Business Context and Reporting Period
The Sherwin-Williams Company 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 months ended March 31, 2020, compared with the three months ended March 31, 2019.
Key Financial Metrics
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Net sales | $4,146.7 million | $4,040.9 million | +2.6% |
| Gross profit | $1,889.7 million | $1,735.1 million | +8.9% |
| Gross margin | 45.6% | 42.9% | +270 basis points |
| Income before income taxes | $392.3 million | $298.9 million | +31.2% |
| Net income | $321.7 million | $245.2 million | +31.2% |
| Diluted EPS | $3.46 | $2.62 | +32.1% |
| Net operating cash flow | $54.9 million | $(36.0) million | Improved $90.9 million |
- SG&A increased to $1,307.6 million from $1,244.0 million, while SG&A as a percentage of sales increased to 31.5% from 30.8%.
- EBITDA, a company-defined non-GAAP measure, increased to $623.1 million from $533.4 million.
- Cash and cash equivalents were $238.5 million at March 31, 2020, compared with $161.8 million at December 31, 2019 and $94.4 million at March 31, 2019.
- Total debt was $9.770 billion, or 74.8% of total capitalization, compared with $8.685 billion and 67.8% at December 31, 2019.
- The company had $2.507 billion of unused borrowing capacity and stated that it remained in compliance with its leverage covenant.
- Capital expenditures were $106.6 million. The company paid $122.9 million in dividends and repurchased $890.3 million of treasury stock.
Material Changes Versus the Prior Comparable Period
- The Americas Group sales increased 7.0% to $2,305.5 million, driven primarily by higher architectural paint volume in North American stores. Comparable U.S. and Canadian store sales increased 7.4%.
- Consumer Brands Group sales declined 4.9% to $622.3 million, primarily due to weaker Asia-Pacific sales and the planned ACE business exit.
- Performance Coatings Group sales declined 1.1% to $1,217.6 million, as weaker demand in portions of Asia-Pacific and Europe and unfavorable currency translation offset growth in packaging and coil businesses.
- Foreign subsidiary sales declined 6.6% to $827.8 million; currency translation reduced consolidated sales by 1.4%.
- Gross margin benefited from higher North American paint volume, price increases and moderating raw-material costs.
- Q1 2020 included a $21.3 million loss on extinguishment of debt. Q1 2019 included a $32.4 million domestic pension settlement charge and $0.08 per share of integration costs, making the year-over-year earnings comparison favorable.
- Shareholders’ equity decreased to $3,289.1 million from $4,123.3 million at December 31, 2019, primarily due to share repurchases, dividends and a $221.6 million increase in accumulated other comprehensive loss.
Guidance, Outlook, Risks and Unusual Items
- Management stated that COVID-19 did not materially adversely affect first-quarter consolidated results but expects the deterioration in U.S. and global economies to adversely affect the business through at least the second quarter. The filing does not provide quantitative full-year earnings or sales guidance.
- The company continued operating stores, manufacturing plants and other facilities because its products were considered essential, while reducing store hours, closing sales floors to the public and shifting to online, phone, curbside and delivery channels.
- Management planned to preserve liquidity by limiting capital expenditures, suspending share repurchases temporarily, reducing discretionary spending and lowering payroll costs.
- COVID-19 risks include weaker demand, store and facility disruptions, supply-chain shortages or delays, higher costs, workforce constraints, customer and supplier failures, asset impairments and reduced access to capital.
- Goodwill and intangible assets were not considered impaired as of March 31, 2020, but management warned that weaker future results or changed valuation assumptions could require impairment charges.
- Environmental accruals totaled approximately $365.9 million, including $308.6 million in other long-term liabilities and $57.6 million in other accruals. The possible unaccrued maximum of estimated environmental costs was $114.0 million above recorded minimum accruals.
- The company maintained a $76.7 million California lead-paint litigation accrual, including $12.0 million current and $64.7 million long-term. Other lead-paint, environmental and personal-injury litigation could produce material additional liabilities, although the filing states that related losses generally cannot currently be estimated.
- The company issued $1.0 billion of senior notes in March 2020: $500.0 million at 2.30% due 2030 and $500.0 million at 3.30% due 2050. Proceeds were primarily used to refinance or repurchase existing debt.
- The company adopted the expected-credit-loss standard on January 1, 2020. The adoption was not material, but first-quarter bad-debt expense included $15.1 million of incremental expected credit losses.
Important Facts for Investors to Verify
- Assess the actual second-quarter and full-year effects of COVID-19 against management’s qualitative outlook.
- Monitor liquidity, short-term borrowings, debt maturities, credit-facility availability and compliance with the 3.75-to-1.00 leverage covenant.
- Verify whether the temporary suspension of share repurchases continued and how capital allocation changed during the pandemic.
- Track gross-margin sustainability, raw-material costs, pricing and demand by reportable segment.
- Review developments in lead-paint litigation, the New Jersey Gibbsboro environmental case, and other environmental contingencies.
- Evaluate potential goodwill, intangible-asset and credit-loss charges if economic conditions weaken further.
- Consider the seasonal nature of the business: management stated that the majority of segment sales traditionally occur in the second and third quarters, so first-quarter results are not indicative of the full year.