Warren Buffett isn’t known for chasing speculative growth stocks or companies in uncertain markets, so if you are looking for those stocks, then look away. However, he is known for buying relatively safe, possibly boring, companies that have the ability to increase earnings from their assets. In this context, specialty chemicals distributor Univar Solutions ((NYSE:UN)VR), paint and coatings company PPG Industries (NYSE😛PG), and electrical equipment maker Hubbell (NYSE:HUBB) strike me as the sort of boring, cash flow generative, and undervalued businesses that Buffett might buy. Here’s why.
Specialty chemicals distribution is a relatively niche and highly fragmented industry, with the top three distributors accounting for around 10% of the market. It’s a relatively low-growth industry, but that won’t worry Univar Solutions investors too much. The case for buying the stock isn’t based on the inherent top-line growth prospects, but rather the company’s ability to raise its margin in line with its peers.
Following a period of disposing of non-core assets and acquiring another chemical and ingredient company, Nexeo Solutions, in 2019, Univar is now in a position to improve its margin. As such, Univar’s management believes it can enact cost savings and productivity improvements, resulting in raising its earnings before interest, taxation, depreciation, and amortization (EBITDA) margin from 7.6% in 2019 to 9% by the end of 2022.
Doing so would significantly improve earnings and free cash flow (FCF), and analysts have Univar generating around $300 million in FCF in 2022, putting the company on a price-to-FCF multiple of just 11.5 times. That would be a very attractive valuation for a business with low-single-digit revenue growth prospects. Moreover, the FCF could give Univar the opportunity to buy more growth through acquisitions.
All told, Univar’s combination of FCF growth potential and margin improvement through a renewed focus on its core business makes it an attractive value proposition that would suit Buffett-type investors.
As boring as watching paint dry — literally — painting and coatings company PPG Industries is a company that might suit Buffett. In fact, Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) already holds a rival, Axalta Coating Systems.
The logic is simple: As long as things like cars, ships, planes, and houses are made, they will need painting and coating too. As such, it’s a relatively safe, albeit cyclical, industry that tends to have companies in it that generate relatively high returns on equity. That just means they are very good at generating income from the money that’s been invested in the company. It’s no coincidence that PPG and Sherwin-Williams are both Dividend Aristocrats. In other words, they consistently increase income in order to be able to pay more dividend.
PPG‘s sales should improve along with the industrial economy, and the company has an opportunity to consolidate the industry starting with its $1.1 billion acquisition of Finland’s Tikkurila, a leading paint brand in the Nordic region and Russia.
Wall Street analysts are expecting PPG‘s sales and earnings to increase from adjusted diluted earnings per share (EPS) of $5.70 in 2020 to $8.23 in 2022, putting PPG on a price-to-earnings (P/E) multiple of 16.8 times earnings. That’s a good valuation for such a solid company capable of growing in line with the economy over time.
Electronic and electrical products company Hubbell isn’t the most exciting company on the market, but its products are essential for its construction, utility, industrial, residential, and non-residential customers. In common with PPG, Hubbell’s sales are set to bounce back in 2021, and the company is expecting organic sales growth of 3% to 5% in 2021.
Thinking longer-term, Hubbell has a growth opportunity from the increased spending on eletric transmission and distribution (T&D) implied by the surge in growth of renewable energy investment. In addition, the T&D market benefits from solid recurring demand for utilities to maintain their grids. It all points to solid demand growth in the coming years.
That’s something investors should welcome because more revenue normally means more EBITDA, and Hubbell tends to do a very good job of converting EBITDA into FCF. Moreover, it trades on a very attractive FCF valuation.
All told, Hubbell’s FCF and boring, but necessary, products make it a good fit for Buffett-type investors. The businesses may be boring, but there’s nothing wrong with making money from Hubbell, PPG, and Univar Solutions, as they all look like a good value at this price.