Updated on January 18th, 2019 by Josh Arnold
Sherwin-Williams is a legendary dividend growth stock.
As a member of the Dividend Aristocrats, Sherwin-Williams is one of just 53 S&P 500 stocks that have raised their dividends each year for 25+ years.
Even among the Dividend Aristocrats, Sherwin-Williams stands out because of its remarkable rate of dividend growth. The company shows no sign of slowing down, either; management’s stated goal for the dividend is 30% of prior year earnings. Management believes it can produce 11% to 14% annual growth in earnings-per-share, so we can reasonably expect the same level of growth for the payout.
Sherwin-Williams’ rapid dividend growth forecasts make it appeal to dividend growth investors. This article will analyze the investment prospects of Sherwin-Williams in detail.
Business Overview
Sherwin-Williams is the world’s second-largest manufacturer of paints and coatings. The company distributes its products through wholesalers as well as retail stores. Sherwin-Williams was founded in 1866, and has grown to a market capitalization of $37 billion and annual sales of $15 billion.
The company distributes its products through wholesalers as well as retail stores that bear the Sherwin-Williams name. Its only competitor of comparable size is fellow Dividend Aristocrat PPG Industries (PPG).
Source: Investor Presentation, page 3
Sherwin-Williams is certainly a market leader. The company has become significantly larger since its relatively recent acquisition of Valspar.
The Valspar merger was transformative for Sherwin-Williams. Post-merger, Sherwin-Williams is now divided into three segments: Americas, Consumer Brands, and Performance Coatings.
Sherwin-Williams is a much more diversified company than it was prior to the Valspar purchase. Management believes it can deliver strong earnings-per-share growth, with less volatility and variability in earnings.
In late October, Sherwin-Williams reported (10/25/18) financial results for the third quarter of fiscal 2018. In the quarter, consolidated net sales increased by 5.0% to $4.73 billion while same store sales for locations in the United States and Canada increased by 5.2%. Sherwin-Williams generated diluted earnings-per-share of $3.72, which represents an 11.7% increase over the same period a year ago.
Excluding nonrecurring accounting charges, Sherwin-Williams generated adjusted earnings-per-share of $5.68, a 19.6% increase year-on-year. Sherwin-Williams also updated its 2018 financial guidance with the publication of its third quarter earnings release. The company now expects to generate adjusted earnings-per-share between $19.05 and $19.20.
Growth Prospects
Sherwin-Williams has grown at strong rates over the past couple of years. Fiscal 2017 saw sales growth of 26% while fiscal 2018 is on pace for a high-teens gain on top of that. This has led to some robust earnings-per-share growth, as our estimate of 2018 earnings-per-share of $19.13 is nearly 60% higher than two years prior. Strong sales growth has helped but margins have been buoyant and a lower tax rate has aided the effort as well.
Looking ahead, Sherwin-Williams stands to benefit from broad-based demand for its products internationally. Demand for Sherwin-Williams’ products is expected to grow most rapidly in the Asia-Pacific region. In addition, the company has scale unlike any of its competitors in Latin America and North America. There is still plenty of growth potential in its more mature markets, but the Valspar acquisition helped to expedite expansion into Asia-Pacific, where the company is relatively small.
These factors should combine to accelerate the company’s revenue growth in the near-term. Sherwin-Williams is expected sales growth of 4%-6% per year through the end of fiscal 2020.
Source: Investor Presentation, page 5
Revenues are just one component of Sherwin-Williams future growth in profitability. The Valspar acquisition has presented some meaningful opportunities to reduce expenses by eliminating duplicate roles, integrating supply chains, and combining SG&A workforces.
All said, Sherwin-Williams is expecting to generate between $400 million and $415 million in annual cost synergies by 2020.
Sherwin-Williams has plenty of opportunities that it can tap to grow its sales and earnings for the foreseeable future. The company also has a very strong track record of historical earnings growth:
Sherwin-Williams is accustomed to growing earnings at double digit rates, and management has guided for that to continue in the coming years. This company has a broad and deep portfolio of popular brands with good margins and a bright sales outlook. In addition, it still has meaningful merger synergies that have yet to accrue, so margins should improve further in the next couple of years. In short, even though Sherwin-Williams is the dominant player in its sector, it is far from done when it comes to growth.
Competitive Advantages & Recession Performance
Sherwin-Williams is not the most recession-resistant Dividend Aristocrat. The company’s performance depends on a healthy U.S. and international housing market, which is the underlying driver of paint and coatings sales.
This impact can be seen by looking at the company’s performance during the 2007-2009 financial crisis:
- 2007 adjusted earnings-per-share: $4.70
- 2008 adjusted earnings-per-share: $4.00 (15% decline)
- 2009 adjusted earnings-per-share: $3.78 (5.5% decline)
- 2010 adjusted earnings-per-share: $4.21 (11% increase)
It took Sherwin-Williams’ earnings three full years to recover from its Great Recession lows; however, the company remained profitable and continued to raise its dividend (which is why it remains a Dividend Aristocrat today).
Another factor that investors should consider is the company’s increased debt load after the closure of the Valspar acquisition. Sherwin-Williams acquired debt to fund the Valspar acquisition, which resulted in a debt to EBITDA ratio of 4.5x when the deal closed. The company has worked to pay off debt since. It lowered its debt to EBITDA ratio to 3.0x at the end of 2018, and the company maintains a long-term target of 2.0x to 2.5x.
Sherwin-Williams elevated debt load combined with our current position in the business cycle may lead some investors to consider investments in more conservative securities. Earnings are likely to fall if the economy begins to contract and the housing market slows. We don’t believe it would result in negative earnings by any means, but certainly, the share price would suffer under such a scenario.
Valuation & Expected Total Returns
Sherwin-Williams has many of the characteristics of a high-quality business, and it is valued as such. The stock trades with a price-to-earnings multiple of 20.9 on its 2018 earnings-per-share estimate of $19.13, which compares to our estimate of fair value of 20.5. That implies a fractional headwind to total returns in the coming years as the stock is essentially fairly valued today.
However, this is not a stock that is likely to sink to a low price-to-earnings ratio, given its enormously successful history of growing earnings. Investors are willing to pay more for premium growth and Sherwin-Williams fits that description.
In addition, we expect 9% long-term annual earnings growth for Sherwin-Williams. The stock also has a secure dividend, which yields 0.9% right now. This results in annual expected returns of nearly 10% over the next five years.
The stock’s fair price and high earnings growth mean that we recommend Sherwin-Williams as a buy. The dividend yield is still quite low, so it isn’t worthwhile as a pure income stock. However, the high rate of dividend increases makes the stock attractive for long-term dividend growth investors.
Final Thoughts
Sherwin-Williams’ acquisition of Valspar, has created some compelling growth opportunities for this high-quality dividend stock.
This is a typical example of a great business trading at a not-so-great price. We’ll let Warren Buffett take this one from here:
“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.” – Warren Buffett
While the stock may not look cheap in a traditional sense, it is fairly valued for the first time in a while. We think there is a lot of growth ahead along with strong payout expansion, and think the stock is worth a look for investors with long time horizons.
