Sherwin-Williams (SHW) is the North American leader in paint and coatings. The company’s ‘Cover the Earth’ logo is instantly recognizable for many.
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
But what you might not know is that Sherwin-Williams’ history as a company goes all the way back to 1866, when Henry A. Sherwin became a partner in a tiny paint and brush company called Truman, Dunham & Company.
Unfortunately, the partnership dissolved. But soon after, Sherwin met Edward Porter Williams, who worked as a supplier to Truman, Dunham, & Company, and the pair decided to go into business together. They formed Sherwin, Williams & Company in 1870. Sherwin-Williams was incorporated in 1884, and the rest is history.
The company now employs approximately 58,000 people and has operations in more than 115 countries worldwide. The company really does ‘cover the earth’ based on its global operations…
But it has done more than that; it has also lined investor’s pockets (or rather, brokerage accounts). The image below shows Sherwin-William’s performance over the last decade.
$1 invested in Sherwin-Williams a decade ago is worth $5.47. The same investment in th S&P 500 ETF (SPY) is worth $1.93. Sherwin-Williams stock has performed exceptionally well.
The company is an established business. Sherwin-Williams is a Dividend Aristocrat thanks to its 37 years of consecutive dividend increases.
To be a Dividend Aristocrat a stock must be a member of the S&P 500 and have paid increasing dividends for 25+ consecutive years. Sherwin-Williams easily qualifies to be a Dividend Aristocrat. You can see all 50 Dividend Aristocrats here.
Keep reading this article to learn more about the investment prospects of Sherwin-Williams.
Sherwin-Williams – Business Overview
Last year, Sherwin-Williams’ sales topped $11 billion. This shows how successful the business has been over its many decades of existence. Today, Sherwin-Williams is split up into four main business categories:
- Paint Stores Group: 64% of Quarterly Sales
- Consumer Group: 15% of Sales
- Global Finishes Group: 17% of Sales
- Latin America Coatings Group: 4% of Sales
The Paint Stores business is by far the most important one for Sherwin Williams. It owns and operates more than 4,100 stores.
Source: 2016 Financial Community Presentation, slide 6
In 2015, the company enjoyed broad-based growth across its business segments. Net sales increased by (all in constant currency numbers):
- 5.2% in the Paint Stores Group
- 11% in the Consumer Group
- 1.1% in the Latin America Coatings Group
- 0.4% decline in the The Global Finishes Group
Sherwin-Williams is benefiting from an improving U.S. consumer, which is due to a steady economic recovery, and a solid housing market.
These tailwinds have helped it to start 2016 as well. Last quarter, net sales increased 2.8% and reached a record $3.22 billion. Diluted earnings-per-share increased 7.8% and also hit a record.
Sherwin-Williams has a management team that is very effective at producing long-term growth for the company. In 2006, the company had earnings-per-share of $4.19; earnings-per-share clocked in at $11.16 last year.
That comes out to a 10% compound annual growth rate over the last decade, which is a very strong performance given that period of time encompassed the Great Recession.
Going forward, Sherwin-Williams’ main growth drivers will be expansion in Asia and the Middle East, which is home to many attractive emerging markets such as China and India.
These markets are very appealing to Sherwin-Williams because they have populations in excess of 1 billion and rising middle classes. This bodes well for a consumer products company. This was one of the main reasons why Sherwin-Williams acquired Valspar in 2016 for $11.3 billion—Valspar has a significant international footprint.
Another growth catalyst the acquisition opens up is in the U.S. market. The Valspar acquisition will help Sherwin-Williams capitalize on the shift from do-it-yourself to contractor services.
For decades, the U.S. consumer has gradually gone away from doing home repairs themselves, to hiring outside help. With Valspar in tow, Sherwin-Williams believes it has an optimal customer mix.
Source: 2016 Financial Community Presentation, slide 7
The consolidation of the paint industry will continue to lead to rising margins. From 2006 to 2015 the company’s net profit margin grew from 7.4% to 9.3%. Synergies from the Valspar acquisition should help to boost margins further over time.
Sherwin-Williams does not pay a particularly high dividend. The company has a 1.2% dividend yield and 25% payout ratio. But, Sherwin-Williams regularly repurchases shares. Net share count has declined by 3.7% a year over the last decade. Continued share repurchases will also drive growth, in addition to margin expansion and organic growth.
I believe Sherwin-Williams can continue to compound its earnings-per-share at between 8% and 12% a year over full economic cycles. Earnings will likely decline during recessions (discussed in the next section of this article), but growth will be strong during times of economic prosperity.
