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

Good morning. My name is David Begleiter of Deutsche Bank's U.S. chemicals equity research team. Thank you for joining us for Deutsche Bank's Virtual Global Industrial Materials Summit. I am very pleased to have with us today John Morikis, Chairman and CEO of Sherwin-Williams Corporation. John is a 30-year veterans at Sherwin-Williams, having begun as a management trainee. John will have -- open with a few prepared comments, and then we'll jump into the Q&A portion of the session. If you would like to ask a question, you can submit them via the web portal via a chat box on the left-hand side of the screen. With that, John, it's all yours.

Well, thank you, and good morning, Dave, and everyone, for joining us. Really appreciate your time. I am John Morikis. I'm joined here today with Jim Jaye, our SVP of Investor Relations; and Eric Swanson, our VP of Relations. I'd like to just maybe start with a few high-level comments and then happy to turn it over to you, Dave, for questions. I would like to begin by thanking our 61,000 employees. It's really just been fantastic to watch their determination and really their resilience in the face of so many challenges in the world this year. Their extraordinary efforts to serve our customers, our company and importantly the communities that we serve, has just been inspiring. While this crisis that we're experiencing isn't over, it does feel like we're beginning to shift from a containment phase to a recovery phase and starting to feel like economies around the world are beginning to reopen and people are beginning to return to work. Here at Sherwin-Williams, our teams are energized and really engaged. We're clearly driving a shift from reaction to action, from defense to offense and from protecting our business to really trying to grow it. In the Americas Group, we're now in the start of the summer painting season, and there is no one better positioned in this market to serve professional painters than we are. We're beginning to open our sales force in multiple states safely and responsibly, and we expect the vast majority of our stores to be open within the next 2 weeks. We still plan on opening about 50 new stores this year while many of our competitors are pausing, some closing stores. We're introducing new products. We talked on our last call about the FlexTemp and Emerald Rain Refresh, which are really generating terrific interests and sales from our customers, and we're excited about the path that we're on there. Customers in all our segments tell us they're eager to get back to work. And as you would expect, our exterior work is recovering faster than interior at this time, largely due to just the social distancing. And while many people are home right now, they prefer not to have painting contractors in the home with them. We also see a significant increase in our e-commerce platform, and we're looking forward to leveraging that as we go forward. In our Consumer Brands Group, just, again, really want to thank this entire team for their efforts in meeting, what I've described as, unprecedented levels of DIY demand. I'm really pleased on how we continue to work closely with our national home center partner, Lowe's, as well as our ability to perform at this time for our other strong and growing customers: Menards, Walmart, Ace and other retailers. In our PCG Group, our Performance Coatings Group, we're working hard across a diverse set of businesses. I describe our packaging business as one that continues to perform as if the pandemic never occurred. Our coil business, we continue to win new business in multiple geographies, and we're really looking for a strong performance from this team throughout the year as well once people can get back to work and these plants start opening up. In auto refinish, we've focused on training and engaging customers. We've not seen the full return to drivers on the roads yet. But when we do, we believe we're very well positioned to grow this business. I traveled with the leadership team from this organization last week, and throughout the country, just feel really -- that we're very well positioned, with our technology and our distribution, to really see a strong year there. Our general industrial and our Industrial Wood businesses are probably on the other end of the spectrum in terms of demand recovery. At the same time, they're launching new products and are having excellent dialogue with our customers, but they're really focused on the areas that they can control. These are businesses that are experiencing pressure, and so we're really focused on driving those areas that we can impact. As we said in our last earnings call, we expect our consolidated net sales in the second quarter will decrease by low to mid-single -- I'm sorry, mid-teens percentage. We expect April to be the toughest month, and it proved out to be for this quarter from a comparison perspective. And gradual improvement throughout the quarter in May and June was expected, and that's exactly what we see playing out. For the year, we guided to a range of sales to reflect the uncertainties and the timing and pace of improvement in the U.S. and global operating environment this year. We continue to feel very confident in the longer-term trajectory of our end markets. Our full year 2020 adjusted EPS guidance is in the range of $19 to $21 per share. Embedded in this guidance is for raw -- the raw material basket to be down a low single-digit percentage for the year. If I could, I'll just add a few more comments concerning our capital allocation. We do have a very strong balance sheet with $239 million of cash on hand as of March 31 and $2.5 billion of unused capacity under our revolving credit facilities. Our net debt-to-EBITDA leverage ratio was 3.1x compared to 3.5 last year. As is typical, we used our credit facilities in the first quarter to fund the architectural inventory build in the U.S. prior to the spring/summer selling season. In the first quarter, we returned $1 billion to our shareholders in the form of dividends and share buybacks. We raised the dividend by 18.6% in the quarter and we're committed to that increase for the remainder of the year. We reduced CapEx to a target of $180 million from $320 million, which was our previous guidance, and we'll manage higher, depending on the trends in demand. We paused spending on our headquarters and R&D facility projects that we announced, and we'll evaluate stock buybacks as we progress through the year, depending on the end market and sales volume progress. To wrap it up, let me just say that we have a long-tenured and experienced leadership team here, a lot of scar tissue here. They've successfully managed the company through a number of challenging times. Our entire global team has taken the actions to navigate through this crisis. And we remain very confident in our ability to manage the near-term impacts we're seeing while positioning ourselves for continued growth. So David, that pretty much captures my opening comments, and happy to answer any questions from you or any of the participants.

