Sherwin-Williams: Inflated Buybacks, Bleak Near-Term Outlook

Bryan Bedder

Sherwin-Williams (NYSE:SHW) was an evident prime for maine to excavation into arsenic I look crossed nan marketplace for nan champion compounders. The institution is simply a dividend aristocrat, pinch a soon to beryllium 45-year dividend summation streak, carries important brand equity, pricing power, and has a agelong history of beating nan market.

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Looking above, an finance of $10,000 successful 2003 would person yielded a 17.45% annualized full return and you'd person ended up pinch astir $250,000 versus astir $52,000 successful nan S&P 500. It's nary mini feat to quintuple nan marketplace returns complete nan past 2 decades.

If you look backmost done nan articles and sum written astir SHW complete time, nan immense mostly discusses nan institution arsenic excessively expensive. I've shifted my mindset somewhat. I decidedly bask uncovering a bully woody successful nan market, but I'd overmuch alternatively own a winner. If nan marketplace assigns a premium aggregate to that company, I'll bargain it. However, I deliberation nan astir useful point you tin do successful that lawsuit is validate nan institution will some proceed winning and proceed to merit its premium multiple.

There are evident exceptions. I'm not going to salary immoderate value for a company.

Company Presentation

SHW transformed itself somewhat pinch its acquisition of Valspar successful 2016. It pushed nan institution into an undisputed activity position successful paints and coatings and opened nan doors to much world operations and an description successful business coatings. SHW has historically excelled successful nan higher-margin residential market. The Valspar acquisition besides helped nan institution seal an exclusive woody pinch Lowe's (NYSE:LOW) successful 2018, which group nan institution up for important vulnerability to nan DIY marketplace connected apical of its master customer guidelines from nan institution branded stores.

Company Presentation

Company Presentation

Across nan board, nan company's operating metrics look beautiful solid. 2020 pulled guardant rather a spot of request successful residential which nan institution is moving disconnected now. Adding to that pain, input costs ostentation and proviso concatenation woes person led to a beautiful bleak outlook from management.

The astir caller 4th saw 9.8% income maturation YOY, pinch afloat twelvemonth 2022 income maturation coming successful astatine 11.1%. EBITDA was up 10.4%. However, guidance outlook for nan coming twelvemonth is for level to down mid-single digits income growth, net per stock of $7.95-8.65 per stock pinch 80-100 caller stores. At nan low-end of guidance, SHW is trading astatine 28X guardant earnings, which isn't great. Here's immoderate colour from nan earnings call:

On nan architectural side, it's nary concealed that U.S. lodging will beryllium nether important unit this year. Single-family permits person been down year-over-year for 10 consecutive months, and single-family starts person been down year-over-year for 8 consecutive months. Mortgage rates besides stay elevated.

As a result, we judge our caller residential measurement could beryllium down anyplace from 10% to 20% this year. We expect our different PRO extremity markets to beryllium much resilient than this, but location are headwinds successful these areas, too.

For example, existing location sales, which thrust a information of our repaint business person declined year-over-year for 16 consecutive months. Now while we spot a backlog of caller commercialized construction, nan Architectural Billing Index has contracted nan past 3 months.

On nan DIY side, we expect ostentation to proceed putting unit connected user behaviour successful nan U.S. and successful Europe. On nan business side, nan PMI numbers for manufacturing successful nan U.S., Europe, China and Brazil person been antagonistic for aggregate months.

We person already seen an business slowdown successful Europe and nan aforesaid is opening to look successful nan U.S. crossed respective sectors. In China, COVID remains a wildcard and nan trajectory of economical betterment is difficult to map. The U.S. lodging slowdown will besides effect immoderate of our business businesses, namely business wood wherever we person already seen unit and coil to immoderate extent.

I cognize that's a wall of text, but it's nan astir position I've seen successful a while from a guidance squad connected really galore headwinds are facing nan business successful nan coming year. SHW does support beautiful important pricing power. Professional painters are not overly delicate to price, pinch overgarment itself not a important portion of nan costs of a coating job. SHW maintains beardown loyalty pinch its customers pinch its loyalty program, jobsite delivery, and innovations successful their overgarment which removes nan inducement for customers to move distant from a favored brand.

However, nan outlook is not rosy, and explains why SHW has sold disconnected beautiful brutally.

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Expenses show nan SHW guidance squad are shrewd operators. The institution operates complete 4,900 stores, and continues to turn nan shop count complete time. With that, we are seeing present expenses increasing slower than revenues for nan company, which is great.

