April 21, 2016 Baird Equity Research Packaging & Coatings Sherwin-Williams Co. (SHW) High-Quality Beat Positive for Shares Strong start to 2016 led by core sales. We believe that the shares of Sherwin-Williams will react favorably to the high-quality 1Q16 earnings report, which was boosted by a near double-digit sales increase (SSS) in the Paint Stores Group segment. We reiterate our Outperform rating on the shares. Crushes 1Q. Sherwin-Williams reported diluted 1Q16 EPS of $1.81 well above consensus ($1.62) and versus $1.38 generated during the 1Q15 quarter. Paint Stores Group driven upside. SSS for the Paint Stores Group segment (PSG) of +9.4% was well above our forecast and partly reflective of easier comparisons on a YOY basis amid continued strength in U.S. construction fundamentals. Consumer also strong. Relative to our model, 1Q sales in the Paint Stores Group was the big outlier on the plus side, with Consumer also tracking higher (HGTV benefit), while Global Finishes was in-line (Latin America weaker). Commensurate operating leverage. Accordingly, operating income for PSG substantially outperformed, with Global Finishes also above forecast (lower raw material costs / productivity benefit), offset by a much higher Corporate Expense line (lower tax rate added $0.08). Solid outlook. As for the outlook, 2Q16 EPS guidance of $3.95 - $4.15 easily brackets consensus ($4.11), with sales expected to increase low-to-mid-sd. For FY16, EPS guidance was raised to $12.50 - $12.70 (consensus at $12.42), with low-sd sales guidance unchanged. Positive for shares. Net:net, given the high-quality 1Q earnings beat, we believe that the shares will react favorably to the 1Q earnings report. Key questions include: 1) why FY16 sales guidance was left unchanged even with 1H16 tracking towards the mid-sd level, 2) clarity behind the enormous FY16 costs related to the pending Valspar acquisition ($185 - $205 million), 3) competitive dynamics in the N.A. Paint market, and 4) guidance on share buybacks for FY16 (zero purchased during 1Q). RESEARCH UPDATE 1-Year Price Chart 320 300 280 260 240 220 200 M-15 J-15 J-15 Stock Data A-15 S-15 219 O-15 Rating: Outperform Suitability: Average Risk Price Target: $300 Price (4/21/16): $300.02 Market Cap (mil): $28,052 Shares Out (mil): 93.5 Average Daily Vol (mil): 0.94 Dividend Yield: 0.5% '16E EV:EBITDA: 14.6x '16E FCF Yield: 4.1% Estimates N-15 D-15 J-16 F-16 M-16 A-16 300 FY Dec 2015A 2016E 2017E Q1 1.38 A 1.81 A Q2 3.70 A 4.04 E Q3 3.97 A 4.33 E Q4 2.12 A 2.44 E Fiscal EPS 11.16 A 12.40 E 13.85 E Fiscal P/E 26.9x 24.2x 21.7x Chart/Table Sources: FactSet and Baird Data. Price chart reflects most recent closing price. EPS (Net): 1Q16 has been updated. FY16, FY17, and price target are pending further review. EPS (Net): Quarterly EPS may not sum to FY EPS due to rounding. Sherwin-Williams is a global leader in the manufacture, development, distribution, and sale of coatings and related products to professional, commercial, and retail customers. [Please refer to Appendix - Important Disclosures and Analyst Certification] Ghansham Panjabi, Ph.D. gpanjabi@rwbaird.com 214.220.3040 Mehul M. Dalia mdalia@rwbaird.com 415.364.3341 Matthew T. Krueger mtkrueger@rwbaird.com 414.298.7699
Details Quarterly Results Comparison - SHW (actual) vs. RWB Estimates Actual vs. Estimate Year/Year Change Reported 1Q16 1Q16E $ Diff %/bps Diff EPS Impact 1Q15 % Change Net Revenue: Paint Stores Group 1,615.3 1,509.0 106.3 7.0% - 1,461.5 10.5% Consumer Group 378.1 365.8 12.3 3.4% - 351.7 7.5% Global Finishes Group 454.2 453.1 1.0 0.2% - 469.6-3.3% Latin America Coatings Group 125.2 129.7 (4.5) -3.4% - 166.2-24.7% Administrative 1.3 1.3 (0.0) -1.8% - 1.3-1.8% Net Revenue 2,574.0 2,458.8 115.2 4.7% - 2,450.3 5.1% Operating Income: Paint Stores Group 253.5 211.0 42.6 20.2% $0.32 176.6 43.6% Consumer Group 64.0 62.0 2.0 3.1% $0.01 55.4 15.4% Global Finishes Group 48.6 38.4 10.1 26.4% $0.08 38.9 24.9% Latin America Coatings Group (0.9) 3.9 (4.8) -123.7% ($0.04) 9.5-109.8% Administrative (100.6) (80.0) (20.6) 25.8% ($0.16) (74.8) -34.5% Operating Income 264.5 235.3 29.2 12.4% $0.22 205.6 28.7% Operating Margins: Paint Stores Group 15.7% 14.0% - 170-12.1% 360 Consumer Group 16.9% 17.0% - - - 15.8% 120 Global Finishes Group 10.7% 8.5% - 220-8.3% 240 Latin America Coatings Group -0.7% 3.0% - (380) - 5.7% (650) Operating Margins 10.3% 9.6% - 70-8.4% 190 Interest Expense (net) 25.7 19.0 6.7 35.4% ($0.05) 12.4 108.3% Pretax Income 238.8 216.3 22.5 10.4% $0.17 193.2 23.6% Taxes 69.2 69.2 0.0 0.0% - 61.8 12.0% Tax Rate 29.0% 32.0% - -3.0% $0.08 32.0% -9.4% Net Income to Restricted Shares - (0.5) 0.5 0.0% $0.01 (0.2) - Net Income to Common Shares 169.6 146.6 23.0 15.7% $0.25 131.2 29.2% Diluted Shares Outstanding 93.5 92.5 1.0 1.1% ($0.02) 94.7-1.3% Diluted EPS $1.81 $1.59 $0.23 14.4% $0.23 $1.38 30.9% Sources: Company filings and estimates * EPS impact may be off by +/- $0.01 due to rounding. Investment Thesis Top-three global coatings player and dominant N.A. franchise. In our opinion, Sherwin-Williams has emerged as a strong No. 3 in the attractive global coatings niche, with outsized exposure toward the N.A. architectural coatings market (~45% share). Products include coatings used in construction (paints and sealants) and product manufacturing (autos/wood furniture), with N.A. architectural coatings encompassing ~70% of the sales portfolio differentiating SHW from its more global peers (75% sales from N.A.). 