John, that's great. First, with the Americas Group, maybe just a little more color on business trends, especially in May into June. What was the cadence of the improvement in May? How did the Memorial Day holiday play out? And what are you -- again, what are you seeing in early June here as weather improves?

Yes. When we finished the quarter, we talked about that we expected April, as I just mentioned, to be the toughest quarter in comparison, and that our results would continue to perform as the quarter went out. We're obviously not providing any update here. I will say though that the quarter is playing out thus far exactly as we planned and what we expected. The exterior gallons are picking up, just as we expected. I did talk, Dave, in the call, that we were not only see -- that not only did we see the exteriors picking up, but that we were -- we continued to see, estimating from the part of our customers, the close rates were improving, and we continue to see that as well. The Northeast and Midwest were lagging the Southeast and Southwest. But as we talked, the New York market, as an example, here, June 8, they're entering the next phase. We have actually had a discussion over the weekend with our largest contractor in New York, who is just thrilled to get back on his projects. So we expect this trend to continue, but we're very confident in the fact that everything that we laid out in the last call is exactly what we're seeing as the quarter is unfolding.

So you mentioned the bidding activity and the backlog amongst some of your big customers. Has the type of bidding changed, or the size of the backlog, changed during this crisis here?

No. It really hasn't. In fact, we stay pretty close to those. We watch the activity in bidding. We watch the activity as it relates to specifications through our spec team, through color demand for color sheets through architectural design firms. And there's been really, really good activity there. And we're utilizing this time while people like many of you, I'm sure, are home in quarantine with orders that are starting to become a little more lax, we use that time to aggressively pursue those relationships, building on those that we had previously and growing them where we had not. But from an activity standpoint, we're feeling pretty good.

And John, household unemployment, despite the good numbers on Friday, remains a big headwind. How do you think about that in terms of your residential demand overall?

Well, it's an interesting situation when you have -- our DIY business, as we've talked, has been just unprecedented, as I said. And so it's a relatively inexpensive project to paint a wall or paint a room in a home while people have more time at home. Not sure of the impact, as you just described, some of the unemployment numbers that have just come out, if that trend is going to continue. But what we do see and what we have great confidence is in the fundamentals. We feel that the fundamentals are still very strong for our company. We feel that we're positioned very well. There's a housing shortage, we feel new construction is going to continue, we're the leader in that space. If for whatever reason, there's a slow and property management ends up picking up some of that slack through multifamily living, we're the leader in that space. People decide not to move, there's some uncertainty, they want to remodel in their homes and stay in place. We're the leader in that space. Any way the table tilts in the market, we're really working hard to be the victors in that segment. And so we feel really good about the position of the company. And we're going to really take advantage of that by really and aggressively moving there. While many other competitors are still in the protect-the-hill mode, we're really trying to take those hills.

