Sherwin Williams Co Q4 FY2022 Earnings Call

Good morning. Thank you for joining the Sherwin-Williams Company's review of fourth quarter 2022 results and our outlook for the first quarter and full year of 2023. With us on today's call are John Morikis, Chairman and CEO; Al Mistysyn, Chief Financial Officer; Heidi Petz, President and COO; Jane Cronin, Senior Vice President, Corporate Controller; and Jim Jaye, Senior Vice President, Investor Relations and Communications. This conference call is being webcast simultaneously in listen-only mode via the Internet at www.sherwin.com. An archived replay of this webcast will be available at www.sherwin.com, beginning approximately two hours after this conference call concludes. This conference call will include certain forward-looking statements as defined under the U.S. federal securities laws with respect to sales, earnings and other matters. Any forward-looking statement speaks only as of the date on which the 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 to everyone. Sherwin-Williams delivered strong fourth quarter results compared to the same period a year ago, including high single-digit percentage sales growth, significant year-over-year gross margin improvement, expanded adjusted operating margins in all three segments, strong double-digit diluted net income per share growth and strong EBITDA growth. Sales in our professional architectural end markets increased by a high-teens percentage. On the industrial side of the business, sales were up by double-digit percentages in North and Latin America, partially offset by softer conditions in Europe and Asia. From a cost perspective, year-over-year inflation remained significant in the quarter, but we are encouraged by a modest sequential decrease in raw material costs for the second quarter in a row. Additionally, we made solid progress on the targeted restructuring and cost reduction actions we announced on our last call, the results of which we expect to begin benefiting us in the first half of 2023. Throughout the quarter, we remained focused on customer solutions and executing on continuous improvement in business optimization activities. We also identified opportunities and prepared for what we currently expect will be a challenging operating environment in 2023. I'd like to highlight just a few of our consolidated fourth quarter numbers. Comparisons in my comments are to the prior year period unless stated otherwise. Starting with the top line. Fourth quarter 2022 consolidated net sales increased 9.8% to $5.23 billion. Consolidated gross margin increased to 42.7%, an improvement of 320 basis points. SG&A expense as a percentage of sales decreased by 40 basis points to 29.8%. Excluding one-time costs related to our previously announced restructuring actions, gross margin improved sequentially to 42.9% in the fourth quarter of 2022 from 42.8% in the third quarter of 2022. And SG&A as a percentage of sales decreased 110 basis points as compared to the prior year. Consolidated profit before tax increased $186 million or 60.2%. Diluted net income per share in the quarter was $1.48 per share versus $1.15 per share a year ago. Excluding Valspar acquisition-related amortization expense and costs related to previously announced restructuring actions, fourth quarter adjusted diluted net income per share increased 41% to $1.89 per share versus $1.34 a year ago. Adjusted EBITDA in the quarter increased $281 million or 52.7%. Let me now turn it over to Heidi, who will provide some commentary on our fourth quarter results by segment. John will follow Heidi with his comments on our full year 2022 results as well as our 2023 outlook before we move on to your questions.

