2023-08-30 23:19:16 ET
Summary
- Good 1H 2023 despite tough comps and a relatively soft demand environment. Margins expanding on the back of cost control efforts.
- Long term strategy based on organic growth, international expansion, and acquisitions could support medium term growth.
- Considering good growth prospects, the valuation may be fair.
American paints and coatings manufacturer Sherwin-Williams' ( SHW ) prospects are stable with a strategy based on international expansion, acquisitions, and organic expansion set to drive medium term growth. Their valuation appears fair.
Company Overview
The Sherwin-Williams Company is an American manufacturer of paint, coatings and related products. The company's products are sold to professional, industrial, commercial and retail customers.
The company’s operating segments are as follows:
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Paint Stores Group (formerly known as the Americas Group) consists of the company’s stores in North America and the Caribbean region which primarily sell paint products. This is their biggest segment accounting for over half of revenues.
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Performance Coatings Group develops and sells industrial coatings for wood finishing and general industrial (metal and plastic) applications, automotive refinish, and packaging coatings among other products. This segment licenses certain technology and trade names worldwide. This is their second-biggest segment accounting for nearly a third of revenues.
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Consumer Brands Group consists of the company’s manufacturing and sales operations which primarily supplies paints, stains, varnishes, wood finishes and adhesives among other products sold to retailers and distributors throughout North America, China, Europe, and Latin America. This is their smallest segment accounting for around 15% of revenues.
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Administrative Segment comprises non-core operating activities such as external leasing revenue of excess headquarters space or leasing of facilities no longer used by the Company in its primary businesses.
Background: Q2 2023 performance, stable top-line growth, margins consistently improve
Sherwin-Williams’ revenues are up 7.4% for 1H 2023 largely driven by price hikes driven by price increases (mid-single digit sales contribution), and volume growth (mid-single digit volume growth driven by Paint Stores Group and a low single digit contribution from acquisitions, partially offset by low double digit decline in the Performance Coatings Group).
Margins continued to expand helped by the company’s cost control efforts announced in Q4 2022, as well as moderating input cost inflation. Gross margins rose to 45.2% for 1H 2023 from 41.4% the same period last year. EBT margin rose to 14% from 11% the same period last year.
Revenue growth has been decelerating over the past few quarters and the trend is likely to continue for the second half of the year due to tougher comps. Therefore despite a reasonably strong 1H 2023, management expects FY2023 top-line growth to be around the low single digits.
Margins have been consistently improving over the past few quarters and may continue benefiting from moderating cost inflation, as well as results from their cost cutting plan which is expected to be completed by the end of 2023. Management expects to realize approximately $50-$70 million in estimated annual savings, 75% of which are expected to be realized by the end of 2023. For perspective, total SG&A expenses amounted to $6 billion in FY2022.
A potential Fed rate cut as well as early signs of a housing market recovery bode well for near term prospects. Goldman Sachs expects the first rate cut in Q2 2024 .
Medium term growth strategy: organic growth international expansion and acquisitions
Sherwin-Williams’s medium term growth strategy has so far been based on a combination of organic and inorganic growth plans and this strategy is largely expected to remain the same. The company has been expanding its store footprint (72 net new stores were opened last year around the world), and management is aiming to expand their store base by an average of 2% each year.
The company has been acquisitive lately; six acquisitions were made in FY2022 for an aggregate purchase price of approximately $1.024 billion. Management made clear in their FY2022 annual report that they intend on remaining acquisitive in line with their long term growth strategy. Many of their recent acquisition targets are located overseas, predominantly Europe, which bolsters their international expansion efforts. International sales totaled approximately 19.4%, 21.2% and 19.5% of total sales in 2022, 2021, 2020, suggesting room for further growth. It remains to be seen how successful their international expansion efforts would be, however favorable factors including targeted acquisitions and their status as the world’s leading paints brand may help increase their chances of success. The global paints and coatings market is expected to grow in the mid single d igits over the coming years and possible market share gains from their growth strategy suggests a medium term growth rate higher than the mid single digits is not far fetched. The company also has a proven track record of consistent growth; Sherwin-Williams’ revenues have grown at a CAGR of 8% over the past decade.
Capex needs are expected to increase in FY2023 due to their expansion efforts (CAPEX spend amounted to $644 million in FY2022). The company is investing in the construction of new facilities and expanding existing ones both domestically (such as their new global headquarters and new research and development (R&D) center in Ohio) and overseas (such as expanding production facilities in the UK to service European markets). Management expects CAPEX to drop off in 2024, which could increase free cash flows.
Conclusion
Sherwin-Williams has a moderate buy analyst consensus rating.
The company’s forward P/E of 27 is considerably higher than the sector median of 14.5 and higher than their five year average of 19.5 which suggests a pricey valuation however considering good growth prospects, the valuation may be fair.
A 2-stage DCF model with the following assumptions suggests the company is worth around $67.5 billion, slightly less than their $69 billion market value currently. The stock could be viewed as a hold.
Revenue growth YoY % | 3% this year, between 6%-7% over the next four years and 2% thereafter |
Operating margin % | 13% gradually increasing to 13.5% |
CAPEX (% of revenues) | 3% over the next two years, and 2% thereafter |
Discount rate % | 7% |
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Sherwin-Williams: Stable Prospects, Looks Pricey