Sherwin-Williams: Once The Cloud Evaporates, Away We Go

Apr.23.07 | About: The Sherwin-Williams (SHW)

Sherwin Williams (NYSE:SHW) Earning Highlights:

• Consolidated net sales were $1.756 billion and diluted net income per common share was $.83
• Opened 27 net new stores; 17 in Paint Stores Group and 10 in Global Group
• Working capital ratio--accounts receivable plus inventories less accounts payable to 12 months sales--was 13.1% for the quarter compared to 13.7% last year
• Gross margin increased 150 basis points to 45.1% of sales from 43.6% last year
• Reaffirming EPS guidance of $4.55 to $4.65 per share for the full year

Christopher M. Connor, Chairman and Chief Executive Officer, commented:

• In spite of the tough paint market in the first quarter, we continued to invest in new stores, opening 17 net new locations in Paint Stores Group and ten in our Global Group. We made further progress in our management of working capital, reducing our working capital ratio to 13.1% of sales from 13.7% in the first quarter last year. Our operating segment management teams continued to achieve improved gross margins as a result of hard work invested over the last few years to return our gross margins to more normal run rates after being pressured by the significant rise in raw material costs during 2004, 2005 and 2006. We created shareholder value by our practical use of cash to buy shares of our own stock and increased the dividend rate (26%), and have strategically positioned our balance sheet to be financially sound and capable of financing our business growth.

• During the second quarter of 2007, we anticipate achieving a percentage increase in consolidated net sales in the low single digits over last year's second quarter. With sales at that level, we expect diluted net income per common share for the second quarter to be in the range of $1.37 to $1.45 per share compared to $1.33 per share last year. For the full year 2007, we anticipate that the percentage increase in our consolidated net sales will be in the low single digits over 2006. With annual sales at that level, we are reaffirming our guidance that our diluted net income per common share for 2007 will be in the range of $4.55 to $4.65 per share compared to $4.19 per share earned in 2006. For the second quarter and full year 2007, we expect the effective tax rates will be slightly higher than the rates recognized in 2006.

Sherwin Williams has taken a hit the past month due to its ties to the U.S. housing market and the RI ruling. A short term negative is virtually meaningless when compared to the California Superior Court Ruling. However, this ruling will eventually lead to the RI case case being filed where it should be: in the garbage can. This quarter's numbers prove that management is adept at managing the company through these headwinds. Let's not forget, these numbers are up against those of 2006, which included a still booming residential housing and DIY (do it yourself) market.

Two key factors contributed to offsetting the earnings decline:

• The Company acquired 3,350,000 shares of its common stock through open market purchases at an average price of $69.27 during the quarter and had remaining authorization at March 31, 2007 to purchase 9,471,000 shares.

• The Global Group's net sales in the quarter increased 5.7% to $402.2 million from $380.6 million in the first quarter last year when stated in U.S. dollars. This Segment's net sales increase of 4.8% in local currency was due primarily to a new product introduction in the U.K., architectural paint selling price increases and volume gains in South America and improved automotive and product finishes sales. Segment profit of the Global Group for the quarter improved $2.9 million, or 9.0%, to $35.4 million from $32.5 million in the first quarter of 2006 and increased as a percent to net sales to 8.8% from 8.5% last year.

The growth in the global group offset the decline in the U.S. DIY and New Residential segment. The shares buybacks did the rest as SHW was able to avoid an earning decline of a strong 2006 comparison. It should not be lost on readers that this international segment will take on further prominence and do more to insulate SHW from the U.S. housing market due to its recent purchase of India's Nitco Paints.

This gives SHW a huge footprint in an paint market, growing at a near double digit rate. The effects of this should be seen in the second half of 2007 and are probably the reason that despite the predicted Q2 earnings miss by the company, they still back their full year estimates.

Another note: this anticipated "earnings miss" is a miss on the current estimates that analysts have for Q2. SHW's estimate of $1.37 to $1.45 a share is still above last year's $1.33 number. I can live with that, given the drastic deterioration in housing since last year.

Let's also not forget the stock buyback. Although they do not expect to use the bulk of the authorization this year, the number of shares they are still authorized to buy represent about 7% of outstanding shares, providing another buffer for we shareholders. Gotta love it.

Lead Paint

After a brief summary of current litigation statuses, the subject was not revisited. Not one analyst on the call ask a single question about this. This is very telling, as during the Altria (NYSE:MO) call last week, several questions referenced the litigation environment surrounding tobacco, despite this being the best that environment has been in almost a decade. This has to lead one to believe that the analysts on the call (as well as yours truly) are not very concerned about the possibility of an eventual negative outcome here. While it is having a restraining effect on the stock now, when this cloud eventually evaporates, away we go.

SHW CEO, Mr. Christopher O'Connor, is another wonderful example of a CEO who takes his fiduciary responsibility to shareholders very seriously. Everything he is doing at SHW (dividend increases, buybacks, overseas expansion) are all geared at rewarding us shareholders. Sherwin is going to be not just a national leader, but a global one at some point soon. I currently own shares and will look to pick up more on weakness.

Disclosure: Author is long SHW.

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