Thank you, Jim. I'll begin with the Americas Group, where sales increased 15.7% driven by mid-single-digit volume growth and continued effective pricing. Segment profit increased by $126.4 million and segment margin improved 210 basis points to 17.2%. Our professional architectural sales grew by a high teens percentage in the quarter, led by property management and followed by new residential, commercial and residential repaint, respectively. Sales in Protective & Marine, DIY and Latin America all increased by double digits, but were below the TAG segment guided range. From a product perspective, interior and exterior paint sales were both strong, with interior sales growing faster and representing a larger part of the mix. We opened 40 net new stores in the fourth quarter and a total of 72 net new stores in 2022. Moving on to our Consumer Brands Group. Sales decreased by 2.4% in the quarter, which was better than our guidance. Sales decreased due to lower volumes and low single-digit FX headwinds, partially offset by price increases. Sales were slightly positive in North America and Europe, but more than offset by significant continued weakness in China due in large part to COVID-related lockdowns. Customers managed their inventories as inflation continued to pressure DIY paint demand from consumers for this segment. Tightness in alkyd resin also impacted our ability to produce stains and aerosols. Adjusted segment margin was 11.3%, up 500 basis points year-over-year. We also made good progress in the quarter on the China architectural and aerosol restructuring actions that we described last quarter. The actions in the fourth quarter resulted in $25.6 million in one-time restructuring costs and a $15.5 million impairment charge. Sales in the Performance Coatings Group increased 4.2% and were driven by mid-teens pricing, partially offset by a low double-digit decrease in volume. Mid-single-digit sales from acquisitions were offset by a mid-single-digit unfavorable FX impact. Adjusted segment margin increased 530 basis points to 14.2% of sales. This is the third straight quarter that this team has delivered year-over-year segment margin improvement driven by execution of our strategy, including effective pricing actions. Sales in PCG varied significantly by region. In North America, sales increased double digits against a challenging comp. Latin America sales also increased by double digits against a strong comp. Sales in Europe decreased high-single-digits against a double-digit comparison and amidst continued economic slowing. Sales decreased by a low teens percentage in Asia against a double-digit comparison and as COVID lockdowns continued to impact demand. From a division perspective, growth was strongest in coil, which was up by a low double-digit percentage, followed by auto refinish and general industrial, which were both up mid-single digits. Packaging was down low single digits driven by negative double-digit FX impact in Europe and Asia and against an extremely strong comparison last year of over 30%. We continue to feel very good about our packaging position and expect this to be a recession-resilient performer. Industrial wood was down low teens as the housing slowdown is impacting furniture, flooring and cabinetry markets. Similar to Consumer Brands Group, Performance Coatings made good progress on its portion of the targeted restructuring actions that we described on our last call, resulting in $22.2 million in one-time costs in the quarter. With that, let me turn it to John for his comments on our full year results and our 2023 outlook.

