Sherwin Williams Co Q4 FY2020 Earnings Call

Good morning. Thank you for joining the Sherwin-Williams Company's Review of Fourth Quarter 2020 Results and our outlook for the First Quarter and Full Year Of 2021. With us on today's call are John Morikis, Chairman and CEO; Al Mistysyn, CFO; Jane Cronin, Senior Vice President and Corporate Controller; and Jim Jaye, Senior Vice President, Investor Relations and Communications. This conference call is being webcast simultaneously in listen-only mode. This conference call will include certain forward-looking statements as defined under US federal securities laws with respect to sales, earnings and other matters. Any forward-looking statement speaks only as of the date on which such statement is made, and the company undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. A full declaration regarding forward-looking statements is provided in the company's earnings release transmitted earlier this morning. After the Company's prepared remarks, we will open the session to questions. I will now turn the call over to Jim Jaye.

Thank you, and good morning everyone. Sherwin-Williams delivered outstanding results in the fourth quarter. The momentum with which we exited the third quarter continued in the fourth quarter, with the pace of growth accelerating across our Pro Architectural and Industrial Customer segments. We saw continued unprecedented growth in our DIY business during the quarter, a double-digit increase in residential repaint, solid expansion in new residential, modest improvements in commercial and property management, and high single-digit growth in our industrial segment. Fourth quarter 2020 consolidated sales increased 9.1% to $4.49 billion dollars. Consolidated gross margin increased 140 basis points to 47.4%. Consolidated profit before tax increased $206.5 million to $503.9 million. The fourth quarter of 2020 included $77.4 million of acquisition-related depreciation and amortization expense. The fourth quarter of 2020 included acquisition-related amortization expense of $0.63 per share. The fourth quarter of 2019 included acquisition-related amortization expense for other adjustments of $1.61 per share as described in our press release. Excluding these items, fourth quarter adjusted diluted earnings per share increased 19.2% to $5.09 per share, compared to $4.27 per share. EBITDA grew to $733.9 million in the quarter or 16.3% of sales. Net operating cash grew to $844.8 million in the quarter or 18.8% of sales. All three of our operating segments delivered excellent top-line growth, margin expansion and strong flow through in the quarter. Segment margin in the Americas Group improved 270 basis points to 21.7% of sales, resulting primarily from operating leverage on the top-line growth and favorable mix. Flow-through was 51.3%. Adjusted segment margin in Consumer Brands Group improved 280 basis points to 13.6% of sales, resulting primarily from operating leverage on the double-digit top line growth. Flow-through was 34.6%. Adjusted segment margin in Performance Coatings Group improved 100 basis points to 14.4% of sales, driven by operating leverage on the high-single digit sales growth and lower input costs. Let me now turn the call over to John Morikis for additional commentary on 2020 along with our guidance for the first quarter and full year 2021. John?

