Mixed 3Q for Valspar, Bumps Ahead

Leading paint and coatings maker The Valspar Corporation’s (VAL - Analyst Report) third-quarter fiscal 2012 (end July 27) adjusted (excluding restructuring expenses) earnings of 97 cents per share beat the Zacks Consensus Estimate by a penny and exceeded the year-ago quarter’s earnings of 80 cents. Profit, as reported, surged 28% year over year to $86.4 million or 92 cents a share, helped by lower cost of sales.

Revenues

Sales crept up 0.7% year over year to $1,078.3 million, missing the Zacks Consensus Estimate of $1,135 million. Revenues were hit by unfavorable currency exchange swings. Barring the currency impact, sales rose 3% in the quarter.

Sales from the Minneapolis-based company’s larger Coatings segment edged up 1.6% to $569.7 million, aided by new businesses. Paints segment revenues improved just 0.2% to $442.6 million, impacted by a soft Australian residential housing market.

Margins and Expenses

Gross margin (as reported) increased to 33.8% in the reported quarter from 30.3% a year ago. Adjusted gross margin rose to 34.2% from 31.4% in the prior-year quarter. Margins benefited from the company’s pricing actions, which helped to offset raw material cost increases. Productivity improvements, prior restructuring actions and incremental margins on new businesses also contributed to the growth.

Cost of sales fell 4.3% year over year to $714.4 million. Research and Development expenses inched down 1.2% year over year to $29.7 million in the quarter. Selling, General and Administrative expenses rose 4.5% to $191.9 million.

Financial Condition

Valspar exited the quarter with cash and cash equivalents of $181.5 million, up 19% year over year. Long-term debt increased 18% year over year to roughly $1,057 million.

Valspar Sees Challenges Ahead

Valspar anticipates a challenging fourth quarter based on the uncertain macroeconomic backdrop, slow recovery in the U.S. and decelerating growth in China. The company expects sluggish growth in North America and sustained weakness in some overseas markets.

Nevertheless, Valspar has reaffirmed its adjusted earnings guidance of $3.20 to $3.30 per share for fiscal 2012 as it expects its ability to win new business, productivity initiatives and strong execution will help it to weather the economic headwinds. The current Zacks Consensus Estimate is $3.24 per share.

Our Take

Valspar has a strong pipeline of new products and significant opportunities for share gains in both its Paint and Coatings segments. The company is also expected to benefit from its restructuring actions and productivity gains while maintaining its operational and pricing discipline.

Winning new businesses also remain a company-wide focus that will position Valspar well for the future and help offset lower demand in core markets. Its fastest growing markets are the emerging economies, such as China.

However, we are concerned about cost pressures associated with raw material inflation. Moreover, weakness in the residential housing market in Australia may continue to hurt paint sales moving ahead.

Valspar, which competes with Sherwin Williams Company (SHW - Analyst Report) and PPG Industries Inc. (PPG - Analyst Report), currently retains a short-term Zacks #3 Rank (Hold). We have a long-term (more than 6 months) Neutral recommendation on the stock.