The Sherwin-Williams Company (SHW) Earnings Call Transcript & Summary

Good morning, everybody. This is Bob Koort, I run the U.S. equity research effort here at Goldman Sachs on the chemical space. And from my team, I've also -- I've got Anthony Walker, who helps me cover Sherwin-Williams. From the Sherwin-Williams team, we've got John Morikis, Chairman and CEO; we've also got Jim Jaye, who's the Senior VP of IR and Corporate Communications; and Eric Swanson, who's VP of IR. Format, as with all our presentations today, Anthony and I will drill John and the team with questions. We've got a whole boat load lined up, but we'd prefer to ask client questions. So if you have any, on the web chat there, you've got a box where you can submit your question and we will filter those into the discussion. So with that, why don't we get started?

John, if you wouldn't mind, maybe from a high level, just talk about to begin what it is that Sherwin does that's so special or different or unique that gives you this superior growth you've seen in the industry over time? What are those Sherwin-Williams secret weapons, competitive advantages, if you don't mind?

Thank you, Bob, and good morning, everyone. And I'd just like to start by thanking everyone for their interest in Sherwin-Williams, and to wish you and your families continued safety as we continue to work through this very challenging time. Yes, thank you for that question, Bob, because I think it gives us an opportunity to talk a little bit about what we're most proud of. And the idea that we've got such a strong engine in our TAG business would be probably the first thing that I would point to. Over the last several years, we've made significant investments. And that, we believe, has enabled us to grow 1.5 to 2.0x the market. So to your point, we do believe we're outpacing the market in this important business as well as many others. Our view is that we want to invest in areas that give us a competitive advantage. To do that, we have a very focused and defined strategy. So we're not chasing every shiny object out there. The idea here is, is that we look to differentiate ourselves with a unique model and a different approach, avoiding just becoming a commodity, but really driving this simple mindset that we want to bring solutions to our customers. That allows us to be more valuable in their eyes. We do that through our TAG business with over 4,400 stores. So convenience is an important element. We do that with a very strong and determined effort towards the quality of our people. We hire over 1,000 management trainees on average per year. So we're bringing college graduates in where they're learning how to run a business, read a P&L, an income statement and balance sheet in their areas of responsibility and we invest heavily in those people, and we believe that's a key element in differentiation as well. Innovation is another important area. Just in the architectural side alone, Bob, we introduce anywhere from 20 to 25 new products annually, and all driven towards the productivity of our customers, again, solutions. We are investing in areas like our e-commerce platform. That helps our productivity, but it also helps the success of our customers. Right now, we're introducing modules that help customers estimate, to quote, to invoice, even their inventory management. And so again, all focused on their productivity. We've got a terrific infrastructure that we believe is a competitive advantage that we want to build on. When we compete, particularly with larger customers, we're often faced with competition. And these competitors are often promising to build what it is that Sherwin has in place right now. And so if you can imagine, national accounts, for example, that are looking at whatever it might be, property management, new residential, name the type of customer. We've got a store typically within 20 to 30 minutes of wherever they might be in the country. We've got reps covering the entire country. Anything they want to execute on, we can do that through our controlled distribution model 8:00 a.m. the next morning. Very few people have that capability. And that controlled distribution model allows us to execute with inventory, with pricing, service in a very unique way. And finally, I'd say with both leadership and with the quality of people that we have, we're really determined to bring in the right people. We spend a lot of time in hiring the right people. We spend a lot of time developing these people. And then we retain them. Our employee turnover is phenomenal. And with the 4,400 stores, our employee turnover is between 7% and 8%, voluntary turnover. And what that tells you is that we're out there hiring really good quality people, and we give them the opportunity to win and they want to stay. And the more they stay and the more we develop them, the more valuable they become in what we believe is the secret sauce, which is building these relationships built on solutions for our customers that are long standing. We want to be part of our customers' business and have them feel like we're an extension of their business. I referenced a lot of TAG in that response, but the principles are the same across every business we run. We want to be a partner and a part of their success, not a commodity.

