MorningWord 07/14/14: A Sure Win? – $SHW

by Enis July 14, 2014 9:39 am • Commentary

Sherwin Williams caught our eye last week as we discussed stocks that report earnings this week.  SHW is an iconic American brand, founded in 1866 just after the U.S. Civil War.  The company is known for paint, and its ad campaigns over the decades have created a long-lasting brand awareness among American consumers.

However, though the paint business is no novel concept, SHW has been a terrific investment since the start of 2012, more than doubling in the past 2.5 years.  SHW’s weekly stock chart over the last over the last 5 years illustrates the consistency of the uptrend:

SHW weekly chart, 50 week ma in pink, Courtesy of Bloomberg
SHW weekly chart, 50 week ma in pink, Courtesy of Bloomberg

The stock’s advance means that SHW is now a $20 billion market cap stock, one of the largest in the paint industry worldwide.  Our reaction last week was – “Wait a second, this is the same old paint company???”

Reading SHW’s last quarterly release in April, management gives the impression that business is gradually growing (sales growth of 9% year-over-year) with no major surprises on the horizon.  Perhaps the largest strategic advantage for SHW over the past few years has been its large company-owned store network, which allows SHW to cut out the big box retailing middlemen like HD and LOW (Sherwin Williams gets 80% of its sales from the U.S.).  Competitors are less nimble in pricing and re-stocking, and SHW is able to capture a higher margin on its own sales as well.

GS Research laid out the positives alongside the valuation negative in a May note:

we continue to project strong long-term EPS growth for SHW through the combination of improving paint demand, higher selling prices, market share gains, contribution of the US and Canadian Comex assets, operating leverage, a benign raw material environment, and a resumption of SHW’s share repurchase program. Though these factors may make SHW an attractive large-cap equity to express a US housing recovery, we see limited room for further multiple expansion, and prefer other names in our coverage at this time.

However, SHW has clearly been boosted by the overall stock market environment as well.  SHW is one of many stocks in traditional sectors that have benefitted from a trend towards higher valuation multiples in the broader market.  The trailing 12 month P/E is near a 10 year high:

SHW trailing 12 month P/E, Courtesy of Bloomberg
SHW trailing 12 month P/E, Courtesy of Bloomberg

Besides the benign market backdrop, a major driver for the premium valuation is that return-on-equity has steadily increased for SHW over the past few years.  While SHW’s ROE was between 25 and 40% between 2003 and 2009, it is now closer to 50%.  That’s despite the fact that gross margins (around 45%) and sales growth (around 10%) have not been much different.  The higher ROE is partly a reflection of the improvement in operations as well as lower tax rates and increased financial leverage.  Of course, that theme is hardly unique to SHW.

SHW is already up 10.5% year-to-date, and the options market is implying around a 3.5% move on earnings this week (vs. 4.5% average move over the past 4 quarters).  The stock is only 3% from its all-time high of $208.63 in March.  SHW has had quite a run, and is a testament to the fact that this bull market has led to extraordinary gains, even for stocks that have been doing the same thing for the past 150 years.