DuluxGroup Limited (ASX: DLX) is a boring company. At its core it is a largescale manufacturer and distributor of paint operating in a mature industry. Shares in Dulux are not likely to double in a short space of time but they are likely to grind slowly higher over many years.
The strength of the company lies in the highly recognisable Dulux brand which affords the company significant pricing power. Dulux has the luxury of being able to increase its prices a few percent each year without risk of losing market share.
Further evidence of the value of the Dulux name is provided by the impressive margins that are achieved in its paint division. The Paints and Coatings ANZ division achieves earnings before interest and tax (EBIT) margins of more than 17% compared to less than 10% for Dulux's other businesses.
The Paints and Coatings ANZ business contributes around 73% to group EBIT before corporate costs and the Consumer and Construction Products ANZ contributes 12%, Garage Doors & Openers 5%, Cabinet & Architectural Hardware 3% and Other businesses 7%. Broadly speaking, Dulux's businesses are exposed to the home improvement industry and products are marketed through both trade and retail channels.
Part of management's strategy is to use existing distribution channels to grow sales of new product categories and this was part of the rationale for the substantial acquisition of Alesco in 2012 for $258 million. Whilst Dulux has been successful in cutting duplicate costs from the business, sales performance has mainly lagged the traditional paint business so far.
Management are still optimistic about the growth prospects for the Alesco group of operations but I am unconvinced. The acquired businesses sell things such as construction equipment, cabinet and window products and garage doors and openers. The economics of these items is inferior to paint where a single product can be applied to buildings of any shape and which must be used within a certain time frame once opened. Furthermore, painting is popular as an inexpensive and easy way to redecorate whereas a new garage door is tricky to install and is more of a one-off purchase.
The other key difference between Dulux's paint division and the rest is branding. As discussed earlier, the Dulux name enables the company to sell its paint at a premium and this does not extend to its other products.
Despite my misgivings about the Alesco acquisition, I believe that management is committed to improving the Dulux business over the long-term. Managing director Patrick Houlihan owns almost $14 million worth of shares in the company and CFO Stuart Boxer owns just under $4 million worth. The recent decision to build a new factory doubling existing capacity is an example of long-term decision making. The main benefits will not be realised until 2019 and the project will cost $165 million but it will help Dulux to continue to produce the highest quality paint in ever larger quantities for years to come.
Valuation
Unfortunately Dulux shares are not cheap today. Recently trading at $6.14, I have the stock on an enterprise value to earnings multiple of just over 23x based on my forecast underlying earnings for 2015 of $120 million. However, Dulux is a high quality company and so buying at today's prices is still likely to deliver decent returns over the long term. In the meantime, the stock pays a 3.5% fully franked dividend yield that compares favourably to current term deposit rates and is likely to rise in the future.
Foolish takeaway
DuluxGroup is a superior yet dull business with strong pricing power, focused management and low debt. At current prices, Dulux shares look a little expensive but the stock is still likely to perform well over the coming years. One question mark hanging over the business for me is how it will perform when Australia next has a recession. If the GFC is anything to go by then it will prove resilient, but I have a nagging suspicion that people put off home improvements during hard times, even cheap paint jobs.
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