It's excellent, very comprehensive. Oman's got great clients. Have a bunch of questions already coming in, so let me go right to those. One asking about with the COVID presenting new decisions by customers, DIY versus contractor-based paint, how do you see those trends playing out in the short, medium and long term? And are there any surveys or other work you guys have been doing to assess that potential shift?

Yes. So as you would expect, we do a lot of surveys and a lot of feedback. We're blessed to have over, well over 3,000 sales reps that are out there every day through a custom-built CRM program, providing us feedback that we mine as well as the market research that we do. Some of what I would tell you, when you think about market research, our customer feedback on service right now through our stores is the highest it's ever been. What's the score? Draw on a blank on that -- Net Promoter Score is the highest it's ever been. And we're really determined to drive that. Now when you -- your question spoke, I think, specifically to the potential of shift to do-it-yourself -- from do-it-yourself to do-it-for-me, if I understood your question. And I would say that our interpretation of that is that there is certainly -- we call it nesting inside Sherwin, which is a result of a lot of people spending more time at home. But we believe the underlying principles are still intact. The aging demographics, the home price appreciation, the aging housing stock. And in the last recession, DIY did grow, but not any huge amounts, and it wasn't protracted. So we think right now, as we look at what's happening, it clearly will play to our advantage on a number of fronts. We've tried to manage the company when we talk about strategy and not shine -- and not just chasing shiny objects. We try to position the company so that if one piece of the business grew, that we were there. Hence, our position at Lowe's and Menards and some of the other retailers. So if the DIY piece grows, and in our stores, by the way, which has been growing very well, we're positioned very well to get that as well as on the other side, the residential piece. As it relates to any shifts in purchasing, we're trying to be the catalyst to those. So we are experiencing a very high utilization rate of people that are using, for example, our online request for color strips, which is fulfilled almost immediately and you receive those at home. The curbside service. We've just been receiving such terrific feedback from our customers on it, as well as the professionals who are using our digital platform at a much, much higher rate. Now I'll give you that it wasn't as high as our in-store relationships, but it's growing significantly, and we think it's going to be an important part of our future. So we actually love this. I mean, these changes in the marketplace give us a terrific opportunity to build on the relationships that we have and become more important to our customers. And it's working exactly as we'd hoped.

So John, e-commerce, certainly, the digital effort you guys have done, starting to gain more traction. Question from a client, and maybe it's like at my house, where at least in the last month, the most traffic on my street seems like it's Amazon vans. So can you talk about your competitive advantage to your peer group through e-commerce? And then is there any sort of threat from Amazon and those types of distributors coming into your markets?

Yes. So I can absolutely talk to it. We think it's a terrific opportunity. And I would say that when we look at this utilization, the ordering online, the invoice review, the project management from the professional side. We'll start with -- we love that. Our goal is on the professional side to leverage the combination of our online platform and our brick-and-mortar in a way that has our customers continue to lean on us in an even greater way than they have in the past. And the ability for these contractors to run their business off of our platform and utilize it for estimating, invoicing, ordering, job pickup, order -- color order reference, reminders for follow-up. I mean, we're utilizing it to help them train their people. And even right now, putting programs together on etiquette in this type of environment. And so there's all types of opportunities, and we believe we're uniquely positioned with an established relationship with customers and the brick-and-mortar in the marketplace to really enhance the experience and increase the stickiness. And that's what we're seeing. As it relates to the do-it-yourself side, obviously, it's a much smaller percentage of our business, it's growing dramatically. And we do believe that it's a terrific opportunity to once again leverage the platform that we have. And so we're testing now in areas, not only color fulfillment and virtual color specification support for DIY customers, but also fulfillment locally from those stores. We're uniquely positioned with these stores in the marketplace, with delivery vehicles in the marketplace and to serve these customers are opportunities that we're clearly exploring. So we're excited about what's down in the pipe here for us.

John, it's Anthony Walker. I did want to dive a little bit into the current environment, and we'll get into some of the headwinds impacting the TAG group as well as the balance of the business. But maybe to start out, we're getting some client questions around raw materials. And help us think through the impact of lower oil prices on your business in both 2020 and 2021? And then maybe more specifically, how the decline in oil potentially impacts your ability to get to the higher end of your longer-term gross margin target of the higher 40% range?