And John, that's a great segue because you've been investing in innovation, e-commerce even through this downturn. You've been gaining share in this business for a decade-plus. Is that the plan going forward, or the expectation that share gains will continue, driven by these investments and your -- obviously, your competitively advantaged store network?

Yes. We don't want to continue to perform in the same fashion. We want to grow faster. So yes, we think we've grown share and we're pleased with it, but we really think that coming out of this, our expectations -- my expectations of that team is that we are really positioned very well. This coil is really cranked down and it should be springing here. And so we are aggressively positioning our teams to grow share at a faster pace.

And John, can you just touch on the e-commerce platform? And specifically, what have you done there? The investments you've made? And what's your advantage versus sort of peers, do you think?

Yes. So let me start with the last piece, and then I'll go in. I think what's different between us and our competitors -- well, one thing I would say is that we're uniquely positioned in the market with the brick-and-mortar that we have. And so when people talk about the last mile and the ability to serve those customers, we're right there. We're 20 minutes from anywhere in this country with paint. And additionally, we're really in a very strong position, given the relationship that we have with contractors and the ability to really leverage that relationship even further. Where do we see it going? I would say our ultimate goal would be to position ourselves with our customers, leveraging and enhancing the existing store, the existing rep relationship, the existing manager relationship, the existing assistant manager relationship, with this digital platform that makes it so easy to do business with us. And so where is it going? Well, we launched, for example -- I will use this example. We launched an estimating program, software that makes it very easy for customers to estimate projects. And that will seamlessly feed. So the customer can estimate, produce that estimate, e-mail it to the customer. And that would seamlessly flow through the process to our stores as an order and then to have the ability for that customer to invoice right off of that. And so when you look at our goal and what we are aspiring for, and I believe what we are tracking to, is to position us ourselves so favorably that if or when one of our customers ends up having to use a competitor for whatever reason, a specification, a relationship, whatever it might be, we really want them racing back, telling us how difficult it was, that they had to do task 1, task 2 or task 3 themselves, things that we do for them naturally and seamlessly. And the ability to manage projects and spec and recover information. If it's going back and understanding what product, what color, what sheen was needed or ordering it with a touch of a button and knowing when it's going to arrive. And when you think about 90% of a painting contractor's cost of goods is labor. 90%. And so everything that we do to help make them more efficient makes them more profitable. And we think this digital platform is yet another tool in our arsenal, innovation and all the service and people, skills that we bring, it's another tool that helps to make our customers more successful in what their goal is. And that's what we're really striving to do. We help our customers make more money. And as a result, their loyalty and the stickiness increases.

Very good. John, switching maybe now to Consumer Brands, the unprecedented growth, quite stunning. It continued through May, is it continuing into June as well?

Well, yes, I'd say, again, we're not providing any updates. But what I would say is the -- we laid out in the quarter how we expected it to unfold, and it's unfolding exactly as we expected.

Understood. Clearly, the Lowe's partnership is working quite well. How does it compare to when you were selling some of your nonpaint brands to their large competitor? How different and better is this partnership?

Well, it's night and day. When you think about selling some of those other brands, these were Hero brands, leader brands. You take Purdy brush, the #1 by a wide margin preferred brush by painting contractor. Well, if they're on the shelf and they're helping to draw contractors -- and maybe not even just draw, but just having the ability to solidify the merits of a department because they have a brand like that in the department, while that equity was transferred to that department, our shareholders didn't gain a chance of selling any paint in that department. Why? Because we weren't selling liquid paint in those -- in that outlet. Now what you find is these brands are really working hard, and they're helping to drive -- put steps into a department. And as a result, with the agreement that we have, our shareholders are absolutely guaranteed a return on those -- on the equity of those brands because of the exclusive relationship. The nature of our relationship is such that if that brand is working and driving more people into that department, our shareholders are going to win. And so our goal there quickly shifts to, okay, let's help our customers win because when they win, our shareholders win. And that stands true for Lowe's and some of the other customers that we're working with. The value of those brands and helping our customers to win is something that we're really leveraging quite well, and we're really excited about it. Now one other thing that I would add is gone are the days of arguing or debating over time with employees for training, which products go on index, the positioning of the products, the confusion of what and who has this price point versus that price point? There's just so much collaboration, so much effort on how do we sell paint, not how do we fight with the people across the shelves or across the aisle. It's a very collaborative effort in how do we grow together?