70% sales base housing biased. In following, Sherwin-Williams is clearly exposed to U.S. housing fundamentals, noting that architectural coatings usage in the U.S. is down roughly 15% since the 2005 peak. Regardless, built on considerable brand equity and a differentiated controlled distribution model (70% of sales through retail stores), SHW has consistently gained share across N.A., while exhibiting pricing power via six price increases since 2010 (to offset rapid propylene and TiO2 increases). Near-term outlook attractive. Regardless, we believe that SHW fundamentals are attractive near term, with improving end-market dynamics boosted by a stable to declining raw material cost environment. 2
Valuation. Our $300 price target is based on 14.5x '16E EV:EBITDA, above the company's historical average of 8.5x LTM EV:EBITDA, which we believe is justified given the Sherwin s strong brand equity, significant free cash flow generation, pricing power, and cash flow allocation track record. Risks & Caveats Outsized exposure to U.S. architectural coatings. Continued weakness in the U.S. housing market and U.S. architectural coatings market (~70% of Sherwin's sales) is a major risk. Volatile raw material costs. Though raw material inflation is weakening, spikes in propylene and TiO2 costs (both major cost inputs) could hurt Sherwin's profitability. Significant operating leases. At current, Sherwin-Williams has ~$700 million in operating leases (NPV), as 93% of its stores are leased, which we believe could become a risk if leasing terms become unfavorable in the future. Lead-based paint litigation. Sherwin-Williams is an easy target for lead-based paint related litigation given its dominance in the U.S. architectural coatings market, its significant FCF generation, and the relatively low number of existing prior lead-based paint producers left in business at current (most have gone bankrupt). Environmental liabilities. Sherwin-Williams mentions environmental litigation as an ongoing concern in their filings, and accrues potential liabilities from adverse rulings when it is increasingly probable that a liability will materialize and an amount can be determined. Company Description Founded in 1866, The Sherwin-Williams Company is a global leader in the manufacture, development, distribution, and sale of coatings and related products to professional, industrial, commercial, and retail customers. The company manufactures products under well-known brands such as Sherwin-Williams, Dutch Boy, Krylon, Minwax, Thompson s WaterSeal, and many more. With global headquarters in Cleveland, Ohio, Sherwin-Williams branded products are sold exclusively through a chain of more than 4,000 company-operated stores and facilities, while the company s other brands are sold through leading mass merchandisers, home centers, independent paint dealers, hardware stores, automotive retailers, and industrial distributors. The Sherwin-Williams Global Finishes Group distributes a wide range of products in more than 109 countries around the world. 3
Appendix - Important Disclosures and Analyst Certification Rating and Price Target History for: Sherwin-Williams Co. (SHW) as of 04-20-2016 05/24/13 O:$205 03/19/14 O:$225 10/02/14 O:$240 12/11/14 O:$260 01/14/15 O:$300 320 280 240 200 160 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 120 2014 2015 2016 Created by BlueMatrix 1 Incorporated makes a market in the securities of SHW. Incorporated and/or its affiliates expect to receive or intend to seek investment banking related compensation from the company or companies mentioned in this report within the next three months. Incorporated may not be licensed to execute transactions in all foreign listed securities directly. Transactions in foreign listed securities may be prohibited for residents of the United States. Please contact a Baird representative for more information. Investment Ratings: Outperform (O) - Expected to outperform on a total return, risk-adjusted basis the broader U.S. equity market over the next 12 months. Neutral (N) - Expected to perform in