23, 2006

Dutch Boy takes a Beating in Rhode Island (SHW)

As Geoff Gannon pointed out so well in his blog yesterday, Sherwin-Williams (SHW) decline yesterday is well worth noting. The beating continues today.

Sherwin-Williams is a marvelous collection of brand names: Dutch Boy, Sherwin-Williams, Krylon, and Kem-Tone among others.

The company received an adverse ruling in Rhode Island yesterday due to lead paint liability. In the first trial, a hung jury was 4-2 in favor of defendants. DuPont avoided the second trial by paying off the lawyers $12 million. Not sure how much of this found its way to the injured or wronged! In the second trial, the jury also became deadlocked, however, the judge ordered the jury to deliberate further.

Lead paint can easily be made safe…paint over it. Landlords or homeowners should be the ones held liable for old lead paint. But put reason aside, this is tort law in America! Go for the dough!

Next Tuesday, RI and defendant attorneys will make recommendations to the jury on punitive damages to be assessed. The jury will make its recommendation to the judge who may or may not agree. Expect appeals from SHW at the state level and beyond if necessary.

Back to fundamental comments about the company. In the period from year end 2001 to September 2005 (the last reported quarter) SHW has generated CFFO of $2.5 billion. Capex over this period was $635 million, roughly equal to depreciation of $600 million. The company has made $720 million in acquisitions over this period.

How were the shareholders treated? Free cash flow for the period totaled $1.9 billion of which $540 million was returned to shareholders by way of dividends. An additional $1.08 billion was returned through share buybacks!

Return on invested capital for the most recent twelve months has been 21%, well above recent history of around 11%.

The total decline in market value since the “news” broke has been $1.6 billion or over 22%. EV/EBIT is down to about 8 times!

As I recall, Mr. Buffett viewed the paint industry quite favorably with his purchase of Benjamin Moore back in December 2000.

What about other competitors. PPG has a ROIC of 14.1 times and trades at EV/EBIT of 10.5 times…it tends to be viewed as being more cyclical than SHW due to its automotive supplier role. RPM International (RPM) has a ROIC of only 5.6% and trades at 13.9 times. Finally, Valspar (VAL) with a ROIC of 9% trades at EV/EBIT of 11.6 times.

What to do? Deep value players will be very interested, grave dancers who party every time that Altria (MO) loses a tobacco liability case. Many institutional investors will bail because they can’t or won’t face the uncertainty of contingent liability. Technicians see a falling knife.

The plaintiff bar will no doubt view this as a clear signal to pursue similar cases in every jurisdiction it can.

Wall Street analysts as of yet have been non-committal, talking of great uncertainty. To his credit, the analyst at Buckingham Research continues to have an accumulate and has written a decent overview of the subject. Good man!

I can’t stand the value opportunity. I will be buying a partial position 24 hours after this post.


At 9:19 PM, Anonymous Anonymous said...

I think the real story is how DuPont was able to buy their way out of the case with a $12 million charity donation. Either they got off WAY easy, or the future liability to SHW won't be that big. Afterall, do you know what brand of paint is on your house's walls? Unless you put it there recently you have no idea. Paint doesn't exactly come with a label once its applied. I just can't see the company having to shell out substantial $ for this.

At 4:06 PM, Blogger Market Participant said...

Even if they do reach a class settlement it will probably involve free lead paint removal, which is much much cheaper than dealing with endless cancer cases (like asbestos).

The last use of lead paint was almost 30 years ago. Where as the asbestos trials began while was still being used.

At 1:18 PM, Blogger Bill said...

Just a personal note about this stock. In 1968, my father, who was an employee of SW, purchased 300 shares at $3.00 a share. When my mother passed away in Feb of 2006, this had grown to 7200 shares (no additional purchases)trading at $50 a share. Value investing for sure..


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