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

Good afternoon, everyone. Cheers from Cleveland, the home of the pending Super Bowl Champs, The Browns. Hopefully, my buddies at Sherwin-Williams, will know that's true. With that said, I wanted to introduce Sherwin-Williams, whose stock is up about 16% year-to-date versus the S&P 500, up 11%. Longer term, if you bought Sherwin-Williams in '09, you bought $10,000. You're worth a little over $100,000 today. It's one of the best performing companies on my coverage list. The last down year in EPS growth for Sherwin-Williams is 2009. They've generated EPS growth every year since then to 2020, was up 16%, and the outlook points to another year of growth in 2021. With us today, we have John Morikis, the Chief Executive Officer; as well as Eric Swanson, Vice President of Investor Relations. [Operator Instructions] And if anybody wants to see my new business tropical suit in person. Just let me know, we are allowed to do in-person meetings and look forward to seeing everybody. With that, I know, John, you had some opening comments that you'd like to make. Why don't we -- I set it off to you.

Thanks, Mike. I do have a couple of comments I'd like to make, but I'm going to change those as you just kicked it over and start with, Go, Browns. I agree with you there. We're looking forward to that. I'll be brief, Mike. I know we only have 30 minutes, and I want to make sure that we leave time for our discussion and any questions. We appreciate you virtually hosting us here at this conference, and I'd like to just share just a few comments. First, regarding our first quarter, we feel we delivered a terrific quarter. Capitalizing on some extremely robust demand across both architectural and industrial. These led to sales in 2 of our segments that exceeded the guidance we provided at the beginning of the quarter. Generated double-digit growth, once again, in our residential repaint as well as new residential and DIY. And we also generated double-digit growth in our industrial business with improvement in every region. We've seen very positive trends as economies continue to reopen. And as we've often said, volume is the strongest driver of our results, and we leverage the strong growth to deliver improved profitability in every segment in the quarter. On the raw material front, we continued to face transitory supply and price headwinds and now expect raw material inflation for the year to be in the high single-digit to low double-digit range, a significant increase in the low to mid-single-digit range we communicated in January. In an already challenged supply chain due to the COVID-19 experience that we all fought through the February natural disaster in Texas, further impacted the complex petrochemical network causing pretty significant disruptions. These production disruptions coupled with surging architectural and industrial demand of pressured supply and rapidly driven commodity prices upward. Overall recovery has been significant in recent weeks and is improving, but still got a long ways to go. We've been highly proactive in managing the supply chain disruptions to minimize the impact on our customers, working closely with our customers and working with them to forecast their needs and position ourselves to be able to be responsive to their needs. Looking at our outlook. We continue to see robust demand in North America residential repaint and new residential and continued recovery in commercial and property maintenance. The comparisons in DIY will be challenging over the remainder of the year, though we're excited about opportunities to work with our retail partners to grow in other segments, particularly in this area of pros who paint, which we think is an extension, not overlap to the business that we enjoy through our own control distribution store model. We expect industrial demand will continue to improve as the year progresses. And finally, As most of you on the call know, we did not update our full year guidance, although we do look forward to providing an update at our financial community presentation on June 8, where we expect to have greater clarity of raw material availability and cost inflation trends as well as further confirmation of the strong demand trends we're currently seeing. So with that, Mike, I'll turn it back over to you. Happy to answer any questions that you or the members on the call have.

Sure, John. Thanks for the opening comments. One of the things I wanted to touch, it does seem like the pandemic has incrementally changed the housing market to some degree. Our Wells Fargo team expects sort of this trend for de-urbanization to persist for several years, i.e., folks looking to move to the suburbs, move into homes. Just wanted to get your thoughts there and what that would mean for the architectural paint market sort of near term and longer term?