Thank you, Heidi, for that color on our fourth quarter segment results. I want to thank our teams for working hard to deliver a strong finish to the year. I'm particularly pleased with the significant adjusted profit margin improvement that all three segments delivered compared to the fourth quarter a year ago. Our fourth quarter completed a strong year for Sherwin-Williams and I'd like to provide just a few high-level comments on our full year performance. On a consolidated basis, we delivered record sales, adjusted EBITDA and adjusted diluted net income per share in 2022. We generated these results in a difficult operating environment, including relentless inflation, less-than-optimal raw material availability, a war in Europe and COVID lockdowns in China. Our people refused to be deterred by these challenges and continue to do what they do best, serve our customers. Our success stems from executing on our strategy, which remains unchanged. We provide differentiated solutions that enable our customers to increase their productivity and their profitability. These solutions center on industry and application expertise, innovation, value-added services and differentiated distribution. None of this happens without the determination and dedication of our greatest asset, the more than 61,000 employees of Sherwin-Williams. Together, this team grew full year consolidated sales by 11.1% to a record $22.1 billion. It was the 12th consecutive year we have grown the business. On a segment basis, the Americas Group delivered 12.9% sales growth and grew profit before tax $197.5 million. Our largest customer segment, residential repaint, grew by a double-digit percentage for the seventh year in a row. Sales in all other customer segments were also up by double digits for the year. Consumer Brand sales were down 1.1% for the year. Sales were up mid-single digits in North America, our largest region. This was more than offset by double-digit declines in Europe and China. Although the bottom line results weren't what we expected, 2022 was a transition year for Consumer Brands Group as they completed a number of restructuring and simplification efforts to position the business for long-term success and drive operating margins back to the high teens. Performance Coating sales were up 13.2% for the year against a 22% comparison. All divisions grew with the exception of industrial wood, which was down less than 1%. Adjusted segment margin expanded 250 basis points to 14.1% for the year as we continue to recover from the highest cost inflation in the company and pursue our high-teens margin target for this segment. Adjusted diluted net income per share increased 7.1% to a record $8.73 per share. Adjusted EBITDA for the year was $3.61 billion or 16.3% of sales. Net operating cash for the year was $1.9 billion or 18.7% of sales. We returned a total of $1.5 billion to our shareholders in the forms of dividends and share buybacks in 2022. We invested $883 million to purchase 3.35 million shares at an average price of $263.64. We distributed $618.5 million in dividends, an increase of 5.4%. We also invested $644.5 million in our business through capital expenditures, including approximately $188 million for our building our future projects. We ended the year with a net debt to adjusted EBITDA ratio of 2.9 times. Additionally, we invested $1 billion in acquisitions that accelerated our strategy. I'd also like to mention our ESG efforts where we continue to work toward meeting our longer-term targets. Newsweek, Forbes and other third parties once again recognized various aspects of our program. Throughout the year, we continue to execute on continuous improvement initiatives and targeted investments to drive growth, competitiveness, efficiency and profitability. We opened 72 new paint stores and hired 1,400 management trainees. We introduced multiple new products while reducing SKUs and formulations. We expanded production capacity and enhanced procurement and logistics processes. We also continued on our digital and sustainability journeys, and we executed on our acquisition strategy. I am confident we widened the gap between Sherwin-Williams and our competitors in 2022, and that's just what we intend to do again in 2023. So turning to our outlook. We enter 2023 with confidence, energy and a commitment to seize profitable growth opportunities wherever we find them. We have clarity of mission. We have the right strategy. We're focused on solutions for our customers. We're spending more time selling products and less time sourcing them, thanks to recovery in the supply chain. We're simplifying the business, and we're executing on targeted restructuring actions. We've made the right growth investments, and we'll continue to do so. We also have a portfolio that should be more resilient than in prior recessions. And above all, we've got the right people. We expect to outperform the market just as we have in the past. At the same time, we're not operating with our heads in the sand. We currently see a very challenging demand environment in 2023, and visibility beyond our first half is limited. The Fed has also been quite clear about its intention to slow down demand in its effort to tame inflation. These factors have not changed from what we communicated on our third quarter call and our base case in 2023 remains to prepare for the worst. Based on current indicators, we believe this is the most realistic outlook at this time. On the architectural side, it's no secret that U.S. housing will be under significant pressure this year. Single-family permits have been down year-over-year for 10 consecutive months, and single-family starts have been down year-over-year for eight consecutive months. Mortgage rates also remain elevated. As a result, we believe our new residential volume could be down anywhere from 10% to 20% this year. We expect our other PRO end markets to be more resilient than this, but there are headwinds in these areas, too. For example, existing home sales, which drive a portion of our repaint business, have declined year-over-year for 16 straight months. Now while we see a backlog of new commercial construction, the Architectural Billing Index has contracted the last three months. On the DIY side, we expect inflation to continue putting pressure on consumer behavior in the U.S. and in Europe. On the industrial side, the PMI numbers for manufacturing in the U.S., Europe, China and Brazil have been negative for multiple months. We have already seen an industrial slowdown in Europe and the same is beginning to appear in the U.S. across several sectors. In China, COVID remains a wildcard and the trajectory of economic recovery is difficult to map. The U.S. housing slowdown will also impact some of our industrial businesses, namely industrial wood where we have already seen pressure and coil to some extent. Our team fully understands the importance of winning new accounts and growing share of wallet in this environment, and that is where we will be focused. From a cadence standpoint, we expect year-over-year sales and earnings performance will be significantly better in the first half than in our second half, driven by several factors. Our total company comparison will be much more favorable in the first half of 2023 as we delivered a very strong second half performance in 2022, where sales were up 13.8% and adjusted earnings per share grew by over 37%. As we've often said, volume is the key driver for operating leverage in our model. In the Americas Group, which is our largest and most profitable segment, our year-over-year volume comparisons are expected to be meaningfully better in the first half versus in the second half based on the trends