John, any concern that there's very strong growth at Lowe's, Menards, Walmart, is coming at the expense of your store network?

No. No. When you look at the -- we do a lot of research, and we did before, and we continue to do the research. When you look at the consumers that are in a specialty store -- I'll talk about consumers first, and then I'll quickly talk about the Pro. When you talk about the consumers, they're looking for a different experience in a specialty store. One, they're willing to pay more. Second, their expectations are higher. And so there's an expectation. Now these are, in the specialty store, almost -- people that are almost looking for that appearance that a painting contractor or a professional has completed the project. These are typically areas that are common areas or exposed areas that they really want a high-quality product and are really, really concerned with what it looks like. Oftentimes, what you'll find in home centers are people that might be a bit more price-conscious, that are truly do-it-yourselfers and are trying to knock out a project. And the quality of products that we fit -- sell for them are very fitting for them. When you look at the professional side and through our specialty stores or our controlled distribution, we're really focused on the painting contractor. Those people that paint for a living, which you'll find on the other side, are people that paint as a part of a project. And oftentimes, you'll find people in that category that prefer a home center. Why? Because they're picking up drywall or plumbing fixtures, whatever it might be, and paint is one of the categories that they're shopping, unlike the painters who are coming in shopping in one category. And so our goal is very much in line with our customers who prefer to focus on that painting contractor -- or I'm sorry, the professional that paints as part of a project. Quite frankly, for many years, there's been very little attention paid for those -- on those customers. We've tried to pursue them through our stores and we've had some success, but nowhere near the success that we're continuing to work with, with our customers on the home center channel because the breadth of customer -- the breadth of products that they offer fits their needs. They're looking for other categories that aren't offered in a paint store. And so we're really excited about growing that, and we absolutely stay very close to the fact that guiding and watching over any cannibalization between the 2. And we really don't feel that there's any.

Great. Switching to Performance Coatings. You gave a nice rundown of the various businesses. Just 2 questions. John, in packaging and coil coatings, what's driving the new business wins? Is it technology? Is it something else? And how sustainable are these business wins and share gains you're seeing?

I believe they're very sustainable to begin with. And I believe that the innovation that we are bringing on the packaging side, the dependability of supply, the quality and consistency, all are driving our success in packaging. I would tell you, if you want a good day in my line of work, you go spend time with that packaging team. I mean, they are just very driven, very successful team that work very well with their customers. Again, I'll point out that the similarities, even between the industrial packaging business and our stores business, very similar from a strategic standpoint. We're looking to make our customers successful. And so when you look at the attributes of our V70 product, the non-BPA, it allows a much more efficient production line. Their production is up, their scrap is down, the environment is better for their employees. It's just been terrific. And we expect that business to continue to roll it at this pace. On the coil business, it's really been exciting. I would tell you, innovation has played a part of it. The product consistency is a part of it. I think a big -- perhaps the biggest part of it has been the responsiveness. This team has had some significant new business growth, both domestically and internationally. And this strong and growing position, we think, will continue. I mentioned some of the expected choppiness in the second quarter as customers were impacted by the mandatory shutdowns. But this team has really been focused on demand-building and positioning this business for growth going forward, and we expect that to continue. It's a strong business.

Okay. Very good. And also on auto refinish, John, you compete here with some very large competitors and we've done very well. How are we gaining share and outperforming some of these much larger competitors in auto refinish?

Well, a big part of it has been the technology. We have, I think, 2 fronts that we're leveraging. The technology -- the combined technologies, the base coat that came with the Valspar acquisition, combined with our clear coats and primers, has given us a terrific footing. And again, I'd mentioned earlier that I was with this team for 3 days last week in the field, and just amazing to hear the productivity of these vehicle repair facilities, the output that they're able to gain, the dramatic decrease in rework that's required. And I heard comments even about the experienced painters in the back of the shop giving the new painters a hard time because they were capturing as much volume as the experienced guys. And the one fellow was giving me a hard time, telling me that our product's making him look bad because it's making the new guys more productive. So when you're getting comments like that from pretty seasoned applicators, I'm feeling pretty good. I would say the second point here is that much like our stores, again, this controlled distribution is a key and differentiated part here in North America for this business as well. The responsiveness that we're able to provide these businesses up until recently, they're starting to see more, but this has been very difficult as the more stay-at-home orders that were placed, less vehicles were on the road, obviously, and it impacted this business. It is ramping up. The ability for people to get back in, online with the color tools that we give them and help their productivity through our controlled distribution. Again, we can do this for them around the country like very few people can. We're not relying on third parties to stand up and meet the commitments we're making. These are our employees through our stores, well trained, well equipped with the products that they need to serve our customers.

