By the Valuentum team
Sherwin-Williams’ (NYSE: SHW) the brand’s reputation in the paint, coatings and related products market has allowed it to capitalize on the improvement in the home improvement market in recent years. Dividend Aristocrat Rose its dividend for the past 40 consecutive years after adjusting for stock splits. The company’s free cash flow generating capabilities are impressive, and we expect Sherwin-Williams to continue to increase its dividend at a rapid pace over the next few years. Although Sherwin-Williams shares are roughly valued based on our discounted cash flow process, we believe the company should be on everyone’s dividend growth radar. The company is reporting around 0.9% at the time of this writing.
Key Sherwin-Williams Investment Considerations
Sherwin-Williams manufactures and sells paint, coatings and related products to professional, industrial, commercial and retail customers primarily in North and South America with additional operations in the Caribbean region, Europe and Asia . It completed a 3:1 stock split in 2021. The company was founded in 1866 and is headquartered in Cleveland, Ohio.
Sherwin-Williams bought Valspar for approximately $11.3 billion in an all-cash transaction in 2017. It has achieved hundreds of millions in annual cost synergies since then and significant cash flow improvements have also been obvious.
Valspar’s business brings new growth opportunities, particularly in coil and packaging, as well as a stronger geographic footprint in growing markets such as the Asia-Pacific region. However, management has a lot on its plate to deleverage the balance sheet. The company has significant net debt on the books.
Sherwin-Williams is home to well-known paint, coating and sealant brands with ample pricing power. It has the #1 architectural paint brand [SWP]#1 Stain (Minwax), #1 Spray Paint (Krylon), #1 Automotive Specialty Paint (Dupli-Color), #1 Paint Tool Brand (Purdy), and Sealer for wood n°1 (Thompson’s).
Sherwin-Williams is a dividend aristocrat and has increased its dividend for the past 40 consecutive years. The company’s ability to generate free cash flow in almost any operating environment is impressive, and its growth prospects are quite promising, despite some recent short-term setbacks that caused management to lower its earnings forecast. diluted per share adjusted this year.
We like the pricing power of Sherwin-Williams. During the company’s second quarter 2022 earnings press release, management responded to inflationary pressures by raising prices in The Americas Group by 10%, a hike that will take place in early September. The company also noted in the press release that there will be “significant additional pricing actions…taken in (its) two other operating segments.”
Sherwin-Williams Economic Profit Analysis
The best measure of a company’s ability to create value for its shareholders is expressed by comparing its return on invested capital to its weighted average cost of capital. The gap or difference between ROIC and WACC is called the economic profit gap of the firm. Sherwin-Williams’ 3-year historical return on invested capital (excluding goodwill) is 39.9%, which is higher than its cost of capital estimate of 8.6%.
As such, we give Sherwin-Williams an EXCELLENT value creation rating. In the chart below, we show the likely trajectory of ROIC in the coming years based on the estimated volatility of the main drivers of the metric. The solid gray line reflects the most likely outcome, in our view, and represents the scenario that results in our estimate of fair value. Sherwin-Williams remains a fantastic generator of economic value.
Sherwin-Williams Cash Flow Valuation Analysis
We believe Sherwin-Williams is worth $256 per share with a fair value range of $192.00 to $320.00. Shares of Sherwin-Williams are trading roughly at our estimate of fair value at the time of this writing. The safety margin around our estimate of fair value is determined by the company’s AVERAGE ValueRisk rating, which is derived from an assessment of the historical volatility of key valuation factors and a future assessment of these. .
Our near-term operating forecasts, including revenue and earnings, do not differ materially from consensus estimates or management guidance. Our model reflects a revenue compound annual growth rate of 5.9% over the next five years, faster than the company’s historical 3-year compound annual growth rate of 4.4%.
Our valuation model reflects a projected 5-year average operating margin of 18.1%, which is above Sherwin-Williams’ 3-year average. Beyond year 5, we assume that free cash flow will grow at an annual rate of 2.7% for the next 15 years and 3% in perpetuity. For Sherwin-Williams, we use a weighted average cost of capital of 8.6% to discount future free cash flow.
Sherwin-Williams Margin of Safety Analysis
Our discounted cash flow process evaluates each business based on the present value of all future free cash flows. Although we estimate the company’s fair value at approximately $256 per share, each company has a range of likely fair values that is created by the uncertainty of key valuation factors (such as future revenue or earnings, for example). After all, if the future were known with certainty, we wouldn’t see much volatility in the markets, as stocks would trade precisely at their known fair values.
This is an important way to view markets as an iterative function of future expectations. As future expectations change, the value of the company and its stock price should also change. Stock prices are not a function of fixed historical data, but rather act to capture future expectations as part of constructing company valuation. It’s a key part of our book Value Trap: Universal Valuation Theory.
Our ValueRisk Rating defines the margin of safety or range of fair value we assign to each stock. In the chart above, we show this likely range of fair values for Sherwin-Williams. We think the company is attractive below $192 per share (the green line), but quite expensive above $320 per share (the red line). Prices that fall along the yellow line, which includes our estimate of fair value, represent a reasonable valuation for the business, in our view.
Sherwin-Williams Dividend Growth Analysis
The Dividend Cushion Cash Flow Bridge, shown in the image above, illustrates the components of the Dividend Cushion ratio and highlights in detail the many factors behind it. Sherwin-Williams’ dividend cushion cash flow bridge reveals that the sum of the company’s 5-year cumulative free cash flow generation, as measured by operating cash flow less all capital, plus its net cash/debt position on the balance sheet, as of last year, is greater than the sum of expected cash dividends paid over the next 5 years. Since the Dividend Cushion ratio is forward-looking and reflects the trajectory of the company’s free cash flow generation and dividend growth, it reveals whether there will be a cash surplus or deficit at the end of the year. the 5-year period, taking into account the leverage effect on the balance sheet, the main source of risk.
On a fundamental basis, we believe that companies that have a strong net cash position on the balance sheet and generate a significant amount of free cash flow are better able to pay and grow their dividend over time. Companies that are buried under a mountain of debt and do not sufficiently cover their dividend with free cash flow are more at risk of a dividend cut or a suspension of growth, all other things being equal, our opinion. Generally speaking, the more positive the “blue bar” to the right, the more sustainable a company’s dividend, and the more negative the “blue bar” to the right, the less sustainable a company’s dividend. Sherwin-Williams has fantastic dividend coverage based on our forecast.
The biggest risk to Sherwin-Williams’ dividend program is its sizable net debt, although its free cash flow generating capabilities continue to impress. Competing capital allocation options are another concern as Sherwin-Williams has repurchased a significant amount of its stock in recent years. Management aims to pay out about 30% of Sherwin-Williams’ prior year earnings. Rising expectations for capital expenditures related to its new headquarters and R&D facilities will negatively impact Sherwin-Williams’ free cash flow generating capabilities in the near term, although in the long term it will aims to spend less than 2% of its sales on capital expenditures. Although Sherwin-Williams’ share price is about right, we think we like its dividend growth outlook which is supported by its strong fundamentals and pricing power.
This article or report and any links it contains are for informational purposes only and should not be considered a solicitation to buy or sell securities. Valuentum is not responsible for any errors or omissions or results obtained from the use of this article and assumes no responsibility for how readers may choose to use the content. Assumptions, opinions and estimates are based on our judgment as of the date of the article and are subject to change without notice.