Business Context and Reporting Period
The Sherwin-Williams Company manufactures, distributes and sells paints, coatings and related products through three reportable segments: The Americas Group, Consumer Brands Group and Performance Coatings Group. This unaudited Form 10-Q covers the three and nine months ended September 30, 2020, compared with the same periods in 2019.
Key Financial Metrics
| Metric | Q3 2020 | Q3 2019 | Change |
|---|---|---|---|
| Net sales | $5,122.2 million | $4,867.7 million | +5.2% |
| Gross profit | $2,455.3 million | $2,225.6 million | +10.3% |
| Gross margin | 47.9% | 45.7% | +220 bps |
| Income before taxes | $875.6 million | $709.8 million | +23.4% |
| Net income | $705.8 million | $576.5 million | +22.4% |
| Diluted EPS | $7.66 | $6.16 | +24.4% |
| Metric | 9M 2020 | 9M 2019 | Change |
|---|---|---|---|
| Net sales | $13,872.9 million | $13,786.4 million | +0.6% |
| Gross profit | $6,553.9 million | $6,142.1 million | +6.7% |
| Gross margin | 47.2% | 44.6% | +260 bps |
| Income before taxes | $2,015.3 million | $1,684.4 million | +19.6% |
| Net income | $1,623.4 million | $1,292.7 million | +25.6% |
| Diluted EPS | $17.60 | $13.82 | +27.4% |
Third-quarter operating margin before taxes was 17.1%, compared with 14.6% in the prior-year quarter. Nine-month operating margin before taxes was 14.5%, compared with 12.2%. SG&A was 27.5% of sales in the quarter versus 27.6% in the prior year, but increased to 28.9% of sales for the nine-month period from 28.4%.
Nine-month net operating cash flow was $2,563.8 million, up from $1,661.4 million. Capital expenditures were $193.8 million, acquisitions used $72.6 million, dividends paid were $367.8 million, and treasury stock purchases were $1,294.7 million. Cash and cash equivalents were $619.9 million at September 30, 2020, compared with $161.8 million at December 31, 2019.
Total debt was $8,291 million at September 30, 2020, representing 66.3% of total capitalization, compared with $8,685 million and 67.8% at December 31, 2019. The Company reported $3.5 billion of unused borrowing capacity, no borrowings under its revolving credit lines or commercial paper program, and a current ratio of 1.19.
Material Changes Versus the Prior Comparable Period
- The Americas Group sales increased 2.8% in the quarter, supported by residential repaint, do-it-yourself and new residential demand; comparable-store sales in the U.S. and Canada increased 3.1%.
- Consumer Brands Group sales increased 23.5% in the quarter and 14.2% year to date, driven primarily by higher retail customer volumes.
- Performance Coatings Group sales increased 1.2% in the quarter as demand improved, but declined 5.6% year to date because of COVID-19-related weakness and currency effects.
- Gross margin benefited from favorable customer and product mix and moderating raw material costs.
- The 2019 comparable periods included a $34.7 million California litigation benefit, $32.4 million of domestic pension settlement expense, integration costs and a $74.3 million tax provision related to renewable energy tax credit funds. The 2020 period included a $21.3 million loss on debt extinguishment.
- The Company recognized approximately $21 million of incremental bad-debt expense during the first nine months related to the expected effects of COVID-19.
- Shares outstanding declined, and the Company repurchased 2.3 million shares during the first nine months, including 600,000 shares in the third quarter. The quarterly dividend increased from $1.13 to $1.34 per share.
Guidance, Outlook, Commentary and Risks
Management did not provide a specific numerical full-year sales or earnings outlook in the filing. It stated that COVID-19 had not materially adversely affected consolidated results through the first three quarters, but that deterioration in U.S. and global economies could adversely affect future periods. Results are seasonal, with most segment sales traditionally occurring in the second and third quarters.
The Company kept its stores, manufacturing plants and other facilities operating as essential businesses while implementing online and telephone ordering, curbside pickup, delivery, remote work and enhanced health protocols. Management cited strong DIY and residential demand, but noted that architectural and industrial markets recovered at different rates.
- COVID-19 could cause additional facility disruptions, demand volatility, supply-chain interruptions, higher costs, workforce constraints, cybersecurity exposure and impairment of tangible or intangible assets.
- Goodwill and intangible assets were not considered impaired as of September 30, 2020, but management noted that changes in sales forecasts or other assumptions could require future impairment charges.
- Environmental accruals totaled approximately $368.1 million, including $310.5 million in other long-term liabilities and $57.6 million in current accruals. The estimated unaccrued maximum of currently estimable environmental costs was $115.9 million above the minimum accrual.
- California lead-paint litigation accruals totaled $64.7 million at September 30, 2020. Other lead-pigment and lead-paint proceedings remain unresolved and could result in material costs, although no amounts were accrued for most such matters.
- The Company had $8.291 billion of debt and was in compliance with its 3.75-to-1.00 leverage covenant. Interest-rate, foreign-currency and commodity risks remain, although management does not expect them to have a material adverse effect.
Important Facts for Investors to Verify
- Whether COVID-19-related demand strength, especially DIY and residential demand, persists or normalizes in subsequent quarters.
- The sustainability of the substantial gross-margin improvement and the effect of raw material costs, product mix and customer mix.
- Future Performance Coatings demand, foreign-currency effects and recovery in industrial and architectural end markets.
- Debt repayment plans, leverage covenant headroom and the continued availability of the $3.5 billion credit capacity.
- Potential changes to environmental reserves and the ultimate cost and timing of lead-paint, lead-pigment and other litigation.
- Whether future economic conditions trigger goodwill or intangible-asset impairment charges.
- The pace of share repurchases and the Company’s ability to maintain the increased dividend while funding operations and debt obligations.