Sherwin-Williams: A colorful success
Sherwin-Williams is a global market leader in paints and coatings. While paints and coatings may not sound like the most exciting thing to be investing in, Sherwin-Williams has outperformed both the S&P500 and its peers over the last five years. Is Sherwin-Williams still a good investment? This is what I'm going to examine in this analysis.
This is not a financial advice. I am not a financial advisor and I only do these posts in order to do my own analysis and elaborate about my decisions, especially for my copiers and followers. If you consider investing in any of the ideas I present, you should do your own research or contact a professional financial advisor, as all investing comes with a risk of losing money. You are also more than welcome to copy me.
Since attending the workshop with Phil Town, I have decided to make some changes to the layout of my analyses. I will perform additional calculations and also provide a brief explanation of why the company is significant to me. If you want to learn more about my company evaluation process, please visit the "MY STRATEGY" section on my website.
For full disclosure, I should start by mentioning that at the time of writing this analysis, I do not own any shares of Sherwin-Williams. If you would like to view the stocks in my portfolio or copy my portfolio, you can do so on eToro. Instructions on how to do so can be found here. I don't own any stocks in Sherwin-Williams' competitors either. Thus, I have no personal stake in Sherwin-Williams. If you want to purchase shares (or fractional shares) of Sherwin-Williams, you can do so through eToro. eToro is a highly user-friendly platform that allows you to start your investment journey with as little as $50.
Sherwin Williams was founded in Cleveland, Ohio, USA in 1866. Sherwin-Williams develops, manufactures, distributes, and sells paint, coatings, and related products to professional, industrial, commercial, and retail customers. They primarily operate in North and South America but also have operations in the Caribbean, Europe, Asia, and Australia. Their portfolio consists of both branded and private label products. The Sherwin-Williams branded products are exclusively sold through the 5.000 company-operated stores in the United States, Canada, the Caribbean, and Latin America. Other brands are sold through mass merchandisers, home centers, independent paint dealers, hardware stores, automotive retailers, and industrial distributors. Some of the most well-known retailers include Lowe's and Walmart. Sherwin-Williams operates in three different segments. The largest segment is the Americas Group, which accounts for 57% of sales. This segment sells paints and paint-related products through company-operated stores in the U.S., Canada, the Caribbean, Brazil, Chile, Ecuador, Mexico, and Uruguay. Additionally, a few third-party sellers also distribute their products in Latin America. The second largest segment is the Performance Coatings Group, which accounts for 31% of sales. This segment sells coatings and related products through both company-operated stores and third-party sellers in North America, Latin America, Europe, Asia, and Australia. The last segment is the Consumer Brands Group, which accounts for 12% of sales. This segment sells branded and private label products through third-party sellers in the United States, Canada, Europe, and China. Sherwin-Williams has built a strong brand over more than 150 years, which gives them a brand moat.
Their CEO is John Morikis. He joined Sherwin-Williams as a management trainee in 1984 and became the CEO in 2016. He is the first member of the management trainee program to become a CEO. He holds a bachelor's degree in Business from National Louis University in Evanston, Illinois. He believes that the future of Sherwin-Williams is built on its past. Therefore, he strives to lead the company with the same values as its founder, Henry Sherwin, who emphasized quality, order, cleanliness, and thrift. John Morikis also believes that Sherwin-Williams will improve by hiring the right individuals, providing them with proper training, and equipping them with the necessary resources to succeed. This mirrors John Morikis' own experience when he joined Sherwin-Williams through the management trainee program. John Morikis has done a commendable job since assuming the role of CEO, as evidenced by the Sherwin-Williams stock outperforming both the S&P 500 and their peer group since 2017, which marked his first full year as CEO. According to Comparably, John Morikis has an employee rating of 70/100, which places him in the top 40% of companies of similar size. I appreciate that John Morikis brings extensive experience to the company, having been a part of it for nearly 40 years and holding various positions. I would like to see his employee rating a bit higher, but I'm still confident in John Morikis' ability to grow Sherwin-Williams moving forward.
