While children all over America were dyeing their Easter eggs in the first week of April, the largest U.S. paint companies were likewise brightening the picture.
On April 5 PPG Industries (NYSE:PPG - News), the leading U.S. player in the global paint and coatings industry, revised its first-quarter guidance upward. The following Monday, domestic paint leader Sherwin-Williams (NYSE:SHW - News) did the same. Smaller rival RPM International (NYSE:RPM - News) reported quarterly results April 5 that beat expectations.
In a statement, PPG Chief Executive Charles Bunch cited several bullish trends.
"In general, business conditions during the quarter were strong in North America and solid in Asia and other emerging regions," he said. "PPG benefited from year-over-year growth in several end-use markets, including aerospace, optical, automotive OEM (original equipment manufacturer) and industrial. Also, our architectural coatings business (i.e., house paints) in the United States benefited from early signs of a construction recovery and mild winter weather.
U.S. construction remained "well below historical levels," he said, and the recovery in Europe was slow. To deal with that sluggishness, Bunch announced 2,000 layoffs in house paints and European operations. PPG shares settled 3% higher after the news, trading in very heavy volume.
The improvement in paints' end markets — including automobiles, whose sales rose 13% in March — has helped heft the group to a No. 56 ranking, up from 97 just three months ago.
The Industry Group Though the group is called "paints," the companies make all kinds of coatings, including lacquers, varnish, shellac and specialty coatings created to decorate and protect everything from soda cans to airplanes. Some companies in the group also make glue, glass, flooring and similar items.
PPG is the largest company in the group. But the top stock is Valspar (NYSE:VAL - News), which boasts a 98 Composite Rating thanks to its popular house paints and its successful penetration of emerging markets such as China.
There are only four stocks total in this IBD industry group, but they are not the only players. The global leader in coatings is the venerable Dutch company Akzo Nobel, whose stock does not trade in the U.S.
Closer to home, Sherwin-Williams owns some 30% of the U.S. market through its chain of 3,400 paint stores, putting it in the Retail/Wholesale-building products group.
Diversified giant DuPont De Nemours (NYSE:DD - News) also has a significant chunk of the market, though it's trying to sell off its auto-paint business. In Valspar's most recent conference call, officials brushed off a suggestion they might make a bid, saying the $4 billion price tag was too high.
• Name of the game: Going by all these industry leaders, the best way to be a leading paint company today is to have been a leading paint company for at least 50 years already. The industry is old and highly consolidated.
"It's a question of manufacturing efficiencies and ability to market," said analyst Dmitry Silversteyn of Longbow Research. "Given that 90% of their cost of goods is raw materials, there's a lot of synergies to be had by becoming a bigger buyer of raw materials.
Market-Climate Akzo Nobel recently estimated the global coatings market at about $92 billion. Decorative paints make up 44% of the market, with general industrial coatings in a distant second-place at 10% and new cars at 9%. The rest goes to packaging, ships and a variety of specialty uses.
Researcher Freedonia put the U.S. market at $18 billion in 2010. It forecast annual growth averaging just under 8%, to $26.2 billion by 2015.
House paint, labeled architectural markets, was the fastest growing piece of that picture. Freedonia put that market at $8.5 billion, growing at an 11% clip through 2015.
Overseas, paint makers are growing mainly by moving into emerging markets. Because paint doesn't ship well and must be mixed locally, global companies generally move into markets through joint ventures with, or outright acquisitions of, domestic firms.
In 2006, Valspar bought a controlling interest in China's Huarun Paints, a Sherwin-Williams-like paint producer-retailer. PPG has found a growth driver in the Chinese auto business, which is now the world's largest.
In terms of end markets, most sectors are growing at a modest rate, although the ship and used-car markets remain sluggish.
The cost of titanium dioxide, used for basic white pigment, has been an issue for the whole industry. Last year the commodity's price rose around 40%. Silversteyn estimates it will increase another 20% this year. The short list of miners and metals producers that supply the mineral have become even more consolidated than paints, with the mergers leading to a general reduction in production capacity.
Companies are looking to alternate sources in China, but there are quality issues with those suppliers. They're also seeking to reformulate their paints to use less titanium.
Health and safety issues also drive technological changes in paint formulations. Under pressure from the federal government, paint makers have for decades been trying to reduce the quantity of volatile organic compounds in their paints.
VOCs such as formaldehyde have been tied to pollution and respiratory problems. Typically, paint companies have been doing this by creating paints based on water rather than solvents.
They face steep challenges in developing water-based products that can compete with the durability of oil and solvent-based products.
Outlook Views differ. Silversteyn says he expects the U.S. coatings business to grow this year at about the same pace as gross domestic product, possibly a bit higher. Nonetheless, he expects raw-material costs to continue to be an issue, especially if petrochemical prices — which have been low lately — start to pick up again. He expects industry consolidation to continue, as both Valspar and RPM have continued to make acquisitions.
Freedonia sees growth at approximately twice GDP, with architectural coatings running well ahead of that.
• Upside: The economic recovery, especially in the industrial sector, will continue to drive demand for paint and coatings. Emerging markets should continue to provide opportunities.
• Risks: Raw material costs and a soft housing recovery could continue to pressure margins in the architectural paints markets.