we are currently seeing. We also expect more carryover price in the first half of 2023, which will have the full benefit of our September 6, 2022 price increase in TAG as well as prior price increases in the other two segments, all of which will annualize in the back half of this year. Additionally, we expect new residential sales will hold up better in our first half before very meaningful deceleration of demand in the back half of the year. Acquisitions will also be a tailwind in our first half as we expect incremental sales of approximately $140 million from transactions which closed after July 1 of last year. Given these factors and the softening demand environment, we believe our expectations for the back half of 2023 are tempered appropriately at this time. As you would expect, we will gain more clarity as the year progresses, and we will provide a more finely tuned view of our second half outlook during our second quarter conference call. As we said on our last call, we anticipated the demand environment would be challenging in 2023, leading us to get out ahead on cost management with the targeted restructuring we began in the fourth quarter. We estimate the annual savings from this effort to be in the $50 million to $70 million range, with about 75% realized by the end of 2023, and we are reaffirming those estimates today. Our outlook also assumes our raw material costs will be down by a low to mid-single-digit percentage in 2023 compared to 2022. We expect to see the largest benefit occurring in the second and third quarters. We expect to see decreases across many commodity categories, though the ranges likely will vary widely. From an availability standpoint, certain alkyd resins remain a pain point, impacting stains, aerosols and some industrial products. We expect supply of these resins to continue improving through the first half of the year, in part due to ramping of our own internal production. We expect other costs, including wages, energy and transportation, to be up in the mid to high single-digit range. For the first quarter of 2023, we anticipate our consolidated net sales will be flat to up by a mid-single-digit percentage compared to the first quarter of 2022, inclusive of a mid-single-digit price increase. Our sales expectations for the quarter by segment are included in our slide deck. For the full year 2023, we expect consolidated net sales to be flat to down mid-single digits, inclusive of a mid-single-digit price carryover from 2022. Our sales expectations for the year by segment are included in our slide deck. We expect diluted net income per share for 2023 to be in the range of $6.79 to $7.59 per share. Full year 2023 earnings per share guidance includes acquisition-related amortization expense of approximately $0.81 per share and includes expense related to our previously announced targeted restructuring actions of approximately $0.25 to $0.35 per share. On an adjusted basis, we expect full year 2023 earnings per share in the range of $7.95 to $8.65. We provided a GAAP reconciliation in the Reg G table within our press release. Let me close with some additional data points and an update on our capital allocation priorities. Given carryover pricing, raw material deflation and our ongoing continuous improvement initiatives, we would expect full year gross margin expansion. We expect SG&A as a percent of sales to increase in 2023. This is similar to the slowdown in 2008 and 2009, where we continued to invest in long-term solutions for our customers that allowed us to grow at a multiple of the market when demand normalized. We'll also control costs tightly in non-customer-facing functions and execute on our restructuring initiatives. We have a variety of SG&A levers we can pull depending on a material change to our outlook up or down. We expect operating margin to modestly improve year-over-year, excluding restructuring and impairment costs and acquisition-related amortization expense. While we don't typically provide this level of color, we believe it is helpful to do so this year given the higher level of non-operating expenses impacting 2023. We expect to open between 80 to 100 new stores in the U.S. and Canada in 2023. We'll also be focused on sales reps, capacity and productivity improvements as well as systems and product innovation. We expect to complete the targeted restructuring actions we announced on our previous call, including the benefits and one-time costs we have outlined. We will continue to simplify and optimize the organization. The Latin American business of the Americas Group is now being managed and reported within the Consumer Brands Group. The change allows TAG leadership to focus more exclusively on its core U.S. and Canada stores business, while the Latin America architectural demand and service model are trending to be more in line with CBG's strategy. This business had sales of approximately $700 million in 2022. The change will be marginally accretive to TAG and marginally dilutive to CBG. You will see this change when we report first quarter results in April. Prior-year segment results will be restated at that time to reflect the change. The first quarter and full year guidance for 2023 we've communicated today does not reflect this change. Next month, at our Board of Directors meeting, we will recommend an annual dividend increase of 0.8% to $2.42 per share, up from $2.40 last year. If approved, this will mark the 45th consecutive year we've increased our dividend. We expect to continue making opportunistic share repurchases. We do not have any long-term debt maturities due in 2023. However, we will reduce short-term debt to trend our adjusted EBITDA leverage ratio towards the high end of our long-term target of 2 to 2.5 times. We'll also continue to evaluate acquisitions that fit our strategy. In addition, I will refer you to the slide deck issued with our press release this morning, which provides guidance on our expectations for currency exchange, effective tax rate, CapEx, depreciation and amortization and interest expense. Given the many variables at play, limited visibility beyond the first half and the high level of uncertainty in the global economy, we believe our outlook is a realistic one. Our slide deck further outlines the assumptions underlying our guidance and is based on our current dialogue with customers and suppliers and our reading of numerous macro indicators. As we get through our first half and we see more information, those assumptions could change. If those assumptions change for the better, we would expect to do better than the guidance we are laying out today. While we can't defy gravity, we do expect to outperform the market and our competitors in 2023. I'm highly confident in our leadership team, which is deep and experienced and has been through many previous business cycles. We've transformed our business in many ways since the last significant downturn, and we are now a stronger and a more resilient company. We also know our guidance is clearly reflective of the market pressure we are experiencing. We anticipated 2023 would be challenging. We've planned accordingly. We have and will continue taking appropriate actions. We expect strong momentum coming out of this period of uncertainty, similar to prior downturns. That momentum will stem from our strategy of providing innovative solutions that help our customers to be more productive and more profitable. In challenging environments, like the current one, we can be an even more valuable partner to our customers, while we're also earning new ones. This concludes our prepared remarks. With that, I'd like to thank you for joining us this morning, and we'll be happy to take your questions.