Management is projecting SG&A arsenic a percent of revenues expanding this adjacent year. With gross projecting to beryllium level to down, that's not surprising. SG&A expenses are expected to emergence connected mid single-digit increases successful wages, power and proscription costs.

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I'm showing you a very zoomed retired look astatine margins to show really unchangeable SHW has been complete nan agelong term. There's a somewhat affirmative slope connected operating margin, but you're seeing a business that maintains costs and expenses passim nan economical cycle.

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Returns connected invested superior are a small little rosy. While ROIC is greater than WACC and shows shareholder worth creation, I'd for illustration to spot higher returns connected superior deployed. The large alteration present is apt nan Valspar acquisition successful 2016. What this shows maine is little than perfect superior deployment to thrust maturation successful nan bottommost line.

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Long-term indebtedness changeable up connected nan Valspar acquisition, and guidance has discussed delevering nan equilibrium expanse complete time. They are presently targeting 2-2.5X EBITDA leverage ratios. Free rate travel hasn't needfully grown each that good complete time, but capex has. SHW is presently moving done a restructuring expected to output $50-70M successful savings complete nan adjacent mates of years. Additionally, caller shop openings and improvements to nan proviso concatenation are each superior intensive operations.

But, adding to that is what I deliberation is simply a deal-breaker for me. SHW is an costly stock, and has been for a agelong time. However, guidance remains committed to buying backmost shares astatine what I deliberation are inflated prices. This past year, nan institution spent $883M to repurchase 3.35M shares astatine an mean value of $263.64. The existent stock value is $223 springiness aliases take. $263.64 puts nan institution astatine 33X nan low-end of guardant net guidance.

The dividend this coming twelvemonth is getting hiked by 0.8%, aliases $.02 to $2.42 per share. I understand stock buybacks tin thief boost EPS erstwhile you trim nan denominator. However, that money would beryllium amended spent either delevering aliases expanding nan dividend further. With dividend aristocrats, though, guidance teams are often hesitant to overly expanding nan dividend because they'll suffer immoderate of their investor guidelines if they ever person to trim it. Either way, I can't get myself location connected reasoning these buybacks are a bully idea.

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The stock value has been crushed since 2021's euphoric highs disconnected of outsized 2020 demand. However, nan banal still isn't cheap, and nan outlook for income and net maturation is unsmooth complete nan adjacent term.

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Based connected expert estimates for net growth, an finance coming would output <4% annualized if nan institution returns to its semipermanent mean valuation against earnings.

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If nan institution maintains its higher valuation of caller years, an finance coming could output person to 11% annualized.

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Looking astatine free rate flow, and arsenic I discussed supra they've taken a deed pinch caller investments. However, anterior to that we saw a bully inclination upwards of compounding free rate travel growth, and it's projected to proceed starting successful 2024.

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Based connected expert estimates for rate flows and nan company's semipermanent P/FCF multiple, investors could beryllium looking astatine astir a 10% annualized full return.

SHW is assuredly a beardown operator. The institution maintains a activity position successful paints and coatings, and has galore levers to propulsion to support its pricing power. The institution has done a bully occupation of controlling disbursal maturation arsenic it expands its shop footprint. There will travel a constituent wherever they saturate nan marketplace pinch overgarment stores, but it doesn't look to beryllium successful nan adjacent to mean term.

However, nan near-term outlook is bleak. I'm consenting to look past that successful almost each cases, because SHW will do conscionable good successful nan agelong run. However, investors aren't really getting a woody connected nan institution considering that outlook. The institution is still trading astatine a premium to its ain semipermanent premium averages.

Additionally, stock buybacks astatine inflated prices is simply a unspeakable usage of capital. ROIC's person declined since nan Valspar acquisition, and you're decidedly not buying this institution for existent income. All successful all, SHW banal is simply a hold. I wouldn't waste complete these concerns, but this isn't a institution I'm looking to bargain here. Give maine immoderate much Lowe's banal instead.

I person been penning present since 2016.  My extremity is to item nan highest value companies successful nan market, worth aliases growth.  I bargain pinch a semipermanent clip horizon, and americium typically looking for companies pinch beardown competitory advantages, coagulated management, and a history of creating shareholder value.My portfolio consists of some stalwart semipermanent dividend payers and high-growth, precocious value names.  I deliberation of it arsenic a barbell attack to investing, wherever nan value/dividend-paying companies shield nan remainder of nan portfolio successful a downswing.https://www.tipranks.com/bloggers/jonathan-wheeler