Dividend Aristocrats in Focus Part 12: Sherwin-Williams - Sure Dividend Sure Dividend

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Dividend Aristocrats in Focus Part 12: Sherwin-Williams

Published by Nick McCullum on October 17th, 2017

Sherwin-Williams is a legendary dividend growth stock.

As a member of the Dividend Aristocrats, Sherwin-Williams is one of just 51 S&P 500 stocks that have raised their dividends each year for 25+ years.

Even among the Dividend Aristocrats, Sherwin-Williams stands out because of its remarkable rate of dividend growth. The company shows no sign of slowing down, either; Sherwin-Williams estimates that its annual dividend payment will grow to at least $5.20 by 2020, which represents a CAGR of 11.5% from 2016’s level.

SHW Sherwin-Williams Dividends Per Share

Source: Sherwin-Williams October 2017 Investor Presentation

Sherwin-Williams’ rapid dividend growth forecasts make it appeal to dividend growth investors. This article will analyze the investment prospects of Sherwin-Williams in detail.

Business Overview

Sherwin-Williams is the world’s second-largest manufacturer of paints and coatings. The company distributes its products through wholesalers as well as retail stores that bear the Sherwin-Williams name. Founded in 1866, Sherwin-Williams has grown to a market capitalization of $35.8 billion. Its only competitor of larger size is fellow Dividend Aristocrat PPG Industries (PPG).

SHW Sherwin-Williams Top Global Manufacturers

Source: Sherwin-Williams October 2017 Investor Presentation

Sherwin-Williams is certainly a market leader. The company has become significantly larger since it was covered in last year’s Dividend Aristocrats in Focus series due to the sizeable acquisition of Valspar.

The Valspar merger was transformative for Sherwin-Williams. Unsurprisingly, the company had to comply with regulatory demands in order to have the merger approved, with slowed the process down considerably. The Valspar acquisition was originally announced on March 20, 2016 before eventually closing on June 1, 2017.

Sherwin-Williams’ final purchase price was $113 per share, which amounts to roughly $11.3 billion in total. Regulators requested that Sherwin-Williams divest Valspar’s North American Industrial Wood Coatings business, which was sold for $420 million.

Sherwin-Williams’ reporting segments have changed due to the Valspar acquisition. Previously, Valspar reported financial performance in the following segments:

Post-merger, Sherwin-Williams is now divided into three segments, shown below along with annual sales figures:

Additional details about each of Sherwin-Williams operating units can be seen below.

SHW Sherwin-Williams New Reportable Segments

Source: Sherwin-Williams October 2017 Investor Presentation

The Valspar acquisition was strategically important for many reasons. The transaction meaningfully improved Sherwin-Williams’ business unit diversification, which had previously been heavily reliant on the legacy Paint Stores group to generate revenue and profits. Now, Sherwin-Williams has a more healthy unit mix between its three new segments. This transition can be seen below.

SHW Sherwin-Williams Company Overview Significant Growth and Synergy Opportunities

Source: Sherwin-Williams October 2017 Investor Presentation

The Valspar acquisition has created a number of compelling growth prospects for Sherwin-Williams, which are discussed in the next section of this analysis.

Growth Prospects

Sherwin-Williams has grown at satisfactory rates over the past several fiscal years. While sales growth has been in the low to mid-single digits, earnings-per-share increased by 27.1% and 11.6% in fiscal 2015 and fiscal 2016, respectively. More information on the company’s performance during this two-year period can be found in the following slide.

SHW Sherwin-Williams Company Overview

Source: Sherwin-Williams October 2017 Investor Presentation

Looking ahead, Sherwin-Williams stands to benefit from broad-based demand for its products internationally, as shown below.

SHW Sherwin-Williams Projected Demand by Region

Source: Sherwin-Williams October 2017 Investor Presentation

Demand for Sherwin-Williams’ products is expected to grow most rapidly in the Asia-Pacific region.

The Valspar acquisition acts as a powerful magnifier of this trend because it significantly increased the proportion of Sherwin-Williams’ revenue that is generated internationally. The ‘legacy’ Sherwin-Williams generated just 13% of revenues in international markets (defined as non-U.S. and non-Canada countries). Together, the ‘new’ Sherwin-Williams and Valspar combined entity generated 21% of revenues internationally.