Yes, Anthony, this is Jim. I'll take this one. What I would say is, certainly, with the move in crude, we adjusted our outlook on raw materials for the year. If you remember, back in January, our initial outlook for the year was that raw materials would be flat. When we came out here in April with our results, we revised that and said, raw materials would be down low single digits for the year. The biggest part of our basket, obviously, is the petrochemical derivatives. So as crude translates -- we don't buy crude specifically. But as it goes into the downstream derivatives, propylene, ethylene and then ultimately, the products that we buy that are -- use those as feedstocks. We would expect -- we have been seeing benefit year-over-year, and we're probably going to see additional benefits going into the back half. I think on the TiO2 side, which is the other significant component of our basket, to this point, it's been very stable. We haven't seen a lot of move yet. In this demand environment, we could see some additional TiO2 benefit in the back half, but I think it was a little early to call that right now. So the view is, a low single-digit decline for the year, and perhaps some upside if you see TiO2 move and crude stays in this lower band for a sustained period of time.

And regarding the price, Bob, if I may, I think looking at it historically may give you some information on how we've been able to hold on to this in the past. If you look back, for example, 2010, 2012, I believe, was a period where, if you'll recall, we had that explosive TiO2 pricing experience during that time. And if I'm not mistaken, I think we had 6 price increases in 22 months just to offset the TiO2. It was a pretty challenging time for us. The reason I share that with you is, is because if you fast forward then to 2013 through 2015, when the raw material costs begun to ease, our margin expanded by about 300 basis points as we were able to hold on to that price. And I think a big part of that has to do with a lot of the points I made in answering your first question, the differentiation of Sherwin and how we're focused on the solutions for our customers. And I'll remind you that from a painting contractor's perspective, as an example, roughly 90% -- 85% to -- maybe between 80% and 90% of their costs are labor. So paint represents a pretty small percentage of their total costs. And what we find are, if we're positioning ourselves strategically, as we're determined to continue to do, our customers are willing to pay for that value and service. You might ask, well, why? It's because they make more money when they use us. And that -- earlier, you asked about the research that we do. That's the #1 question I go to in our research. Typically, the last section of the research that we do, who helps you make more money? And that gap is a very important area that we watch, and we try to continue to drive that further and further. The more our customers realize that they make more money with us, the more successful we are, and that's what we're really determined in doing. And that's why all the things we talked about as far as investments and innovation and people and the quality of people and retention of those people and the digital platforms, all of that, that all drives that last section in our research.

That's great. And then obviously, we've all been stuck in our homes for the better part of a month. And I would imagine that in terms of mix, you are seeing increased demand on the exterior side on behalf of professional and maybe some DIY customers as well. Can you just remind us of the mix for Sherwin as it relates to interior versus exterior paints? And then how the price points skew between those. Correct me if I'm wrong, but I think the exterior pricing is actually higher than interior.

Yes, Anthony, this is Jim again. What I would tell you, if you look at the industry as a whole, gallons are about 2/3 interior, 1/3 exterior. Sherwin would skew a little bit more exterior than the industry overall, given our position with national homebuilders and commercial.

Well, and painting contractors are typically doing exterior projects more so than do-it-yourselfers.

Right. And from a pricing standpoint, the pricing on exterior gallons is a little bit higher. Margins pretty similar, though, for interior and exterior products, maybe exterior a little bit better. So you could see some favorable mix as exterior becomes a bigger part of what we're selling.

Great. And then if you could just give us some insight into the recent trends in the business, particularly maybe starting in TAG. How volumes have fared in the month of April? And if you've seen any recovery as we've gotten into early May, and stay-at-home orders in some geographies have started to be lifted, that would be helpful?

Yes, I'd say, we're not updating any guidance, as you know. I would say that what we shared on the call is that the April comparison would be the toughest in the quarter, that we had confidence in our ability as the quarter went on that we would step up, that we expected to begin opening the sales floors of our stores and we expected to see a bump in those stores as we open them. And the best I would say right now would be that it's playing out exactly as we expected.

