RPM - RPM International: Premium Play Needs Margin Expansion To Justify Appeal

2023-12-28 15:16:17 ET

Summary

• RPM International has seen solid growth driven by organic and inorganic performance, complemented by minor margin gains and small share buybacks.
• The company is a leader in specialty coatings, sealants, and building materials, with strong positions in niche markets.
• RPM International aims to improve its margins under the MAP 2025 program, which could potentially boost earnings to $6-7 per share.

It has been quite a while since I last covered RPM International Inc. ( RPM ). In the fall of 2016, I offered my last take on the shares of the sound capital allocator after it announced another bolt-on acquisition. In the years which followed, the company has seen solid growth, driven by organic and inorganic performance, complemented by minor margin gains and small share buybacks.

All of this added to the great long-term track record of the business, but to see the appeal at current highs, real margin work under the 2025 program needs to be executed upon.

A Recap

RPM is a holding company of multiple construction chemical products and paints, used by consumers as well as industrial users and in specialty applications. With strong positions in niche markets, the firm at large has become a leader in specialty coatings, sealants, and building materials.

The company owns a broad range of smaller brands, mostly focused on maintenance and repair activities. On the consumer side, products can be found at large retailers such as Home Depot ( HD ) , Lowe's ( LOW ) , and Walmart ( WMT ) , among others.

The company aims to preserve the entrepreneurial spirit by being organized in a decentralized manner, while manufacturing, technology, and distribution functions are centralized to benefit from scale synergies.

The company has relied on a real bolt-on M&A strategy and has a strong track record, as it has executed over a hundred deals in the past, which have driven the business to become a $4.5 billion operation in 2015, with a third of revenues generated overseas. On top of the organic and inorganic growth trajectory, RPM is a real dividend aristocrat, having raised the dividend for 42 years in a row at the time.

All this was perfectly manageable as the company operated with $1.4 billion in net debt at the time, and EBITDA being reported at half that number. The resulting 2 times leverage ratio looked fair, albeit that the net debt load excluded about $600 million in liabilities related to pension deficits.

With the company posting earnings which topped $2.50 per share, a $50 stock traded around 20 times earnings. This looked quite fair, but quite frankly I was looking for a discount before getting involved, something which regrettably has not happened.

Steady As She Goes

Shares of RPM were actually stuck around the $50 mark until 2018 but rose to the $70 mark pre-pandemic. Since 2021, shares have been trading in a pretty tight range, between $80 and $100 per share, although that a rally in recent weeks has pushed shares up to a fresh all-time high of around $113 per share.

In the 7-year time period since I last covered RPM, shares have essentially doubled, but this has been backed up by strong growth. As of the fiscal year 2023, the company has grown sales to $7.3 billion, marking some 60% revenue growth, with its 17,000 employees being active across the globe.

Over this time period, operating margins have been rather stable in the low double-digit percentages, as sales growth was accompanied by a modest 5% reduction in the share count, coming on top of the strong dividends, which by now have been hiked for 50 years in a row. In fact, a near 10% increase in the quarterly dividend has recently been announced, albeit that a $0.46 per share quarterly payout results in a yield of a mere 1.6% here.

Current Valuations

In July, RPM posted its fiscal 2023 results, a year in which revenues rose by 8% to $7.26 billion. Adjusted operating earnings rose by 18% to $842 million, with some margin expansion seen again, as adjusted earnings came in at $4.30 per share, up over 70% from 2016 levels. It should be said that GAAP earnings came in at $3.72 per share, with the discrepancy largely being the result of margin achievement initiatives, designed to increase profit margins in a more sustained way.

Net debt was reported at nearly $2.5 billion, all while EBITDA comes in around a billion, although that pension related liabilities have come down over time. For the fiscal year 2024, the company guided for mid-single digit revenue growth and adjusted EBIT growth in the low-double to mid-teens digits, marking the first step of margin expansion.

This largely translates into a $4.75-$4.95 earnings per share guidance, which has pushed up the valuation multiple to 23 times forward earnings at current highs.

A Solid Start To the Year

In October, the company announced its next bolt-on acquisition, which has taken some time as the business spent a mere $47 million on dealmaking efforts during the fiscal year 2023. The company reached a deal to acquire the Wall System fabrication segment of NOW Specialties, in a transaction which adds about $20 million in annual sales, adding about a quarter of a percent to total sales, marking a truly bolt-on deal.

A day later, RPM posted a 4% increase in first-quarter sales to $2.01 billion, yet adjusted operating profits rose more than 12% to $309 million, in what seasonally is a stronger quarter. Net debt ticked down to less than $2.3 billion following decent working capital management, pushing leverage ratios down to just over 2 times. The company maintained the full-year guidance, and in fact, saw accelerating growth in the second half of the year.

The anticipated growth acceleration is likely due to the fact that interest rates have moved lower, with the business of course benefiting from stronger housing and real estate markets at large. These will likely see some relief, after a historical decline in interest rates in recent weeks.

And Now?

While RPM has not participated in the consolidation move which took place during in the (paint) industry in the 2010s, it has focused on bolt-on dealmaking to consolidate a fragmented market. Nonetheless, the company could of course remain a prey for one of its larger peers in the industry, or even adjacent players.

Weighing it all together, it seems that RPM has added nicely to its long-term growth trajectory and track record in recent years, all of which look pretty decent. This makes it easy to understand why RPM has traditionally commanded a fair to a premium multiple, now trading at 23 times forward earnings.

Given all this, I recognize that shares are not cheap at fresh all-time highs, but there is another wildcard in the works. This includes the MAP 2025 ambitions, designed to structurally improve low double-digit margins, as the decentralized structure makes that margins have been lagging compared to some peers.

The potential of this is large, as every percent point increase in EBIT margins works down to roughly half a dollar in earnings per share, meaning that a 2-point improvement could boost earnings to $6 per share. This would reduce the earnings multiple to 19-20 times earnings here, as the ambitions of RPM are obviously greater.

This strategic ambition was announced in the summer of 2022, and called for mid-double-digit EBIT margins by 2025, some two years down the road of course from today. If delivered upon, that could easily translate into earnings of around $6-$7 per share.

With RPM International Inc. shares having risen from $90 in October to $113 at the moment of writing, it is the rapid increase in the share price which has lifted expectations a lot. This makes me cautious to get involved here and to chase the shares, yet credits are due where they are due. Assuming there is a real credible roadmap to earnings of $6 per share next year, I am tempted to buy any substantial dip to the $100 mark, with a true long-term horizon.

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