Thank you, Jim, and good morning everyone. The strong results in our fourth quarter led to another record year for Sherwin-Williams. My deepest appreciation and respect go out to all 61,000 members of our incredible global family and to our leadership team for everything they've done. While none of us anticipated the severity of this year's challenges, our people responded as they always do when facing adversity, with extraordinary effort, determination, and resiliency. When it mattered most, this team delivered, and I'm incredibly grateful for all they do. To that end, our full-year 2020 results demonstrate the strength of our people, our business model and our solutions-based approach to meeting customer needs. We generated record sales despite the impacts of COVID-19. Cash from operations, net income, and net income per diluted share also were in records and increased by double-digit percentages over 2019. I'd like to call out just a few full-year highlights in more detail. Sales increased 2.6%, including a negative impact of 1.1% related to currency translation, to a record $18.4 billion. Gross margin improved 240 basis points to 47.3%. EBITDA grew to a record $3.4 billion or 18.7% of sales. Segment margin expanded in all three business groups. Adjusted diluted net income per share, which excludes acquisition-related amortization expense and other items called out in our press release, increased 16.4% to $24.58 per share. Net operating cash for the year increased to a record $3.41 billion or 18.6% of sales. We returned approximately $2.93 billion to our shareholders in the form of dividends and share buybacks, an increase of 145% over the prior year. We invested $303.8 million in our business through capital expenditures. And we retired $400 million in debt, ending the year with a debt to EBITDA ratio of 2.4 times. As Jim described, we achieved these record full-year results with a strong close to the year. Let me provide some more detail about our segment performance in the fourth quarter. In the Americas Group, fourth quarter sales increased by 9% over the same period a year ago, including just under 2 percentage points of price and a headwind of 1.2 percentage points related to unfavorable currency translation. Same-store sales in the US and Canada were up 9.3%. We saw consistent trends across the business in the quarter, and we significantly outpaced the rate of growth we delivered in our third quarter. In Residential Repaint, our largest segment, we delivered double-digit growth in the quarter. Interior and exterior work were both strong. Existing home sales are robust, and contractors are reporting solid backlogs. I'm also pleased to report that once again we grew this segment by double-digits on a full-year basis. We continue to see great opportunities here for share gains going forward. Demand remained unprecedented in our DIY business where sales were up by a double-digit percentage for the fourth consecutive quarter. New residential also remained an area of strength for us with the rate of growth accelerating from mid-single digits in the third quarter to high single digits in the fourth quarter. New housing permits and starts have been trending very well since summer, and customers are reporting solid order rates. We've not yet seen meaningful recovery in our commercial business, which was up slightly in the fourth quarter. The predominant theme remains that projects are being delayed rather than canceled. Property maintenance was also up slightly in the quarter, though turnover in multifamily properties remains low. Protective and Marine was down by double-digit percentage where growth in our smaller customer segments such as Flooring, Bridge and Highway and Water and Wastewater treatment, was more than offset by softness in the Oil and Gas segment. We continue to aggressively pursue opportunities in all of these end markets. From a product perspective, sales in both Interior and Exterior paint were up by double-digit percentages, with Interior becoming a larger part of the mix than it was in the third quarter, as is normal for our fourth quarter. Heavy equipment sales also were up double digits in the quarter. Contractors typically invest in this type of equipment in anticipation of solid demand. In December we announced a 3% to 4% price increase to our US and Canada customers effective February 1. We would expect to realize approximately 1.5% from price in the first quarter and just under 2% in the following quarter. We opened 54 new stores for the full year in the US and Canada, partially offset by consolidation of underperforming stores, the majority of which were in Latin America. Along with these stores, we continue to make investments in sales reps, management trainees, innovative new product and productivity-enhancing services to drive additional growth. We're also pleased by a continuing uptick in the use of our e-commerce platform. Moving onto our Consumer Brands Group, we delivered sales growth of 13.6% in the quarter, including 1.4 percentage points of positive impact related to currency translation as DIY demand remained robust. Sales in North America increased in line with our mid-teens segment growth guidance. International demand was variable with Australia up low-double digits, Europe up low-single digits, and Asia down mid-single digits, respectively. Our global supply chain organization continued to perform at a high level in the quarter, working collaboratively with our customers and businesses to help meet the strong demand. The strong sales growth, along with prior portfolio improvements and international cost reductions, drove this significant improvement in our margin performance. Last, let me comment on our fourth quarter trends in Performance Coatings Group. Following an encouraging third quarter, we continued to build momentum across the business in the fourth quarter. Group sales increased by high single-digit percentage. The impact of currency translation was not material in the quarter. Price was positive in all regions, and all regions and all divisions generated growth. Regionally, sales in Asia grew the fastest in the quarter, up by a strong double-digit percentage. Europe and Latin America also grew by double-digit percentages. North America sales were just slightly positive. From a divisional perspective, I'll start with our Coil Coatings business, where growth was up double digits in the quarter and positive in every region. This team continues to do a remarkable job at winning new accounts in all regions. We're also seeing the gradual resumption of selected commercial construction projects. Our Packaging Team also continues to deliver great results. Sales were up double digits in the quarter and positive in every region. Demand for food and beverage cans remains robust. Our non-BPA coating continued to gain traction, and both we and our customers are investing in capacity expansion. Sales in the Industrial Wood division were up by a double-digit percentage in the quarter. Positive trends in new residential construction are driving increased demand for kitchen cabinetry, flooring, and furniture. We're especially encouraged by the return to growth in our General Industrial division, where sales were up by a high-single digit percentage in the quarter. We saw a meaningful improvement in portions of our Heavy Equipment, Building Products and Container segments as well as more General Finishing. We believe the strong performance was a mix of inventory restocking by some of our customers and growing demand. Sales were up in all regions except North America, which was down about 1% but improved significantly from the third quarter. Sales were also slightly positive in the Automotive Refinish division in the quarter. Heightened social restrictions and lower than normal holiday travel due to a resurgence in COVID pressured miles driven and collision shop volume. Turning to our 2021 outlook, we see an operating environment with very solid North American new residential and residential repaint demand. The trajectory of recovery in Commercial and Property Maintenance is likely to be choppy and comparisons in DIY will be challenging. We anticipate Industrial demand will continue to improve as the year progresses. The impact of variables such as the timing of the COVID vaccine, the incoming US administration and proposed stimulus and infrastructure spending are hard to gauge at this point. That said, our team is skilled at adapting to any number of conditions. And we have many opportunities to grow share in all of our businesses. We'll continue to target growing at a rate that outpaces the market through customer-driven solutions based on innovation, value-added service and differentiated distribution. For the first quarter of 2021, we anticipate our consolidated net sales will increase by a high-single-digit percentage compared to the first quarter of 2020. We expect the Americas Group to be up high-single digits. We expect Consumer Brands to be up by a mid-teens percentage, and we expect Performance Coatings Group to be up by mid-to-high single digits. For the full year 2021, we expect net sales to increase by a mid-to-high single digit percentage. First half growth is expected to be stronger than the second half given the negative impact COVID had on our first half a year ago. We expect the Americas Group to be up a mid-to-high-single-digit percentage, Consumer Brands Group to be up or down by low-single-digit percentage and Performance Coatings Group to be up by a mid-single-digit percentage. We expect diluted net income per share for 2021 to be in the range of $23.87 to $24.67 per share compared to $22.08 per share earned in 2020. Full year 2021 earnings per share guidance includes acquisition-related amortization expense of approximately $2.53 per share. On an adjusted basis, we expect full-year 2021 earnings per share of $26.40 to $27.20, an increase of 9% at the midpoint over the $24.58 we delivered in 2020.