Please follow the instructions to ask a question. Our first question is coming from Christopher Parkinson from Mizuho. Your line is live.

Great. Thank you so much for taking my question. On Slide 8, you have some helpful framework specifically on TAG volumes. John, obviously, you've been discussing this for a while, but can you talk about the differences, what you're seeing in the new residential side versus the residential repaint side, and what you're hearing from your team regarding pent-up demand on the repaint side? How do you feel about that versus a quarter or six months ago and how that shapes up throughout 2023? Thank you so much.

Sure, Chris. I'll start with new residential. I'll talk a little about new residential and then hand it over to Heidi to share her view. She's obviously working closely with her teams, and then I'll pick back up on repaint. New residential, I would start with an important fact: over the last 10 years, we've had a 10-year compounded growth rate of about 10.5%. This has been an area of focus for us, and it's one where we have clearly demonstrated significant success, and we are determined to continue to drive that success. Permits and starts are down as we all know. Our relationships with our national builders are strong and getting stronger. There's a lot going on, and we're working closely with them. Heidi, why don't I give that to you? Maybe you could talk a little about what you're working on in new residential?

Yes, sure. The last 10 years that John referred to has really put us in a strong position in new residential. We have every intention of aggressively pursuing share gains, especially during what we expect will be choppy waters ahead. We're going to continue to focus on growing our exclusive relationships. I would expect that we're going to add to an already strong percentage of mutually beneficial exclusive relationships. We look at our partnerships broadly with these builders. It's allowing us to collaborate in areas such as reducing complexity, simplification and importantly, execution, utilizing our store platform, our technology, our supply chain and our technical teams. We're really partnering to help these builders respond to today's challenges and help them reach their goals. Reducing complexity may assist their efforts to drive efficiency and productivity. New products really play a key role in helping during these challenging times. For example, we're introducing an extreme high-build interior latex. In a segment that will be under pressure, you may be asking why we're bringing new products. But this is where we help our customers win. This extreme high-build lets the contractor build eight to 12 mils wet film thickness versus the more conventional four to six mils. Minimizing surface imperfections and excellent touch-up, especially in an environment where labor is a challenge for drywallers and painters. This product helps to hide the defects of less experienced applicators and improves speed for painters. Essentially, everyone wins here. So you can ask what to expect. John mentioned rate increases that will pressure our builders, and we will grow share, but we are not immune to the impact of these rates. We'll respond to these changes. I would expect builders will do the same. They may adjust floor plans and look at standardization. But no one will respond like Sherwin-Williams. We're going to take this expertise and aggressively go after builders that may have relationships with competitors, and we'll demonstrate capabilities that will allow us to grow share. So while in the short term we'll likely feel pressure, we like the favorable demographics. The existing housing shortage gives us a great deal of confidence that our strong and growing position in new residential will benefit our shareholders. We look at the business through both a short- and long-term lens. In the short term, given our success and position, we may over-index while working through near-term choppiness. In the long term, we believe this is in our best interest to continue to pursue these important gallons.

