Report
Charles Gross
EUR 850.00 For Business Accounts Only

Morningstar | Sherwin Williams Notches a Solid Second Quarter; Lowering FVE on Reduced Long-Term Assumptions

Sherwin's second quarter was solid despite lackluster housing figures and pockets of weakness among industrial categories. Consolidated sales rose just over 2% to $4.88 billion in the quarter, while holding the line on adjusted EBITDA margins at 18.9%. The largest surprise of the quarter was an exceptionally strong performance from Consumer Brands, which generated its highest segment profit margin in years. However, we've reduced our long-term assumptions for Sherwin Williams, leading us to reduce our fair value estimate to $330 per share from $360. Our narrow-moat rating is unchanged. With shares trading well above our fair value estimate, we currently view them as overvalued.

Our fair value estimate reduction is predicated on reduced long-term expectations for Sherwin Williams. The explicit 10-year forecast has remained similar to our prior views on the company. We expect that a gradual strengthening of the housing market should support sales growth in The Americas Group and Consumer Brands segments. Margins should expand from present levels thanks to the successful pass-through of recent price increases. Beyond our explicit forecast period, we've reduced our EBI growth expectations to just 4.5%, as we feel it's more reflective of realistic volume and price growth over the full economic cycle.

We believe that current market expectations surrounding Sherwin Williams' shares are too rosy. To support a fair value estimate of $450 per share or higher, we would need to assume that the company could surpass its highest-ever EBITDA margins during midcycle conditions and grow EBI by 10% per year over the five years beyond our explicit forecast. This not only implies a remarkable amount of pricing power for the company, but it also inherently requires volume growth that suggests rapid share gains in this slow-growing industry. While Sherwin Williams is surely a very high-quality company to own, we would recommend that investors purchase shares at a far lower price.

Our uncertainty rating has also fallen to medium from high. After reviewing the revenue growth rates, operating margins, and EBITDA margins of large public coatings companies since 2000, we think the range of reasonable outcomes is narrower than we previously modeled. This narrower set of reasonable expectations over the coming 10 years gives us additional confidence that today's share price reflects unrealistic expectations.

Americas Group sales grew 5% versus the prior year, driven by a combination of higher volumes and selling prices increases. Same-store sales rose 4.3%, driven by fairly strong residential repaint demand. These results are particularly impressive in light of what has been an unremarkable spring selling season in real estate and fairly tepid new home construction. Segment profit margin rose to just over 22% in the quarter, up 0.5% from the prior year thanks to both higher prices and operating leverage. We expect recent price increases should continue to support wider margins over the next few years.

The Consumer Brands segment posted a surprisingly strong quarter, with segment profit margins up nearly 6% from the prior year. Although this was mostly due to efficiency gains associated with the combination of Sherwin and Valspar, the segment is also benefiting from falling purchase accounting effects. While the second quarter always tends to be seasonally strong, these gains reflect solid momentum in improving segment profitability after a couple challenging years.
Underlying
Sherwin-Williams Company

Sherwin-Williams is engaged in the development, manufacture, distribution and sale of paint, coatings and related products to industrial, commercial and retail customers. The company's segments are: The Americas Group, which markets and sells Sherwin-Williams? and other controlled brand architectural paint and coatings, protective and marine products, OEM product finishes and related products; Consumer Brands Group, which supplies architectural paints, stains, varnishes, and industrial products, among others; and Performance Coatings Group, which develops and sells industrial coatings, automotive refinish, protective and marine coatings, coil coatings, packaging coatings and resins and colorants.

Provider
Morningstar
Morningstar

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. The company offer an extensive line of products and services for individual investors, financial advisors, asset managers, and retirement plan providers and sponsors.

Morningstar provides data on approximately 530,000 investment offerings, including stocks, mutual funds, and similar vehicles, along with real-time global market data on more than 18 million equities, indexes, futures, options, commodities, and precious metals, in addition to foreign exchange and Treasury markets. Morningstar also offers investment management services through its investment advisory subsidiaries and had approximately $185 billion in assets under advisement and management as of June 30, 2016.

We have operations in 27 countries.

Analysts
Charles Gross

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