I believe that Sherwin-Williams has a moat, and I also have a positive opinion of their management. Now, let us investigate the numbers to determine if Sherwin-Williams meets our criteria for having a strong competitive advantage. In case you want an explanation about what the numbers are, you can have a look at "MY STRATEGY" on the website.
The first number we will investigate is the return on invested capital, also known as ROIC. We require a 10-year history with all figures exceeding 10% for each year. These numbers are certainly encouraging, as Sherwin-Williams has managed to deliver a return on invested capital (ROIC) above 10% in nine out of ten years. One thing worth noting is that since Sherwin-Williams acquired Valspar in 2017, the return on invested capital (ROIC) has never reached the levels it was at before the acquisition. However, Sherwin-Williams continues to deliver a strong return on invested capital (ROIC) every year. It is encouraging to note that they achieved a ROIC above 10% in 2022, despite it being a challenging year for most companies.
The following numbers represent the book value + dividend. In my previous format, this was referred to as the equity growth rate. It was the most important of the four growth rates I used in my analyses, which is why I will continue to use it in the future. As you are accustomed to seeing numbers in percentage form, I have decided to provide both the actual numbers and the year-over-year percentage growth. Sherwin-Williams acquired Valspar in 2017, which is why the numbers have been higher since then. The numbers are a bit mixed throughout the years. But it is nice to see that Sherwin-Williams managed to grow their equity again in 2022, even though it is still low in a historical context. Hopefully, we will see equity growth again in 2023.
Finally, we will investigate the free cash flow. Free cash flow, in short, refers to the cash that a company generates after covering its operating expenses and capital expenditures. Levered free cash flow is the amount of money a company has remaining after paying all of its financial obligations. I use margins to enhance clarity and improve understanding. Free cash flow yield refers to the amount of free cash flow per share that a company is projected to generate in relation to its market value per share. It is not surprising that Sherwin-Williams has managed to deliver positive free cash flow in all 10 years. The free cash flow in 2022 is the lowest since the Valspar acquisition, but considering it was a challenging year for most companies, I will give Sherwin-Williams a pass. However, the levered free cash flow margin and free cash flow yield are the lowest they have been in the past decade. Thus, it seems like Sherwin-Williams is trading at a high price, but we will address that later in the analysis.
Another important aspect to consider is the level of debt. It is crucial to determine whether a business has manageable debt that can be repaid within a three-year period. We calculate this by dividing the total long-term debt by earnings. After performing the calculation on Sherwin-Williams, I found that the company has 4,75 years of earnings in debt. It is higher than I would prefer, and it should be closely monitored in the future.
Based on my findings thus far, I believe that Sherwin-Williams is an intriguing company. However, no investment is without risk, and Sherwin-Williams also has its fair share of risks. One risk is macroeconomics. In the annual report, Sherwin-Williams mentions that their business is sensitive to global and regional business and economic conditions. Changes in such conditions may reduce the demand for some of their products. They also mention that factors such as high inflation, higher interest rates, and higher labor costs will affect their business. Many of these factors are already a reality, and if they continue to persist, they could have a prolonged negative impact on Sherwin-Williams' business. Competition. An analysis from Fortune Business Insights found that the painting industry is highly competitive and fragmented. This means that Sherwin-Williams faces significant competition from numerous international, national, regional, and local competitors. Some of these competitors operate more extensively in specific regions around the world and possess greater financial or operational resources. On the other hand, there are smaller competitors that may offer more specialized products. Raw material prices and availability. In the past few years, there have been shortages and cost increases of raw materials like petrochemical-derived resins, latex and solvents, and titanium dioxide. These factors have had an impact on the business of Sherwin-Williams, as mentioned by CEO John Morikis in his letter to shareholders. While prices and availability have improved, the results of Sherwin-Williams will always be affected by the price and availability of raw materials.
