Thursday, November 15, 2007

Sherwin Williams: A Bargain For Potential Buyers

I think it is only a matter of time before someone makes a play for my favorite paint company and my guess will be that a chemical company, looking to expand it coatings business will be the suitor.

Let's look at Sherwin (SHW). In the Q3 that ended Sept. 30. Sales increased 4% and EPS increased a whopping 19%. The profit surge came from two events, both of which are excellent signs for shareholders. Higher margins on price increases and cost controls illustrate demand for their products is still strong and that the company is using the current slow period to maintain efficiency. A 6% lower share count during the period means Sherwin is directing cash flow into buying its own shares, which increase shareholders ownership of earnings. YTD the company has retired 10 million shares and just got approval to repurchase another 20 million, or more than 14% of Sherwin's remaining shares.

Investors currently will pay 12.7 times this year's earnings, a discount of 20%-30% to the S&P 500. This year's and next year's earnings forecasts suggest a long-term growth of around 10% minimum, about what the broad market typically delivers meaning shares could increase that amount (20% to 30%) and then be "fairly valued" to the market.

As a takeover target and not an investment, Sherwin looks just as, if not more attractive. It has an EV (enterprise value)/Ebitda ratio of 7. Great, but what does that mean? . It's the cost to buy all the outstanding shares and retire its debt, while using its available cash toward the purchase. Ebitda stands for earnings before interest, taxes, depreciation and amortization. It's used to gauge essentially earnings from operations. So think of EV/Ebitda as the ratio of a company's takeover price to its earnings potential. What does Sherwin's ratio of 7 mean? It is currently valued about 30% below the median for the S&P 500. A bargain.

Sherwin produces about $800 million in cash flow from operations and produces almost $600 million in net income each year.

Who then? Sherwin has a market cap of $7.5 billion making any of the chemical majors a potential buyer. Dow Chemical (DOW) as I have written several times is the most likely but DuPont (DD) and BASF (BASF) are just as capable

Dow CEO Andrew Liveris has said any potential acquisition must be accredive and a Dow purchase of Sherwin would be just that, and best of all it could be had at a bargain.

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