Well, we love it. Obviously, as there are shifts of any kind, we worked hard to position the company to be able to take advantage of those changes. not just those changes, but any change, quite frankly. The strategy we've deployed over the last quite long period of time has been to position the company to be the leader in any of these subsegments that might benefit from these or other moves. So to your point, people are moving into new areas, new homes. We're positioned there with a very strong presence in these receiving markets, if you will. Strong presence, meaning both stores and sales reps. We're very unique in our ability to serve those customers, and the painting contractor business that oftentimes is benefiting from that business has been a very keen focus on -- for us and through our tag business. This has been going on for some time. As I mentioned, we've had 5 consecutive years of double-digit growth. This most recent quarter was the second straight quarter with 20% or greater growth. Our contractors are returning back to the interior work at a greater pace. Obviously, that's shorter term. We have the same excitement longer term. But clearly, this is indicating that homeowners are comfortable with having painting contractors entering their home. But the data supports it. If you look at the macro data like existing home sales, the remodel indexing, the LIRA. It's overall, just supports everything that we're experiencing with these direct model relationships, which is the contractor base that's extremely bullish about not only the current market, but the foreseeable market.

Great. And then can we talk a little bit about your stores that's been sort of the hallmark growth story over the last decade? Where are you now in terms of store count? And what do you think has been sort of the secret sauce, if you will, to generate that consistency and growth over the last decade.

Yes. I'd say that we're -- we still got a lot -- I'd say, a number of innings to go here. I mean, this store count, we're continuing to add anywhere between 80 and 100 stores. We believe that the opportunity to continue to invest in stores is another area of unique differentiation between us and our competitors. That last mile, if you will, has proven extremely important as contractors are working not only before COVID, but during and now, as I believe, as we're coming out of this, contractors, the responsiveness that they've been able to have utilizing our stores to their customers' needs. If you're talking about customers who at one time were going to be looking at exterior or interior work, finding themselves doing exterior work or on a commercial project where distancing is important, finding themselves having to work in other areas than they've planned. All of these things play right to our advantage. I mean, this is actually -- I mean, no one in their right mind would ever hope for something like we've experienced. But I will say we're exiting with a much higher level of loyalty from our customers who, in many cases, are really learning to appreciate our distribution model, our people and our ability to respond. You used a very key word there, Mike, a couple of words there, about the secret sauce. And I would say that the secret sauce that we see revolves around our people. We hire about 1,400 college graduates a year that come into our management training program. I think we're very unique in that we're bringing really highly-qualified people, very well trained, with the right resources, strategy and ability to deliver on their commitments. And because of that, as we open these new stores, they get on the map quickly and contractors learn to appreciate that utilizing Sherwin-Williams is a key part of their ability to make more money. And that's an important gauge that we monitor regularly. It's always been a wide gap between us and our competitors. I would tell you, I'm proud to say that it's growing significantly as we go through this. And we expect that as we exit this, that, that loyalty will have been enhanced, and it will be what we refer to as the coiled spring that we've seen exiting other challenging periods of time. If it be the housing crisis, the financial crisis any of those. We've been able to come out of those much stronger, and we expect to be able to do that as we exit here.

Right. And then just curious, in terms of the stores, what did you do during the pandemic? A lot of businesses have changed. I've been working from home I think fairly productively over the last year, at least I hope my boss thinks that's the case. And just curious what you did there and what will -- will some of those changes persist as you go forward in terms of serving those customers?

Yes. I think there's a number of things that we did, many of which were unique, some at the time, some moving forward. We moved on a Thursday, early on in the process with the mindset that we were going to go curbside. And by Monday, we executed that across over 4,000 stores. There aren't many retailers that could do that, certainly not those that choose third-party distribution. We effectively did that over a weekend and began delivering through that on a Monday. And we think that was an important element in keeping our contractors in business. One of the reasons I say that we exit with higher loyalty indexes is that we measure this through our CRM and the research that we do, and we did work very closely with our customers. 85% of our people never left their post in our company, never left. So while some people were working at home, our people were in their stores, on their territories and in the plant and distribution centers, delivering our products to our customers. I couldn't tell you how grateful I am because it's unmeasurable what our people did. As a result, though, what I would say is, is that this opportunity to grow became very apparent. Early on in the process, Mike, we sensed that we had competitors that were kind of protecting their hill, if you will, or going underground to protect themselves. And we talked openly throughout the company that we weren't protecting our hill, we were attacking hills, and we were aggressively pursuing customers and opportunities throughout the almost overwhelming challenges. I'm proud to tell you that during this pandemic, we opened more new accounts through the pandemic than we did the prior year. I don't know that there's many companies that could quote something like that. So we think we've been planning a lot of really good seeds. Our people have done a wonderful job, and I think you have and will continue to see those results as a result of the hard work and efforts of our people.