Maybe one or two more points on new residential, Chris. Our relationships with new residential contractors are reaching new highs. We're collaborating and working together. There's a steady stream of product and service introductions that help our customers. Heidi and Justin Binns, our Group President of TAG, are taking these products and services beyond large national homebuilders and driving them further into regional builders, where there's terrific opportunity for growth. While we expect choppiness in new residential, it's important to say we're not passive. We'll come out fighting and be aggressive. We do well with large national homebuilders and will pursue regionals and other customers we don't currently serve. We expect new residential starts to be down in the 20% to 30% range based on public information, but we expect to outperform that and achieve a much better result for our business, though we will feel pressure. On residential repaint, I'll turn to Heidi shortly, but generally, over the last 10 years we've had strong growth there — about 11.5% compounded — and we expect some deceleration in annual gains tied to existing home sales, but painting remains a relatively inexpensive, highly impactful project. Aging housing stock and home price appreciation will be positive factors for repaint. Heidi, could you talk about repaint?

Part of our momentum in repaint is by design: continued development of innovative products, services and solutions to differentiate ourselves. Our managers and reps play an extremely significant role, and our high-touch personal service helps differentiate our model in res repaint. Our people are our secret weapon. We're helping customers navigate unprecedented challenges like labor shortages. Our full product line allows contractors to step up in quality, which helps compensate for less experienced applicators. As customers step up in quality, they become more successful. We're preparing our customers for choppiness ahead. In addition to products, we're preparing for new substrates. For example, we're rolling out a new kitchen cabinet refinish paint product. Homeowners affected by higher costs may choose to refinish cabinets rather than replace them, and we're helping contractors serve these clients with profitable solutions. We're also introducing a self-cleaning Exterior Woodscapes Stain for exterior use. With this technology, dirt will wash away with every rain and the home will continue to look freshly painted, which is a notable innovation. Our position in res repaint continues to improve. We continue to grow share and accelerate some of these gains. While bid activity has adjusted, overall it's still strong. Our average job size is increasing, and our focus will be on new accounts and share of wallet.

One more point on repaint: the quality of leads and bids seems to be improving. While some bid activity may have tempered, the quality and scope are increasing. We're helping customers with expanded offerings such as cabinets and garage floors and helping new residential contractors move into repaint. We're partnering well with customers to help drive their success and profitability. Chris, great question on these two segments. We think they are important for 2023.

John, given all that substance, I'll pass it on. Thank you so much.

Your next question is coming from Truman Patterson from Wolfe Research. Your line is live.

Good morning, everyone. Thanks for taking my questions. You're expecting raw materials to decline in the low to mid-single-digit range in 2023. Is this based off spot pricing for petrochemicals as you see it today? Does this incorporate an expectation for some incremental deflation in spot prices as we move through the year? Petrochemical futures are bouncing around now, and I'm trying to understand how you expect the spot market to play out and what's embedded in the guidance.

Good morning, Truman. We've seen a sequential decrease from the third quarter into the fourth quarter and expect that trend to continue. In our first quarter, we're expecting the basket to be flat to slightly up, and you'll see a bigger benefit as the year goes on. Key feedstocks like propylene have started to come down meaningfully. Eventually, that will work its way into the resins and solvents that we buy. We buy some of our raw materials on spot prices, so we can take advantage where it makes sense, and we have some on contract. Each commodity has its own dynamics, so while we expect down low singles to mid-singles for the basket, there is a wide range across the products we buy. Some will be better than that range and some worse. You're also seeing input cost pressures from energy and wages, which are volatile. The takeaway is we will continue working closely with suppliers to bring costs in line with industry demand levels, and our position in the marketplace helps.

