The industrial paints business is posting strong numbers on the back of an industry-wide recovery and global sourcing. But rising raw material prices and a slowing housing market are the biggest obstacles in Valspar's near-term growth. For fiscal 2008, the company anticipates a 5%-8% rise in raw material costs.

At this point, we believe Valspar will find it extremely difficult to achieve the level of price increases necessary to fully offset these higher costs at larger retailers such as Lowe's. The latter has been very resistant to price increases.

Currently, Valspar Corporation is trading at 12.0x our 2008 EPS estimate of $1.54. Owing to high raw material costs and a slowing housing market, margins may fall. However, its acquisition strategy and rationalizing activities undertaken to restore margins inspire confidence that the stock deserves to trade at a higher P/E multiple. Thus, we rate the stock a Hold. Our target price of $21.00 is 13.6x our 2008 EPS estimate.

Aracruz Meeting Pulp Demand

We are keeping our Hold recommendation on Brazil-based pulp producer Aracruz Celulose S.A. (ARA). The company's expansion plans are solid, and they are going to enhance the stock's value over the long term. The international pulp and paper markets remain tight, and the short-term outlook for pulp prices is positive.

From 2006 through the first half of 2008, the global pulp market was heated. Demand also remains strong in Asia, a trend that we expect will continue in the following quarters. In North America, however, demand declined, though pulp market conditions remain tight.

Aracruz invested US$338 million in 2007 in order to increase its installed capacity to face the continued growing pulp demand worldwide. Particularly interesting is the optimization of the Barra do Riacho mill whose output has been increased to 2.9 million tons a year and also the expansion of the Guaiba unit for US$2.6 billion investment, which is expected to increase nominal capacity from 450,000 million tons now to 1.8 million tons by 2010.

The company continues with its policy to pay dividends in advance, and has already declared interests on equity of US$0.41 per ADR in March and US$0.54 per ADR on June 20, 2008.

Yet we remain concerned over the strength of the Brazilian real against the U.S. dollar, and its impact on Aracruz's costs and competitiveness. Even worse, there were some considerable worldwide inflation pressures together with hike in interest rates in many countries, mainly in emerging markets. We believe this development could create a more challenging environment for commodities prices in the following quarters, including pulp prices. Finally, second quarter results were disappointing.