Kevin McCarthy, Chemical Analyst, Vertical Research Partners08.23.17
Sherwin-Williams Company (SHW: Hold, $341 PT)
2Q Softer as Legacy Sherwin Results Underwhelm
• 2Q17 EPS a touch light as margins and sales underperform. SHW posted 2Q17 EPS of $4.52 ex acquisition-related costs, which compares to our $4.72E, the FactSet estimate of $4.56, and Bloomberg consensus at $4.64. Sales of $3.74bn came in near our $3.77bn. On a segment basis, the Paint Stores Group (PSG) posted weaker than expected sales and margins, which drove a negative EPS variance of $0.14 vs. our estimate. We consider Sherwin’s same-store sales (SSS) growth of +4.9% in 2Q17 to be disappointing relative to investor expectations and the SSS growth of 8.1% that we had expected. Elsewhere, Consumer continues to struggle as sales and EBIT disappointed, and Latin America saw a steep sequential decline in earnings. The lone bright spot is Global Finishes, largely on account of the Valspar merger contribution. In the sections that follow, we compare results based on legacy Sherwin segmentation.
• EPS guide for 2017 is increased as the Valspar merger has closed. Sherwin increased its 2017 EPS guidance range to $14.80-15.20 (ex. $2.50 in acquisition costs) to reflect $0.75-0.95 of EPS accretion from the closure of the Valspar transaction on 1 June. The midpoint of the new guide is $0.85 below our estimate, but is more or less in line with the Bloomberg consensus of $15.04, though it is unclear to us whether all analysts have included the effect of the Valspar transaction therein. As highlighted in our recent estimate revision note (link), our numbers include deal-related EPS accretion of $0.75 in 2017, at the lower end of management’s guidance range. Management also put forth a range for 3Q17 EPS of $4.80-5.20 (ex $1.10 in acquisition costs), which brackets our $5.10E, FactSet consensus of $4.96, and Bloomberg consensus of $4.83.
• Legacy Paint Stores Group drags on results. Ex a prior change in revenue classification, SSS grew 4.9% vs. the 8.1% increase that we had modeled. While the consensus estimate for SSS was 6.2%, we get the sense that investor expectations were closer to our estimate, or perhaps even higher in some cases following robust census data for May. PSG segment sales were inline on account of an additional 2.2% boost due to a larger revenue reclassification impact than we had modeled. However, EBIT for the segment came in at $545mn vs. our $563mn, an EPS drag of $0.18 vs. our forecast, and a reflection of the weaker top line ex the zero margin reclassification sales.
• Legacy Consumer Business drags on results. EBIT of $97mn came in materially weaker than our estimate of $124mn. The variance is driven by the legacy SHW Consumer business as corresponding EBIT of $83.3mn is ~$25mn worse than the $108mn we expected for the segment ex the Valspar contribution. Sales at the legacy Sherwin business declined 11.9% y-y in the quarter, worse than the drop of 10.7% that the company reported in 1Q17. Elevated raw material costs clearly weighed on results as well. Legacy margins for Consumer compressed 225bps y-y, a stark comparison to 1Q where margins were up 100bps y-y despite a similar sales pattern. The Valspar contribution to the segment also lagged our estimate marginally, although we had included the Valspar Auto business within Consumer, which should instead be included in Performance as per this morning’s release.
• Global Finishes is the lone bright spot. Sales of $761mn beat the $694mn we estimated with the majority of the differential coming from the Valspar acquisition, including the presence of the auto business which we had segmented into the Consumer Segment. EBIT margins of 13.2% came in 50bps above our estimate as well and improved 10bps y-y, which is impressive given elevated deal-related amortization and the margin related pressures faced by legacy Valspar’s industrial business.
• Latin American Coatings saw a steep decline. Sales of $135mn came in below our $145mn estimate. EBIT of $-12mn is materially worse than the +$1.5mn we had penciled in. The press release is sparse on details, but we suspect that raw material pressure was a likely culprit.
• We rate SHW shares Hold. Our price target of $341 suggests shares are fairly valued in the wake of this morning’s pullback. As a reminder, our valuation of SHW is based on an average of two methodologies: DCF analysis and a relative P/E framework. Our DCF analysis suggests a warranted stock price of $349. Using our relative P/E framework wherein we apply a 15% premium to the S&P500 multiple, we calculate warranted value of $333 per share.
