Sherwin-Williams: Consistent Growth And Profitability But Too Pricey (NYSE:SHW)

Overview

The Sherwin-Williams Company (NYSE:SHW) is a global provider of paints, coatings, and related products. The company is headquartered in Cleveland, Ohio, United States. The company’s business model is based on selling a wide range of high-quality coatings products in over 60 countries around the world, with a network of over 5,000 company-owned stores, independent dealer stores, and other retail outlets as well as through contractors and professional painting contractors.

SHW products are used in a variety of applications, including residential and commercial buildings, transportation, and industrial and marine environments. The company’s product lines include architectural paints and coatings, industrial and marine coatings, automotive finishes, and related products. In addition to its core coatings business, SHW also manufactures and sells a range of other products, including paint thinners, solvents, and other related products.

The company has a long-storied history dating back to 1866 when it was founded by Henry Sherwin and Edward Williams in Cleveland, Ohio, United States. It was initially established as a small retail store selling paints, varnishes, and other related products. In 1875, the company introduced its first patented product, “Sherwin’s Universal Oil Paint,” which was an oil-based paint that could be thinned with turpentine and was suitable for both indoor and outdoor use.

Over the years, The Sherwin-Williams Company has grown and evolved, expanding its product line and entering new markets around the world. The company has a long history of innovation, and it has introduced many new products and technologies over the years, including the first water-based architectural paint and the first low-VOC (volatile organic compound) paint. Today, SHW is a leader in the coatings industry, with a strong presence in both the residential and commercial markets.

Track Record

SHW has an impressive management team, currently led by its Chairman and Chief Executive Officer, John G. Morikis. a post he’s held since 2016. Morikis has been with the company since 1984 when he started as a management trainee in the Paint Stores Group. He has held a number of leadership positions within the organization, including President and General Manager of the Paint Stores Group and President and Chief Operating Officer.

Morikis holds bachelor’s degrees in both Business Administration and Psychology from Saint Joseph’s College in Rensselaer, Indiana, and a master’s degree in Business from National Louis University in Evanston, Illinois.

In addition to being on the SHW board of directors, Morikis has been trusted to serve on the board of directors of Fortune Brands Home & Security and the American Coatings Association. He is also the chairman of the Harvard University Policy Advisory Board and the Joint Center for Housing Studies, and the vice chairman of University Hospitals Health System in Cleveland, Ohio. Additionally, he is involved in various civic and community boards in Cleveland.

Under Morikis’ leadership, Sherwin-Williams has continued to focus on innovation, customer service, and sustainability, and the company has consistently delivered strong financial performance. The company’s revenue has more than doubled over the past decade. Even more impressive, there hasn’t been a single year of revenue declines over the past ten years.

In addition to SHW’s impressive revenue growth, the company’s free cash flow growth has also been great, although free cash flows have declined significant in recent years.

Beyond impressive revenue and free cash flow growth, SHW has demonstrated an excellent track record of profitability by averaging a return on equity of 65.7% over the past decade, without a single year under 25%.

SHW’s growth and profitability have been phenomenal. However, investors should take note that the company has a significant amount of debt. SHW currently has more than $12 billion in total debt, up from just $1.1 billion from 2013. For some context, the company has a debt-to-equity ratio of 4.79 and a current ratio of just 1.0.

The company’s debt may sound off alarms for some investors, still others will be pleased to see its dividend growth and share repurchases. Over the past decade SHW has grown its dividend by 250% and currently only has a 31% payout ratio.

Overall, SHW management has established a strong track record of growth and profitability while being shareholder-friendly through steady dividend growth and share repurchases. However, the company’s high debt levels should be concerning to investors.

Growth Driver’s

SHW has three reportable operating segments: The Americas Group, Consumer Brands Group and Performance Coatings Group. The Americas Group consists of 4,859 company-operated specialty paint stores in the United States, Canada, Latin America, and the Caribbean region. These stores provide services to architectural and industrial paint contractors, as well as do-it-yourself homeowners.

The company continues to open new stores. In the 3Q22 earnings call, management stated they opened 32 net new stores year-to-date and plan to open 40 to 50 new stores in the fourth quarter, with plans to open 80 to 100 stores in 2023. In addition, the company also recently added sales reps and territories, and it continues to invest in growth projects including innovative new products, e-commerce, and productivity-enhancing services.