As Jim mentioned, we achieved these record full-year results with a strong close to the year. The Americas Group fourth quarter sales increased by 9% over the same period a year ago, including just under 2 percentage points of price and a headwind of 1.2 percentage points related to unfavorable currency translation. Same-store sales in the US and Canada were up 9.3%. We saw consistent trends across the business in the quarter and significantly outpaced the rate of growth we delivered in our third quarter. Residential Repaint, our largest segment, delivered double-digit growth in the quarter. Interior and exterior work were both strong. Existing home sales are robust, and contractors are reporting solid backlogs. We've not yet seen meaningful recovery in our commercial business, which was up slightly in the fourth quarter. The predominant theme remains that projects are being delayed rather than canceled. We continue to aggressively pursue opportunities across all end markets. Moving onto our Consumer Brands Group, we delivered sales growth of 13.6% in the quarter, supported by strong demand, and our expectations for 2021 are cautiously optimistic.

Thank you. Good morning, everybody. I guess, first off, on your fiscal year 2021 guidance, TAG up mid-to-high-single digits. Can you sort of walk us through your current view on the various subsegments in there? There has been some divergence thus far in Residential versus Commercial Construction in the US, how do you sort of expect that to evolve as the year unfolds?

Ghansham, I'd say first, we have great confidence in the market here. We've been working very hard to position the company to strategically thrive whichever way the table tilts. So while there may be some shifts in the market, we believe we'll be able to capitalize on the opportunities regardless of which way the market may move. Let me just run through quickly to answer your question. I think from a New Residential standpoint, we think coming off a high-single digits in the fourth quarter, we believe that permits are strong, and our position in New Residential is very strong. We've got a terrific position with 18 of the top 20 homebuilders. And we expect that momentum that they are experiencing will result in some nice gains for us. We're also very pleased with the gains that we've been making with the regional builders.