SHW Sherwin-Williams Broader Geographic Footprint

Source: Sherwin-Williams October 2017 Investor Presentation

These factors should combine to accelerate the company’s revenue growth in the near-term. Sherwin-Williams is expected sales growth of 4%-6% per year through the end of fiscal 2020.

Revenues are just one component of Sherwin-Williams future growth in profitability. The Valspar acquisition has presented some meaningful opportunities to reduce expenses by eliminating duplicate roles, integrating supply chains, and combining SG&A workforces.

All said, Sherwin-Williams is expecting to generate between $385 million and $415 million in annual cost synergies by 2020. For context, the company reported total expenses of $10.1 billion in fiscal 2016. ~$400 million of cost synergies will reduce the company’s pre-merger expense basis by ~4%, which will certainly be felt by the company’s shareholders.

SHW Sherwin-Williams Consolidated Run Rate Synergies Progress

Source: Sherwin-Williams October 2017 Investor Presentation

In sum, Sherwin-Williams has plenty of opportunities that it can tap to grow its business for the foreseeable future. The company also has a very strong track record of historical earnings growth:

SHW Sherwin-Williams Adjusted Earnings-Per-Share Growth

Source: Value Line

Sherwin-Williams has compounded its adjusted earnings-per-share at 14% per year over the past 15 years. We believe that while growth will be slower moving forward, the company is still likely to average 7%-9% earnings growth over full economic cycles.

Competitive Advantage & Recession Performance

Sherwin-Williams is not the most recession-resistant Dividend Aristocrat. The company’s performance depends on a healthy U.S. and international housing market, which is the underlying driver of paint and coatings sales.

This impact can be seen by looking at the company’s performance during the 2007-2009 financial crisis:

It took Sherwin-Williams’ earnings three full years to recover from its Great Recession lows; however, the company remained profitable and continued to raise its dividend (which is why it remains a Dividend Aristocrat today).

Another factor that investors should consider is the company’s increased debt load after the closure of the Valspar acquisition. Sherwin-Williams acquired significant bridge financing from Citigroup (C) to fund the Valspar acquisition, which has resulted in its debt to EBITDA ratio being much higher than any other point in recent history:

SHW Sherwin-Williams Debt to EBITDA Leverage

Source: Sherwin-Williams October 2017 Investor Presentation

Sherwin-Williams elevated debt load combined with our current position in the business cycle may lead some investors to consider investments in more conservative securities. Valspar’s earnings are likely to fall if the economy begins to contract and the housing market slows.

Valuation & Expected Total Returns

Sherwin-Williams has many of the characteristics of a high-quality business; however, we have concerns that the company’s high elevation will have a negative impact on its expected total returns.

More specifically, Value Line (a resource that we use and trust) expects Sherwin-Williams to report adjusted earnings-per-share of $15 in fiscal 2017. Note that this figure is not the most accurate estimate we’ve used in our analyses because of the uncertainties presented by the newly-integrated Valspar business. In any case, though, Sherwin-Williams’ current stock price of ~$384 represents a price-to-earnings ratio of 25.6.

The following diagram compares Sherwin-Williams’ current valuation to its long-term historical average.

SHW Sherwin-Williams Valuation Analysis

Source: Value Line

Sherwin-Williams’ current price-to-earnings ratio is 25.6 and its 10-year average price-to-earnings ratio is 19.6. The company is noticeably overvalued.

Despite the company’s other appealing characteristics (including the potential for high-single-digit earnings-per-share growth), Sherwin-Williams lofty valuation prevents us from issuing a buy recommendation on this high-quality security. Investors would do well to purchase shares of this stock during the next recession when its valuation is likely to revert to much more attractive levels. Income-oriented investors should note that the security has little capability to generate income, as its dividend yield is currently well below 1%.

Final Thoughts

Sherwin-Williams’ acquisition of Valspar, which closed this summer, has created some compelling growth opportunities for this high-quality dividend stock. Indeed, the company is likely to continue growing its earnings in the high-single-digits for the foreseeable future.

This is a typical example of a great business trading at a not-so-great price. We’ll let Warren Buffett take this one from here:

“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.” – Warren Buffett

We recommend waiting for a better entry price for Sherwin-Williams shares, although the company remains a hold for investors carrying the stock at much lower cost bases.

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