Current Price: $567 Price Target: $660
Position Size: 3.4% TTM Performance: +45%
SHW missed on revenue and earnings. Miss was driven by softness in certain industrial end markets and choppiness in their international businesses. This was offset by strength in the America’s group (their chain of paint stores) and growth with their largest North American retail partners. They again had strong paint stores SSS performance of ~5%. In terms of 2020 outlook, management said they expect a similar environment with North American architectural demand remaining solid and industrial demand remaining variable by geography and end market. Last quarter they called out the same weakness.
Key Takeaways:
· For full year 2020, they expect sales to increase 2% to 4%. By segment, they expect the Americas Group to be at or above the high end of that range. They expect Consumer Brands to be flat or slightly up and Performance Coatings to be up low-single-digits.
· Guided to adj. 2020 EPS of $22.70 to $23.50 (+9.4% at the midpoint). This is below consensus of $24.33.
· Management expects flat raw material costs for 2020, with 1H being down slightly.
· They gave multiple data points on the strength they are seeing in US commercial and residential end markets including contractor and builder sentiment and strengthening in single and multifamily permits.
· “We enter 2020 well positioned and focused on what we can control.”
· For FY19 margins increased in all 3 segments. Gross margin expanded as pricing initiatives offset the raw material inflation they have experienced since 2017.
· The Americas Group: 55% of sales, +5% in Q4
o SSS of +5%. Prices increases will be a tailwind to 2020 SSS.
o Opened 62 net new stores for the year.
o Professional painting contractor customers continue to report strong demand.
· Consumer Brands Group: 16% of sales, +1% in Q4
o Q4 growth due to selling price increases and higher volume sales to some of the group’s retail customers.
o Full year segment sales decreased due to lower than expected sales in Asia and Australia and the impact of the Guardsman divestiture.
o Supply chain efficiencies, pricing initiatives, moderating raw material costs aided margins
· Performance Coatings Group: 29% of sales, -5% in Q4
o Softer sales outside of North America and unfavorable currency translation, partially offset by selling price increases.
o Sales for the year were variable by geography and end market. Growth in North America and Latin America was more than offset by softness in Europe and Asia. Mid-single-digit growth in packaging and coil lines was offset by softness in other product lines, most notably industrial wood.
Valuation:
- Expected free cash flow of ~$2.2B in 2020, trading at >4% FCF yield.
- 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 lack of exposure to the cyclical sensitive auto OEM end market.
· Share buybacks should increase in 2020 as their leverage ratio is now below target of 3x.
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
[category earnings]
[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