Yes, John, sure. And good morning, Ghansham. If you look at the New Residential piece, obviously John mentioned it, but permits starts have been very strong since the summer. You look at in December they were up mid-single digit. The last three months it's up double digits on starts. Single family has been a bit stronger obviously than multifamily. You look at some of the other indicators. The 30-year fixed mortgage, still very supportive around 2.7 or so in December. US consumer confidence, a little bit shaky at this point, and unemployment still about 6, but we think everything that we're seeing, hearing from our customers on the new residential side is very solid.

Hey, Ghansham, this is Al Mistysyn, only one other comment to add, because of the way 2020 unfolded with a weaker first half and a stronger second half, it's important that we get off to a good start. And as we've talked about in the past with our Paint Stores Group North America having a strong second half of 2020, up mid-single digits, and then especially with the fourth quarter being up high-single digits, that typically translates to growth in our first half and gives us confidence about the Paint Store and Architectural volume to start the year into our first half.

Okay, that's very thorough. Thank you so much. And then just real quick for my second question on the inflation side, I mean you're very specific in terms of raw materials, in terms of how that's going to sequence in 2021. You called out pricing in TAG. How should we think about performance pricing, like what have you announced so far? Three years ago we had an inflation cycle. The industry was distracted, including you guys closing up Valspar. How are you going to approach inflation differently in this particular inflation cycle?

Yes, Ghansham. I think we're in a completely different spot than where we were when we closed Valspar in 2017. As you recall, there was not a lot of price out in the market relative to industrial as raw materials were increasing in '17. And then we collectively as an industry chased it for the following two years. I think we are ahead of it in the sense that we are out with price across different of our divisions. We have more price to go as Jim or as John talked about. It's heavier on the petrochem side. And we are absolutely out in the market with price a little bit higher than what I would say you would see on our TAG Architectural business because of the higher increase we see on petrochem; so I think you're going to see a different environment.

Thank you, Ghansham.

Thanks very much. Hi, good morning. Your administrative costs in the quarter were up, I don't know $65 million. Maybe they were up $55 million for the year. Did something unusual happen in the fourth quarter? And what's your outlook for administrative costs in 2021?

Yes, Jeff, if you look at the year-over-year in the fourth quarter, most of that increase was due to Brazilian tax credits and occurred in the fourth quarter. Aside from that, the remaining increases were due to higher comp and incentives, including stock-based compensation. We had a higher environmental expense in the quarter, and then we took the opportunity in the fourth quarter as we saw a stronger sales than what we had guided to - our guidance as you recall was to be up three to seven. We ended up above the high end of that range at little bit over 9%. Some of the spending we delayed in IT infrastructure, and some of the digital initiatives across the enterprise we put some money back in there that drove that increase up a little bit. That was partially offset by a decrease in integration costs. If you look at our outlook for 2021, my expectation is interest expense will be pretty flat year-over-year. And then I would expect to be flat to down slightly on admin for the rest of the year.

And then - thank you for that. And then from a strategic point of view, I don't think you bid on Tikkurila. Can you talk about why you didn't or why that would have been a good fit or a bad fit? Can you - can you reflect on that asset as relates to Sherwin-Williams?

Jeff, I don't know that I want to talk about any one particular asset. I might give you our thinking overall and let you drive your own thinking to that. Our pipeline as we see it is robust, and we continue to evaluate what we believe are strategic fits for our company. And to us, we look at very unique and differentiated solutions and solutions that allow us to drive our customer success. Our strategy is not going to be defined by what comes up for sale. And we're not trying to be everything to everyone nor trying to be everyone - or everywhere for everyone. We look proactively for targets that are fits for our strategy, that fit us in geographic areas that we feel that are a gap, that provide a technology that we can leverage or adds to our distribution that fits our strategy.

Jeff, the only thing I would add to that is we don't have a gun to our head. We've talked about this in the past, we believe we can grow organically. And if you look at the last two years, '19 and '20, we grew sales a modest 2.3% CAGR. That's over $800 million incremental dollars. And with that though, we grew adjusted PBT just under $640 million of flow through of 77%. I think that talks to the strength of the model and the strategy that we put in place, and then when you look at our 2021 sales guidance to be up mid-to-high-single digits, we expect to accelerate that growth in 2021.

Thank you very much.

