Business Context and Reporting Period
The Sherwin-Williams Company develops, manufactures, distributes and sells paints, coatings and related products to professional, industrial, commercial and retail customers. Reportable segments are Paint Stores, Consumer, Global Finishes and Latin America Coatings. This unaudited Form 10-Q covers the three and six months ended June 30, 2016, compared with the corresponding 2015 periods.
Key Financial Metrics
| Metric | Three Months 2016 | Three Months 2015 | Six Months 2016 | Six Months 2015 |
|---|---|---|---|---|
| Net sales | $3.220 billion | $3.132 billion | $5.794 billion | $5.582 billion |
| Gross profit | $1.636 billion | $1.530 billion | $2.898 billion | $2.662 billion |
| Gross margin | 50.8% | 48.8% | 50.0% | 47.7% |
| Income before taxes | $539.2 million | $507.8 million | $755.6 million | $701.0 million |
| Net income | $378.1 million | $349.9 million | $542.9 million | $481.3 million |
| Diluted EPS | $3.99 | $3.70 | $5.76 | $5.07 |
| EBITDA | $630.1 million | $569.6 million | $920.9 million | $824.6 million |
- Net operating cash flow was $510.0 million for the first six months, compared with $349.0 million in 2015. Capital expenditures were $114.1 million, cash dividends were $155.7 million, and net investing cash usage was $149.0 million.
- Cash and cash equivalents were $402.7 million at June 30, 2016, versus $75.1 million at June 30, 2015. The current ratio was 1.33, compared with 0.89 a year earlier.
- Total debt was approximately $1.971 billion, or 61.3% of total capitalization, versus approximately $2.279 billion and 75.1% a year earlier. Remaining short-term borrowing capacity was $2.221 billion.
- Shareholders’ equity was $1.247 billion at June 30, 2016, compared with $757.3 million a year earlier. The quarterly dividend increased to $0.84 per share from $0.67.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 2.8% and first-half sales increased 3.8%, primarily due to higher paint volume in the Paint Stores Group. Comparable-store sales increased 5.2% in the quarter and 7.0% in the first half.
- Paint Stores sales increased 6.2% in the quarter and 8.0% in the first half; segment income before taxes increased 17.4% and 25.0%, respectively.
- Consumer sales declined 2.6% in the quarter but increased 1.6% in the first half. Global Finishes sales declined 1.3% and 2.3%, while segment profitability increased 13.9% and 18.4%.
- Latin America Coatings sales declined 11.2% in the quarter and 18.3% in the first half, with segment losses of $9.6 million and $10.6 million, compared with profits in the 2015 periods. Unfavorable currency translation materially affected foreign results.
- Gross margin expanded by 200 basis points in the quarter and 230 basis points in the first half, primarily from higher paint volume, improved operating efficiency, lower raw-material costs in Global Finishes and cost control.
- SG&A increased to 32.7% of sales in the quarter and 35.5% in the first half, partly due to new-store activity and $35.6 million of Valspar-related expenses in the first half.
- Interest expense increased by $28.0 million in the quarter and $41.4 million in the first half due to debt issued in July 2015 and amortization of 2016 credit-facility costs.
- Early adoption of ASU 2016-09 reduced income-tax expense and increased first-half net income by $29.7 million, including a $0.28 diluted EPS benefit.
Outlook, Unusual Items, Risks and Contingencies
- The company announced a planned all-cash acquisition of Valspar for $113 per share, valued at approximately $9.5 billion plus assumed debt. It obtained committed financing consisting of a $7.3 billion bridge facility and a $2.0 billion term loan; no amounts had been drawn at June 30. The transaction remained subject to shareholder, regulatory and other closing conditions.
- If required divestitures exceed $650 million of net sales, consideration would be reduced to $105 per share; the company is not required to close if required divestitures exceed $1.5 billion of net sales. Management identified integration, financing, regulatory, synergy and additional leverage risks.
- The company entered into interest-rate locks with a combined notional amount of $3.6 billion. A $174.7 million liability and related pretax loss were recorded in accumulated other comprehensive loss.
- Environmental accruals totaled approximately $165.5 million, including $143.0 million in long-term liabilities and $22.5 million in current accruals. The unaccrued maximum of the estimated range of possible environmental outcomes exceeded the recorded minimum by $83.9 million. Management stated that timing and ultimate costs remain uncertain.
- The company has not accrued amounts for lead-pigment and lead-based-paint litigation. A California judgment held the company jointly and severally liable for $1.15 billion for abatement, but the judgment was stayed pending appeal. The company stated that a loss was not considered probable and that the potential loss could not be estimated.
- The company was in compliance with its 3.50-to-1.00 leverage covenant at June 30, 2016. Default and cross-default provisions could accelerate debt maturities if triggered.
- No specific earnings or revenue guidance was provided in the filing. Management described liquidity and operating cash flow as strong but cautioned that results are exposed to economic conditions, raw-material costs, foreign exchange, regulation, litigation, weather and acquisition execution.
Important Facts for Investors to Verify
- Confirm the status, regulatory remedies, financing and eventual closing terms of the Valspar acquisition, including any required divestitures.
- Assess the effect of Valspar-related costs, interest-rate locks and expected acquisition debt on future interest expense, leverage and cash flow.
- Monitor Paint Stores momentum and whether gross-margin expansion offsets higher SG&A and acquisition-related costs.
- Review foreign-exchange exposure and the continued weakness in Latin America Coatings and other international operations.
- Track environmental accruals, the California lead-paint appeal and other litigation because the filing states that material adverse outcomes cannot be estimated.
- Separate the $29.7 million ASU 2016-09 tax benefit from underlying operating earnings when evaluating year-over-year profit and EPS growth.