line with the broader U.S. equity market over the next 12 months. Underperform (U) - Expected to underperform on a total return, risk-adjusted basis the broader U.S. equity market over the next 12 months. Risk Ratings: L - Lower Risk - Higher-quality companies for investors seeking capital appreciation or income with an emphasis on safety. Company characteristics may include: stable earnings, conservative balance sheets, and an established history of revenue and earnings. A - Average Risk - Growth situations for investors seeking capital appreciation with an emphasis on safety. Company characteristics may include: moderate volatility, modest balance-sheet leverage, and stable patterns of revenue and earnings. H - Higher Risk - Higher-growth situations appropriate for investors seeking capital appreciation with the acceptance of risk. Company characteristics may include: higher balance-sheet leverage, dynamic business environments, and higher levels of earnings and price volatility. S - Speculative Risk - High-growth situations appropriate only for investors willing to accept a high degree of volatility and risk. Company characteristics may include: unpredictable earnings, small capitalization, aggressive growth strategies, rapidly changing market dynamics, high leverage, extreme price volatility and unknown competitive challenges. Valuation, Ratings and Risks. The recommendation and price target contained within this report are based on a time horizon of 12 months but there is no guarantee the objective will be achieved within the specified time horizon. Price targets are determined by a subjective review of fundamental and/or quantitative factors of the issuer, its industry, and the security type. A variety of methods may be used to determine the value of a security including, but not limited to, discounted cash flow, earnings multiples, peer group comparisons, and sum of the parts. Overall market risk, interest rate risk, and general economic risks impact all securities. Specific information regarding the price target and recommendation is provided in the text of our most recent research report. Distribution of Investment Ratings. As of March 31, 2016, Baird U.S. Equity Research covered 710 companies, with 51% rated Outperform/Buy, 48% rated Neutral/Hold and 1% rated Underperform/Sell. Within these rating categories, 14% of Outperform/Buy-rated and 5% of Neutral/Hold-rated companies have compensated Baird for investment banking services in the past 12 months and/or Baird managed or co-managed a public offering of securities for these companies in the past 12 months. Analyst Compensation. Analyst compensation is based on: 1) the correlation between the analyst's recommendations and stock price performance; 2) ratings and direct feedback from our investing clients, our institutional and retail sales force (as applicable) and from independent rating services; 3) the analyst's productivity, including the quality of the analyst's research and the analyst's contribution to the growth and development of our overall research effort and 4) compliance with all of Robert W. Baird s internal policies and procedures. This compensation criteria and actual compensation is reviewed and approved on an annual basis by Baird's Research Oversight Committee. Analyst compensation is derived from all revenue sources of the firm, including revenues from investment banking. Baird does not compensate research analysts based on specific investment banking transactions. A complete listing of all companies covered by Baird U.S. Equity Research and applicable research disclosures can be accessed at http://www.rwbaird.com/research-insights/research/coverage/research-disclosure.aspx. 4
You can also call 1-800-792-2473 or write: Incorporated, Equity Research, 777 E. Wisconsin Avenue, Milwaukee, WI 53202. Analyst Certification. The senior research analyst(s) certifies that the views expressed in this research report and/or financial model accurately reflect such senior analyst's personal views about the subject securities or issuers and that no part of his or her compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report. Disclaimers Baird prohibits analysts from owning stock in companies they cover. This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy. ADDITIONAL INFORMATION ON COMPANIES MENTIONED HEREIN IS AVAILABLE UPON REQUEST The Dow Jones Industrial Average, S&P 500, S&P 400 and Russell 2000 are unmanaged common stock indices used to measure and report performance of various sectors of the stock market; direct investment in indices is not available. Baird is exempt from the requirement to hold an Australian financial services license. Baird is regulated by the United States Securities and Exchange Commission, FINRA, and