Thank you, and good morning, everyone. I'm just trying to contextualize the performance - the impressive performance in the fourth quarter and TAG north of 9% versus I think a 4.5% comp in the prior period. And I'm assuming, particularly in Residential Repaint, that your customers don't have complete access to their customers for COVID reason. So I'm just wondering if you can help us understand or if you know from your customers sort of what percentage of their book of business or their perspective book of business, they actually have complete access to sort of exiting the fourth quarter versus maybe where they were entering or in the third quarter, just so that we can get a sense of how the opportunities that's going to progress as we move through 2021.

I think you should plan on the opportunities to be very solid. I don't have a number. I think it varies by customer and probably by geography, but as you would expect with over 3,000 sales reps and nearly 5,000 store managers out there every day working this customer, we have a very good feeling about what they're doing and through our CRM, we've got an understanding of the activity there, and I would tell you it's terrific. In a number of ways I would say the confidence that we have presents itself. The drive that we have in new account activity for further growth - there's an interesting fact. In 2020, we actually opened more new accounts, many of them in Residential Repaint in 2020 than we did in 2019. So the visual I'd like for you to understand is that we've got this terrific customer base that's growing in their loyalty to us through the introduction of new products and innovative solutions, the digital platform.

If I could just ask on the raws and price, the February one start date versus I think last year was a June one start date, I mean what - what were you waiting for to make the price increase announcement and how - what caused the percentage increase that you chose? There are a lot of folks that are worried about further inflation in the back half and the crude oil chain further into petrochemicals or in TiO2. So are you confident that you took enough or should we think that maybe possibly you'll need to take more during the year if necessary?

Yes, Vincent. The timing of our price increase was largely influenced by the rapid escalation in raw material costs that we observed as the fourth quarter progressed. Initially, we did not intend to implement the increase this early due to our expectations about the raw material environment. We monitor the situation monthly and project potential movements in costs for both Architectural and Industrial sectors. When we noted the swift rise in propylene prices, we adjusted our approach and decided on a price increase that we believe is appropriate for Architectural. For Industrial, since we are still working through certain processes, we have the flexibility to modify the price increase compared to our initial estimates. Consequently, we anticipate needing to implement a larger increase for Industrial than we did for Architectural. As the year advances, if raw material costs exceed our projections or guidance, we maintain the discipline to adjust pricing accordingly. Historically, as seen in 2010, 2011, and 2012, we enacted multiple price increases over an 18-month period whenever necessary to cover our costs. Currently, we feel confident about the price increases we are introducing to the market.

Thanks for the detail and looking forward to a great 2021.

Hi, thanks. I had two questions. One was you mentioned digital investment with the home centers. Could you get a little more specific in terms of what that is and how we should think of that strategically?

Yes, I think there is a digital investment and a home center digital investment. So I want to make sure that you're clear with our comments there, Greg. We are very excited about our relationship. We share our definition of success with our Consumer Brands customers that has us leaning forward and anxious on growing - this growing opportunity. We're interested in retention of the customers that our customers are experiencing. And we're working with them in ways to help them do that. Internally, ours, we're very excited about that as well. I'd splinter that out into both the do-it-yourself, again lesser part of our business. We're spending a little bit of time on to serve those customers, and several investments and attention going towards our professional digital platform, Greg.

That's great. And the follow-up for Al is on leverage. The 2.4 times now with the amount of cash you generated last year. Where are you comfortable with that? Does that need to get down to two or are we at a point now that free cash flow should really just be generally buying back stock or investment M&A, whatever?

Yes, Greg, as I've talked, the target leverage that we are looking at was 2 to 2.5. I'm very comfortable at 2.4, and I think you're absolutely right. We're not going to pay down debt in 2021, and we'll use the free cash flow for M&A. And absent M&A, we're going to buy our stock back.

Hey guys, nice end of the year there. So sort of taking a look at the sales growth that you guys put up in '19 and 2020, yet the '21 outlook is stronger. Yet the midpoint of your guidance for EPS is a little bit less, so just curious what - given that your sales growth is pretty good, but what's sort of holding back some of the EPS growth leverage relative to the last couple of years?

Mike, we did have a little bit of a tailwind in 2020 relative to raw materials. As we've talked about with raw materials going up low to mid-single-digit percentage and the pricing that we have to put it to get on top of that, unfortunately that doesn't go to our bottom line as much. But I think we're excited about the 9% on top of a 16.4% increase to your point and expect segment operating margin improvement across all segments. We do expect to see modest gross margin expansion as we have the volume growth. We have the price increases to offset inflation, but then we also have this continuous improvement culture that we've talked about in the past.