John, it's Bob again. In the interim, can you just talk about how you're operating those stores when the showroom is not open?

Yes. So that element of our business is -- I gave a lot of credit to our team, if you recall on the call, Bob, because they turned this thing almost immediately, which is really a challenge. And I think it speaks to the power of a controlled distribution model. We decided on Thursday, we were going to go on the curbside only to protect our employees and to protect our customers. The cloud of what was going on at that time had us all concerned with the safety of our employees. We made that decision on a Thursday morning. On Monday morning, across 4,400 plus stores across the country, we executed it successfully. Got better every day. It's working very well now. And what's happening during that process, Bob, is you can place an order online, you can place an order by phone, you call when you get there, our employees walk out, put it into your vehicle or we deliver it through our distribution -- local distribution model with our store's vehicles. And customers have been very pleased. Recently, we've begun opening some of the stores up. We've had Atlanta open up. I think we had the Carolinas open up. And so we are seeing -- we see in those areas, some customers continuing to prefer this because of the speed and efficiency and in other areas, people are really excited to come in and see their buddies. I mentioned on the call, my own experience running a store. Many of these customers, they really see us as part of their business. And so many of them start with their employees in our sales floor, picking up everything they need, kind of getting the paint for that day, placing their order for the next day. And I've used this, and you'll get a kick out of this. I've used this on a number of occasions, Bob. You and I are about the same age. I've used this with store managers, although I'm learning with younger store managers, they don't understand it as well. I talk to them how we want to create an atmosphere in our stores similar to Cheers when Norm walks in. I mean, we want that kind of feeling. And it worked incredibly up until these young kids started coming in. And I said, it's kind of like Cheers when Norm walks in and they look at me and they're like, who's Norm and what's Cheers? So I've had to modify my coaching, but we try to create that kind of feeling in our stores, and it works really well.

I share that the detachment from having the right analogies anymore. I'll share a few with you off-line later that are pretty funny. Let me ask you about Lowe's. A few years ago, you guys weren't there in any significant way, and now you run the entire paint aisle. Can you talk about the evolution of your activity there? And why it's better to have a single supplier in the paint aisle, and what that's meant for you?

Yes. So we're really excited about our Lowe's partnership, and we're very pleased with the progress that we're making. And to your point, it's been progress. Initially, if you'll recall, we went in, we were one of three suppliers. And there were some challenges associated with that. You had 3 mouths to feed, if you will, from a Lowe's perspective, different people wanting index, different people wanting training with their employees, how they should approach customers, some, I would say, confusion, if you will, in the product offering and price points. And we've simplified that. All of that has gone away. Now there's 2 teams working together. And our goal is, just as I described on the store side, is to help them be successful. And so we monitor our success truly by paint coming off the shelf. It's not our goal just to fill up their shelves. It's to help them move paint off the shelf. And we work very hard in our ability to be able to do that. As it relates to -- and the only slight change I'll make to your question, if I may is, it's not one customer. There's one national home center that we're aligned with, Lowe's. But we still have terrific relationships with customers like Menards. And we still sell a lot into Ace, and we sell product at Walmart, and a lot of different customers. But obviously, largest is Lowe's. And as to why our decision there -- why we believe that made sense, if you'll recall, we had product in the -- in those competitors -- national competitor. And -- but we didn't have paint. And so our brands, our brands like Purdy, the #1 brush by a wide margin for professional painting contractors, Minwax, the #1 stain by a wide margin, Thompson's WaterSeal, Cabot, on and on, all these brands. They were terrific brands to have if you wanted to build a business and grow your paint business. The problem was, there was 0 probability of us selling a gallon of paint because we didn't have any 1-gallon or 5-gallon buckets of paint in the store. So our brands -- strategically, it was a misfit from our perspective. It was helping establish a paint department and helping to add credibility to the painting contractor, but our shareholders weren't getting a reward with any of the paint sales. The agreement that we have now is the exact opposite. Our brands are working. They're working hard. They're driving traffic. And our customers -- through Lowe's by purchasing a gallon of paint, reward our shareholders with 100% certainty, because we are the only paint in there. And we've worked really hard to be able to do that. And during that time, we've simplified the process, we've made it easier for Lowe's and it's giving us access into a different professional than we've been able to really attract inside our stores. The people that come into our stores are typically painters that are painting on a regular basis. The professionals that are in a home center oftentimes, they're choosing to be in a home center because of the different departments, the breadth of the product that is available in a home center versus a paint store. So they might be in there buying drywall, they might be in there buying a ceiling fan and so on, and they just prefer that channel. Up until now, it's been unencumbered for the most part. One national home center has been making a run at it. And now we're partnered with a team that would like to grow that business, and we'd like to grow that with them.