Great. And then sort of the last question on TAG and the stores. I recall some commentary that the backlog of paint projects has never been higher from the PROs. Is that still the case? And labor, historically, was maybe a challenge in meeting some of that growth. Has that been resolved as well?

The backlog does remain significant. So I think that continues as does the labor shortage. Again, to us, adversity creates opportunities. So the fact that our contractors are staring at a long pipeline of projects works to our advantage. The fact that many of them are looking at more projects than they can get to us extends that tail out quite a bit. But it also results in a few other elements in our business that are important. We see more and more contractors relying on our stores and our reps for many of the things that I spoke about earlier. They are leaning on our stores to have the inventory, the support from a sales rep or store manager to be able to be responsive as projects shift and move, which they do for many reasons. I'd say the other element here is that as you look at the fact that there are less skilled or might dare say, even less qualified painters out there, the need for higher-quality grows. And so we are experiencing and continue to see a positive mix shift in higher quality products that allow a less experienced painter to perform and leave a project behind him or her that they may not have been able to do with what we would call maybe a more standard contractor product. The rheology and chemistry that goes into our products allow for better flow and leveling and absolutely better touch up. Whereas we are one of the few -- might be the only that I know paid company that owns our own colorant, which allows us to calibrate and formulate our products and our colorants. That may not seem like a lot to many people. But when you manage that as one as opposed to a third-party or second-party supplier shipping colorants in, any changes in their process, their chemistry, anything they do. They may not realize the impact it has on the finished product. We went out years ago and bought what we believe to be the best colorants company in the world and have integrated that in. And our ability now to supply products that are very unique in their application and touch up, take into account labor that may not be as experienced and maybe hide some of the sins of that less experienced applicator.

Right. I wanted to move to the consumer group, had a very impressive 2020. One of the main strategic moves over the last couple of years is to really partner with Lowe's. So I thought maybe give us an update there that obviously has been a really good move, particularly given 2020 results. How is the relationship with Lowe's? And how do you grow that business with them going forward?

Yes. I think, Mike, if I take one step back and say that we are proud of that relationship, we do believe it's growing and its effectiveness is also improving. But the part that I would maybe step back and highlight is that as a company, strategically, we've been working very hard to position Sherwin to capitalize on whichever segment becomes hot or the market might move to. So whichever the table -- way the table shifts is where we want to be. And so that element was an important part of our overall strategy. So now if you look at if it's a residential repaint contractor or a new residential, we're positioned. If it's someone deciding to rent versus buy property management, we're the leader there. Commercial, we're the leader there. The res repaint is clearly a huge opportunity. We're the leader there, but there's significant opportunity. 5 years of double-digit growth, and we still are salivating over the opportunities for growth there. As it relates to DIY, it was an area where we wanted to be better positioned, and that was part of our strategy. And we think the exclusive relationship at Lowe's going into it was terrific. And you're right. It played out really well for us during these challenging times. But as you said, we also know people are going to be going back to work. They're not going to be home painting all the time. And so again, we've positioned the company if they're going back to work, we expect that there'll be more painters doing -- painting their homes. If they're going back to the plant, in plants, an occupation in inside a plant, our industrial business is going to be there to capitalize as we are seeing pickup in manufacturing. And so even within the home center themselves, there's been a predominantly a focus on the DIY business. We think that there's a terrific opportunity in the segment -- subsegment that we're calling the PRO that paints. Now in our stores, we focus on the painting contractor. Their project is painting. There are other contractors who prefer -- I'm sorry, prefer a home center experience because their projects include perhaps putting up cabinets or a ceiling fan or remodeling a bathroom, whatever it might be, and they might be purchasing paint as a part of that project. We've worked and looked and tried to penetrate that business. We've been unable to really crack through it because we don't offer all of those other products, all those other categories. So our ability to align with our customers and really better pursue that business, we think is a virtually untouched -- unimpacted segment for our company, one with terrific growth, which we're excited to grow. So short term, are we excited about the CBG business? Absolutely. It's its growth in DIY is terrific. We're equally excited about being able -- our ability to penetrate this PRO that paints through that same channel.