Got it. And then just a quick follow-up on TAG, and I apologize if I missed this. Are you planning any new stores this year, and are there any particular areas in the country that you're going to focus on? And then just sort of a comment, I hope you have a lot of orange and brown paint readily available given the Browns are finally on its way.

Well, we love that you just made that comment, well most of us. Our Pittsburgh fan here, Al Mistysyn, is a Steeler fan, but the rest of us are right there with you. Yes, we do plan on continuing to invest in our stores. We just mentioned investments, and stores and reps are an important part of that. And we're going to be back into that range likely in the 80 to 100 as we go into 2021. And a lot of that I'll have to do with how this pandemic flows, but it's an important investment that we continue to expect to put fuel in that tank for sure.

Yes, thanks for taking my question. I guess two things, one on the - if we assume that the DIY markets really didn't eat much into the do-it-for-me side, I guess, how much - is there a way to think about how much pent-up demand there is just given the COVID situation in 2020? And is this, in your opinion, do we have a multi-year catch-up or is this - can a lot of it be really made up in 2021?

I think it's likely a longer build up than most would realize. I mean when you think, to your point, the do-it-for-me I think is a growing population. There was a DIY surge, about 60% of the people saying that they undertook some home improvement projects. We believe that there is such a backlog right now given the surge that we've already seen in DIY. When you talk to our painting contractors, we believe that there is still quite a bit of pent-up demand, and there are underlying long-term demand drivers we think that support that, the aging population, the home price appreciation, aging housing stock, the stock market appreciation, dual-income families. All of those we think continue to feed the do-it-for-me. And we're working really hard to be the one that those contractors turn to.

Great, thanks. Good morning, thanks for taking my question. Congratulations on the great performance in 2020. I guess maybe I'll ask the question on Consumer and Performance. Could you just walk us through how you see both of those segments kind of evolving through '21? Obviously, you got the tough comps in Consumer in '21. I think on your last call you may have indicated that maybe in those periods you showed negative growth in Consumer. Are you still thinking that way? And then similarly in performance, just given the weak Q2, do you think that the year would actually result in that segment being above your overall sales guidance? Thanks.

Yes, Arun, let me start with the consumer. And we've guided for the full year to be up or down low-single digits, and our expectation with DIY is that we'll see that strength certainly through the first quarter and most likely into the second quarter. And it just depends on whether that continues into our third quarter or not. And so, yes, we do have two - the middle quarters up over 20% in Consumer. But I think the team has done a lot of good work on helping our customers retain and/or gain a bigger share of the DIY sales. I think we'll see how results and the market share comes out, but we believe our customers are gaining share relative to their peers, in particular our largest customer in the home center channel.

We're especially encouraged by the return to growth in our General Industrial division, where sales were up by a high-single digit percentage in the quarter. We saw a meaningful improvement in portions of our Heavy Equipment, Building Products and Container segments as well as more General Finishing. We believe the strong performance was a mix of inventory restocking by some of our customers and growing in demand. Sales were up in all regions except North America, which was down about 1% but improved significantly from the third quarter. Sales were also slightly positive in the Automotive Refinish division in the quarter. We believe these trends will play a significant role in our business going forward, and we're excited about the opportunities they present. Let me close with some additional data points and an update to our capital allocation priorities. Given volume growth, pricing actions and our ongoing continuous improvement initiatives, we expect full-year gross margin expansion. We expect to get SG&A leverage in 2021 by controlling costs tightly in non-customer facing functions. We'll continue to make investments across the enterprise that will enhance our ability to provide differentiated solutions to our customers.

That's great. Good luck, guys.

We will now start the question-and-answer session. The first question comes from Ghansham Panjabi with Baird. Please go ahead with your questions.

Thank you, John. On the large dividend increase, are you trying to target a certain yield, and if so, what is that yield?

Yes, David, you know, the 23.5% increase in the dividend to $6.62 represents 30% of our prior year EPS as reported. This has been a consistent policy of ours, and we've historically targeted that.