Founded in 1866, The Sherwin Williams Company (SHW) primarily manufactures, distributes, and sells paints and coatings to private, commercial and industrial customers worldwide. SHW has three Reportable Operating Segments: the Paint Stores Group, the Consumer Group, and the Global Finishes Group. Through these three business segments, SHW is active in all the major categories of paints and coatings, namely Architectural Coatings, OEM Finishes, and Special Purpose Coatings.
The Paint Stores Group is made up of 3,390 company operated paint stores in North America and the Caribbean. In addition to Sherwin-Williams® branded architectural paint and coatings, the stores also sell OEM finishes, industrial and marine products and related items. The Paint Stores Groups has historically been the largest operating segment by sales and is also the segment with the highest pre-tax profit margins. As expected, the ongoing housing crisis and difficult economic times have had an impact on the sales and margins of this segment. However, the impact has not been extreme.
TABLE 1.
Source: SHW financial statements, Annual 10-K Reports
The Consumer Group is the manufacturing and distribution arm of the company. This Operating Group supplies paints and coatings to third party customer that include large retailers, as well as the Paint Stores Group. The company claims that certain individual customers are of such size that the loss of any one single large customer would not have an adverse impact on the group’s bottom line.
TABLE 2.
The Global Finishes Group develops, manufactures, distributes, and sells all the products that the other operating segments deal in, as well as automotive finishes and refinishes. This segment covers the Americas, Europe, and Asia. In addition to the Unites States, the Global Finishes Group consists of operations in 45 foreign countries, 3 foreign joint ventures, and licensing income in 16 countries. The Net external sales of all consolidated foreign subsidiaries in 2010 were $1.46 billion and the consolidated profit of these subsidiaries was $87 million during the same period.
TABLE 3.
As is evident from the performance of the operating segments The Sherwin Williams Company has faced a difficult operating environment worldwide for the past three years. It is important to further explore the company’s performance by looking at other indicators that might present a clearer picture as to the stability of its sales, profits, and net worth.
Business Model
The Sherwin Williams Company, much like other large, international coatings companies has focused on quality and innovation as far its product offerings are concerned. The company has combined its high quality products with strong distribution systems, innovations that lower business costs while increasing value to the customer, and a high level of customer service.
In 1959 Sherwin Williams was the first paint company to introduce in-store mixing. This innovation lowered inventory costs at both the manufacturing and retailing stages of the supply chain. Additionally, customers benefitted greatly from being able to choose from a much larger range of colors and shades. Company-operated paint stores also have helped the company keep control over the quality of customer service, store appearance, and in my opinion most importantly allowed the company to stay close to its retail customers. The success of this strategy is reflected in the Paint Stores Group’s earnings performance over the years.
The Consumer Group manufactures and markets much the same retail products as the Paint Stores Group but through the large national and regional retail chains. By maintaining a presence in a number of retail chains Sherwin Williams supplements the offering of the products and services available in the paint stores Group.
In keeping with the strategy of staying close to its customers, maintaining a presence across product classes and varied geographic markets, and providing high quality customer service Sherwin Williams’ Global Finishes Group operates 564 branches in North and South America, Europe, and Asia. The Global Finishes Group also offers products through the Paint Stores Group. Products are marketed through direct sales, as well as outside sales representatives to retailers, jobbers, distributors, and licensees. The Global Finishes Group goal is to ensure that quality, service levels, and distribution systems are consistent with Sherwin Williams’ standards across all geographies.
In an industry dominated by a few large players with innovative products and strategies of their own, Sherwin Williams challenges are many: to preserve and protect its profits through a business model based on innovation, preserve a robust product offering, and continue to grow and expand its presence across broad geographies and customer types.
Has Sherwin Williams managed to do justice to its business model and goals?
SWOT Analysis
Strengths
- Maintained strong operating cash flows and free cash flows even during the current extended recession.
- Large number of exclusive retail outlets as well as a presence in the large nationwide chain stores.
- A diverse international presence that is increasing in size and scope.
- Large and varied product portfolio.
- Reputation for quality.
- Well-developed distribution channels.
- Constant innovation with a large patent estate.
- Well-recognized brand.
Weaknesses
- Highly dependent on the U.S. market for profits as international profits make up for less than 20% of the total.
- Susceptible to government fines and large payouts related to environmental litigation.
- Profits are very dependent on the retail market which remains badly affected by the recession.
- Competition is made up of comparably large companies making creation of a defensive moat almost impossible
- Vulnerable to lower-price competitors.
- Exposure to internationally determined raw material prices.
Opportunities
- High economic growth in many international markets in Asia and South America where Sherwin Williams has a presence.
- Greater awareness about and a desire for environmentally friendly coatings among consumers.
- The do-it-yourself consumer continues to be stronger than the professional painter group of consumers – a situation that the company can take advantage of through its company-operated stores by offering value-added services.