Okay. Thank you. When you mentioned the lead demand indicators, what are those? And you mentioned less visibility into the back half. How is today different than prior periods outside of general uncertainty in the economy?

Truman, the indicators we've cited for many years include the LIRA Remodeling Index and existing home sales for res repaint, and permits and starts for new residential. For commercial, there are a couple of different indicators, and on the industrial side, the PMI numbers are relevant. These external indicators are married with real-time feedback we get from our customers and our direct distribution model, which gives us an advantage.

On the second half visibility, the view between the first half and back half is tied to a very fluid market. Interest rates are moving up and housing starts are adjusting. In times like this, contractors vary in their ability to anticipate what's happening. Some may look at short-term books and believe everything is okay. We're working with contractors to help them understand pressures coming down the pipe. We leverage our CRM and the fact that we have nearly 5,000 store managers and nearly 4,000 sales reps that provide a great deal of market understanding. Right now there's a bit of a disconnect: some customers feel more bullish than we think they should, while others understand the pipeline. The bids and contracts our customers have in hand give us better confidence in the first half. As we said, we won't be adjusting our earnings forecast after the first quarter. We expect a very good first quarter, but we'll wait to see how the second quarter shapes the balance of the year. Our relationships with customers improved over recent challenges, giving us better line of sight; as we get through the second quarter, we'll have a clearer picture.

All right. Thanks for taking my questions and good luck in the coming year.

Your next question is coming from Ghansham Panjabi from Baird. Your line is live.

Good morning. On Performance Coatings Group, can you give us a sense of volume expectations by sub-segments, from auto refinish through packaging and industrial wood? That would be very helpful.

On refinish, demand is high, coupled with shortages of body parts contributing to backlogs. We're working through a backlog as raw material availability improves. As availability improves, we push more product out. We're pleased with gains in automotive refinish and expect that to continue. Packaging had a terrific year, finishing in the mid-teens on top of last year's high 20s; tough comparisons. We're gaining share and investing in capacity, which sells out quickly. Coil has had seven consecutive quarters of double-digit growth. North America end markets seem to be softening a bit; APAC has soft demand with real estate limiting extrusion business; EMEA saw substantial declines as major coaters shut down lines due to demand. General industrial had another strong year, with heavy equipment markets very strong, particularly in agriculture and construction. Appliance manufacturers look to be slowing production as inventories reset. Transportation and building products are down a bit. Industrial wood is tied to housing and saw tougher performance—down slightly for the year. We've been investing in this business through acquisitions because we believe in the long-term strategy. Confidence in the team and leadership at the group level gives us conviction this will be a key driver as the market normalizes and we'll grow share during choppy times.

Terrific. And regarding TAG and the current environment with higher rates, what would change the calculus for you? Is it simply reversible interest rates? I'm trying to reconcile interest rates pulling back since October.

We won't wait for the market to lift all boats; we'll act. We're not passive. We'll be aggressive. Yes, TAG will be impacted by housing starts and resale, but we have a strong position in property maintenance and new residential. We've done well with national builders and are going after regional builders. Some competitors are backing off because of pressure in segments; we'll be aggressive in pursuing those opportunities.

Ghansham, interest rates have bounced around. As interest rates rise, it takes time to filter through the market into paint. Paint is at the end of projects, so even if starts flip today, you're talking three to four months before we get to our part of the project, assuming no supply chain challenges. We'll keep monitoring timing and push with our teams to capture outsized share as demand returns.

Perfect. Thank you.

Your next question is coming from David Begleiter from Deutsche Bank. Your line is live.

Good morning. John, in TAG, are you thinking about additional price increases this year?

David, our view on pricing looks at the total cost basket, not just raw materials but labor, transportation, containers and everything that goes into our products. We have not announced additional pricing. We've shown the ability and willingness to implement pricing when necessary. If we need additional pricing, we'll inform our customers first and then advise the Street of our actions.

