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golden 6 months

  • Signal from Noise
Oct 23, 2019

– SHW posts strong Q3 results; gross margins rising; price increases sticking  – A “tortoise on wheels;” with consistent EPS, divvy growth expected in 2020 – Homebuilders and related stocks group entering the “Golden 6 Months’ period Homebuilders and the related complex of stocks—from construction and lumber to paint and furniture—is a sector we recently noted (Oct. 18) as one whose equities look to be set up for a potentially nice run in the next six months, and not just because of low mortgage rates.  (More on this below.) But it’s a big group of stocks and where does one begin?  I like to choose from among the best in the sector, and that will lead you to Sherwin Williams (SHW), the global maker of paints, coatings and related products for retail, professional, commercial and industrial customers.  If you used Dutch Boy paints, you bought a SHW product.  Sporting a $52 billion market cap, it sells both through its own 4,900 stores as well as the big box home retailers. As a company with numerous well-recognized global brands and a strong track record, the stock isn’t cheap, with a price/earnings ratio of 23 times next year’s consensus $24.30 EPS expectation, 1/3 or more higher than peers. With a new 52-week high reached yesterday after a particularly impressive set of results in the third quarter, that P/E is still below SHW’s 26 times median P/E in the past decade. However, when you pay up for SHW stock, about $560, you get a company that’s been firing on all cylinders for a long while and has good prospects of continuing. It’s not a glamorous or sexy tech stock, but it gets a premium valuation for a reason: it leads specialty paint coating peers: 2018 growth in EPS from continuing operations at 23%, to $18.53 from $15.07.  Other big names in the group, whether PPG Industries (PPG) or Axalta Coatings (AXTA), or others, are substantially weaker, with single digit or even negative growth. Investors are always searching for growth, and SHW isn’t glamorous but it’s consistent, notes Daniel Morgan, a portfolio manager at Synovus Trust.  “Think of it as a tortoise with wheels.” Although the stock is around 52-week highs, it’s previous outperformance of the market has waned somewhat. See nearby chart.  The fact that SHW has raised its annual dividend for 40 straight years is indicative of the consistency of its business. I see this stock as a potential opportunity on our call that the market is mid-cycle and not late cycle and that the sector will outperform over the next six months. SHW yesterday reported another strong quarter—as third quarter sales rose 3% to $4.9 billion and diluted operating EPS rose to $6.65 from $5.68, thanks to higher paint sales in North America and price increases.  SHW also upped the midpoint of its 2019 EPS guidance range to $21.10 from $20.90. Its 2020 sales growth target of 4%-6%  compares favorably to the Standard & Poor’s 500 index projection of 2.2% growth.  Investors can certainly draw some confidence from the record, Morgan adds.   Paint price hikes, lower raw material costs and geographic concentration are helping to drive growth, and SHW is able to effect price increases because its products are tailored to the needs of the domestic paint contractor, Morgan says.  Third quarter gross margins were 45.7%, up from 42.7% in the year ago period and 44.7% in the second quarter. The company’s history of generally consistent results and returns was reinforced by the third quarter results. Five brokerages raised their SHW targets after earnings were out to $630 to $650 per share. I’m not playing up the benefits to SHW from a continuation of the lower interest rate environment around the globe, but it should help all the homebuilding and related stocks. While new home construction is important for SHW, remodeling and folks just plain moving is another big driver of SHW sales. On the downside, SHW has seen some softness outside North America, which isn’t a surprise given the economic slowdown in the rest of the world. But if, as I expect, the U.S. economy rebounds in 2020, it should help other economies recover. SHW has one more thing going for it: sector appeal.  The homebuilders and related stocks have already been on tear this year, up 50%. As noted in our weekly newsletter last Friday, there’s important bullish prospect to this group that could be seen in the next six months. My colleague Tom Lee has written that about a curious seasonality to homebuilder (and related equities) called the “Golden 6 Months.” Since 1999, homebuilder equities have tended to bottom around October 20 (mean date) and then rally some 19% through April 30 (about 80% of time), outperforming the Standard & Poor’s 500 index by about 1,310 basis points. Equities related to the US housing cycle are showing strong relative performance. Stocks involved in the chain from “build” a house to “furnish it” and the resulting “now I need a car” are outperforming the broader market. The group already has rallied hard, you might note. Despite this, history suggests that this seasonal “golden” period could play out.  In 2012, homebuilders were already up 35% at this point in the year but managed to gain another 18% during the “golden” period. Similar action took place in 2000 and 2003. SHW, for its part, has seen since 1999 an average 15% rise in the “Golden 6 Months” period. SHW’s stock looks a keeper. Where could I be wrong:  If, as the bears insist, the U.S. economy is about to undergo a slowdown—not my base case—it will hurt SHW’s results. Still, the company has weathered economic storms since 1866, and it will likely withstand the next one. Bottom Line:  SHW shares could benefit both from its own strong growth as well as the low interest rate environment around the world. CAT Update $135/Share:    Wednesday, Caterpillar (CAT) lowered its earnings outlook for the year after posting lower third-quarter sales. Yet the stock, which I wrote about favorably in August when it was $120, rose on this bad news. I view this as a sign the stock is indeed washed out. 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