01—Abstract
Summary
Summary of the 10-K filed February 22, 2019. Cited figures are marked; the original filing is the authoritative source.
The Sherwin-Williams Company (SHW) reported record-scale results for 2018, driven largely by the July 2017 Valspar acquisition (closed June 1, 2017 for about $8.9 billiona).
Net sales rose 17.0% to $17.534 billionb from $14.984 billion, with incremental Valspar sales contributing 12.4 points of growth, higher Americas paint volume, and selling price increases. Gross margin compressed to 42.3% from 44.8% on raw material inflation, a full year of Valspar mix, and a new customer program's supply chain costs. Diluted EPS from continuing operations fell to $11.67 from $18.64 (and $18.20 total in 2017, which included a one-time $7.04/share tax benefit), while the company absorbed $4.15/share of acquisition-related costs plus about $2.71/share of non-operating charges, including a $167.6 million environmental provision, a $136.3 million California lead-paint litigation charge, and a $37.6 million pension settlement.
Balance sheet and cash flow were the strongest part of the story. Net operating cash flow was a record $1.944 billionc, and free cash flow (operating cash less capex and dividends, as defined by management) was $1.370 billion. Management used this cash to reduce total debt by about $1.18 billion to $9.344 billion, repurchase $613 million of stock, and pay $323 million in dividends.
Total debt to capitalization improved to 71.5% from 74.3%, though leverage remains elevated. The Board raised the quarterly dividend to $1.13d per share in February 2019, implying $4.52 annualized for 2019.
Key risks for investors include the lead pigment and lead-based paint litigation, particularly the Santa Clara County, California public nuisance judgment, where the company has accrued $136.3 million but acknowledges joint and several liability could expose it to the full abatement fund. Other risks include ongoing environmental remediation exposure at four major sites, integration of Valspar synergies, rising raw material and petrochemical costs, cyclical housing and construction demand, and a pending SCAQMD civil complaint seeking an initial $30 million in penalties.
02—Key points
Key Highlights
- Net sales grew 17.0% to $17.53 billion, with Valspar contributing 12.4 percentage points of growth; Performance Coatings sales rose 39.4% and Consumer Brands rose 27.1%.
- Gross margin fell to 42.3% from 44.8% due to raw material inflation, Valspar mix, and supply chain costs for a new customer program.
- Diluted EPS from continuing operations dropped to $11.67 from $18.64, pressured by $4.15/share of acquisition costs, $1.32/share of environmental provisions, $1.09/share of California litigation expense, and $0.30/share of pension settlement expense.
- Record net operating cash of $1.944 billion and free cash flow of $1.370 billion supported $1.18 billion of debt reduction, $613 million of share repurchases, and $323 million of dividends.
- Total debt fell to $9.344 billion and debt-to-capitalization improved to 71.5% from 74.3%; the company remained in compliance with its 4.75x leverage covenant.
- Quarterly dividend raised to $1.13 per share in February 2019 (about $4.52 annualized), extending a 40-year record of consecutive annual dividend payments.
- Material litigation exposure: $136.3 million accrued for the Santa Clara County lead abatement judgment, with joint and several liability creating potential exposure to the full abatement fund, and an unaccrued maximum environmental exposure of $117.5 million.
03—One dollar
Follow one dollar
Of each $1.00 of revenue in FY2018, Sherwin Williams Co kept $0.06.
- Revenue$17.53B100.0%
- Cost of revenue−$10.12B57.7%
- Gross profit$7.42B42.3%
- Operating costs−$4.81B27.4%
- Operating income$2.61B14.9%
- Interest, other & tax−$1.50B8.6%
- Net income$1.11B6.3%
Where FY2018 revenue went
$17.53B- Cost of revenue: $10.12B, 58% of revenue
- SG&A: $5.03B, 29% of revenue
- Net income: $1.11B, 6.3% of revenue
- R&D: $51.9M, 0.3% of revenue
- Interest, other & tax: $1.50B, 8.6% of revenue
Kept 6.3% as net incomeNet income $1.11B · 6.3%R&D $51.9M · 0.3%
Full revenue history →04—Financials
Financial Highlights
Figures from 10-KFY2018filed February 22, 2019Financial Statements
FY2018 against FY2017
| Line item | FY2018FY2017 | Change |
|---|---|---|
| Revenue | $17.53B$14.98B | +17.0% |
| Cost of Revenue | $10.12B$8.26B | +22.4% |
| Gross Profit | $7.42B$6.72B | +10.4% |
| R&D Expenses | $51.92M$58.47M | −11.2% |
| SG&A Expenses | $5.03B$4.80B | +4.9% |
| Operating Income | $2.61B$2.24B | +16.8% |
| Interest Expense | $366.70M$263.50M | +39.2% |
| Net Income | $1.11B$1.73B | −35.8% |
| EPS (Basic) | $3.97$6.20 | −35.9% |
| EPS (Diluted) | $3.89$6.07 | −35.9% |
| Shares Outstanding (Basic) | 278.98M278.73M | +0.1% |
| Shares Outstanding (Diluted) | 284.96M284.78M | +0.1% |
05—Questions
Frequently Asked Questions
Why did Sherwin-Williams' earnings per share decline sharply in 2018 despite strong sales growth?
Diluted EPS from continuing operations fell to $11.67 from $18.64 in 2017. The 2017 figure included a one-time $7.04/share benefit from U.S. tax reform, so the comparison is distorted. Excluding that benefit, 2017 EPS was roughly $11.60, and 2018 results absorbed about $6.46/share of acquisition costs, environmental provisions, California litigation, and pension settlement charges. Gross margin compression from raw material costs and higher interest expense ($367 million, up $103 million) also weighed on results.
How significant is the California lead paint litigation for investors?
The Santa Clara County public nuisance judgment held the company jointly and severally liable for a $1.15 billion abatement fund, later reduced by the trial court to $409.1 million. The company has accrued $136.3 million, one-third of the fund, but acknowledges it could ultimately be liable for the full amount if co-defendants cannot pay. Separately, the company faces Pennsylvania county suits and personal injury cases for which it has not accrued amounts, so the total litigation exposure cannot currently be estimated.
Is Sherwin-Williams' debt load manageable?
Total debt of $9.3 billion remains high relative to equity of $3.7 billion, and interest coverage fell to 4.7x from 6.6x. However, free cash flow of $1.37 billion covers dividends and reduces debt, and the company reduced total debt by $1.18 billion during 2018. The company has $3.2 billion of remaining short-term borrowing capacity and no specific long-term external financing needs for 2019 capital expenditures, but its ability to service debt depends on sustained cash generation.
What are the main drivers of growth and the risks to the 2019 outlook?
Growth drivers include a full year of Valspar sales, continued store expansion (targeting about 2.5% annual growth in The Americas Group), selling price increases, and pension cost savings expected in 2019 after the 2018 plan termination. Risks include rising titanium dioxide and petrochemical feedstock costs, cyclical housing and construction demand as mortgage rates rise, realization of Valspar cost synergies, integration execution, and potential adverse developments in lead litigation and environmental remediation.
06—Continue