2023-04-23 05:45:05 ET
Summary
- Sherwin-Williams has seen a solid 2022, aided by inflationary trends.
- This growth is set to reverse in 2023 amidst a pullback in (housing) markets.
- While I appreciate the long track record of the business, the current valuations are still too demanding, even if shares are down a third from their highs.
Shares of Sherwin-Williams ( SHW ) hit the newswires over the past week as the company announced a small divestment, selling its Chinese architectural paint business to peer Akzo Nobel (AKZOY)(AKZOF)[AKZO.AS].
This makes for an interesting time to update the thesis as there are many moving parts to this investment case including inflationary pressures, big movements in commodity prices and exposure to paint intensive markets such as real estate and/or housing.
Some Background
Sherwin-Williams is a huge paint conglomerate whose history goes back deep into the 19th century. The company has made a huge deal and took part of industry consolidation as it acquired Valspar in a more than $11 billion deal back in 2016, shaping the business as we know it today.
By 2022 Sherwin has grown to a $22.1 billion sales base, as the range of operations is simply very large. The company employs 64,000 workers, has over 5,000 stores and operates over a hundred facilities across the globe, operating in some 120 countries.
The largest segment is the $12.7 billion Americas Group, which posts solid margins at 19% and change. These markets are highly geared towards residential, both new and repainting and maintenance, of course in the Americas.
The is complemented by a $6.8 billion Performance Coating Group which generates margins of around 14%. These revenues are generated from industrial applications, wood, coil, packaging, automotive finishing and protective & marine.
The company has a smaller $2.7 billion Consumer Brand Group as well, with paints available at many retailer and home improvement stores, as adjusted margins of 13% are the lowest, especially after they have come down in recent years amidst competitive pressures.
The combination of organic growth and bolt-on dealmaking has served growth and long term investors well. Over the past decade that company has been able to just more than double sales, improve margins a bit, as the share count is down by about 15%, creating a very balanced approach to capital allocation and very solid earnings per share growth.
The Numbers
In January the company posted its 2022 results with sales up 11% to $22.15 billion, largely amidst inflationary pressures as gross margins actually saw a bit of pressure, down 70 basis points. Pre-tax earnings rose 14% to $2.57 billion, mostly become of some smaller incidental income.
Amidst a slightly higher tax rate and modest share buybacks, the company grew GAAP earnings per share by nearly 11% to $7.72 per share. Adjusted earnings per share rose only 7% to $8.73 per share with the vast majority of the adjustment relating to acquisition- and related impairment charges.
Net debt of $10.4 billion works down to a less than 3 times leverage ratio based on $3.6 billion in EBITDA. Leverage is relatively stable and not too low, but on the other hand is that the business is quite stable. Moreover, a lot of debt is fixed in terms of the interest rates and has long term maturities.
This is comforting as the 2023 guidance is not too invoicing with adjusted earnings seen between $7.95 and $8.65 per share this year, at the midpoint coming in at $8.30 per share, down about 5% year-over-year. This lower earnings outlook comes on the back of sales anticipated to be down between flat and mid-single digit percentages. These sales declines will weigh on earnings, as GAAP earnings might take a larger beating amidst some restructuring efforts.
With 260 million shares trading at $233, the company commands a $60 billion equity valuation, or about $70 billion enterprise valuation, at just over 3 times sales. The market has partially priced in the headwinds from cooling end markets (notably housing of course) as shares fell from $350 at the start of 2022 to $233 at the moment of writing. This pullback of a third is substantial, but based on the adjusted earnings guidance for this year the company still trades at 28 times adjusted earnings, as leverage is still quite high.
This comes as investors like the predictability of the (long term) growth, certainly on a per-share basis, of Sherwin over the past decades.
A Small Deal
As part of refining its strategic focus, Sherwin-Williams announced a small deal in mid-April, as it divested its Chinese architectural pain business to Akzo Nobel.
The business generated about $100 million in sales, less than half a percent of total sales, and employs about 300 people. Unfortunately no purchase price has been communicated, but given the sales numbers the effective purchase prices likely comes in around a few hundred million, thereby not moving the needle, but likely a small help in keeping leverage in check.
Weighing It All Together
The reality that Sherwin-Williams has a great long term value creating track record ad as alluded to above, the current valuation is relatively high, as some leverage is apparent on the balance sheet as well. Moreover, while the company has a great dividend track record, including many years of uninterrupted dividend hikes, the reality is that the yield is stuck around a percent.
2023 is set to become a softer year as the company sees little visibility beyond the summer of this year, as the housing slowdown is set to impact the industrial business as well.
Hence, I am performing a balancing act between the substantial pullback seen already, although the overall valuations remain quite elevated. In the end valuations matter, making me cautious to pick up the shares here just yet.
Hence, I am looking for entry points at $200 or below, as the near term potential, given the soft business momentum and high valuation create a tough reason to become upbeat despite the great long term value creation.
For further details see:
Sherwin-Williams: Not Painting A Pretty Picture