Competitive Advantages & Recession Performance
Sherwin-Williams does not enjoy a highly recession-resistant business model. The paint and coatings industry is reliant on a healthy real estate market.
During the Great Recession, the collapse of the U.S. housing market hit Sherwin-Williams hard, and its earnings fell considerably.
The good news is that because of the company’s strong brand and high margins, it bounced back quickly and took only a few years to achieve record earnings. The company’s earnings-per-share through the Great Recession and subsequent recovery are shown below to illustrate this point:
- 2007 earnings-per-share of $4.70 (high earnings mark at the time)
- 2008 earnings-per-share of $4.00 (decline due to start of recessions)
- 2009 earnings-per-share of $3.78 (recession low)
- 2010 earnings-per-share of $4.21 (partial recovery from recession)
- 2011 earnings-per-share of $4.14 (high oil prices reduce margins)
- 2012 earnings-per-share of $6.02 (new earnings high)
As you can see, it took Sherwin-Williams 3 full years to recover from 2009 recession lows. However, the company did remain profitable throughout the recession, which allowed it to continue paying its dividend.
While Sherwin-Williams is not the most recession resistant stock, it does have a strong and durable competitive advantage. The company is one of the 3 large global coatings businesses.
Source: Financial Community Industry Overview, slide 4
Note: Image shows Sherwin-Williams and Valspar as separate
The company’s large size gives it economies of scale. This gives it an advantage over smaller competitors. The coatings industry is still highly fragmented. Expect the larger companies to continue to consolidate the industry by acquiring smaller players.
Sherwin-Williams also controls many well-known brands in the coatings industry. This gives the company brand recognition which helps the company to sell more coatings products at higher prices.
[drizzle]Source: Financial Community Company Overview, slide 10
The company is constantly investing to improve its products. Sherwin-Williams has spent around $50 million a year in each of its last 3 years on research and development. This helps to ensure that its well-known brands offer quality products to customers. Sherwin-Williams also supports its brands with large advertising expenditures. Advertising spend over the last 3 years is shown below:
- 2015 Advertising spend of $338 million
- 2014 Advertising spend of $299 million
- 2013 Advertising spend of $263 million
Sherwin-Williams combination of brand and scale based competitive advantages make it very likely the company continues to reward shareholders with rising dividends over a long period of time.
It’s also important to note that Sherwin-Williams operates in a slow changing industry. The paint industry realizes incremental improvements with technology, but the core offering does not change much over time.
Valuation & Expected Total Return
Sherwin-Williams stock trades for a price-to-earnings ratio of 24. This is right on par with the average S&P 500 price-to-earnings ratio. Given Sherwin-Williams’ strong rate of earnings growth over the past several years, the stock could be viewed as undervalued in today’s low interest rate environment. As the saying goes, premium companies can command premium valuations.
With that said, the company is trading far above its historical price-to-earnings ratio (as is much of the market).
Sherwin-Williams price-to-earnings ratio traded in the teens for much of the last decade. The market has only recently (in the last 3 years or so) come to appreciate Sherwin-Williams as a high quality business – with a resulting increase in its price-to-earnings ratio.
Sherwin-Williams investors will earn a significant portion of future returns from dividends and dividend growth. . Over the past five years, Sherwin-Williams has increased its dividend by 18% compounded annually. The company currently has a low payout ratio of just 25%. Investors should expect dividend growth ahead of expected 8% to 12% earnings-per-share growth going forward.
Sherwin-Williams investors should expect total returns of around 9% to 13% a year before changes in the valuation multiple based on its expected earnings-per-share growth and current dividend yield of 1.2%.
Sherwin-Williams has several traits that should be highly sought after for dividend investors. The company has a strong position in its industry, generates high profit margins, and has a long runway of growth ahead, particularly in new geographic markets. It also has a shareholder-friendly management team committed to growing dividends over time.
The only downside for the stock is that it has a low current yield of 1.2%. This is significantly below the average dividend yield in the S&P 500 Index of 2%. As a result, Sherwin-Williams stock may not appeal to investors wanting high levels of current income.
That being said, as a Dividend Aristocrat with double-digit annual dividend growth potential, Sherwin-Williams stock is an attractive stock to hold for dividend growth investors. The company ranks well using The 8 Rules of Dividend Investing due to its growth potential and low payout ratio. Dividend Aristocrat and coatings peer PPG (PPG) ranks above Sherwin-Williams at current prices, however.
Article by Bob Ciura