- The U.S population is one of the fastest growing of all advanced economies. Sooner or later this recession will end and there will be a return to demand for housing.
Threats
- Rising raw material costs due to increasing crude oil prices.
- High possibility of further turmoil in the financial markets which might make raising funds more difficult.
- Like all other companies that use and dispose of chemicals, Sherwin Williams is also exposed to the possibility of unfavorable outcomes in environmental lawsuits.
- Stricter environmental legislation.
- A persistently fragile economy.
- Competition from low maintenance alternatives like siding.
Analysis of Financial and Operating Performance
Much like any other company tied to the housing industry, Sherwin Williams was negatively impacted by the downturn. Sales in 2009 fell more than 11 percent over the previous year with an 8.6 percent fall in net income. After two years of declines in revenues and net income 2010 was a better year. Both, revenues and net income increased in 2010 over the previous year. It is important to see how the company performed on other factors crucial to determine whether the company remains on a strong footing. A brief analysis follows.
Liquidity Analysis
Sherwin Williams has largely maintained a favorable current ratio over the years. The ratio dipped below 1 in 2007 and 2008 but current assets are greater than current liabilities for the past two years.
TABLE 4 – Liquidity Ratios
Cash Conversion Cycle (or Operating Cycle) = Days Inventory Outstanding + Days Sales Outstanding – Days Payables Outstanding
In 2010 the company has lowered the number of days that it takes to churn cash. For the past two years it has been paying suppliers later and has also lowered inventories in 2010. This strategy, while potentially affecting the current ratio, forces efficiencies in inventory management, and strengthens the company’s cash position (liquidity).
FIGURE 1.
FIGURE 2.
Debt Management
The debt ratios show a trend towards increasing debt levels compared to equity. There is a clear shift in the mix of debt and equity that reflects a change in the manner the company finances its operations. While the actual debt-equity ratio is not a cause for alarm, the trend towards increasing levels of debt is something to watch for in this company’s future financial reports. Sherwin Williams increased long-term debt substantially in 2009 by $479 million, which explains the sharp increase in the capitalization ratio that year. As that debt gets paid down, and assuming there are no large increases in long-term debt this year, there should be a further drop in the company’s capitalization ratio.
Of course the company can’t be faulted for taking advantage of extremely low interest rates at this time.
FIGURE 3.
It should also be noted that Debt-equity ratios in excess of 200% are not uncommon for large, well-established companies.
Cash Flow Analysis
Sherwin Williams has been known to be a company with consistently positive cash flows. For a company with a long history of paying dividends, free cash flow is very important. Some companies make dividend payouts even when their cash flow is insufficient to cover such outflows, i.e. they pay dividends with borrowed money. This company is clearly not one of those.
TABLE 5 – Free Cash Flow
The amount of free cash flow has fluctuated widely over the past few years, and this is to be expected: sales fell steeply in 2008 and 2009 with corresponding falls in capital expenditures and raw material expenses, resulting in spikes in free cash flow. With 2010’s healthy sales increase, CAPEX and raw material expense outflows have gone up.
FIGURE 4.
For any conservative investor who considers cash flow to be the most important indicator of health for a company and an indicator of the ability of a company to weather difficult times, Sherwin Williams is indeed a very healthy company. As the above graph shows, operating cash flows were enough to cover capital expenditures and dividend payouts.
Profitability
FIGURE 5.
The company has been giving quite consistent returns on equity for the past five years, with a spike in 2007. Return on assets show a slight downtrend keeping with the difficult economic times, with net profit margins remaining subdued during the ongoing recession. The current recession is quite tenacious, but the company has managed to continue making profits and most importantly generate substantial cash flows while boosting sales last year. It is important for Sherwin Williams to improve its net profit margins from continuing operations and boost returns on assets in 2011.
Operating Performance
FIGURE 6.
Sherwin Williams is moderately capital intensive. The company managed to turnover its inventory 9.39 times in 2010 which is close to its average of 9.2 over the past 4 years. The above figures show no drastic changes in the company’s operating situation over the past few years.
Conclusion
The Sherwin Williams Company has a long history of paying increasing dividends – 31 years in fact. The 2010 dividend yield was 1.8 percent. The P/E ratio (trailing twelve months) on March 2, 2011 is 18.97. For most value investors, anything above 15 is not a good value investment. Given that this company is dependent very heavily on housing market growth for sales and profit increases, and in the absence of any compelling macroeconomic trends that hint at massive growth in the housing sector, I tend to agree.
In 2010 the company’s EPS figures recovered after a steep fall in the previous year by rising from $3.78 per share (Diluted) to $4.21 per share (Diluted). If the economy holds in 2011, Sherwin Williams could very well provide some decent earnings figures.
I believe that Sherwin Williams is a good investment choice for a long-term investor. Patience is a virtue and waiting for market dips (for more favorable P/E ratios) would maximize returns from this strong company.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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