various other self-regulatory organizations and those laws and regulations may differ from Australian laws. This report has been prepared in accordance with the laws and regulations governing United States broker-dealers and not Australian laws. Copyright 2016 Incorporated Other Disclosures The information and rating included in this report represent the Analyst s long-term (12 month) view as described above. The research analyst(s) named in this report may at times, discuss, at the request of our clients, including salespersons and traders, or may have discussed in this report, certain trading strategies based on catalysts or events that may have a near-term impact on the market price of the equity securities discussed in this report. These trading strategies may differ from the analysts published price target or rating for such securities. Any such trading strategies are distinct from and do not affect the analysts fundamental long-term (12 month) rating for such securities, as described above. In addition, Incorporated and/or its affiliates (Baird) may provide to certain clients additional or research supplemental products or services, such as outlooks, commentaries and other detailed analyses, which focus on covered stocks, companies, industries or sectors. Not all clients who receive our standard company-specific research reports are eligible to receive these additional or supplemental products or services. Baird determines in its sole discretion the clients who will receive additional or supplemental products or services, in light of various factors including the size and scope of the client relationships. These additional or supplemental products or services may feature different analytical or research techniques and information than are contained in Baird s standard research reports. Any ratings and recommendations contained in such additional or research supplemental products are consistent with the Analyst s long-term ratings and recommendations contained in more broadly disseminated standard research reports. United Kingdom ( UK ) disclosure requirements for the purpose of distributing this research into the UK and other countries for which Robert W. Baird Limited ( RWBL ) holds a MiFID passport. This material is distributed in the UK and the European Economic Area ( EEA ) by RWBL, which has an office at Finsbury Circus House, 15 Finsbury Circus, London EC2M 7EB and is authorized and regulated by the Financial Conduct Authority ( FCA ). For the purposes of the FCA requirements, this investment research report is classified as investment research and is objective. This material is only directed at and is only made available to persons in the EEA who would satisfy the criteria of being "Professional" investors under MiFID and to persons in the UK falling within articles 19, 38, 47, and 49 of the Financial Services and Markets Act of 2000 (Financial Promotion) Order 2005 (all such persons being referred to as relevant persons ). Accordingly, this document is intended only for persons regarded as investment professionals (or equivalent) and is not to be distributed to or passed onto any other person (such as persons who would be classified as Retail clients under MiFID). Incorporated and RWBL have in place organizational and administrative arrangements for the disclosure and avoidance of conflicts of interest with respect to research recommendations. This material is not intended for persons in jurisdictions where the distribution or publication of this research report is not permitted under the applicable laws or regulations of such jurisdiction. Investment involves risk. The price of securities may fluctuate and past performance is not indicative of future results. Any recommendation contained in the research report does not have regard to the specific investment objectives, financial situation and the particular needs of any individuals. You are advised to exercise caution in relation to the research report. If you are in any doubt about any of the contents of this document, you should obtain independent professional advice. RWBL is exempt from the requirement to hold an Australian financial services license. RWBL is regulated by the FCA under UK laws, which may differ from Australian laws. This document has been prepared in accordance with FCA requirements and not Australian laws. Dividend Yield. As used in this report, the term dividend yield refers, on a percentage basis, to the historical distributions made by the issuer relative to its current market price. Such distributions are not guaranteed, may be modified at the issuer s discretion, may exceed operating cash flow, subsidized by borrowed funds or include a return of investment principal. Ask the analyst a question Click here to unsubscribe 5