Sherwin-Williams Growth Is Already Priced In

Good News Isn’t Good Enough For Sherwin-Williams 

Sherwin-Williams NYSE: SHW Q4 results helped catalyze an idea that has been brewing among us. The headwinds it is facing are cutting into the results in a way that no matter how good it is doing it isn’t meeting up to expectations or, rather, it is only meeting expectations which is just as bad. The company reports unprecedented supply chain challenges that they estimate cut into results by at least 500 basis points in top-line revenue. 

What’s worse is that guidance is weak as well, in regards to the expectations, and that has the stock set up for a bigger decline than it has already seen. Not only is Sherwin-Williams' growth outlook already priced into the market but the market overpriced the outlook and worse, the stock trades at a very high multiple as well and valuations are coming down all over the market. 

"Our full year and fourth quarter were marked by industry-wide supply chain disruptions, unprecedented cost inflation and ongoing challenges related to the pandemic," said Chairman, President and Chief Executive Officer, John G. Morikis … “While we focused on meeting customer needs, we also mitigated rising costs with pricing actions in all businesses throughout the year. Near term pressure on our margins was significant, but we remain highly confident they will recover just as they have in past cycles, as we grow the business and see commodity costs moderate over time.”

Sherwin-Williams Falls On Lackluster Results 

Sherwin-Williams had a good quarter but not a great one with supply chain issues cutting into the top line and inflation biting into the bottom line. The company reported $4.76 billion in revenue which is good for a gain of 6.1% but only as-expected in terms of the analyst's estimates and we were really expecting above-consensus results. Strength was driven by growth in the America’s group of 3.0% and Performance Coatings of 18.7% but offset by a decline of 7.8% in the Consumer group. The worst part is that margins fell considerably in all segments and left earnings below the Marketbeat.com consensus estimate. 

Moving down to the earnings, margin contracted by at least 450 basis points in all segments. The good news is that cost-mitigating efforts helped to offset them and resulted in only an 85 basis point decrease in gross margin and that was offset by an improvement in SG&A expense as well. The bad news is that margins came in below expectation and resulted in adjusted EPS of $1.34 or a penny shy of the Marketbeat.com consensus estimate. 

Looking forward, the guidance is positive and at least carries the hope of margin improvement if at the cost of higher selling prices for paint consumers. The good news here is that earnings of $9.25 to $9.65 imply 16% YOY growth in fiscal 2022. The bad news here is that the mid-point of that range $9.45, and even the high-end of $9.65, compares badly with the Marketbeat.com consensus of $9.83. 

Sherwin-Williams Capital Returns Are In Danger Of Shrinking

Sherwin-Williams was able to deliver more than $3 billion in capital to shareholders in F21 but there is a problem for us here as well. Capital returns are more than a billion in excess of operating cash and are resulting in higher debt levels. In our view, this is not sustainable in the best of times and we are facing an interest rate-hiking cycle. In our view, the 0.75% dividend is safe enough but we aren’t holding our breath in terms of repurchases. The company has 48.6 million shares left under the current allotment and we think those will be purchased, the question is how soon, how quickly, and how much will be added when the authorization runs out? 

Turning to the charts, shares of Sherwin-Williams are down in the wake of the report and appear to be heading lower. The shares are falling from newly established resistance at the $300 level and will probably move to the $275 level and possibly lower. Assuming the $275 level does not hold, we see this stock moving down to $265 and even $250.