Very good. And that kind of segues into my next question on M&A and cap allocation. You've made it quite clear that OEM coatings is not part of your strategy. However, you do have -- you do like your refinish business. Would you consider getting bigger in refinish through acquisitions?

I'd say we look at different opportunities around the world. Let me take just a couple of thousand feet and say that we look at every business and we look at opportunities to differentiate in those businesses. So we're not just simply looking to be everything to everyone, everywhere. What drives our decisions at its core is shareholder value. And so we look at opportunities across our businesses and understand what is it that would allow us to differentiate and what is it that would allow us to create shareholder value? Not just be bigger, but to be better at serving our customers in a unique way. And so we look at those opportunities and we weigh them against our own internal hurdles, our 10-year discounted cash flow model that we use, and we make really well informed decisions. But we're not out just chasing business, in auto or anywhere else. Then it comes down to strategy. Are those the priorities that we would want to make? Are the commitments that we would see long term in that business to be able to continue to deliver the shareholder value over an enhanced period of time?

Very clear. And on that note, how is the M&A pipeline right now for some of these opportunities?

Yes. I'd say they're good. There was a period here, just like everything else, in the heat of the pandemic, there was kind of a slowdown in conversations and discussions. But I'd say those -- that period of time feels as though it's opening back up. We've made -- we -- in this business, and this is an element of the business, understand that time has to be on your side, you have to be willing. We had deals that I worked on, when we were in stores, we courted people for 4, 5 years. We had a large East Coast acquisition that we did, it took 5 years of dinners and conversations. And so we're looking for those right opportunities. And I would say that there are perhaps more customer -- or more competitors that are at least interested in talking, if not right now, as the world kind of settles down, because they've lived through something that they may not want to experience again. So I would describe it as active, and in this area, activity is increasing.

Very good. And John, a last topic I want to touch on, raw materials. Oil prices have come up the lows quite sharply. Does this quality -- question your forecast of low single-digit declines in raws for 2020?

Yes. Let me ask Eric to jump in on that one.

Yes, Dave. So no, we still feel pretty confident in our outlook for raw material costs to be down low single digits. That outlook was predicated on the year-over-year declines lessening in the back half of the year, so seeing a greater benefit in the first half of the year. The majority of those declines, as we indicated, were crude oil derivatives, the propylene and ethylene derivatives. And yes, if we were to see an uptick in those, I mean, I still think we'd be in pretty good shape. The other big variable and question mark is TiO2. Our outlook calls for TiO2 pricing to remain stable. I think if we could see some downward pressure in TiO2 in the back half of the year, that could be a little bit of further upside. But overall, we feel pretty good with our outlook for raw material cost to be down low single digits.

Very good. And last thing, John. Where do you think you can take gross margins at Sherwin-Williams over the next 2, 3 years here?

Yes, Dave, this is Jim. What we've talked about as a target is 45% to 48% gross margin. And you've seen, as -- over the last couple of years, as we've furthered the integration and gotten pricing, that we've made continuous progress on that. So we're not happy just yet where we're at. We've made good progress, as I mentioned, but at 45% to 48%, I think is still the target here near term. And when we hit that, we're an organization that always is trying to go to the next level, so we'll set another target after that. If you dial back to right before -- at the time we bought Valspar, our combined margin as a company back then was 46%. So if you were to do a pro forma on the 2 companies coming together, so we're still a little bit shy of that on a full year basis, but there's certainly room to go.

Very good. And with that, our time is up. So John, Jim and Eric, thank you very much, and have a great day. Thank you.

Thank you very much.

Thanks, everybody.