The Consumer Brands Group produces and sells a range of branded and private-label products including paints, stains, varnishes, and other industrial products. These products are sold to retailers and distributors in North America, China, and Europe. In addition to these products, the Consumer Brands Group also provides research and development, manufacturing, distribution, and logistics support for the company’s other businesses worldwide.

The Performance Coatings Group produces and sells industrial coatings for a variety of applications, including wood finishing, general industrial coatings for metal and plastic, automotive refinish coatings, protective and marine coatings, coil coatings, packaging coatings, and performance-based resins and colorants. These products are sold worldwide. This is The Sherwin-Williams Company’s best-growing segment, growing 22% year over year.

SHW’s management team recently approved plans to simplify its operations and reduce costs in all regions of its Consumer Brands Group and Performance Coatings Group. These changes are intended to help the company achieve above-market growth and increase shareholder value.

The focus of these changes will be on the China architectural business, the aerosol portfolio, and optimizing the overall retail portfolio. These changes are expected to result in pre-tax charges of between $160 million and $180 million over the next four quarters, with approximately half of these charges occurring in the fourth quarter of 2022. However, the actual amount and timing of these charges may vary.

Valuation

We will run comparative and discounted cash flow (“DCF”) analyses to estimate the intrinsic value of SHW. To begin, we’ll start with the comparative analysis and look at the highest, lowest, and average price-to-earnings ratios the market has paid for SHW over the past five years. We’ll also look at the sector median P/E, which is 11.65. Finally, we’ll multiply these ratios by the average analyst estimate of 2023 earnings, which is $10.29.

Scenario	P/E	2023 Earnings Estimate	Intrinsic Value Estimate	% Change from Current price
Bear Case	19.64 – 2018 PE	$10.29	$202.09	-14.84%
Average	33.25 – 5-year average	$10.29	$342.12	44.15 %
Bull Case	48.18 – 2021 P/E	$10.29	$495.77	108.89%
Sector Median Valuation	11.65	$10.29	$119.87	-49.49%

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On a comparative analysis, SHW has slightly more upside than downside, however there are extreme scenarios on both sides. Investors would realize an excellent 108.89% return if the market were bullish and applied the 48.18 multiple, seen in 2021, to next year’s earnings estimate. However, suppose the market would value SHW at the bearish multiple seen in 2018 or even worse. In that case, if the market valued SHW at the sector median multiple, investors could see as much as a -49.49% return on their investment.

Turning to the discounted cash flow analysis, we will begin by taking the average of the last five years of free cash flows, which is $1.9 billion. Then we will apply a 10% growth rate for the next ten years based on rule 72, which states a 10% growth rate will double the original value in 7 years. We will follow rule 72 for this DCF because it’s challenging to accurately forecast free cash flow growth rates multiple years into the future. Still, I am confident that SHW will be able to more than double its free cash flow over the next decade because of the growth drivers previously mentioned.

Following the 10th year, we will use a 2.5% growth rate into perpetuity to determine the terminal value. We will then use a discount rate of 10% based. I use this discount rate because it’s my personal required rate of return. With these inputs, the DCF analysis gives us an intrinsic value of $174.11, representing a downside of -26.6% from SHW’s current share price.

If you believe a 10% growth rate over the next 10 years is too conservative, consider that SHW would need over a 14% growth rate for the estimated intrinsic value to match its current share price.

Takeaway

Led by an experienced leadership team, SHW has established an impressive track record of growth and profitability. In addition, SHW has been a shareholder-friendly company, increasingly buying back shares and raising its dividend. The company should enjoy more growth in the future, powered by new store openings, innovative new products, and investments in e-commerce and productivity-enhancing services.

There are a few red flags with SHW that investors need to consider. First is its rising debt. The company currently has a debt-to-equity ratio of 4.79 and a current ratio of 1.0. These high debt levels may impact SHW’s ability to invest in new growth projects or return capital to shareholders. In addition, The Sherwin-Williams Company does not have a wide margin of safety in its current share price based on the valuation analysis above.

There is a lot to like about The Sherwin-Williams Company. However, I do not believe this is the best time to invest in SHW, but if you disagree, please let me know in the comments section below. Thank you for reading!