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 investment, Sherwin-Williams has outperformed both the S&P 500 and its peers over the last five years. Management expects that this outperformance will continue in the future. Is Sherwin-Williams still a good investment? This is what I am 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.

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 get started on investing with as little as $50.

The Business

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 approximately 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 through three segments: Paint Stores Group, Consumer Brands Group, and Performance Coatings Group. The Paint Stores Group segment offers architectural paints and coatings, protective and marine products, OEM product finishes, and related products for architectural and industrial paint contractors, as well as for do-it-yourself homeowners. The Paint Stores Group segment generates 56% of sales. The Consumer Brands Group segment supplies a portfolio of branded and private-label architectural paints, stains, varnishes, industrial products, wood finishes, wood preservatives, applicators, corrosion inhibitors, aerosols, caulks, and adhesives to retailers. The Consumer Brands Group generates 14% of sales. The Performance Coatings Group segment develops and sells industrial coatings for wood finishing and general industrial applications, automotive refinish products, protective and marine coatings, coil coatings, packaging coatings, as well as performance-based resins and colorants. The Performance Coatings Group generates 30% of sales. Sherwin-Williams has built a strong brand that customers have trusted for over 150 years, giving them a brand moat.

Management

The CEO is Heidi Petz. She joined Sherwin-Williams through the acquisition of The Valspar Corporation in 2017. Since joining the company, she has held positions of increasing responsibility, including President of the Consumer Brands Group, President of The Americas Group, and most recently, President and Chief Operating Officer. She assumed the role of CEO on January 1, 2024. Prior to joining Sherwin-Williams and Valspar, Heidi Petz held various leadership roles with Newell Rubbermaid, Target Corporation, and PricewaterhouseCoopers. Heidi Petz holds a bachelor's degree in Business and Leadership from the University of Richmond and a Master of Business Administration from Loyola University Maryland. She is also a director of Ulta Beauty and serves on the Board of Directors of the University Hospitals Health System. She was selected as a CEO due to her track record of profitable growth and operational excellence, which has resulted in increased value for customers, shareholders, and employees. She is known as a tireless advocate for customers and employees, dedicated to enhancing the performance-driven culture that Sherwin-Williams is known for. While Heidi Petz is new as a CEO, she has extensive experience from several roles in the company. She was selected through a comprehensive process and a multi-year organizational succession plan to identify the best candidate to lead the company. Thus, I am confident in Heidi Petz leading the company moving forward.

The Numbers

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 the highest Return on Invested Capital (ROIC) since the Valspar acquisition in 2023.

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 and 2023 after it decreased in the two previous years. It is also encouraging that the equity reached its second-highest level ever in 2023.

Finally, we will analyze 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. I use levered free cash flow margin because I believe that margins offer a better understanding of the numbers. Free cash flow yield refers to the amount of free cash flow per share that a company is expected 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. Sherwin-Williams managed to deliver its second-highest free cash flow in 2023, which is encouraging considering that 2022 was underwhelming. The levered free cash flow margin was also at its second-highest level in 2023, which is another encouraging sign, especially because Sherwin-Williams delivered an underwhelming levered free cash margin in both 2021 and 2022. The free cash flow yield is lower than the ten-year average, which suggests that Sherwin-Williams is trading at a high price. However, we will revisit this 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 3,51 years of earnings in debt. It is higher than I would prefer, and it should be closely monitored in the future. Especially because management has stated that they expect to refinance the debt at higher rates.

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Risks

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 increased labor costs will affect their business. Many of these factors are already a reality, and management has mentioned that macroeconomic factors still contain a number of uncertainties. They also mentioned that they do not currently see a macroeconomic catalyst driving meaningful improvement in consumer demand. If these macroeconomic factors continue to persist, they could have a prolonged negative impact on Sherwin-Williams' business.

Competition. An analysis by Fortune Business Insights revealed that the painting industry is highly competitive and fragmented. This indicates that Sherwin-Williams faces significant competition from numerous international, national, regional, and local competitors of various sizes in the manufacturing, distribution, and sale of their paint, coatings, and related products. Some of these competitors operate more extensively in specific regions around the world and possess greater financial or operational resources. This means they may secure better terms from certain vendors, adopt more aggressive pricing strategies, and allocate more resources to specific product lines or other aspects of their business. 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 such as petrochemical-derived resins, latex, solvents, and titanium dioxide. These factors have impacted Sherwin-Williams' business, as evidenced by the results in 2021 and 2022. If the cost of raw materials increases, Sherwin-Williams may not be able to offset the higher costs promptly by reducing their operating costs sufficiently or by increasing the prices of their products. After two years of historic inflation, some raw material prices decreased in 2023. However, ongoing global supply and demand dynamics continue to drive the cost of raw materials, which could lead to further periods of volatility in the future. This volatility may adversely affect Sherwin-Williams' earnings and cash flow.

Reasons to invest

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 repaints, property maintenance, automotive refinishing, 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 the United States and Canada in 2024, while also adding sales representatives and entering new territories. Sherwin-Williams will also continue to introduce innovative products, expand its digital platform, and leverage its 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. Furthermore, if interest rates moderate, home turnover should pick up, which would be a tailwind for Sherwin-Williams.

Dividends and buybacks. Sherwin-Williams has consistently provided substantial returns to its shareholders over the years. When they increased their dividend by 18,2% in 2024, it marked the 45th consecutive year of dividend increases. The company has increased its dividend at a Compound Annual Growth Rate (CAGR) of approximately 14% over the past ten years. 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.

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Valuation

Now it is time to calculate the share price. I perform three different calculations that I learned at a Phil Town seminar. If you want to make the calculations yourself for this or other stocks, you can do so through the tools page on my website, where you have access to all three calculators.

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 9,25, which is from the year 2023. I have selected a projected future EPS growth rate of 8%. Finbox expects EPS to grow by 8,2% in the next five years. Additionally, I have selected a projected future P/E ratio of 16, which is double the growth rate. This decision is based on Sherwin-Williams's historically higher price-to-earnings (P/E) ratio. Finally, our minimum acceptable rate of return has already been established at 15%. After performing the calculations, we determined the sticker price (also known as fair value or intrinsic value) to be $78,98. 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 $39,49 (or lower, obviously) if we use the Margin of Safety price.

The second calculation is known as the Ten Cap price. The rate of return that a company owner (or stockholder) receives on the purchase price of the company essentially represents its return on investment. The minimum annual return should be at least 10%, which I calculate as follows: The operating cash flow last year was 3.522, and capital expenditures were 888. I attempted to analyze their annual report to calculate the percentage of capital expenditures allocated to maintenance. I couldn't find it, but as a rule of thumb, you can expect that 70% of the capital expenditures will be allocated to maintenance purposes. This means that we will use 622 in our calculations. The tax provision was 721. We have 254,543 outstanding shares. Hence, the calculation will be as follows: (3.522 – 622 + 721) / 254,543 x 10 = $142,25 in Ten Cap price.

The final calculation is referred to as 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 $10,29 and a growth rate of 8%, if you want to recoup your investment in 8 years, the Payback Time price is $118,21.

Conclusion

Sherwin-Williams is an intriguing company because it holds a global market leadership position in a sector that shows no signs of decline. The CEO is new but has extensive experience from various roles in the company. Sherwin-Williams may face some short-term headwinds due to macroeconomic conditions, but they are expected to perform better than in previous economic downturns because of their efforts to make their portfolio more resilient. Raw material prices will always have an effect on Sherwin-Williams, but these effects will be cyclical. Competition poses a long-term risk, but Sherwin-Williams has been in operation 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 presented some reliable historical data, 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 $142,26.

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