RPM International – Improved Business Practices Reward Investors – RPM International Inc. (NYSE:RPM)

The Stock

RPM International, Inc. (NYSE:RPM) owns subsidiaries that are world leaders in specialty coatings, sealants, building materials, and related services across three segments. RPM’s industrial products include roofing systems, sealants, corrosion control coatings, flooring coatings and other construction chemicals. Industrial companies include Stonhard, Tremco, illbruck, Carboline, Flowcrete, Euclid Chemical and RPM Belgium Vandex.

Due to several operational improvements in RPM’s business, including the replacement of several managers, its stock has recently broken out of its multi-year trading range, risen by over 33% since April 2017. This newfound bullish momentum has not shown signs of abating soon, as the short-term resistance at $72 was broken through last week, providing investors with an opportunity to enter positions on a strong breakout.

(Source: Google Finance)

RPM’s business practice improved due to the recently announced agreement with Elliott Management to create new initiatives to improve operating and financial performance and enhance shareholder value. This has resulted in the new Operating Improvement Committee. The OIC’s review will center around setting and achieving new company margin targets based on top-performing industry standards and the optimization of RPM’s balance sheet, including streamlining working capital and implementing new capital allocation guidelines and capital return plans

Jeff Rosenbaum (Elliot Management)– “We are confident that this ‘no stone unturned’ review will lead to several hundred basis points of margin improvement, capital returned to shareholders, and superior overall results for the Company.” (Source: BusinessWire)

This has already begun yielding results, with a 150 basis point improvement in SG&A as a percent of sales achieved in fiscal 2018 over RPM’s fiscal 2017 results. The expense reduction and plant consolidation activities (announced in the fourth quarter of fiscal 2018) will generate $25 million of savings on an annualized basis, and $23 million of which will be realized in fiscal 2019. Additional cost reduction and production optimization activities over the first half of fiscal 2019 will result in a similar magnitude of annualized savings once they are completed. Two consumer product manufacturing facilities were also closed, eliminating approximately 150 positions. In the industrial segment, RPM also closed a non-profitable business in China and a polymer flooring facility in North America, which will now be serviced from another location.

After these activities, I believe we will have completed three innings of a nine-inning process that will play out over the next 2.5 years, which will include additional SG&A efficiencies, further production optimization and a related organizational realignment that is already in process….Elliott Management, contacted us because they believe that RPM stock was undervalued, particularly in relationship to opportunities to improve our operating performance and margin profile. (Source: RPM International Inc. Q4 2018 Results – Earnings Call Transcript)

Quarterly Performance

During 4Q18, RPM incurred restructuring and other charges totaling $24.6 million due to the efficiency initiatives, which will position RPM for long-term growth. Inventory-related charges of $37.7 million were incurred mainly from the consumer segment due to “a strategic shift in direction” (product lines being altered). Winter-like conditions, which have persisted for several months, resulted in subdued results, and increases in raw material costs (chiefly in silicones and epoxies) have added to the difficulties facing RPM in the short term. Despite these difficulties, strong growth was still achieved in the majority of business segments. Sales in RPM’s industrial segment increased 10.8%, driven mostly by organic growth of 6.2%, with acquisitions contributing 1.7%. Industrial sales continue to be driven by solid results in most of RPM’s international markets, with sales in Europe up by ~8%. In the energy sector, sales were up, a trend management expects to continue in fiscal ’19 despite the slowdown in orders from Brazil due to its severe financial downturn. In total, EBIT up 8.1% on an as-adjusted basis over the quarter.

Importantly, this year saw the final liability payment for historical asbestos cases. Over the last 15 years, RPM has paid out almost $1.4 billion, $800 million of which was paid in the last 3.5 years. With this liability concluded, RPM’s capital allocation has been significantly freed up, allowing management to accelerate growth through further acquisitions or return capital directly to shareholders.

Strong Momentum

Due to RPM’s recent strong upwards moves, many investors are likely hesitant to enter a position, fearing the stock is now overvalued:

However, I believe that the improvements in management as well as the increase in FCF due to the winding down of asbestos-related liabilities will result in further upward strength over the next several quarters. Further acquisitions, an increased dividend distribution, and share buybacks are all possible announcements next quarter due to the increased cash flow enabled by the reduction in asbestos liability payments.

Capital Management/Dividend Distribution

RPM’s management has consistently raised its dividend distribution, with 2018’s payments increasing 6.7% y/y. As such, the fall in RPM’s yield is simply due to share price appreciation over the past 12 months:

Ex-Div. Date	Amount	Type	Yield	Change	Decl. Date	Pay. Date
7/16/2018	$0.32	Quarter	2.1%	N/A	7/5/2018	7/31/2018
4/16/2018	$0.32	Quarter	2.6%	N/A	4/4/2018	4/30/2018
1/16/2018	$0.32	Quarter	2.4%	N/A	1/3/2018	1/31/2018
10/13/2017	$0.32	Quarter	2.5%	+6.7%	10/5/2017	10/31/2017
7/13/2017	$0.30	Quarter	2.2%	N/A	7/5/2017	7/31/2017
4/11/2017	$0.30	Quarter	2.3%	N/A	4/4/2017	4/28/2017
1/11/2017	$0.30	Quarter	2.3%	N/A	1/4/2017	1/31/2017
10/13/2016	$0.30	Quarter	2.5%	+9.1%	10/6/2016	10/31/2016

Using Options To Profit From Potential Increase In Volatility

As RPM’s implied volatility has fallen towards its 30-day lows, rather than simply entering long-term positions, traders may wish to use options to profit from the current all-time high stock price. I believe volatility will increase as long-term investors either increase positions as a result of the recent price breakthrough or begin taking profits, fearing potential near-term downside exposure:

(Source: Market Chameleon)

To achieve a favorable risk/reward over the next month and to limit downside exposure, creating a long ATM straddle trade limits maximum risk while profiting from a move either to the downside or upside. Due to RPM’s low IV, a move in either direction of only 5% before expiry (21 Sept. 18) results in profits larger than maximum losses:

(Source: Market Chameleon)

Conclusion

The combination of improved business practices brought about by RPM’s partnership with Elliott Management and the conclusion of $1.4 billion asbestos liabilities has renewed investors’ faith in the company, and the significantly improved free cash flow arising from the conclusion of the asbestos liability payments has the potential to further reward investors over the next several quarters with the potential for increased dividends, further acquisitions, or share buybacks now becoming possible. The newfound bullish momentum in RPM’s stock has not shown signs of abating soon; with the recent breakthrough of significant resistance at $72, investors have been provided with an opportunity to enter positions on a strong breakout.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.