Sherwin-Williams (SHW: Hold, $412 PT)
4Q EPS in Line on Tax; Valspar and Consumer Struggles Continue
• Operating earnings came in below our expectation. Our first blush analysis suggests that SHW posted 4Q17 EPS of $3.16 excluding transaction-related costs and deal-related amortization expense vs. consensus of $3.15 and our estimate of $3.58 on an apples-apples basis. Although numerous special items make for a “messy” quarter, our preliminary analysis is that a lower adjusted 4Q tax rate of 18.8% contributed $0.32 to EPS vs. our forecast rate of 28.8%. Disclosure of certain tax effects is limited, so we may need to refine our numbers following the conference call at 11:00AM ET. Including the deal related amortization, we estimate EPS came in at $2.63, which we view as a more comparable non-GAAP figure relative to the balance of our coverage universe where amortization expense is not typically added back to compute adjusted EPS. Sales of $3.98bn came in a bit shy of our $4.03bn but beat the Street at $3.94bn. SHW posted 4Q adjusted EBITDA of $606mn vs. the $640mn that we had modeled and consensus of $613mn, reflecting margin of 15.2% or 70bps below our forecast of 15.9%. On a segment basis, earnings came in better than expected in Performance Coatings, while The Americas Group (TAG) came in a touch light and Consumer fell short of our forecast by a wider margin. In TAG, same-store sales (SSS) growth grew +6.3% in 4Q17, which came in below the SSS growth of 10.4% that we had expected (we modeled a volume boost after storms and had price forecast up 4.5% given contributions from two distinct price waves during 4Q). Despite presumed capture of synergies (unquantified in release), we estimate that legacy Valspar EBIT declined 15% y-y to $111mn from $131mn. Net debt declined $425mn in 4Q17 to $10.3bn or 3.2x our estimate of 2018 EBITDA.
• Initial 2018 EPS range looks a touch light vs. our (tax-adjusted) estimate. Sherwin initiated 2018 EPS guidance range of $18.80-19.30, or a midpoint of $19.05. This range adds back $3.45 for acquisition-related costs and purchase accounting. The midpoint of $19.05 exceeds consensus of $18.36, although it is not clear to us what proportion of analyst estimates included therein reflect the new US tax regime. Our apples-apples EPS estimate would be $20.00 with amortization expense added back, and a forecast tax rate of 23.6% that seems consistent with Sherwin’s updated tax guide to the low-to-mid-20% range...
• TAG missed our mark on lower than expected SSS growth and Latin America margins. North American Paint Stores Group (PSG) SSS grew 6.3% vs. the 10.4% increase that we had modeled and consensus of 8.7%. Given the combination of two separate price initiatives rolling through PSG on the quarter, we believe the implied volume growth in 4Q could be ~2%, which we see as modestly disappointing. The press release does not mention any hurricane-related headwinds or tailwinds, so we will be interested to see how this may have impacted results. EBIT at $406mn for TAG was a $12mn miss, or $0.09 vs. our estimate in EPS terms with Latin America representing the larger absolute headwind. Incremental margins for PSG at nearly 37% were better than the 33% we anticipated and helped recover some lost ground from the weaker than expected top line.
• Consumer Brands falls short. Sales of $572mn came in well below our estimates, primarily due to a lower sales contribution from legacy Valspar and another 7% y-y decline in the legacy Sherwin business. While some competitors had mentioned sequential improvement in y-y big box results in 4Q, that strength appears to have evaded legacy Valspar, with comparable sales down 3% y-y. EBIT was equally weak though it appears deal-related amortization has stepped up in the segment by ~$12mn sequentially, vs. ~$21mn in 3Q17 (after backing out inventory component of 3Q17 purchase adjustments). Legacy Valspar EBIT of -$12.3mn, or $20.5mn after backing out deal-related amortization, appears weak relative to legacy Valspar performance, especially when you consider synergies should be accruing to results. Legacy Sherwin Consumer EBIT looks equally weak to us, with segment results down nearly 30% y-y. Looking forward...
