Sherwin-Williams

Moat: 3/5

Understandability: 2/5

Balance Sheet Health: 3/5

Sherwin-Williams is a global paints, coatings, and related products company, primarily focused on selling to professional, industrial, and retail customers in North and South America, the Caribbean, Europe, and Asia.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Sherwin-Williams operates in the highly competitive coatings industry, which is very sensitive to macroeconomic conditions and input costs.

Business Overview

Sherwin-Williams (SHW) is a major player in the global coatings industry with operations segmented into the following:

  • The Americas Group: This is the largest segment, involved in the manufacture, distribution, and sale of architectural paints, coatings, and related products in North and South America. It operates through a network of stores, and directly to retailers.

  • The Consumer Brands Group: This segment produces and distributes branded and private-label paints, coatings, and related products through big-box retailers, home centers, independent retailers, and industrial distributors.

  • The Performance Coatings Group: This segment serves a variety of industries including industrial, auto-refinishing, packaging, and specialty coatings.

The company uses a vertically integrated business model—manufacturing the product, distributing it through its own outlets, and selling it directly to customers.

Industry Landscape

The coatings industry is characterized by:

  • Fragmented Market: Although dominated by several large players, the market is still very fragmented and competitive.

  • Cyclicality: Demand for coatings often correlates with economic conditions, impacting sales volume and margins.

  • Raw Material Volatility: Input costs, including raw materials, fluctuate significantly, affecting companies’ profitability.
  • Shift in preferences: Consumers preferences and tastes can change rapidly.
  • Regulatory Requirements: Regulations on the use of certain materials such as VOCs adds to the complexities.

What Makes SHW Different

  • Extensive Retail Network: Sherwin-Williams boasts a vast store network, which often provides a convenient way to access their products. This network allows for direct sales, direct feedback from customers, and provides data to inform supply chain.
  • Strong Brands: Sherwin-Williams, Sherwin-Williams Aerospace, Krylon, and Minwax are all well-known brands which allows SHW to command a premium price for its products.
  • Proprietary Products: While not always the most technologically complex products, SHW does have its own technology that it uses for the products, and which it sometimes licenses to third-parties. This allows for both a revenue stream and competitive advantage in select areas.

Financials

Sherwin Williams has experienced several issues regarding earnings in the recent past, as indicated in their recent earnings call. Supply chain disruptions, inflation, rising interest rates, and the impact of a strong dollar have all had material effects on profitability.

Here’s an in-depth review:

  • Revenues: SHW’s revenues are diversified geographically and by product type, with the Consumer and Paint segments taking the lion’s share of the sales. They have, in general, been growing steadily as can be observed by looking at their financial statements. Their revenue stream is a good blend of B2B and B2C segments.
    • The company’s net sales increased by 11.6% in 2022, reflecting higher sales volume and price increases in all segments.
    • For Q3 of 2023, Sales of The Americas Group were up 10.5%, Performance Coatings were up 6.7%, but Consumer Brands were down by -5.9%.
  • Profit Margins: SHW has decent profit margins and its financial track records shows this. It shows consistent growth in profits over time. However, margins are vulnerable to changes in input costs and volatile macroeconomic conditions.
    • For the first nine months of 2023, Adjusted EBITDA as a percent of net sales is 16.2% which is lower than 18.9% of previous year.
    • The company has also noted a decline in gross margin in Q3 of 2023 by 1.1 percentage points.
  • Financials: Their financials are well-managed though debt has climbed, and are fairly easy to understand.
    • Long-term debt increased to over 10 Billion dollars.
    • The Company repurchased $2.8 million worth of common stock.
  • Cash Flows: The company has an excellent track record of growing cash flows, though this has taken a hit in recent times as seen in Q3 of 2023, mainly because of lower net earnings.
  • Debt: The company uses a decent amount of debt in its capital structure. This increases its risk and may force them to act less opportunistically, or become vulnerable to credit downgrades.
    • In 2022, the company’s total debt stood at $9.9 Billion.
    • The company reported they were exploring the use of proceeds from their planned divestitures to reduce their leverage.
  • Stock Price: the stock price has seen volatility in recent times, because of macroeconomic conditions impacting the overall business.

Even with all the issues, The company has been very consistent about their ability to meet their long-term revenue and profitability targets in their latest 2023 earnings call. Also, they claim their volume growth is higher than the market.

Moat Analysis

  • Brand Recognition: SHW’s brands like Sherwin-Williams and others do provide a level of brand value, however, there are plenty of comparable products and many competitors have decent brand recognition as well. Therefore, this only constitutes a narrow moat.
  • Distribution Network: As mentioned above, SHW has a formidable distribution network, specifically in the paint sector, and this definitely constitutes a durable competitive advantage and moat, making it hard for new entrants to compete effectively.
  • Innovation and R&D: While it has some patents and technology which it uses in production, these are easily replicable and don’t create enough of an advantage to constitute a moat.
  • Switching Costs: Switching costs for SHW’s products are primarily present for B2B customers and not so much in B2C market. For B2B customers the cost of switching can be very high and can be a barrier to competition.

Considering these factors, SHW has a Narrow Moat.

Risks

  • Raw Material Costs: Fluctuations in raw material costs (such as resin and titanium dioxide) can severely impact SHW’s profit margins, as they are highly volatile and hard to hedge. Management has highlighted that this will continue to be an issue through 2024.
  • Economic Downturn: Demand for paints and coatings is tied to the economic cycle. Recessions or slowdowns in economic growth will have an negative impact on volumes and prices.
  • Foreign Exchange: As a global business, SHW is exposed to significant foreign currency exchange risk. Fluctuation in currency exchange rates may cause their reported profits to fluctuate or decline. Management has reported that adverse effects from foreign exchange was a strong factor in recent losses in their Q3 2023 Earnings call.
  • Competitive Pressures: Although SHW has a large and formidable distribution network, competition is still strong. Competitors could try to undercut SHW on prices and eat into its margins.
  • Loss of Key Customers: Because SHW has an active B2B business, where a few larger clients make up a bulk of their sales, any loss of such a client would hurt their revenue projections and could affect profitability.

Business Resilience

SHW has shown good resilience over time in the face of external challenges. But given the economic volatility the business isn’t completely recession-proof. Therefore, business has a Moderate Resilience.

SHW has identified that there is significant uncertainty regarding the macroeconomic environment and there is a possibility of a sharp and material downturn in business results. The company has also had some major recent earnings misses because of this.

Understandability

While the general outline of SHW’s business isn’t that difficult to understand (a paint company), it is difficult to figure out how their various segments operate, what drives their profitability, their competitive environment and how those things interplay. Understanding the minutia of each segment, how they are affected by different variables, requires some in-depth analysis, which is beyond the layman investor. Therefore I’d give it a rating of 2 / 5 for understandability.

Balance Sheet Health

  • Debt-to-equity ratio has seen a marked increase. This implies that the company is more vulnerable to macroeconomic conditions and changes in interest rate.
  • A considerable portion of their assets are intangible, and that may or may not hold value over the long run.
  • Despite recent dips, they still have a track record of cash flow generation.
  • Their net working capital has been quite volatile.
  • Given all the above, their balance sheet can be rated as 3 / 5. It is not terribly unhealthy, but does not come across as being exceptionally healthy either.