We are recommending the following changed to our Focused Equity portfolio:
Selling MMM, putting proceeds to bring SHW to 3% weight, and remaining proceed to IVV.
Sell MMM thesis:
We reviewed the original buy thesis following last week’s earnings release.
1. The original thesis is broken:
a. “diversified industrial revenue stream”: resilient segments did not offset larger decline in more cyclical segments
b. “margin expansion from scale and international expansion”: most segments saw a margin contraction as a result of delayed reaction by the company to end markets softness
c. “ROIC strength”: decline forecasted
d. “good capital allocator”: debt has funded a lot of the EPS growth, while cash flow from operations set to decline
2. Even after a big pull-back the stock is not cheap (both on P/E and DCF)
3. At this stage of the cycle, being patient with this name is risky (we see more slow down possible in revenue + restructuring story might not be enough)
Buying to SHW 3%:
- They can take price to offset raw material inflation. Not owning SHW when oil price was going up would have been a mistake.
- Tailwinds in key housing end market. Factors driving residential paint market:
a) Housing turnover should improve as mortgage rates are back below average rate of outstanding mortgages. This reduces the mortgage rate lock-in effect that weighed on the housing market last year.
b) Aging housing stock – by 2020 54% of the housing stock will be >40 years old.
c) Aging in place – Baby boomers, over the last couple years, have accounted for about 50% of the remodeling spend
d) Housing starts should increase. Rate of new home construction has been unsustainably low given continued strength in household formation. Historically housing starts run at ~1.3x HH formation to make up for housing units that are taken out of stock (natural disaster or demolition). Over the past 4 yrs. housing starts have run in-line with household formations.
Julie S. Praline
Director, Equity Analyst
Direct: 617.226.0025
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square
Suite 500
Boston, MA 02109