• Performance Coatings beats on better industrial recovery. Sales of $1.22bn came in ahead of our $1.09bn estimate driven by better organic growth and a lower estimated legacy Valspar base level in 4Q16. EBIT margins of 18.6% were essentially in line with our estimate, leaving the better sales result to drive the EBIT beat of $120mn vs. our 101mn estimate. Under the hood, performance again appears mixed however. Legacy Sherwin core operating profit was up 7%, but EBIT at legacy Valspar appears to be down nearly 20% y-y, even after adding back the $42.1mn in deal-related amortization. We estimate that the business generated about $20mn in synergies on the quarter, though this number remains unquantified in the release...
• We rate SHW shares Hold with a price target of $412. Our target suggests limited upside including a 0.8% dividend yield. SHW shares trade for 16.1x our estimate of 2018 EBITDA, which represents a 33% premium to coatings peers, and 23.9x our 2018 EPS estimate, or a premium of 21% vs. the peer average of 19.7x and a premium of 31% vs. Buy-rated PPG. 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 $417. Using our relative P/E framework wherein we apply a 20% premium to the S&P500 multiple, we calculate warranted value of $408 per share.
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Praxair, Inc. (PX: Hold, $159 PT)
Adding a Nickel to 2018E on Industrial Volume Momentum
• Praxair finished 2017 in style. The industrial recovery is gaining momentum. Praxair posted impressive volume growth of 7% y-y in 4Q, up from an already healthy 5% in 3Q, aided by double-digit growth in electronics, chemicals and energy. Total company volume grew nearly 5% in 2017 marking the best such result since 2011. Looking ahead, we expect volumetric strength to persist, since Praxair’s project pipeline appears to be in good shape and leading indicators, such as the hardgoods component of packaged gases, are growing at a substantially more rapid pace. If there is a knock on 4Q results, it would be an apparent lack of operating leverage in that Praxair’s total company operating margin actually compressed 40bps y-y in 4Q17 on an underlying basis. However, management expressed visibility into improvement here as soon as 1Q18. Meanwhile, the company’s pending merger of equals with Linde is “on track” to close in mid-2018 with required divestitures that are not expected to exceed the threshold levels as specified in the agreement. With regard to the stock, we maintain a more balanced view in light of the magnitude of Praxair’s valuation premium at 14.0x our estimate of 2018 (standalone) EBITDA vs. peer APD (12.2x) and the broader chemical sector (10.5x).
• Top 10 takeaways: (1) Adjusted 4Q EPS of $1.52 vs. our $1.47E, consensus of $1.48, and the company’s prior range of $1.45-1.50 ex a provisional net charge of $394mn related to US tax reform; (2) sales of $2.95bn came in well ahead our $2.85bn, driven primarily by better volumes, especially in North America (+8%); (3) in EPS terms, consolidated EBITDA of $973mn was a $0.09 beat against the $939mn we had penciled in; (4) on a segment basis, EBIT outperformed our expectation in all segments except Asia, which was in line; (5) volume growth of 7% overall accelerated from the 5% level posted in 3Q17; (6) total EBIT margin declined 60bps y-y and 40bps on an underlying basis, although management expressed confidence in...
• Changes to our model: We increase our 2018 EPS estimate by $0.05 from $6.60 to $6.65, including $1.56E for 1Q18. Our revisions reflect a higher projected sales base, driven by more robust volume growth and more favorable FX translation relative to our prior model. We have also tweaked lower our projected tax rate by 10bps to 24.0% (the midpoint of Praxair’s new range) from the 24.1% level that we had estimated in our 2018 Outlook (click here).
• We maintain our rating of Hold and raise our price target. In light of improved earnings and cash flow and in respect of higher market trading multiples, we raise our price target by $8 from $151 to $159, which suggests that shares offer modest upside, including a dividend yield of 1.9%. As a reminder, we value PX based on an average of our DCF analysis and a relative P/E-based framework. Our updated DCF analysis suggests a warranted stock price of $140, and includes a weighted-average cost of capital (WACC) estimate of 7.8% and a terminal growth rate of 2.5%. Our relative P/E-based framework indicates a warranted value of $141 per share based on a 20% premium to the S&P500 index’s multiple as applied to our new 2018 EPS estimate of $6.65. Finally, we attribute additional value of $18 per share to reflect the expected value to be created from Praxair’s pending MOE with Linde.