Great. And then shifting gears to maybe Performance Coatings Group, you did see a strong recovery in the first quarter. Looks like you're going to see accelerating growth for 2021. Operating margins still sit in the mid-teens. And as I recall, that was -- the goal was to get that higher. Can you maybe update us on sort of where you think that profitability can go and what you think you need to do to get it there?

Yes. It's a good observation, Mike. We've been talking about getting this level -- this margin level up into the high-teens, low-20s. We absolutely expect that we'll get there. We did face some of the raw material issues that we faced head on here in this business. The other thing I would say is that we entered the year with a goal of -- synergy goal of about $100 million in the supply chain area between -- mainly Europe, a little bit more in Asia. But I would say that with the COVID situation, while we were able to penetrate that $100 million goal, we were able to achieve probably around $20 million of it. So there's still upside for us there as well. But the fact here is that on the backside, there are those opportunities. On the top side, we're really focused on those areas. Those segments where there are higher-margin opportunities, solutions that we can bring to our customers that they're willing to pay for. And I'd love, quite frankly, when competitors are out pursuing commodity-type coatings or buying commodity coating companies because that ties up their attention, their capital and their effort. We believe that we're unique, and we're very proud of the position that we are establishing, focused on the segments that we are focusing on, where we avoid the commoditization, where customers are absolutely willing to pay us for these solutions because we help them. We help them make more money, become more efficient and we solve problems for them. So we want to see faster penetration into that high-teens, low-20 operating margins. I think you'll continue to see that as we go forward.

Great. And then I do have a couple of questions in the queue. One on raw materials or pricing. The comment was there's sort of a hope that the industry -- the coatings industry can offset the gap by year-end. That's what others have potentially said. Why is pricing better this time around versus prior period? And then you noted that you're willing to share some of the pain near term with customers? And just wanted to get your thoughts on that comment.

Yes. I can really appreciate that question. And inside -- we're sitting in our boardroom, we often -- I'm going to respond as I would hear that in one of our management meetings that hope is not a strategy. We're not hoping, we're executing. And we do expect that we'll absolutely recover from these raw materials. There's no question in my mind in our ability to do that. In fact, If you look back for decades, our company has been able to do that. In fact, as raws have increased, we get the price, the raw material prices roll over, and we retain that price. So it's been an important part of our gross margin expansion. In fact, if you look at the wider sense of our efforts, the opportunity to do that and not only get the price, but to retain the customer has been the key element in that. We've demonstrated, in my mind, clearly, an ability to do that. I'll take you back to 2010, a period where we had a 22-month period, 6 price increases during a rapidly increasing raw material environment. Here, we find ourselves in a unique situation, obviously, with a spike up as a result of some transitory issues related to the natural disaster in Texas. We went out on our store site. Our customers are quoting products or projects. As we mentioned, there's a heavy backlog there. So we're taking, I believe, to be a very traditional Sherwin approach. Well, we believe, as you mentioned, there might be some short-term compression in margins. I'll gladly trade short-term compression for long-term price effectiveness and customer retention. So if you look at the history of the company, we've done this. We've done it regularly. We'll do it again, and we'll come out of this with the pricing that we need while keeping the customer. And the other element in that that's important is that our customers will come through more loyal to us as a result of the way that we're handling it.

