Sherwin-Williams Company: Q2 2018 Form 10-Q Summary
Business Context and Reporting Period
The Sherwin-Williams Company develops, manufactures, distributes and sells paints, coatings and related products through The Americas Group, Consumer Brands Group and Performance Coatings Group. This unaudited Form 10-Q covers the three and six months ended June 30, 2018, compared with the corresponding 2017 periods.
Results include the full-period impact of the June 1, 2017 acquisition of The Valspar Corporation. Valspar contributed $1.216 billion of sales in the second quarter and $2.284 billion in the first six months of 2018.
Key Financial Metrics
| Metric | Q2 2018 | Q2 2017 | Six Months 2018 | Six Months 2017 |
|---|---|---|---|---|
| Net sales | $4.774 billion | $3.736 billion | $8.739 billion | $6.497 billion |
| Gross profit | $2.039 billion | $1.735 billion | $3.725 billion | $3.078 billion |
| Gross margin | 42.7% | 46.4% | 42.6% | 47.4% |
| Net income from continuing operations | $403.6 million | $360.7 million | $653.7 million | $599.8 million |
| Diluted EPS | $4.25 | $3.36 | $6.86 | $5.90 |
| Operating cash flow | Not separately provided | Not separately provided | $579.1 million | $586.1 million |
| EBITDA from continuing operations | $778.0 million | $645.0 million | $1.330 billion | $1.028 billion |
SG&A increased in dollars but declined as a percentage of sales to 27.4% from 30.9% in the quarter and to 28.9% from 33.3% year to date, primarily reflecting Valspar administrative synergies. Effective tax rates declined to 25.0% from 29.1% in the quarter and to 22.3% from 26.5% year to date, primarily due to the Tax Cuts and Jobs Act.
At June 30, 2018, cash and cash equivalents were $155.0 million, total debt was approximately $10.375 billion, shareholders’ equity was $3.747 billion and the current ratio was 1.20. Remaining short-term borrowing ability was $1.985 billion. The company reported compliance with its 4.75-to-1.00 leverage covenant.
Material Changes Versus the Prior Comparable Period
- Second-quarter sales increased 27.8%; first-half sales increased 34.5%, primarily from Valspar, higher pricing and increased paint volume.
- Performance Coatings sales increased 79.9% in the quarter and 108.5% year to date; Consumer Brands sales increased 45.0% and 66.8%, respectively; The Americas Group increased 7.7% and 7.2%.
- Gross margin declined 370 basis points in the quarter and 480 basis points year to date, primarily because of the acquisition mix, higher raw-material costs and, in the quarter, unfavorable currency impacts.
- Interest expense increased $36.8 million in the quarter and $102.6 million year to date due primarily to acquisition-related debt. Amortization increased $45.0 million and $123.9 million, respectively, due to acquired intangible assets and purchase accounting.
- Total debt declined $1.129 billion from June 30, 2017 and $145.8 million from December 31, 2017. Cash flow from operations was broadly stable despite increased working-capital requirements.
- The company repurchased 850,000 shares during the first six months and paid $161.6 million in dividends. The quarterly dividend increased to $0.86 per share.
- 2017 included a $41.5 million tax charge, or approximately $0.44 per diluted share, from the divestiture of Valspar’s North American industrial wood coatings business; no comparable discontinued-operation charge occurred in 2018.
Outlook, Commentary, Risks and Unusual Items
Management characterized financial condition, liquidity and cash flow as strong and stated that available cash and borrowing capacity were sufficient for current operating needs. No specific full-year sales or earnings guidance was provided in the filing text.
- Management expects continued benefits from Valspar integration and administrative synergies, but cautioned that acquisition integration and achievement of expected synergies remain risks.
- Raw-material and energy prices, competitive pricing, foreign currency movements, interest rates, economic conditions, weather and natural disasters could affect results.
- Environmental accruals totaled approximately $242.1 million at June 30, 2018. The unaccrued maximum of the estimated range of possible environmental outcomes exceeded the recorded minimum by $101.5 million.
- The company faces lead-pigment and lead-based-paint litigation. In the Santa Clara County matter, liability was affirmed for pre-1951 residences, but the abatement amount remained unresolved. Plaintiffs proposed a $730.0 million fund, while the defendants proposed no more than $409.05 million. The company stated that it could ultimately be jointly and severally liable for the full fund and had not accrued a loss because the range could not be reasonably estimated.
- Product warranty accruals were $142.6 million at June 30, 2018. The company closed 11 Americas Group stores and six Performance Coatings branches during the first six months.
- The company expects the new lease standard, effective in 2019, to have a material balance-sheet impact, particularly from retail operating leases.
- On July 19, 2018, after quarter-end, the company entered into a new five-year $2.0 billion credit agreement, replacing an earlier facility and allowing potential increases to $2.75 billion, subject to lender approval.
- Internal control over financial reporting did not yet include Valspar; management stated Valspar would be included in the December 31, 2018 assessment.
Important Facts for Investors to Verify
- Whether gross-margin pressure from raw materials and acquisition mix moderates and whether announced Valspar synergies are realized.
- Debt reduction, interest expense, leverage covenant headroom and refinancing requirements.
- Working-capital trends, especially the $520.5 million increase in accounts receivable during the first six months.
- The ultimate Santa Clara County lead-paint abatement amount and the company’s potential joint-and-several exposure.
- Environmental liability developments and whether the $101.5 million unaccrued range expands.
- The effect of the 2019 lease standard and the completion of Valspar internal-control integration.
- The sustainability of tax benefits from the Tax Cuts and Jobs Act and the effect of future purchase-accounting adjustments.