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Celanese Corporation (CE: Hold, $109 PT)
Beats Street on Acetyls Upside and Tax
• CE posted solid 4Q results, albeit was a less favorable earnings mix. Adjusted EPS of $1.98 was in line with our $1.98E and ahead of consensus of $1.87. While we consider results to be quite good overall, mix is less than ideal in two respects: (1) Celanese’s lower multiple commodity acetyls business out-earned its higher multiple specialty chemical lines; and (2) a lower adjusted tax rate of 15.9% added $0.05 to EPS relative to the 4Q tax rate of 17.9% that we had forecast. Heading into the print, we had increased our EPS estimate by $0.05 to account for stronger acetic acid prices, but we could have added even more as Acetyl Intermediates (AI) segment income surpassed our forecast by ~10%, while other segments lagged. On balance, operating profit of $352mn paled vs. our $360mn, but beat consensus of $334mn rather handily. Net debt increased $137mn q-q to $3.06bn, or 1.7x our estimate of 2018 EBITDA as Celanese made a voluntary contribution of $316mn to the company’s US pension plan.
• Management guides 2018 EPS to ~$8.50 with FCF of $900mn+. This compares to our $8.35E and consensus of $8.29. The company signaled a 2018 tax rate of 14%, a reduction of 200bps, whereas our prior published estimate of $8.35 incorporated a tax rate of 16.9%. We would be at $8.64E pro forma for the lower tax rate, all else held constant. Celanese’s pending filter tow JV deal with Blackstone is expected to be EPS neutral in 2018 as is the company’s pending acquisition of Omni Plastics ($100mn in sales). With regard to FCF, Celanese put forth “more than $900mn”, which compares to our forecast of $1.07bn. Capital expenditures are expected to rise to a range of $300-350mn from $267mn in 2018.
• Acetyls delivers impressive upside. AI has been a significant driver of positive earnings variance over the past few quarters, both on price and margin, and this trend continued as EBIT of $162mn came in $0.09 ahead of our $147mn estimate. Top line results did fall a bit short of our estimate, a function of a 4% y-y decline in volumes. That said, better pricing drove upside to margins, which were 260bps better than we had anticipated. EBIT margins at the segment level, ex JV income, are now over 20%, nearly 900bps stronger than 4Q16 and up an additional 30 bps sequentially. The one headwind associated with the Acetyl Chain on the quarter was lower margins in Industrial Specialties, which came in 160bps below our expectation resulting in a variance of $3mn or $0.02 in EPS terms. Looking ahead, acetic acid prices have continued to rally and we expect solid results in the Acetyl chain to continue in 1Q. That said the restart of Eastman’s acetic unit in Kingsport in late December should bring some welcome supply back to the market.
• AEM beats Street although margin pressure persists. Celanese’s Advanced Engineered Materials (AEM) segment EBIT of $135mn came in below our $141mn but exceeded the Street’s $130mn. Segment income margin declined 870bps y-y and 250bps sequentially to 24.5%, mainly on mix effects related to acquisitions, though prepared comments also cite additional manufacturing costs. We had expected incremental synergy capture to arrest the margin pressure, but 870bps of degradation is actually worse than the 770 bps of y-y decline realized in 3Q17. We do remain encouraged by the pace of new product innovation, with the company launching an additional 587 projects in 4Q17 vs. 585 in 3Q17, while also setting a lofty goal of ~3,000 new products in 2018, a 34% y-y increase.
• Consumer weakens moderately with outlook calling for stability. At $75mn in adjusted EBIT, results in acetate tow missed our estimate of $80mn. Performance reflects a sequential decline of $4mn, though we do not yet see results as a material deviation from management’s call for relatively flat performance. Looking ahead, trends in 2018 are expected to remain stable, with management forecasting results consistent with recent quarterly performance. Celanese’s pending filter tow JV deal with Blackstone remains in phase II review by the European Commission. Meanwhile, Celanese continues to prepare by creating new legal entities and operating structures.
• We rate CE shares Hold with a price target of $109. Our PT suggests shares are fairly valued after considering a dividend yield of 1.6%. As a reminder, we value Celanese based on an average of three methodologies; DCF analysis, a relative P/E framework, and a relative EV/EBITDA framework. Our DCF suggests a warranted stock price of $137. Using our relative valuation framework, our P/E multiple implies a fair value of $97 while our EV/EBITDA implies a fair value of $91 per CE share.
