Sherwin-Williams Company — Form 10-Q Summary
Business context and reporting period
The filing covers the three and nine months ended September 30, 2018. Sherwin-Williams develops, manufactures, distributes and sells paints, coatings and related products through The Americas Group, Consumer Brands Group and Performance Coatings Group. Results include the Valspar acquisition, completed June 1, 2017, with five additional months of Valspar results included in the first nine months of 2018 versus the comparable 2017 period.
Key financial metrics
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|---|---|---|---|
| Net sales | $4.731 billion | $4.507 billion | $13.470 billion | $11.004 billion |
| Gross profit | $2.010 billion | $1.902 billion | $5.736 billion | $4.979 billion |
| Gross margin | 42.5% | 42.2% | 42.6% | 45.3% |
| Income from continuing operations | $354.0 million | $316.6 million | $1.008 billion | $916.4 million |
| Diluted EPS | $3.72 | $3.33 | $10.59 | $9.67 |
| Net operating cash flow | Not separately provided | Not separately provided | $1.431 billion | $1.259 billion |
| EBITDA from continuing operations | $655.7 million | $670.3 million | $1.985 billion | $1.698 billion |
Q3 income before taxes was $416.0 million, compared with $427.7 million in the prior-year quarter. The effective tax rate declined to 14.9% from 26.0%; the reduction primarily reflected the Tax Cuts and Jobs Act and included a $17.4 million favorable tax benefit from completion of the 2017 U.S. tax return. SG&A declined to 26.9% of sales from 29.0%. Nine-month SG&A declined to 28.2% from 31.6%, while nine-month gross margin contracted because of Valspar mix, higher raw-material costs and supply-chain costs.
Liquidity, debt and capital allocation
- Cash and cash equivalents were $181.5 million at September 30, 2018, versus $207.9 million a year earlier.
- Total debt was $9.672 billion, down $1.278 billion year over year and representing 70.9% of total capitalization, versus 80.0% at September 30, 2017.
- Short-term borrowing capacity remaining was $2.882 billion. The company reported $467.7 million of commercial paper borrowings and $150.0 million outstanding under credit agreements.
- The current ratio was 1.04, compared with 1.07 a year earlier and 1.12 at December 31, 2017.
- Capital expenditures were $166.2 million through nine months. The company paid $242.5 million in dividends and repurchased $368.3 million of stock.
- The company amended and expanded credit facilities during 2018, including a new five-year $2.0 billion credit agreement and increases to other facilities.
- The company was in compliance with its 4.75-to-1.00 consolidated leverage covenant at September 30, 2018.
Material changes versus the prior comparable period
- Q3 sales increased 5.0%, driven primarily by higher paint volume in The Americas and Consumer Brands Groups and price increases. Currency translation reduced sales by 1.1%, and ASC 606 reduced reported sales by approximately 0.8%.
- Nine-month sales increased 22.4%, primarily due to incremental Valspar sales, higher paint volume and price increases.
- Segment sales increased in Q3 by 5.0% in The Americas Group, 6.5% in Consumer Brands and 4.2% in Performance Coatings. Nine-month increases were 6.4%, 39.3% and 56.4%, respectively.
- Q3 segment profit increased in all operating segments, but consolidated pretax income declined because of the $136.3 million California litigation accrual, acquisition-related interest and amortization.
- Acquisition-related costs and purchase-accounting amortization reduced Q3 net income by $111.7 million and nine-month net income by $346.9 million; related interest expense was $66.6 million and $204.4 million, respectively.
- ASC 606 reclassified certain advertising support from SG&A to a reduction of revenue. The nine-month effect was $87.2 million, with no impact on net income.
Guidance, outlook, risks and unusual items
- The filing does not provide a specific sales or EPS forecast. Management stated that liquidity and cash flow remained strong and that available borrowing capacity was sufficient for current operating needs.
- Management expects a $41 million to $61 million pension settlement charge, with approximately $20 million expected in the fourth quarter of 2018 and the remainder in 2019. Actual charges may fall outside that range.
- California lead-paint litigation: the company accrued $136.3 million, representing one-third of the $409.1 million abatement fund determined by the trial court. Because of joint and several liability, the company could potentially be responsible for the full fund; the ultimate amount and payment timing remain uncertain. The U.S. Supreme Court denied the company’s review petition in October 2018.
- Environmental accruals included $209.9 million for extended activities and $27.0 million for current investigation and remediation. The unaccrued maximum of estimated possible outcomes exceeded the minimum estimate by $99.6 million.
- Lead pigment and lead-based paint litigation remains subject to potentially material, unaccrued claims. Management cannot estimate the potential exposure.
- A California air-quality regulator proposed an approximately $1.5 million penalty relating to alleged excess emissions; the company disputes certain allegations and planned negotiations.
- The company expects the new lease standard, effective January 1, 2019, to materially affect the consolidated balance sheet, primarily through recognition of retail operating lease assets and liabilities.
- Key operating risks include raw-material and energy costs, foreign currency, economic and retail conditions, customer and supplier relationships, acquisition integration and synergies, environmental regulation, litigation, competition, adverse weather and natural disasters.
- Valspar represented $3.4 billion of nine-month sales and $2.7 billion of assets, but was not yet included in management’s internal-control assessment; inclusion was planned for December 31, 2018.
Important facts for investors to verify
- Reconcile reported growth with the effects of Valspar inclusion, ASC 606 revenue reclassification, currency translation and price versus volume changes.
- Assess normalized earnings excluding the California litigation accrual, acquisition-related costs, purchase-accounting amortization and favorable tax effects.
- Monitor debt maturities, commercial paper usage, leverage covenant headroom and available credit capacity.
- Track the final California abatement liability and any developments in broader lead-paint litigation and insurance coverage.
- Verify the timing and amount of pension settlement charges expected in late 2018 and 2019.
- Evaluate the impact of raw-material inflation, supply-chain costs and Consumer Brands margin pressure.
- Assess the balance-sheet effect of adopting the lease standard on January 1, 2019.