Got you. A couple of questions somewhat related here. In terms of your do-it-for-me contractor customer base, folks wondering what the backlog there looks like? Is there the potential for an air pocket, I guess, some architectural billings index numbers suggest there could be a little bit of a change. What are you seeing in that sector?

Well, it depends on what area you're talking about. Maybe I could just skim over at 50,000 feet and try to touch on a few of them to give you some color. If you look at the residential side, we believe that there's a pause in what's happened as many of the homeowners who are now home, in many cases, through orders of stay-in-place, are preferring not to have painting contractors inside their home, and we respect that. We understand that. As -- in answering, I think it was Anthony's question, it might have been yours, Bob, but about the interior, exterior we're starting to see the exterior play out exactly as we expected, as we believe homeowners are more willing to have painting contractors on the outside of their home than the inside. And we expect that, that will continue. We are witnessing an increase in estimating. And actually, just yesterday, we had our management meeting, and interesting feedback that we're getting is that the close rate is as high as we've seen according to our customers. So they're out there. They're estimating and the close rate is up significantly. And so we are feeling that this pause is just that, not necessarily destruction of the market, but a pause in what we see. Now when you look at new residential and commercial, I'll start with commercial. I mean, these -- many of these projects are underway, under roof that have been either slowed -- that have been slowed down or put on hold completely, they're going to be impacted in many different ways. First, the ability to get on the project. And then once on the project, there are likely going to be some element of distancing that will impact the business. All of this, Bob, I could go segment by segment, and maybe I'll just say this, all of this creates change and variability on the part of the contractor. All of that plays to our advantage in a significant way. We help people make money. And so if there are distancing issues or challenges on, even on a commercial project, we're talking to them about systems that might help them be more productive, high build surface products that will eliminate a quote, the importance of having the delivery on time, when they're going to have it and the color accuracy, whatever it might be, given any different project. That's where we swing. We're letting the pitches go by on, hey, lowest price wins this or this or that -- that's -- we add value. And in these commercial projects, there are many cases, large projects that are competitive for our customers. They need an efficient project, and no one helps them make more money than Sherwin. And so while there are changes, and we'll adapt to them, we like the change.

John, just on that last topic of changes, one of the most significant changes to the Sherwin portfolio over the last 5 years or so has really been the acquisition of Valspar. Maybe just talk about your expectations of that business as we exit this period of volume headwinds, in particular. And one of the things that we've noted is that coming out of '08, '09, you saw both significant margin expansion, but also a really quick snap back in volumes for the Valspar business in particular. In tandem with the cost that you've taken out of the business, how should we think about the long-term margin opportunity for the Performance Coatings segment?

Yes. So 2 -- I'm sensing 2 questions there. The margin improvement as well as kind of the snap back, if you will. Am I hearing that correctly?

That's right.

