The Best Materials Stocks of 2012: Sherwin-Williams

As New Year's Eve quickly approaches, and we all prepare to make our 2013 investing resolutions, it's a good time to reflect on the materials sector in 2012. In this December series, our writers will recap some of the most popular, highest-performing stocks in this sector. We'll examine whether these companies can sustain the gains they gave shareholders in 2012, or whether those increases merely owe to one-time events or fizzling trends. Consider these pieces our gifts to any Foolish long-term investors seeking exposure to the materials sector. Enjoy, and Fool on!

A pretty good year
2012 provided Sherwin-Williams (NYSE: SHW  ) , the nation's largest paint manufacturer and retailer, with some solid footing, and now the company's off to the races. With its stock up 65% since the first of the year, Sherwin and its investors should be waiting eagerly for the gun to signal the start of 2013.

Sherwin was able to capitalize on several important factors during 2012: continued sales growth, raw materials cost-easing, and leaner operations. Sherwin's sales climbed 9.2% through this year's third quarter, atop 12.7% improvement in the same period of 2011. Declining raw materials pricing provided an added boost to Sherwin's gross profit, which had gotten squeezed by added manufacturing costs. And tough cuts during the economic downturn gave the company leaner operations, which improved both operating profit and selling, general, and administrative expenses as a percentage of sales.

Sherwin also took advantage of its considerable cash flow in 2012 by acquiring two complimentary companies. Comex, a smaller paint retailer, improves the paint giant's position in Latin America, its weakest segment. Geocel, its other purchase, gives Sherwin additional products by an original equipment manufacturer that the company did not previously produce, which could increase its competitive opportunities as manufacturing returns to the U.S. in the coming years.

Opportunities abound
One factor could play the biggest role in Sherwin's continued success in 2013: increased signs of a housing recovery, which really began to develop in the second half of this year. Because the strength of Sherwin's North American paint stores drives the company's performance, a housing recovery, and the return to those stores by painting contractors, could give the company a huge advantage.

Customer Segment

% of Paint Supplies Purchased at Specialty Stores

% of Paint Supplies Purchased at Home Centers

Contractors

90.2%

6.3%

Do-It-Yourselfers

61.0%

15.0%

Source: SHW Investor Presentation

As the recovery continues, Sherwin anticipates a 60/40 split between its contractor and do-it-yourself customers, respectively.

It's only going to get better from here...
Fools shouldn't ask whether Sherwin-Williams' 2012 trends will continue into 2013. They should instead focus on how big an effect those trends could ultimately make.

Architectural coatings represent the company's largest U.S. segment, hinging Sherwin-Williams' performance largely on the housing market. Current paint usage is in the low 600 million gallons, which harkens back to a low point in the early 1990's, but the recent housing boom has increased build space by 25% over that time period. So, by default, paint gallonage needs to rise from current levels in order to keep up with maintenance needs of our current building inventory.

Sherwin's executives expect the gallonage levels to normalize around 730 million, a 115 million gallon increase from current levels. With the housing recovery gaining steam and increasing build space even further, the need for increased gallonage will drive the company's growth and sustain it well beyond 2013.

Competition
The improvements Sherwin experienced in 2012 are evident in most of its competitors as well, indicating that the increased gallonage trends are industrywide. Valspar (NYSE: VAL  ) and PPG (NYSE: PPG  ) , two of Sherwin's direct competition also had a great 2012, with their stocks climbing 56% and 54%, respectively. Home improvement stores are also seeing bumps from the housing recovery, though they do offer more products and services than paint alone. Both Home Depot's (NYSE: HD  ) and Lowes' (NYSE: LOW  ) stocks are up year to date, with Depot taking lead at 47% and Lowes trailing at 37%.

Onward and upward
Investors may want to pay special attention to Sherwin's dividends. The company has increased its dividend for the past 35 years, and investors should expect no difference in 2013. The company historically has paid out around 30% of the prior year's earnings in a cash dividend, so 2013's payout may give investors close to $1.90 per share.

Looking forward
As an investor, it's important to take some time at year's end to reflect on what companies have done during the year, and how those actions position them for the future. With 2012 almost behind us, Sherwin shareholders should feel confident entering 2013. The company has positioned itself to take advantage of cost savings, complimentary business acquisitions, and a recovering housing market. It appears that the paint giant has not been resting on its laurels; with its moves in 2012, Sherwin has placed its feet squarely in the starting blocks, and it's ready to take off in the coming year.

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