01—Abstract
Summary
Summary of the 10-K filed February 23, 2018. Cited figures are marked; the original filing is the authoritative source.
Sherwin-Williams (SHW) reported a transformational 2017 driven by its $8.9 billiona all-cash acquisition of The Valspar Corporation, which closed June 1, 2017.
Net sales rose 26.4% to $14.98 billionb (core operations, excluding Valspar, grew 5.6%), and diluted EPS from continuing operations was $19.11, boosted by a one-time $668.8 million deferred tax benefit from the Tax Cuts and Jobs Act and subsidiary mergers (about $7.04 per share). Excluding that benefit, the effective tax rate was 25.1%, and acquisition costs, purchase accounting, and new Valspar interest expense weighed on results. Total reported diluted EPS was $18.67 after a $41.5 million loss from discontinued operations (the divested industrial wood coatings business).
Gross margin fell to 45.3% from 50.0%, largely due to acquisition inventory adjustments and higher raw material costs. The balance sheet changed materially. Total debt rose to $10.5 billionc from $1.95 billion, and total debt-to-capitalization climbed to 74.0% from 51.0%.
Goodwill and intangibles increased by roughly $11 billiond combined, and total assets reached $19.96 billion. Operating cash flow was $1.88 billion and free cash flow (management's definition) was $1.34 billion. Management held the annual dividend at $3.40 for 2017 and increased the quarterly dividend to $0.86 in February 2018, while noting it is temporarily modifying its payout practice.
The company stated it was in compliance with its 5.25x leverage covenant. The key investor watch items are the Valspar integration and synergy realization, deleveraging from elevated debt levels, and the lead pigment litigation. The Santa Clara County public nuisance judgment, which the company has not accrued and cannot reasonably estimate, was affirmed in part on appeal (pre-1951 residences) and remains a potential exposure, with the company stating it may be jointly and severally liable for the full abatement fund, which was originally $1.15 billion.
02—Key points
Key Highlights
- Net sales rose 26.4% to $14.984 billion, with Valspar contributing from June 1, 2017; core Sherwin-Williams sales grew 5.6% excluding Valspar.
- Diluted EPS from continuing operations was $19.11, including a one-time $7.04/share benefit from Tax Act and subsidiary-merger deferred tax reductions; diluted net EPS was $18.67.
- Gross profit margin fell to 45.3% from 50.0%, driven by acquisition inventory purchase accounting, higher raw material costs, and Valspar mix.
- Total debt increased to $10.521 billion from $1.953 billion, and debt-to-capitalization rose to 74.0% from 51.0%, reflecting the $8.9 billion Valspar acquisition financing.
- Operating cash flow of $1.884 billion and free cash flow of $1.342 billion (management-defined) both improved year over year.
- Store and branch footprint expanded: 4,620 company-operated paint stores (101 net new) and 290 Performance Coatings branches.
- Lead pigment litigation remains unaccrued; the Santa Clara County $1.15 billion abatement judgment was partly affirmed on appeal and the California Supreme Court denied review in February 2018.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2017, Sherwin Williams Co kept $0.12.
- Revenue$14.98B100.0%
- Cost of revenue−$8.27B55.2%
- Gross profit$6.72B44.8%
- Operating costs−$4.48B29.9%
- Operating income$2.24B14.9%
- Interest, other & tax−$507.2M3.4%
- Net income$1.73B11.5%
04—Financials
Financial Highlights
Figures from 10-KFY2017filed February 23, 2018Financial Statements
FY2017 against FY2016
| Line item | FY2017FY2016 | Change |
|---|---|---|
| Revenue | $14.98B$11.86B | +26.4% |
| Cost of Revenue | $8.26B$5.93B | +39.3% |
| Gross Profit | $6.72B$5.92B | +13.5% |
| R&D Expenses | $58.47M$58.04M | +0.7% |
| SG&A Expenses | $4.80B$4.14B | +15.9% |
| Operating Income | $2.24B$2.16B | +3.3% |
| Interest Expense | $263.50M$154.09M | +71.0% |
| Net Income | $1.73B$1.13B | +52.5% |
| EPS (Basic) | $6.20$4.11 | +50.9% |
| EPS (Diluted) | $6.07$4.00 | +51.8% |
| Shares Outstanding (Basic) | 278.73M275.52M | +1.2% |
| Shares Outstanding (Diluted) | 284.78M283.46M | +0.5% |
05—Questions
Frequently Asked Questions
How did the Valspar acquisition change Sherwin-Williams' financial profile?
The $8.9 billion acquisition, completed June 1, 2017 and funded mainly by $6.0 billion of senior notes and a $2.0 billion term loan, nearly doubled the company's size. It added roughly $2.46 billion of 2017 sales, about $5.7 billion of goodwill, and about $6.0 billion of intangible assets, while raising total debt to $10.5 billion and reducing shareholders' equity-to-assets ratio. Management also reorganized into three reportable segments: The Americas Group, Consumer Brands Group, and Performance Coatings Group.
Is the 2017 EPS growth sustainable, given the tax benefit?
No. Diluted EPS from continuing operations of $19.11 included a one-time $7.04 per share benefit from the Tax Act and subsidiary mergers. Excluding that, underlying EPS was materially lower, and 2017 also absorbed about $3.00 per share in acquisition costs and purchase accounting charges. Investors should look at the 2018 run-rate, which will carry higher amortization and interest expense, and the synergy progress from Valspar.
How much debt does the company carry and what are the risks?
Total debt was $10.521 billion at December 31, 2017, with long-term debt of $9.886 billion. Interest expense rose to $263 million from $154 million, and interest coverage fell to 6.8x from 11.4x. The company disclosed it could be downgraded by rating agencies, which would raise borrowing costs and could limit commercial paper access. It was in compliance with its 5.25x leverage covenant.
What is the financial exposure from the lead pigment litigation?
The Santa Clara County, California public nuisance case resulted in a $1.15 billion abatement judgment against the company jointly and severally with two other defendants. The Sixth District Court of Appeal affirmed liability for pre-1951 residences and remanded for recalculation of the fund. The company believes it is probable a loss has occurred but cannot reasonably estimate the range, so it has not accrued an amount and could ultimately be liable for the full fund. Other lead-related suits are also pending, and no accrual has been recorded for them.
Did the company change its shareholder return policy?
Dividends continued to grow, with the 2017 annual dividend at $3.40 per share, the thirty-ninth consecutive year of payments. However, management said it is temporarily modifying its practice of paying 30% of the prior year's diluted EPS, and in February 2018 raised the quarterly dividend to $0.86, implying an annual 2018 dividend of $3.44 if maintained, which is only about 18.4% of 2017 diluted EPS. No open-market share repurchases were made in 2017, leaving 11.65 million shares authorized.
06—Continue