(Please see full report for details)
2Q Softer as Legacy Sherwin Results Underwhelm
• 2Q17 EPS a touch light as margins and sales underperform. SHW posted 2Q17 EPS of $4.52 ex acquisition-related costs, which compares to our $4.72E, the FactSet estimate of $4.56, and Bloomberg consensus at $4.64. Sales of $3.74bn came in near our $3.77bn. On a segment basis, the Paint Stores Group (PSG) posted weaker than expected sales and margins, which drove a negative EPS variance of $0.14 vs. our estimate. We consider Sherwin’s same-store sales (SSS) growth of +4.9% in 2Q17 to be disappointing relative to investor expectations and the SSS growth of 8.1% that we had expected. Elsewhere, Consumer continues to struggle as sales and EBIT disappointed, and Latin America saw a steep sequential decline in earnings. The lone bright spot is Global Finishes, largely on account of the Valspar merger contribution. In the sections that follow, we compare results based on legacy Sherwin segmentation.
• EPS guide for 2017 is increased as the Valspar merger has closed. Sherwin increased its 2017 EPS guidance range to $14.80-15.20 (ex. $2.50 in acquisition costs) to reflect $0.75-0.95 of EPS accretion from the closure of the Valspar transaction on 1 June. The midpoint of the new guide is $0.85 below our estimate, but is more or less in line with the Bloomberg consensus of $15.04, though it is unclear to us whether all analysts have included the effect of the Valspar transaction therein. As highlighted in our recent estimate revision note (link), our numbers include deal-related EPS accretion of $0.75 in 2017, at the lower end of management’s guidance range. Management also put forth a range for 3Q17 EPS of $4.80-5.20 (ex $1.10 in acquisition costs), which brackets our $5.10E, FactSet consensus of $4.96, and Bloomberg consensus of $4.83.
• Legacy Paint Stores Group drags on results. Ex a prior change in revenue classification, SSS grew 4.9% vs. the 8.1% increase that we had modeled. While the consensus estimate for SSS was 6.2%, we get the sense that investor expectations were closer to our estimate, or perhaps even higher in some cases following robust census data for May. PSG segment sales were inline on account of an additional 2.2% boost due to a larger revenue reclassification impact than we had modeled. However, EBIT for the segment came in at $545mn vs. our $563mn, an EPS drag of $0.18 vs. our forecast, and a reflection of the weaker top line ex the zero margin reclassification sales.
• Legacy Consumer Business drags on results. EBIT of $97mn came in materially weaker than our estimate of $124mn. The variance is driven by the legacy SHW Consumer business as corresponding EBIT of $83.3mn is ~$25mn worse than the $108mn we expected for the segment ex the Valspar contribution. Sales at the legacy Sherwin business declined 11.9% y-y in the quarter, worse than the drop of 10.7% that the company reported in 1Q17. Elevated raw material costs clearly weighed on results as well. Legacy margins for Consumer compressed 225bps y-y, a stark comparison to 1Q where margins were up 100bps y-y despite a similar sales pattern. The Valspar contribution to the segment also lagged our estimate marginally, although we had included the Valspar Auto business within Consumer, which should instead be included in Performance as per this morning’s release.
• Global Finishes is the lone bright spot. Sales of $761mn beat the $694mn we estimated with the majority of the differential coming from the Valspar acquisition, including the presence of the auto business which we had segmented into the Consumer Segment. EBIT margins of 13.2% came in 50bps above our estimate as well and improved 10bps y-y, which is impressive given elevated deal-related amortization and the margin related pressures faced by legacy Valspar’s industrial business.
• Latin American Coatings saw a steep decline. Sales of $135mn came in below our $145mn estimate. EBIT of $-12mn is materially worse than the +$1.5mn we had penciled in. The press release is sparse on details, but we suspect that raw material pressure was a likely culprit.
• We rate SHW shares Hold. Our price target of $341 suggests shares are fairly valued in the wake of this morning’s pullback. As a reminder, our valuation of SHW is based on an average of two methodologies: DCF analysis and a relative P/E framework. Our DCF analysis suggests a warranted stock price of $349. Using our relative P/E framework wherein we apply a 15% premium to the S&P500 multiple, we calculate warranted value of $333 per share.
(Please see full report for details)
