If, as Warren Buffett (Trades, Portfolio) and Charlie Munger (Trades, Portfolio) argue, simple businesses are the best, then what should investors make of Sherwin-Williams Company (SHW, Financial), a company solely focused on paint? The gurus behind Berkshire Hathaway (BRK.A)(BRK.B) may not own shares in the company, but I believe it fits well with traditional Buffett-Munger criteria as it is a simple business with attractive fundamentals. It boasts one of the highest returns on equity among all companies in its industry and is currenly undervalued according to the GF Value chart.
About Sherwin-Williams
By market cap, Sherwin-Williams is the biggest paint company in the world at $57.57 billion. Full-year 2022 revenue came in at $22.14 billion. Based in Cleveland, Ohio, it was founded in 1866 and incorporated in 1884. According to its 10-K for 2022, it is “engaged in the development, manufacture, distribution and sale of paint, coatings and related products to professional, industrial, commercial and retail customers primarily in North and South America with additional operations in the Caribbean region, Europe, Asia and Australia.”
It operates through four market segments. The Americas Group operates 4,931 stores in North and South America and the Caribbean region. Those stores distribute and sell architectural and industrial paints to contractors and do-it-yourself homeowners. It represented 57.2% of 2022 revenue. The Consumer Brands Group manufactures and supplies paint and other products to retailers and distributors in North America, China and Europe. According to the company, “Approximately 67% of the total sales of the Consumer Brands Group in 2022 were intersegment transfers of products primarily sold through The Americas Group.” This segment provided 30.7% of 2022 revenue. Performance Coatings Group develops and sells industrial coatings for wood, metal and plastic products. It contributed 12.1% of 2022 revenue. Administrative Group covers the administrative expenses of corporate headquarters, as well as certain expenses related to closed facilities and environmental issues. It is not a contributor to revenue.
Competition
Sherwin-Williams faces competition in all three segments from a variety of players. Among the publicly traded competitors are PPG Industries Inc. (PPG, Financial) and RPM International Inc. (RPM, Financial). This chart from its 10-K shows the company ahead of both the S&P 500 and a peer group in terms of cumulative returns:
Financial strength
The company's interest coverage ratio currently stands at 7.56, which is adequate but not comforting. The Altman Z-Score is 3.39, which again meets the saftey threshold, but could slip from the safe zone to the grey zone (below 3.0).
More reassuring news comes from the debt-to-revenue ratio. With short- and long-term debt at $10.570 billion and 2022 revenue at $22.149 billion, the debt-revenue ratio is 47.72.
From a broader perspective, the debt burden looks less intimidating when we consider that the company has consistently grown its top and bottom lines over the past decade.
Also, the weighted average cost of capital is lower than the return on invested capital, indicating value creation.
Profitability
Because of the factors in the chart below as well as the 5 out of 5 stars business predictability ranking, Sherwin-Williams gets a full 10 out of 10 GuruFocus profitability rating:
The Piotroski F-Score is 6 out of 9. Note, too, the extremely high return on equity of 80.19%. While that might seem high, it is not too far out of the ordinary for Sherwin-Williams. Its ROE has fluctuated between 30.05% and 113.05% over the past 13 years. That’s exponentially better than the chemical industry median of 9.09%.
Growth
Sherwin-Williams' growth of revenue, Ebitda and earnings per share without non-recurring items are about average for the chemical industry. Over the past three years, revenue has grown by an average of 5.5% per year, Ebitda by 10.4% and EPS without NRI by 13%.
The consistency of profitability was somewhat bumpy for a few years, but since then Sherwin-Williams has put EPS without NRI back on track:
Free cash flow was relatively consistent, then dropped off considerably in the past two years:
In its fourth quarter 2022 earnings release, the company explained,
“The Company generated $1.92 billion in net operating cash during the year. This strong cash generation, along with an increase in our short-term borrowings and long-term debt, allowed the Company to return cash of approximately $1.50 billion to our shareholders in the form of dividends and share repurchases, and close five acquisitions during the year. The Company purchased 3.4 million shares of its common stock during the year."
Dividends and repurchases
Based on the share price of $219.44 at the close on March 1, the dividend yield is 1.13%, which is below the S&P 500 average of 1.59% (for February 2023). The 2022 annual dividend marked the 44th consecutive year of increases.
Still, shareholders get a decent return because of share buybacks, which have averaged 2.2% per year over the past three years.
Valuation
As mentioned prior, the company is undervalued based on its GF Value chart. However, we get a modestly overvalued read when considering price-earnings ratio of 28.42, which is well above 17.27 median for the industry, and the PEG ratio of 2.31, which is slightly into overvalued territory.
The 10-year price chart shows the current price well below its recent highs and its trendline:
Gurus
12 gurus held positions in Sherwin-Williams at the end of 2022. According to 13F filings, the three largest stakes were those of Diamond Hill Capital (Trades, Portfolio) with 792,709 shares, Mairs and Power (Trades, Portfolio) with 568,906 shares and Steven Cohen (Trades, Portfolio) of Point72 Asset Management with 262,850 shares.
Institutional investors owned 68.23% of shares outstanding, while insiders held 0.92%. Among the insiders, Chairman and CEO John Morikis had the largest holding, 231,344 shares.
Investors should be aware that 13F filings do not give a complete picture of a firm’s holdings as the reports only include its positions in U.S. stocks and American depository receipts, but they can still provide valuable information. Further, the reports only reflect trades and holdings as of the most-recent portfolio filing date, which may or may not be held by the reporting firm today or even when this article was published.
Conclusion
Sherwin-Williams may operate a simple business, but it is one that has been rewarding shareholders throughout its history, and I expect it to do the same in the next five to 10 years. Its ROE is particularly attractive, although its debt load is not. Overall, I see it as a good business currently trading at a bargain price.