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Air Products and Chemicals (APD: Hold, $164 PT)
Strong Sales, Weaker Margins, Low Tax Bill Make for Mixed F1Q
• APD starts the year with strong volumes; Asia and a lower tax offset weaker margin in Americas. APD posted adjusted F1Q18 EPS of $1.79A vs. our $1.70E, consensus of $1.66, and management’s guided range of $1.60-1.70. Sales increased 18% to $2.22bn, well above our forecast of $2.09bn with the principal variance attributable to a contract termination and plant sale in Asia. Volume growth accelerated, confirming industrial gas demand trends witnessed yesterday at peer Praxair. Air Products’ volume grew 13% or +7% as adjusted for the special circumstance in Asia, which compares to +3.8% in F4Q17 and +2.9% in F3Q17. EBITDA of $735mn came in $3mn above our forecast and ~1% better than consensus, as margin came in 190bps below our model. Adjusted EBIT of $461mn came in light vs. our $480mn and consensus of $477mn, principally due to weaker than expected earnings in North America, partially offset by upside in Asia. In EPS terms this resulted in a negative variance of -$0.07 vs. our model, which was more than offset by stronger equity income +$0.03 and a boost of +$0.13 from a lower 1Q tax rate of 17.5% vs. the 23.5% rate that we had modeled. Net debt increased by $98mn from $285mn to $384mn, or 0.1x our estimate of F2018 EBITDA as management remains patient stewards of excess capital. Finally, the company increased its quarterly dividend yesterday by 16% to $1.10 for a yield of 2.5%.
• Management raised its F2018 EPS range aided by the new US tax regime. APD sees F2018 EPS in a range of $7.15 to $7.35, up $0.30 or ~4% from the prior range of $6.85-7.05. This compares to our $7.40E and consensus of $7.08E, although it is not clear to us how many estimates included therein reflect the new tax regime. Air Products’ new F2018 EPS range now incorporates a full year tax rate range of 20-21%, which is somewhat lower than our previously estimated rate on an apples-apples basis. The company is also raising its F2018 capex expectations to $1.2 to $1.4bn, up from the prior $1.0 to $1.2bn, which was laid out on the F4Q17 release. Finally, for F2Q18, APD foresees EPS of $1.65-1.70 vs. the street at $1.65 and our $1.80E. We note that these guidance figures continue to exclude any Lu’An accretion which we have estimated at $0.10-0.15 per share.
• Industrial Gases –Asia comes in well ahead, although a plant sale skews results. Sales in Gases – Asia of $644mn came in well ahead of the $473mn we had penciled in. That said, results are skewed by a contract termination/plant sale in China, which we estimate added ~28%, or $122mn, to the top line. Adjusted for this one time item, a more comparable sales number would be closer to $522mn, which is still well ahead of our $473mn. Management’s commentary about 240bps of margin expansion y-y excluding the contract termination and plant sale, points to a near $22mn benefit from the plant sale on the quarter, which makes up perhaps two-thirds of the $33mn EBIT beat that Gases Asia reported vs. our estimates. Thus we view a more comparable EBIT of $154mn vs. the $142mn we had estimated and a $176mn reported.
• Industrial Gases – Americas margins under pressure. EBIT on the quarter of $217mn is a sizeable miss vs. our $257mn as margins of 23.9% declined appreciably from the 27.9% reported in F4Q17. The miss to adjusted EBITDA was not as wide as equity earnings were better than our forecast and elevated D&A was a $4mn headwind to EBIT. However, the company also cites costs from higher maintenance expense, which we believe is...
• Industrial Gases – EMEA represents an additional headwind to estimates. In EPS terms, adjusted EBIT of $105mn was a $0.03 miss to the $114mn we had estimated. Margins were under pressure as higher energy pass-through costs weighed on results. That said, we were hoping for a bit more margin progression given our expectation of improving volumes across Europe. Sales in Gases – EMEA of $516mn came in ahead of the…
• We rate shares of APD Hold. Our published price target of $164 suggests limited potential for upside, including a dividend yield of 2.5%. We value APD based on an average of our DCF analysis and a relative P/E-based framework. Our DCF analysis suggests a warranted stock price of $153 and includes a weighted-average cost of capital (WACC) estimate of 8.0% and a terminal growth rate of 2.5%. Our relative P/E multiple applies a 20% premium to the S&P 500 multiple and implies a stock price of $175.