Yes. So let me take the snap back first. I think if you look at our business, what we've talked about in the second quarter and perhaps going forward here in the near-term future, you're going to continue to see, for example, the packaging and the coil business continue to do very well. These 2 businesses are really, really strong businesses for us, and we're putting every ounce of gas we can in the tank of these 2 businesses, the packaging, with their new technology, it's really growing share at a very aggressive price -- pace, I mean, and not based on price. I mean, this is a product, our new V70, it improves the productivity of our customers, flexibility, the efficiency of the plants. And again, it's an exact same example. When you see an uptick in in food and beverage because people are at home, eating and drinking more at home, the efficiency of that plant is critically important to those customers. Our product runs faster, more efficiently, less downtime, less scrap. I mean, it's everything that you want in this product. And so the conversion of this product has gone very well. If you look at Coil, that business is growing extremely well. It's had a slight -- it's going to have a slight bump here in the quarter because we've had customers that are feeling some pressure that -- having to close their plants. But those plants will come back online as the stay-at-home orders are pushed aside. And the number of new accounts that we're winning in this business and the use of technology, the increased distribution as the 2 companies have come together, really just give us a terrific level of confidence. These 2 businesses are just fantastic. If I were to walk down the continuum in, probably the next most likely to kind of regain business back would be our auto business, our auto refinish. As you know, we stay away from the auto OEM. There've been a lot of questions about that over many years. I know the entire time I've been CEO, there've been questions about why aren't you or would you? And we've been adamant about our appreciation for the ability to drive shareholder value and how we are really sticking to our strategy and that we don't see auto OEM as part of that strategy. Again, for the same principles, the auto business is really positioned to do well. I mentioned not only in this most recent call, but the call before that, that I believed that the auto -- our auto refinish business was as favorably positioned as it's been not only in my time as CEO, but also the 9 years as COO. I mean, we've really worked really hard with this business here in the U.S., in particular, with our controlled distribution model on this business. Now what you add is the combination of the Valspar-Sherwin technology and not just systems, but combined systems that are really outperforming anything in the market. We're really positioned well here. What we need here, and again, I've said numerous times, we're not trying to be ambulance chasers here, but with less miles driven, less cars on the road, there are less collisions. And as a result of that, this business is under pressure. During that time, we've been winning business and growing our position in the marketplace. And as there are more return to work states and communities, there are going to be more collisions. And we think 30 to 45 days after you start to see more cars on the road, this business is really well positioned to capitalize on it. The next 2 then are the 2 areas where we're feeling the most pressure, and that would be our general industrial and our industrial wood. By region, it varies a little bit in GI, and general industrial, I'd say our OEMs are beginning to open their plants, and we're starting to see more activity in China now. In Europe, a large percentage of our customers have been required to close. They're becoming -- beginning to come back online now. And I would say the same here in North America. So those -- that GI business is a factor of getting back into these plants and moving -- there's clearly some pressure there that might delay some of that GI business really snapping back, to use your term there, but our position there is really good. And we're really determined, again, here to continue to add value in the speed of production, the amount of scrap and working with our customers in every way to help them be more successful. On the industrial wood, there's continued pressure in this business. In China, for example, while the business is starting to recover there, and China would be the largest percentage of our business in Asia. The Southeast Asia countries are experiencing more pressure now as the virus impact is hitting those markets. So we're starting to see some traction in some and give a little in others. North America in industrial wood, we did see a positive first quarter. We'll see how this virus impacts that business as the quarter goes on here. And in Europe, Southern Europe is really a big part of our business there. It's been under pressure, as everyone has read and understands from the headlines, Italy has been under a lot of pressure. France. So we're feeling the impact of that. That business had been going quite well, if you rewind the clock. After the acquisition, it was running up significantly, some nice gains. It's feeling some pressure now. I don't think that, that one is going to snap back anytime very quickly, but our position there gives us a lot of work and a lot of opportunities to get on top of because the market share opportunities are what we're really focused on now. As it relates to operating margins or margin improvement, why we think we have confidence in our ability to continue to drive, if you'll remember, we talked about the combined businesses. That we wanted to drive those operating margins up into the 20% range as a combined business. And we believe that that opportunity clearly still remains. And again, just as we talked about in stores, when you have customers under pressure, they're looking for suppliers that can help make them more money. We have opportunity to do that as well as the opportunity to become more efficient in the way we do things. So when you look at the plant rationalization and some of the other things that we've spoken about, numerous occasions. Those are still key levers for us, some of which we will be accelerating as a result of this period that we're experiencing. So we are still determined to reach into that range, and have great confidence in our ability to do that.

Good to hear. John, unfortunately, that takes up our time. So to you, Jim, Eric, thanks for participating, and everyone that joined in. Everybody, have a great day.

Thank you.

Thank you, Bob. Thanks, Anthony.