These three stocks are very different, but they all embody certain attributes that you can build a portfolio around. They all operate in fragmented industries that are consolidating, and they all have strong near- and long-term growth catalysts. Let's take a look at why that's important and why you can build your portfolio around paint and coatings company PPG Industries (PPG 2.95%), tool maker Stanley Black & Decker (SWK 0.40%), and heating, ventilation, and air-conditioning (HVAC) company Carrier (CARR 2.29%).
Consolidating industries and PPG
In theory, it's good to invest in an industry that's consolidating because the leading players will often acquire more pricing power as smaller competitors are taken out. Similarly, as the leading players get larger they tend to be able to lower their per-unit costs and therefore increase margins.
That certainly seems to be the case with PPG Industries and the paint and coatings sector at large. The chart below shows an upward trend in earnings before interest, taxation, depreciation, and amortization margins (EBITDA) since the last recession.
Indeed, PPG and its peer Sherwin-Williams (SHW 1.61%) continue to be highly acquisitive companies, with the former acquiring 47 companies in the last five years and the latter 13, including Valspar for a tremendous $11.3 billion. Meanwhile, PPG is set to acquire Finland's Tikkurila in order to build scale in the Nordic region and Russia.
The acquisition appears well-timed, as a recovering economy looks set to lead to improvements in industrial production and house building. That's great news for paint and coating companies that sell into these end markets, so don't be surprised if the sector recovers strongly in 2021.
Thinking longer term, it's a pretty safe bet that the paint and coating industry will track economic growth over the long term, and if that is accompanied by ongoing margin expansion, PPG will prove a good stock to hold over the long term.
HVAC is also a highly fragmented industry in need of consolidation. Indeed, it's no accident that three of the biggest players -- Carrier, Trane Technologies, and Johnson Controls -- have all refocused on HVAC in recent years. Carrier was spun out of United Technologies, Trane was separated from its industrial businesses, and Johnson Controls sold off its automotive battery business in 2019. In each case, part of the rationale was for the company to better position itself to engage in merger and acquisition activity.
Carrier has the potential to take part in industry consolidation now that it's independent, and that's not the only benefit of its separation from the former United Technologies. The company has a plan to cut $700 million in costs by 2022 and is making investments to drive growth in the future.
Carrier's plans involve expanding geographically, building its services business, and taking full advantage of the long-term trend toward HVAC coming from increasing urbanization and increasing demand from the middle classes in the emerging world. Throw in some near-to-medium-term demand coming from the need to create healthier, cleaner buildings as a result of the COVID-19 pandemic (ventilation helps to change the air in a building), and Carrier's future looks bright.
Management is expecting free cash flow (FCF) to improve from $1.38 billion in 2020 to $1.6 billion in 2021, putting Carrier at around 20 times FCF in 2021. Alongside PPG and Stanley Black & Decker, Carrier sits on a very attractive valuation.
Stanley Black & Decker
The excellent work that the company's management has made in recent years has been overshadowed by significant external cost headwinds from tariffs, commodity cost increases, and foreign exchange movements. That's unfortunate because Stanley's management has been aggressively investing in growth initiatives aimed at making the company the consolidator of choice in the tool industry. For example, in recent years Stanley bought the Craftsman brand from Sears and the tools businesses of Newell Brands.
Also, Stanley is set to acquire the remaining 80% of lawn and garden products company MTD in 2021 with the intent to expand into the lawn and garden market. Stanley's management believes it can aggressively expand MTD's margin in the coming years, and the addition of the business will help to leverage Stanley's existing outdoor products.
In the near-to-medium term, Stanley has a great opportunity to build on the surge in interest in DIY activity created by the pandemic and the shift toward online sales -- an area where Stanley has leadership. All told, Stanley is very well positioned to grow in the future.