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Sherwin Williams Needs Time to Cure

·5 min read

Sherwin-Williams Co. (NYSE:SHW) is the largest U.S.-based paint and coatings manufacturer and the third largest in the world. The company operates in North and South America, the Caribbean, Europe, Asia and Australia. Sherwin-Williams was founded in 1866 and is headquartered in Cleveland, Ohio.

Most products are stored, sold and distributed from the companys 5,000+ stores and outlets. They are open to walk-in traffic and originate deliveries to job sites. They boast one of the largest networks of telemarketing and on-field sales staff reaching out to architects, designers, engineers and contractors.


In my opinion, the long-term prospects of the American economy are healthy, which means Sherwin-Williams' shares have high potential to grow. However, the outlook for near-term profit on the stock is bleary due to economic struggles and a weak balance sheet, leaving me moderately bullish for the long-term only.

Sherwin Williams Needs Time to Cure
Sherwin Williams Needs Time to Cure

A cyclical stock

As the economy goes, so goes the Sherwin-Williams share price, as we can see below in the 10-year price chart from GuruFocus. The home improvement industry and Sherwin-Williams got an upward push from the hot housing market caused by money-printing, low interest rates and other record fiscal stimulus during the beginning of the pandemic. The company's fortunes depend on housing starts, DIY construction, auto production, government spending and infrastructure development. All these sectors currently have analysts vacillating and unsure about the future.

In 2022, the impact of supply chain issues, labor shortages, a recession and talk about a major stock market crash clipped the markets resurgence. Negative economic pressures and news have combined to drive down the Sherwin-Williams share price by 17% in one year and by almost $100 per share in the first seven months of 2022. The company's 52-week high was $354.15, but as of this writing it trades at just $251.60.

Sherwin-Williams manufactures and sells paints, coatings and related products to professional, industrial, commercial and retail customers through three segments: the Americas Group, the Consumer Brands Group and the Performance Coatings Group.

The Americas Group handles architectural paints and coatings, protective and marine products and OEM finishes.

The Consumer Brands Group distributes other brands and private-label architectural paints, stains, varnishes, industrial products, wood finishes products, wood preservatives, applicators, corrosion inhibitors, aerosols, caulks and adhesives.

The Performance Coatings Group sells industrial coatings for wood finishing and general industrial applications, automotive refinish products, protective and marine coatings, coil coatings, packaging coatings and performance-based resins and colorants. It serves retailers, dealers, jobbers, licensees and other third-party distributors through its branches and direct sales staff, as well as through outside sales representatives.

Financial strength headwinds

Aside from its cyclical nature, the companys lack of financial strength also gives me pause. The financials reported for the second quarter ending in July missed estimates. As a result, the price-earnings ratio is a high 29.19. The second quarter earnings per share were $2.21 compared to $2.42 in the year-ago quarter.

The full-year guidance was slashed. The company now guides for earnings per share to be $7.65 to $7.95, much lower than the prior estimate of $8.60. Management still sees supply chain issues and inflation eating at profits, with demand pressures creating shortfalls in Europe, China and parts of North America. The company announced a 10% price increase effective Sept. 6, with significant additional pricing actions coming.

I do not foresee any significant deterioration in revenue because of price increases, but maintaining margins is going to be tricky given the company's balance sheet weakness. Sherwin-Williams isn't exactly known for tightening its belt when necessary; the company has an aggressive share buyback program, ranking better than 96% of 809 companies in the chemicals industry, and has repeatedly proven that it is willing to go into unsustainable debt for this purpose.

I have concerns about how this program, juxtaposed to the company debt of about $10 billion, affects the companys financial strength. Its liabilities outdistance cash and receivables by more than $16 billion. The debt has been serviced thus far, and much of it has been incurred from mergers and acquisitions. However, if earnings decline over a long stretch of time, the debt will weigh heavier on the share price, especially as interest rates rise.

In June, Sherwin Williams announced its intent to acquire German industrial coatings company Gross & Perthun GmbH. This company sells into the equipment and transportation coatings industry in which Sherwin-Williams' Valspar excels. The acquisition could undoubtedly be beneficial, but should a company with a cash-debt ratio of 0.03 really be buying more companies going into a worsening economic situation?

The outlook for the American economy is shaky. The economy shrank an annualized 0.9% in the second quarter of 2022, and the numbers softened for Sherwin Williams as well. Residential investment sank 14%, structures 11.7% and equipment 2.7%, all arenas important to Sherwin Williams. Consumer spending is of notable concern for the company. In the overall economy, spending on goods fell 4.4% and government consumption was down 1.9% in the second quarter.

Valuation

The stock has begun moving up, rising about 15% in eight weeks, coinciding with better economic news. Sherwin-Williams shares are still about 127% higher over the past five years. Short interest is a low 1.22%.

The GF Score rates Sherwin Williams a high 94 out of 100. The company gets high marks for growth, momentum and profitability.

Sherwin Williams Needs Time to Cure
Sherwin Williams Needs Time to Cure

The GF Value chart rates the stock as modestly undervalued, but a cyclical downturn would not be likely to do the valuation any favors.

Sherwin Williams Needs Time to Cure
Sherwin Williams Needs Time to Cure

The third quarter earnings report due Oct. 4 will reveal if the company is cutting advertising, slashing overhead and selling inventory - three signs the business forecast is not so bright. My average price target for this stock over the next 12 months is $280 per share unless America enters an admittedly likely recession. The beta is 1.02, revealing the stock has a high volatility risk. If we do enter a recession, I think Sherwin-Williams shares might drop to $225.

This article first appeared on GuruFocus.