There are also numerous reasons to invest in Sherwin-Williams. One reason is that it is a more recession-resilient business than before. Even though Sherwin-Williams will be affected by macroeconomics, they have been working towards a more recession-resilient portfolio. This portfolio includes residential repaint, property maintenance, automotive refinish, and packaging. Sherwin-Williams believes it has strong competitive advantages in these areas. Furthermore, Sherwin-Williams believes that they can compensate for slowing demand in their less recession-resilient areas by acquiring new accounts. Thus, Sherwin-Williams should perform better than in previous recessions. Several growth factors. Sherwin-Williams has highlighted several growth factors moving forward. They expect to open between 80 and 100 new paint stores in 2023, while also adding sales representatives and entering new territories. Sherwin-Williams will also continue to introduce innovative products, expand their digital platform, and leverage their fleet of delivery vehicles. Furthermore, Sherwin-Williams has also implemented restructuring measures that they anticipate will yield annual savings of $50-70 million, thereby enhancing profitability. Dividends and buybacks. Sherwin-Williams has consistently provided substantial returns to its shareholders over the years. When they increased their dividend by 9,1% last year, it marked the 44th consecutive year of dividend increases. Sherwin-Williams is also known for engaging in buybacks, having repurchased over $10 billion worth of shares in the past decade. However, there was a temporary halt in buybacks in 2016 and 2017 due to the Valspar acquisition. Hence, investors can expect more dividend increases and buybacks in the future.
Now it is time to calculate the price of Sherwin-Williams' shares. I perform three different calculations that I learned at a Phil Town seminar. The first is called the Margin of Safety price, which is calculated based on earnings per share (EPS), estimated future EPS growth, and estimated future price-to-earnings ratio (P/E). The minimum acceptable rate of return is 15%. I chose to use an EPS of 7,72, which is from 2022. I have selected a projected future EPS growth rate of 11% (Sherwin-Williams has achieved a compound annual growth rate of 11,7% over the last 5 years), a projected future PE ratio of 22 (which is twice the growth rate, taking into account Sherwin-Williams' historically higher PE ratio), and we already have a minimum acceptable rate of return of 15%. Doing the calculations, we come up with the sticker price (some call it fair value or intrinsic value) of $119,20. We want to have a margin of safety of 50%, so we will divide it by 2. This means that we want to buy Sherwin-Williams at a price of $59,60 (or lower, obviously) if we use the Margin of Safety price.
The second calculation is called the Ten Cap price. The rate of return that an owner of a company (or stock) receives on the purchase price of the company is essentially its return on investment. The return should be at least 10% annually, and I calculate it as follows: The operating cash flow last year was 2.575 capital expenditures were 825. I attempted to review their annual report to determine the percentage of capital expenditures allocated for maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated for maintenance purposes. This means that we will use 578 in our calculations. The tax provision was 657. We have 257,89 outstanding shares. Hence, the calculation will be as follows: (2.575 – 578 + 657) / 257,89 x 10 = $102,91 in Ten Cap price.
The final calculation is called the Payback Time price. It is a calculation based on the free cash flow per share. With Sherwin-Williams' Free Cash Flow Per Share at $4,95 and a growth rate of 11%, if you want to recoup your investment in 8 years, the Payback Time price is $65,16.
Sherwin-Williams is an intriguing company, as it holds a global market leadership position in a sector that shows no signs of decline. Management also has vast experience operating in the sector. Sherwin-Williams may face some short-term headwinds because of macroeconomics, but they are expected to perform better than in previous economic downturns due to their efforts to make their portfolio more resilient. Raw material prices will always have an effect on Sherwin-Williams, but these will be cyclical. Competition is a long-term risk, but Sherwin-Williams has been operating for over 150 years. The strong brand they have built should protect them from competition. Sherwin-Williams has several growth factors ahead of them, which should lead to a stronger company. Furthermore, they have implemented some restructuring measures that are expected to enhance profitability. Hence, there is much to like about Sherwin-Williams as it has identified growth opportunities, operates in a sector that is not likely to disappear, and has made its portfolio more resilient. They have also delivered some solid historical numbers, which is another indication that it is a good company. Hence, I will be opening a position in Sherwin-Williams if it reaches the Ten Cap price of $102,91.
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