- Pandemic tailwinds have given SHW a strong demand boost; however, some analysts argue this won't last forever.
- Historically, the firm is a very strong performer, market leader, and sees constant revenue and profit growth in any market conditions it faces.
- While debt has increased significantly due to a recent acquisition, the debt level is very manageable and the acquisition has proven successful.
- Bears say there is no value in SHW at its current price; however, they make assumptions around a change in operating conditions with no evidence of any change on the horizon.
Investment Thesis: You Won't Find Value Here, But The Sherwin-Williams Company Is Still Good Buying
My view on The Sherwin-Williams Company (NYSE:SHW) is that while it may be difficult to create a case for value investing in the firm, SHW has proven to be a reliable performer and a safe harbour for investors looking to park their money through volatile pandemic markets.
Value investors who have contributed to Seeking Alpha have pointed to DCF valuations to make a bearish case of 20% to 35% overvaluation; however, I believe market conditions and risk-off selling have forced investors to look for more stable performing firms to park their money.
Below, I look at the historical metrics contributing to the rise and rise of SHW, and what the future holds for the firm.
A Dive Into SHW's Success And Its Future
Despite a 44.29 P/E ratio that's well above a modern US market average of 19.6, SHW remains an ever-attractive stock pick for investors over the past 17 years.
The stock has risen to a giddying $334.28 from a humble 2004 price of $14.71, implying a 17-year CAGR of over 20%.
It's worth noting that since 2004, the diluted P/E and P/B have steadily risen year-on-year, so let's delve into the numbers to determine if the continued share price growth is sustainable and what the future might hold for SHW.
Source: TIKR.com, Close Price vs P/E vs P/B ratios compared
Annual Price Change Vs P/E Change
Since 2004, SHW price has risen on average 22% while P/E has only risen 8%, implying that the valuation is rising faster than underlying earnings, but that the dramatic price increases of the last 10 years are within a range of reasonable justification.
Margins: Strong Gross Margins, Improving Net Margins
Gross margins have hovered around a very respectable 47% in the last 16 years, averaging 44% over the last 5 years.
The company has noted that 2021 will be challenging for gross profits, as inflation, material and logistics costs will put pressure on margins, with the third quarter investor report indicating a gross margin of 41.6%, a drop of 630bps.
SHW's net income margins have steadily improved over time, noting below the slight dip due to challenges in 2021 around raw materials and shortages.
The significant 2017-2018 dip was due to the acquisition of the Valspar brand which put a temporary dent in firm profits; however, the acquisition has also net around $350m in synergistic efficiencies (it's not clear from reporting if these efficiencies were on the Valspar or the Sherwin-Williams side of operations; however, there's still a positive net benefit regardless).
EBITDA: Steady Year-on-Year Growth
Impressively, EBITDA has had a strong run upward year-on-year since 2009, indicating the firm continues to grow with excellent underlying profits and scalability.
Dividends: Steadily Rising
Dividends have also seen a strong upward trend since 2004; however, yields have remained stubbornly below 1%, so the majority of an investor's benefit is derived from capital gains in share price.
Dividend payout ratios have fluctuated from above 35% to just under 20%, with an average of 27%.
Long-Term Debt: Growth Through Acquisition
In 2017, SHW acquired the Valspar brand, which required borrowings of approximately $8.6 billion at an average interest rate of 3.57%, totalling $340m in repayments in 2020, representing an interest expense of 11% of Operating Income.
While 3X annual operating income is not excessive debt, it does add a layer of vulnerability to the firm should a downturn impact sales while the balance of cash and short-term equivalents is a mere $313m.
Growth: A CAGR Slowdown Across 3- And 5-Year Time Frames
While both 3-year and 5-year CAGR revenue growth has slowed, 5.59% 5Y CAGR is still a very respectable growth figure for a 150-year-old company writing $19.6 billion in annual revenue.
Forecasts: Above-Trend Revenue Growth, Big Upside In EPS
SHW's forecasts for revenue growth in 2021 and 2022 are 8.6% and 8.2% YoY, respectively, well above 3-year and 5-year CAGR averages of 5.59%.
This, paired with the expectation that 2022 will bring normalisation to costs bringing a vast improvement in EPS, should give investors strong outlooks for the future.
Source: Seeking Alpha
EPS is expected to jump from 8.49 to 10.19 off the back of improved costs associated with raw materials and logistics.
Source: Seeking Alpha
A Look At Bearish Views: DCF Modelling Suggests Downside
Looking at the analysis by other SA contributors, those who see a bearish future for SHW all point to DCF valuations and above-historic average multiples.
Analysis by author Value Investor Research suggested SHW was optimistically 20% overvalued and 35% realistically overvalued. Unfortunately, after writing their piece in June 2021, the stock has grown over 20% in price. It's clear, however, this author was taking a solely value-only view of the firm and not factoring in that investors see SHW as a "safe harbour".
Another author, Thomas Richmond, wrote in mid-August when the share price was $306.03 that SHW was 30% overvalued (again, based on DCF valuation), and shortly thereafter the stock did dip 8.3% to $279. However, this was still quite a distance from Thomas' estimation of fair value of $230.
Wall Street Analysts, however, have remained staunchly bullish on SHW, with 57% of analysts remaining Bullish or Very Bullish, but only 1 analyst of 28 rating the firm Bearish.
Source: Seeking Alpha
Bearish authors all noted that COVID presented strong tailwinds for SHW with homeowners staying home and considering renovations during lockdown, however, they all predicted that this would eventually slow and return to normal. However, these predictions were made with no supporting evidence, and I was not able to find supporting evidence or indicators in my own research.
In fact, lumber prices (an indicator of construction activity), while down from their May 2021 highs, are back on a steep rise again, and March futures are up 3.8% on today's price. Today's cash price of $830 is still double the pre-pandemic $434 price. This indicated the construction industry is still very much active and demand for materials could remain elevated for some time.
Source: CMC Markets
The Investment View: There May Be No Deep Value, But SHW Remains A Strong Safe Harbour
After reviewing the past decade's financials, it's easy to see why investors love SHW as a solid and consistent performer.
Across every operating environment, SHW has maintained strong profits and reliable dividends, pushing consistent growth in its revenues and even making a careful and successful acquisition along the way.
The future looks bright for SHW with costs likely to normalise over the next 2 years, leading to improved gross margins while product demand is expected to remain high.
DCF valuation has been inaccurate for other authors considering SHW, so I believe that the safest bet is to consider Sherwin-Williams as a continued safe bet for investors looking for blue-chip stocks to park their money while COVID continues to ravage the world.
2017-2020 offered a price CAGR of 26%, which I would consider a bearish view of growth for SHW; 2020-2021 saw a price rise of 29%, which I would consider a reasonable expectation for the next 2 years; and 2021's year to date has been 36%, which I would see as a super-bullish future for SHW.
This article was written by
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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