Business Context and Reporting Period
The Sherwin-Williams Company filed its Form 10-K for the fiscal year ended December 31, 2022. The company develops, manufactures, distributes and sells paint, coatings and related products primarily in North and South America, with additional operations in Europe, Asia, Australia and the Caribbean. Reportable segments are The Americas Group, Consumer Brands Group and Performance Coatings Group, with remaining activities reported as Administrative.
At December 31, 2022, the company operated 4,931 Americas Group stores and 317 Performance Coatings branches and employed 64,366 people worldwide.
Key Financial Metrics
| Metric | 2022 | 2021 | Change |
|---|---|---|---|
| Net sales | $22.149 billion | $19.945 billion | +11.1% |
| Gross profit | $9.325 billion | $8.543 billion | +9.2% |
| Gross margin | 42.1% | 42.8% | -70 basis points |
| Income before income taxes | $2.573 billion | $2.249 billion | +14.4% |
| Net income | $2.020 billion | $1.864 billion | +8.4% |
| Diluted EPS | $7.72 | $6.98 | +10.6% |
| Adjusted diluted EPS | $8.73 | $8.15 | +7.1% |
| Net operating cash flow | $1.920 billion | $2.245 billion | -14.5% |
| Capital expenditures | $644.5 million | $372.0 million | +73.3% |
| Adjusted EBITDA | $3.608 billion | $3.268 billion | +10.4% |
- Segment sales: The Americas Group sales rose 12.9% to $12.661 billion; Performance Coatings sales rose 13.2% to $6.794 billion; Consumer Brands sales declined 1.1% to $2.691 billion.
- Segment profit: The Americas Group generated $2.437 billion, Consumer Brands $225.7 million and Performance Coatings $734.9 million. Consumer Brands profit declined 37.0%, while Performance Coatings profit increased 51.2%.
- Liquidity and working capital: Cash and cash equivalents were $198.8 million. Net working capital was a deficit of $53.0 million, improved from a deficit of $665.8 million, and the current ratio improved to 0.99 from 0.88. Inventory increased to $2.627 billion, with inventory days rising to 98 from 75.
- Debt: Total debt was $10.570 billion, up $954.7 million year over year. Net debt was $10.371 billion, equal to 2.9 times adjusted EBITDA. Unused capacity under committed credit agreements was $2.742 billion.
- Cash deployment: The company spent $1.003 billion on five acquisitions, repurchased $883.2 million of stock and paid $618.5 million in dividends. Free cash flow, defined by the company as operating cash flow less capital expenditures and dividends, was $656.9 million versus $1.286 billion in 2021.
- Shareholder returns: The annual dividend was $2.40 per share, representing the 44th consecutive year of increased dividend payments. The board increased the quarterly dividend to $0.605 per share in February 2023.
Material Changes Versus the Prior Comparable Period
- Sales growth was driven primarily by price increases and higher Americas Group volume, partly offset by lower Consumer Brands and Performance Coatings volumes, unfavorable currency translation and the Consumer Brands divestiture of Wattyl.
- Raw material inflation, including higher petrochemical-derived materials and titanium dioxide costs, reduced gross margin to 42.1% from 42.8%.
- SG&A increased $442.0 million but declined as a percentage of sales to 27.2% from 27.9%, reflecting cost controls and operating leverage.
- Interest expense rose $56.1 million to $390.8 million, primarily because of higher short-term borrowing rates.
- The effective tax rate increased to 21.5% from 17.1%, mainly because of lower employee share-based payment tax benefits and other unfavorable tax changes.
- Operating cash flow declined because of increased working capital requirements, particularly a $666.7 million inventory investment and a $200.2 million increase in accounts receivable.
- The company completed five acquisitions in 2022, primarily expanding Performance Coatings capabilities, and recognized approximately $565.8 million of goodwill and $282.8 million of finite-lived intangible assets from those transactions.
- The company approved a restructuring plan in the fourth quarter focused on simplifying the Consumer Brands operating model and brand portfolio and reducing costs across Consumer Brands, Performance Coatings and Administrative. Total expected restructuring expense is approximately $154.5 million, with most actions expected to be completed by the end of 2023.
- The company recorded $15.5 million of trademark impairment expense in Consumer Brands. No goodwill impairment was recorded.
Guidance, Outlook, Commentary and Risks
Management expects a challenging demand environment in 2023 because of inflation, elevated mortgage rates, weaker housing activity, higher wages, energy and transportation costs, supply-chain constraints and geopolitical conditions. The company expects price increases implemented in 2021 and 2022 to benefit 2023 results and anticipates approximately $50 million to $70 million of annual restructuring savings, with approximately 75% expected by year-end 2023. Management also expects gross-margin expansion from cost controls, continuous improvement and anticipated raw-material cost deflation.
- The company plans to reduce short-term borrowings while generating operating cash and has no long-term debt maturities due in 2023.
- Capital expenditures are expected to exceed 2022 levels, including spending on the new global headquarters, a new research and development center, manufacturing and distribution capacity, stores and information systems.
- The company plans to open 80 to 100 new stores in the United States and Canada in 2023 and continue pursuing strategic acquisitions.
- A December 2022 headquarters sale-leaseback did not qualify as an asset sale and was accounted for as real estate financing. The company received approximately $210 million at closing and expects total proceeds of approximately $800 million to $850 million over the construction period.
- Environmental accruals totaled $290.4 million at year-end, including $240.2 million in long-term liabilities and $50.2 million in current accruals. Management identified an additional unaccrued maximum of estimated environmental outcomes of $94.2 million, although it does not expect environmental matters to materially affect financial condition, liquidity or cash flow over time.
- Lead pigment and lead-based paint litigation remains an unquantified contingency. Except for California public nuisance litigation, the company has not accrued amounts because it does not believe a loss is probable or estimable. An adverse outcome could materially affect earnings, liquidity or financial condition.
- Other principal risks include raw-material shortages and volatility, labor constraints, inflation and recession, housing and construction cyclicality, foreign exchange, cybersecurity, regulatory and environmental compliance, acquisition integration, restructuring execution and access to credit markets.
- Management reported effective disclosure controls and internal control over financial reporting. The independent auditor issued unqualified opinions, although 2022 acquisitions representing approximately 5.0% of total assets and 0.6% of sales were excluded from management’s internal-control assessment.
Important Facts for Investors to Verify
- Verify the sustainability of sales growth and pricing benefits if housing, construction, manufacturing or consumer demand weakens.
- Monitor whether raw-material deflation and restructuring savings offset labor, energy, transportation and financing costs.
- Assess leverage, refinancing needs and the impact of higher interest rates, particularly with $978.1 million of short-term borrowings and approximately $2.151 billion of long-term debt maturities in 2024 and 2025.
- Track inventory normalization, receivables collection and conversion of earnings into operating cash flow.
- Evaluate the integration, purchase-price accounting and performance of the five 2022 acquisitions and the pending SIC Holding acquisition.
- Review restructuring execution, including the expected $154.5 million total expense and projected $50 million to $70 million annual savings.
- Assess the financial exposure from environmental remediation, especially the Gibbsboro site, and from lead pigment and lead-based paint litigation and related insurance coverage disputes.
- Note that beginning with the first-quarter 2023 reporting period, the Latin America Division will move from The Americas Group to Consumer Brands, with prior periods recast for comparison.