Got it. And then another question was more of in Performance Coatings Group, it's not a segment that's talked a lot about and really relative to the others over the last year. Can you remind us, which are the major sort of industrial end markets that business targets? And how is that recovering?

Yes. So it varies by business, as you would expect. So in coil, for example, we saw terrific wins in areas of focus like the appliances and commercial construction. Auto Refinish is self-explanatory as -- but I will say that as people return to work and we see more and more traffic on the road, our Automotive Refinish business benefits from that. Packaging is pretty obvious. Food & Beverage remains robust, and we're really thrilled with this business. It's grown its performance every quarter since we've owned that business. It's just a fantastic business. Industrial Wood, we've seen a strong double-digit sales return. Here, I would say that momentum is in the area of furniture, kitchen cabinets, flooring, industrial wood applications, commercial-type applications. It's a good business as well. And particularly, since -- if you look back to the second half of last year, we really started to see some momentum in this business. And then General Industrial -- Industrial Wood and General Industrial would be the 2 largest. General Industrial, the manufacturing PMI is positive in every region. We see a nice movement here and momentum in this business, focuses on everything from heavy equipment, to railcar, to bridge and highway, water, wastewater treatment flooring, pharmaceutical, a lot of areas -- I'm sorry, I drifted into protective and marine, I'm sorry. GI would be in heavy equipment, and things like racking, trailers, any general industrial metal or plastic applications. If you look at it and has a coating on it, we sell that coating. So it's growing -- it's coming back very, very strong, and we expect that momentum to continue. We have terrific -- the last thing I'd say about each one of these is we have terrific leadership in each one of these segments. I think when you combine Sherwin and Valspar, we had a terrific performance in tenure in our architectural and a growing performance and tenure in our industrial business. Valspar brought a lot of talent in this area of Industrial Performance Coatings. And there's a lot of really, really strong talented people that we've been able to retain that came to us from Valspar that are doing just a phenomenal job for us.

Right. We might have to squeeze in one last question, just a quick one on acquisitions. Valspar turned out to be great. What are you looking for? Anything in the hopper? How is the environment there?

Yes. I'd say, we're -- there are a number of projects in the hopper, the pipeline looks good. I'm hopeful that a few of these could close by the end of the year. I would say, as a reminder, we've got, again, a very defined strategy here. We think we're unique and that we're bringing differentiated solutions that our customers are willing to pay for, and we believe the combination of Sherwin and Valspar further differentiates us as we believe we're uniquely positioned that we don't require acquisitions to grow. Acquisitions are an important part of our strategy. But I'd say, the combined Sherwin and Valspar really have us prioritizing opportunities and turning them into shareholder value. We're not out there desperately trying to buy anything that shows its head. We're focused on really defining our strategy and going and finding the companies that further enhance our ability to create shareholder value. So in a nutshell, I'd say that you should expect to see us primarily in the industrial space, our market share and opportunities there give us tremendous opportunity. We like geographic plays that enhance either existing positions or create opportunities in areas that we can penetrate. Again, we don't want to be everything to everyone everywhere. So we're not just throwing a dart at a map and say, "We're not here. We need to be." If we can be there and have the right to win, the value proposition works, we can be rewarded to deploy our shareholders' capital, then we're interested in that. If not, we don't have a desire to try to be everywhere. And then lastly, technology that we can purchase that's underrepresented that oftentimes, you'll find entrepreneurs or technical people who can find their way to technology, but maybe haven't mastered the commercialization of that technology. When we can buy that technology and plug it into our distribution and really leverage it, that's a terrific opportunity to create shareholder value as well. I think that's where you'll see us primarily playing.

Great. Well, John, Eric, I appreciate you spending some time with us today. I hope you can keep brown and orange colors on the shelf. I'm sure it's going to be hot this year, and look forward to seeing you all in person. Have a good day, everyone.

You too. All right. Go, Browns.

Go, Browns.