Current Price: $459 Price Target: $540 (Increasing from $480)
Position Size: 2% TTM Performance: +14%
SHW reported a weak 1Q, missing estimates on lower volumes across all three segments. They saw a slow start to the architectural painting season in N. America and continued challenging conditions in “many end markets outside N. America.” Despite this, the stock is up on positive outlook in N.A. w/ an expected rebound in volumes in 2H and better gross margin performance. Despite miss, management reiterated full year EPS guidance (+13.5% YoY). Very positive commentary on expectations for N. America paint stores (drives majority of their profit) on an expected improvement in housing turnover. In addition, price increases and declining raw material pressure may lead to positive revisions on improved margin expectations.
Key Takeaways:
· SHW is set to benefit from higher product prices, good volume growth, falling raw material costs and an improvement in housing.
· Gross margins improved sequentially, flat YoY, despite the volume shortfall and higher raw material costs. This is encouraging given mgmt. expectation that YoY raw material inflation will be highest in Q1. They expend continued GM expansion and expect volumes to improve over the balance of the year, particularly in the back half.
· They saw broad based softness in Asia and Europe.
· The Americas Group: 55% of sales, +3.6%
o Despite a strong backlog and project pipeline reported by their professional customers, volume growth was slower than expected.
o Weakness this quarter is not a cause for concern. This is the seasonally smallest quarter for their paint stores business, and can be volatile year-to-year. Better indicator of demand is painting contractor’s feedback on project backlog. They are universally optimistic, report seasonably high project backlogs and a very healthy pipeline of new projects.
o They would be a big beneficiary of an improvement in the housing market.
o Opened 15 new stores
· Consumer Brands Group: 16% of sales, down less than 1%
o FX headwinds(-1.6%)
o Most of the softness in demand in the quarter was in markets outside North America, most notably Asia-Pacific.
o Operating margin in the first quarter expanded sequentially and YoY
o “we are very well positioned across all North American retail channels heading into the important spring selling season.”
· Performance Coatings Group: 29% of sales, modest sales growth
o Operating margin improvement despite raw material pressure.
· Guidance Reaffirmed
o Sales guidance for Q2 +2-5%; full year +4-7%
o Reaffirmed full year 2019 adjusted diluted net income per share guidance to be in the range of $20.40 to $21.40 vs $18.53 in 2018. Midpoint slightly below street.
Valuation:
- Expected free cash flow of $2B in 2019, trading at over a 4.7% FCF yield.
- Increased our quarterly dividend by 31%. Dividend yield 1%.
- Given growth prospects, steady FCF margins and high ROIC the stock is undervalued. They deserve a premium multiple based on large exposure to the N. American paint contractor market and no exposure to the cyclical sensitive auto OEM end market.
- Balance sheet leverage from the Valspar acquisition continues to improve; they expect to get to under 3x by the end of the year.
- Buybacks should accelerate in 2019 as Sherwin returns to its historical capital allocation.
Thesis:
- SHW is the largest supplier of architectural coatings in the US. Sherwin-Williams has the leading market share among professional painters, who value brand, quality, and store proximity far more than their consumer (do-it-yourself) counterparts.
- Their acquisition of Valspar creates a more diversified product portfolio, greater geographic reach, and is expected to be accretive to margins and EPS. The combined company is a premier global paint and coatings provider.
- SHW is a high-quality materials company leveraged to the U.S. housing market. Current macro and business factors are supportive of demand:
- High/growing U.S. home equity values. Home equity supportive of renovations.
- Improving household formation rates off trough levels (aging millennials).
- Baby boomers increasingly preferring to hire professionals vs. DIY.
- Solid job gains and low mortgage rates support homeownership.
- Residential repainting makes up two thirds of paint volume. Homeowners view repainting as a low-cost, high-return way of increasing the value of their home, especially before putting it on the market.
$SHW.US
[tag SHW]
Sarah Kanwal
Equity Analyst, Director
Direct: 617.226.0022
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square, Suite 500
Boston, MA 02109