Sherwin Williams Co (SHW): A Dividend Aristocrat Painting High Returns by Simply Safe Dividends

Sherwin Williams (SHW) has annually increased dividends since 1979 and outperformed the market by nearly 14% per year over the last decade.

Watching paint dry has been quite rewarding with coatings producer SHW, but past performance is not necessarily indicative of future results.

As we review Sherwin Williams for potential inclusion in our Top 20 Dividend Stocks portfolio, we will be paying close attention to the factors that have contributed to the company’s historical success and assess the likelihood of these factors persisting far into the future.

Business Overview

SHW has been in business since 1866 and is the largest producer of paints and coatings in the United States (80% of its revenue) and third-largest worldwide. The company primarily serves the needs of architectural and industrial painting contractors and do-it-yourself homeowners through a network of more than 4,000 company-operated retail stores, but it also sells some industrial coatings, automotive finishes, and protective and marine coatings (around 20% of sales in 2014).

Business Analysis

Sherwin Williams’ biggest competitive advantage is its controlled distribution model. The company operates over 4,000 retail stores, about as many as Home Depot and Lowe’s combined and four times as many as PPG (see our analysis of PPG here.)

Controlled distribution accounts for 75% of SHW’s total sales and provides the company with greater control over its brand image, in-store product experience, pricing, customer relationships, and inventory.

The majority of SHW’s customers are contractors, and many of them prefer to deal with dedicated paint specialists rather than working with big box stores like Home Depot. SHW can offer the best range and quality of paints, and its higher quality paints are more valued by contractors, which tend to be less price sensitive than consumers. Contractors know that SHW’s paints can help them complete jobs faster because of their higher quality (e.g. faster dry time, less coats required, etc.), which means more money in their pockets.

Sherwin Williams is also likely to have a convenient location for contractors almost anywhere around the country – more than 90% of the U.S. population lives within a 50-mile radius of a SHW store. As contractors continue taking market share from do-it-yourself consumers, SHW’s business should continue to benefit.

As a result of SHW’s large network of stores, long operating history, strong brands, and direct in-store relationships with customers, it has built up number one brands in architectural paint, stain & protective finish, aerosol paint, auto specialty paint, painting tools, and wood sealers.

In addition to strong pricing power, SHW’s margins also benefit from the company’s vertical integration. Big box retailers must pay wholesale prices for their paint inventory, but SHW produces its own coatings, resulting in higher profits. The business also requires little capital, helping SHW consistently generate excellent free cash flow:

Sherwin Williams

Source: Simply Safe Dividends

Growing free cash flow is a sign of a very healthy business and tends to reward shareholders over long periods of time. SHW is no exception. As seen below, the stock compounded by 21.1% per year from 2006 through 2015, nearly tripling the market’s 7.4% annual return over this time period.

Sherwin Williams

Source: Simply Safe Dividends

Management has created substantial value for shareholders, but can the company’s next decade of life come close to matching its last? The bar has certainly been set high.

The company’s next goal is to hit 5,000 stores in North America, which would be about a 25% increase from where the company ended 2014. Management insists this is not the end goal but rather a milestone along the way of SHW’s long-term growth path.

Given the high level of fragmentation in the paint market, we believe SHW will have opportunities to continue its expansion, but the company is likely much closer to a saturation point (at least in the U.S.) than it was 10 years ago. As we mentioned earlier, SHW’s store count is already substantially higher than Home Depot, Lowe’s, and PPG, and its stores are close to almost all of the country’s population.

Sherwin Williams has also invested in Latin America for international volume growth and continues expanding its product offering through R&D, acquisitions, and organic distribution growth (e.g. its first-ever architectural paint program in Lowe’s stores nationwide under the HGTV HOME by Sherwin-Williams label rolled out over the last year).

We think SHW’s growth outlook looks good over the next 3-5 years, but we are less sure beyond then due to the company’s relatively large store base and geographical concentration in the U.S. market.

Sherwin Williams’ Key Risks

As we alluded to above, we believe the biggest risk to Sherwin Williams’ long-term future is market saturation in the U.S. The company has significantly more stores than its next largest peers and a strong presence in most regions already.

Investors appear to be giving management the benefit of the doubt given the stock’s current earnings multiple (20x). If SHW finds fewer opportunities for profitable store growth than it currently expects, the stock will be in trouble. The company also has less exposure to faster-growing international markets, so it is especially dependent on U.S. growth opportunities.

Additionally, SHW’s market seemingly has few barriers to entry – no one can stop Home Depot or other competitors from building new stores in a location and pressuring prices – but the company’s brands, reputation, and specialization (controlled channel model) help mitigate risk from new competition.

Finally, the state of the housing market and trends in raw material costs (e.g. oil-based materials and titanium dioxide) could impact SHW’s business results over the near-term, but we don’t expect either issue to impair the company’s long-term outlook. As seen below, the U.S. architectural coatings industry is still seeing volumes recover from the housing crisis.

Sherwin Williams

Source: Sherwin Williams Investor Presentation

Dividend Analysis: Sherwin-Williams

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. SHW’s long-term dividend and fundamental data charts can all be seen by clicking here.

Dividend Safety Score

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

SHW’s Dividend Safety Score of 96 suggests that the company’s dividend payment is safer than 97% of all other dividend-paying stocks in the market. As seen below, SHW’s payout ratios have remained low and steady over the last decade, providing plenty of cushion and room for growth. Even if Sherwin Williams’s earnings cut in half, its payout ratio would only increase to around 50%.

Sherwin Williams

Source: Simply Safe Dividends

Sherwin Williams

Source: Simply Safe Dividends

Looking the cyclicality of Sherwin Williams’ business, we can see that sales growth has remained

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