01—Abstract
Summary
Summary of the 10-K filed February 22, 2017. Cited figures are marked; the original filing is the authoritative source.
The Sherwin-Williams Company (SHW) closed 2016 with record results: net sales rose 4.6% to $11.86 billiona, diluted EPS grew 7.5% to $11.99 (including an $0.86 per-share charge for Valspar acquisition costs and a $0.40 benefit from the ASU 2016-09 tax accounting change), and net operating cash was $1.309 billion, the fourth straight year above $1.0 billion.
Growth was led by the Paint Stores Group, where net sales rose 8.1% on higher architectural paint volume and 94 net new stores; the Latin America Coatings Group was the weak spot, posting a segment loss of $17 millionb that included a $10.7 million goodwill and trademark impairment. Gross margin expanded to 50.0% from 49.0%, though SG&A rose to 35.1% of sales, partly due to new stores and deal costs. The dominant forward-looking issue is the pending $9.3 billion acquisition of The Valspar Corporation at $113 per share in cash, expected to close in early 2017.
The deal is subject to antitrust approvals; if required divestitures exceed $650 millionc in net sales, the per-share price drops to $105, and if they exceed $1.5 billion, Sherwin-Williams can walk away. Committed financing of $9.3 billion (a $7.3 billion bridge and a $2.0 billion term loan) means total debt would rise sharply from about $2.0 billion at year-end 2016, shifting the balance sheet from low leverage toward heavier debt service. Shareholder returns remained substantial, with $312 million in dividends paid and a quarterly dividend raised to $0.85.
Investors should also weigh the company's long-running lead pigment and lead-based paint litigation. The most significant item is the $1.15 billiond public nuisance judgment in Santa Clara County, California, which the company is appealing and has not accrued. Management says it cannot estimate a loss from this litigation, so a negative outcome could be material and is a key uncertainty alongside integration and leverage risk.
02—Key points
Key Highlights
- Net sales rose 4.6% to $11.856 billion in 2016, driven mainly by higher paint volume in the Paint Stores Group (+8.1%) and a 1.1% benefit from a revenue reclassification.
- Diluted EPS increased 7.5% to $11.99; results include an $0.86 charge for Valspar deal costs, offset by a $0.40 benefit from the ASU 2016-09 tax change.
- Gross margin improved to 50.0% from 49.0%, while SG&A rose to 35.1% of sales due to new stores and $58.4 million of acquisition expenses.
- Pending Valspar acquisition at $113 per share in cash (about $9.5 billion) is backed by $9.3 billion of committed financing; price falls to $105 if divestitures exceed $650 million in sales and the deal can be terminated above $1.5 billion.
- Net operating cash was $1.309 billion and free cash flow was $757 million; cash and equivalents rose to $890 million ahead of the deal.
- Total debt was about $1.95 billion at year-end 2016; the Valspar financing would substantially increase leverage.
- A $1.15 billion public nuisance judgment in the Santa Clara County lead pigment case is under appeal, with no amounts accrued and management unable to estimate potential losses.
- Latin America Coatings Group posted a $17 million segment loss, including a $10.7 million goodwill and trademark impairment.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2016, Sherwin Williams Co kept $0.10.
- Revenue$11.86B100.0%
- Cost of revenue−$5.93B50.1%
- Gross profit$5.92B49.9%
- Operating costs−$3.76B31.7%
- Operating income$2.16B18.3%
- Interest, other & tax−$1.03B8.7%
- Net income$1.13B9.6%
04—Financials
Financial Highlights
Figures from 10-KFY2016filed February 22, 2017Financial Statements
FY2016 against FY2015
| Line item | FY2016FY2015 | Change |
|---|---|---|
| Revenue | $11.86B$11.34B | +4.6% |
| Cost of Revenue | $5.93B$5.78B | +2.7% |
| Gross Profit | $5.92B$5.56B | +6.5% |
| R&D Expenses | $58.04M$57.67M | +0.6% |
| SG&A Expenses | $4.14B$3.89B | +6.6% |
| Operating Income | $2.16B$1.96B | +10.2% |
| Interest Expense | $154.09M$61.79M | +149.4% |
| Net Income | $1.13B$1.05B | +7.5% |
| EPS (Basic) | $4.11$3.81 | +7.9% |
| EPS (Diluted) | $4.00$3.72 | +7.5% |
| Shares Outstanding (Basic) | 275.52M276.59M | −0.4% |
| Shares Outstanding (Diluted) | 283.46M283.63M | −0.1% |
05—Questions
Frequently Asked Questions
What is the status of the Valspar acquisition and how could its terms change?
The Company agreed on March 19, 2016 to acquire The Valspar Corporation for $113 per share in cash, with closing expected in early 2017 subject to antitrust approvals. If required divestitures exceed $650 million in net sales, the per-share price falls to $105. Sherwin-Williams is not obligated to close if divestitures exceed $1.5 billion in net sales. The deal is not subject to a financing condition, and $9.3 billion of committed financing has been arranged.
How much debt will Sherwin-Williams carry after the Valspar deal?
Total debt was approximately $1.95 billion at December 31, 2016. The Company expects to incur up to $9.3 billion of additional debt to complete the Valspar acquisition, which would raise total debt substantially and increase interest expense and debt service requirements. Debt-to-capitalization was 51.0% at year-end 2016, and the Company must stay within a leverage covenant of 3.50x, which rises to 5.25x after the acquisition closes.
What is the main litigation risk facing the company?
The most significant exposure is the lead pigment and lead-based paint litigation. In January 2014, a California court in the Santa Clara County case ordered the Company, jointly and severally with two other defendants, to pay $1.15 billion to abate a public nuisance. The Company is appealing and believes the judgment is unsupported. It has not accrued any amounts for this litigation, and management states that it cannot estimate potential losses.
Is the dividend sustainable and how is capital being returned?
The company paid $3.36 per share in dividends for 2016, totaling $312 million, and raised its quarterly dividend to $0.85 in February 2017, implying $3.40 for 2017 if maintained. The Company made no share repurchases in 2016 and had authorization for 11.65 million shares remaining. Management is temporarily modifying its payout policy, and the Valspar financing may constrain future buybacks and dividend increases.
Which business segments drove results in 2016?
The Paint Stores Group generated $7.79 billion in sales (up 8.1%) and $1.62 billion in segment profit (up 13.2%), accounting for most of the growth. The Consumer Group grew sales 0.4% to $1.58 billion, and Global Finishes was down 1.4% to $1.89 billion, though its profit rose 18.4%. The Latin America Coatings Group saw sales fall 7.0% to $587 million and posted a segment loss of $17 million amid currency headwinds and an impairment charge.
06—Continue