Dulux Paints A Pretty Picture

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By Chris Shaw

As part of an attempt to streamline its business Orica ((ORI)) has spun-out the DuluxGroup ((DLX)) business, with Dulux listing on the Australian market this week. Dulux is a leading manufacturer and marketer in the Australian and New Zealand paint and woodcare coating markets, while the group has some diversification through ownership of brands such as Selleys, Yates and Cabot's.

This combination of businesses means Dulux is more diversified than many in the market assume, UBS noting 19% of group revenues are generated outside of Australia and 45% of revenues come from the trade and industrial markets. As part of this, Dulux has a network of 70 Trade Centres that complement sales from specialty trade retailers.

Having separated from Orica, UBS expects it is will be largely business as usual for Dulux. This implies a plan to continue the focus on introducing adjacent products to complement brands, with the Selleys cleaning range being a good example of such an approach.

Business as usual suggests some continued good performance, as UBS notes Dulux has consistently delivered high returns on invested capital while continuing to lift market share. As evidence of this, UBS notes in the mature Australian paint market volume growth has averaged minus 0.9% over the past seven years but over the same period Dulux has grown revenues by 5.6%.

This has translated into capitalised annual growth in earnings before interest and tax (EBIT) of 7.9% between 2002-2009, which Macquarie suggests highights the defensive nature of earnings and good earnings certainty.

This trend should continue in Macquarie's view, driven by new product development in the coatings and home improvement markets as well as further modest growth in the paint market. As part of a focus on new products, Dulux has 130 chemists and technologists and research facilities in both Victoria and New South Wales.

Mergers and acquisitions are another avenue for growth, though the Yates purchase in 2004 was a limited success and so UBS expects any further deals to be closer to core capabilities. This implies deals in specialty coatings, further moves into Asia or complementary deals in the fragmented Garden Products sector.

Given the maturity of the Australian paint market both UBS and Macquarie note competition is likely to be an issue, especially as major competitor Wattyl is soon to come under the control of US group Valspar.

Distribution also offers some risks, as while Dulux currently relies on its Trade Centres and retail channels such as Bunnings the potential impact of the entry of Lowe's/Woolworths ((WOW)) into the retail sector remains an unknown.

What will help the company continue to grow its business according to Macquarie is the combination of strong cash flow and a sound balance sheet. Given relatively low capex requirements, Dulux has generated cash conversion levels of between 90-110%.

As well, Macquarie notes the company has around $150 million available from a $400 million debt facility. Net debt in Dulux at present is around $249 million, with Macquarie noting EBIT to interest cover is 6.4 times.

The fact the company delivers strong cash flows should also allow for attractive dividends in Macquarie's view, the broker's forecasts calling for dividends per share of 14.9c in 2011 and 15.8c in 2012 (no dividend is expected in 2010). This implies a dividend yield of around 6% in both 2011 and 2012.

Following its listing this week both Macquarie and UBS have initiated coverage on Dulux with Buy ratings, setting respective price targets of $2.84 and $2.95 on the stock. These targets are based on earnings per share (EPS) forecasts of 20c in FY10, 23c in FY11 and 26c in FY12 according to UBS and 19.5c, 21.2c and 22.5c respectively for Macquarie.

UBS estimates at its target price Dulux would trade on a multiple of 12.8 times FY11 EPS and 11.5 times EPS in FY12. The broker notes this compared to an emerging industrials average earnings multiple of 10.6 times in FY11, the premium reflecting both low earnings volatility and high barriers to entry.

Shares in Dulux today are down slightly, trading 3c lower at $2.52 as at 1.10pm. This compares to a range since listing of $2.50 to $2.78 and implies upside of around 14% to the broker price targets. Macquarie and UBS are currently the only brokers in the FNArena database to cover Dulux. 

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