Can Valspar Paint Your Portfolio?

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Paint maker Valspar's (NYS: VAL) third-quarter revenues surged, but its bottom line slumped due to high costs -- yet another story of cost eating into revenues.

But Valspar might still be worth a watch. Want to know why? Read on...

In detail
Valspar's revenues for the quarter surged 22.5% from the year-ago quarter to $1.07 billion, driven by higher product prices. Acquisitions also contributed almost 12% to top-line growth. Volumes in both the coatings and paint segment fell by around 1% in the quarter. Also, last year, the company lost its deal with Wal-Mart (NYS: WMT) , which was a key driver of sales in Valspar's paint segment. However, in spite of this loss, its paint segment's sales were up 37%, driven in part by sales from an Australian paint maker that Valspar had acquired last year.

In spite of a growing top line, Valspar's gross margin fell from 34% to 30.3% year over year, as input costs shot through the roof. Net income, as a result, slipped 10% to $67.4 million. Paint companies have been buckling under the pressure of higher titanium dioxide (TiO2) prices. Peer Sherwin-Williams' (NYS: SHW) 9.9% revenue growth in its second quarter also failed to boost margins because of high costs.

Reaching out
Valspar is increasing its presence in the emerging markets. It opened around 100 new warrant stores in China during the just-concluded quarter. Earlier in the year, Valspar acquired a Brazil-based coating company to strengthen its foothold in Latin America.

Valspar has also forayed into the big-shipping-container coating market, starting with a major China-based company.

Restructuring-countering moves
The paint business also depends largely on factors like the housing market (especially sales of used homes). Seeing the prolonged housing downturn, Valspar lined up some restructuring activities, such as shutting down a few facilities dedicated to housing-related wood coating product line. Such restructuring moves, which cost Valspar $0.10 per share in Q3, will help it in cutting down costs. This looks like an intelligent move, especially at a time when higher costs have been hurting margins.

At the same time, to counter higher costs, paint companies have been hiking prices. Valspar last raised prices in July. Peer PPG Industries (NYS: PPG) has recently announced raising prices effective from October -- all moves attempt to offset costs.

The input game
I, however, am concerned how far price hikes can move margins for paint companies, as prices of TiO2 (a key input for paint companies) continue to soar. With major titanium dioxide players like DuPont (NYS: DD) and Kronos Worldwide (NYS: KRO) consistently hiking prices, I expect high input costs to continue weighing on the margins of paint companies.

The Foolish bottom line
With Valspar's management expecting another 20% jump in raw-material costs for the year, one may remain a little cautious now. Otherwise, the Minneapolis-based company seems to be doing well. It also pays dividends consistently (current dividend yield is 2.4%). To me, it looks like a stock worth keeping an eye on in the longer run.

To stay up to speed on the top news and analysis on Valspar, click here to add it to your stock Watchlist.

At the time this article was published Neha Chamaria does not own shares of any of the companies mentioned in this article. The Motley Fool owns shares of Wal-Mart Stores.Motley Fool newsletter serviceshave recommended buying shares of Sherwin-Williams and Wal-Mart Stores.Motley Fool newsletter serviceshave recommended creating a diagonal call position in Wal-Mart Stores. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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