David, to add color on 2023 pricing: on our third quarter call we said we had no additional pricing and expected a mid-single-digit price impact on full year 2023. That impact will be a little higher in Q1. We expect to maintain the majority of our price like we've done in the past. We think we've passed the margin contraction portion of the cycle, and we expect sequential and year-over-year margin improvement to continue into 2023.

Very good. Al, do you still expect production this year to be below volume sell-through? How much is the dollar impact on earnings?

We won't quantify the exact dollar impact. Because we had to build inventory in 2022 to get back to more historic levels, we expect a negative impact. Specifically, we expect a 5% to 7% decline in production gallons in architectural. That will have a drag on Consumer Brands Group margins, as that group's global supply chain is embedded in those operations. So you won't see as much segment margin dollar improvement there, all else equal.

Thank you very much.

Your next question is coming from Adam Baumgarten from Zelman. Your line is live.

Thanks for taking my question. You mentioned in the slides some inventory destocking in the North America retail channel. Are you seeing destocking outside of that channel, perhaps among some OEM customers?

Most of our OEM customers operate on low min/max levels and lean on us to be responsive. While some may have inventory, they generally rely on us and we support that to help their success.

On the retail channel, coming out of the third quarter some peers talked about destocking. We did not see that at that time; we were a quarter later and as a result, consumer did a little better in the fourth quarter than we had planned.

Got it. That's helpful. You previously touched on positive trends in the Pros Who Paint business. Has that slowed going into the fourth quarter and into this year?

Pros Who Paint sits within Consumer Brands Group. Todd Rea, our President there, and his team are focused on capturing opportunity in house flipping and remodeling customers who prefer a broader assortment and availability than our stores. We're excited to pursue this market and disrupt others who have had unencumbered runs at it. There's good momentum and significant opportunity ahead.

Great. Thanks a lot. Good luck.

Your next question is coming from Kevin McCarthy from Vertical Research Partners. Your line is live.

As you move the Latin American business over to Consumer Brands, can you help us understand what the associated margin uplift might be to Consumer from that repositioning?

Kevin, it's not a material change. When you restate the income statement, it might give TAG a little lift because Latin America has been dilutive to TAG. On the consumer side, I don't think you'll see a material change to either segment because of this. From a strategic and focus standpoint, it's the right decision. Latin America has done a lot of hard work and rightsizing, and now they're back to focusing on growth.

Kevin, the move also has a positive impact on TAG by allowing focus on North America. Alberto Benavidez and his team in Latin America are well positioned, and aligning those businesses will allow us to share best practices across regions.

Okay. Thank you. Secondly, thoughts on alkyd resins: it sounded like a meaningful constraint in Q4. Can you size that and is availability beginning to improve in Q1?

Alkyd resin availability remains an industry-wide challenge. Our technical and commercial teams deserve credit for substitutions and adjustments during the constraint. We've isolated the issue to very few SKUs and are seeing sequential improvements into our production. You can expect over the next few quarters to be in a much better position.

We haven't called it out further because it's not material to consolidated results. It's split across consumer and industrial and is not material at the consolidated level, which is why we haven't emphasized it more.

While not material at the consolidated level, it's very material to those directly impacted — customers and certain teams. We've had to work through challenging situations with customers affected by alkyd resin constraints.

Appreciate the perspective. Thank you.

Your next question is coming from Jeff Zekauskas from JPMorgan. Your line is live.

Thanks. I was looking at your midrange assumptions on Slide 8. You assume prices are up about 5%, which is about $1.1 billion. If volumes are down 5%, the detriment is about $550 million. SG&A up mid-single digits is about $300 million, FX maybe $100 million, offset by raw material decrease of 4%. With those assumptions, why shouldn't EBITDA be up $400 million rather than down $150 million at the midpoint? What is pulling returns down if price is up 5%?

Jeff, we discussed this at length. The mid-single-digit ranges have wide margins. At the midpoint, we are somewhat lighter on price impact and a bit heavier on demand and volume than your example. There's nuance within the ranges. If you take the high end of positives and low end of negatives, you get a different result. At the midpoint, we do expect EBITDA margin expansion and EBITDA growth, but not as large as the example you described.

And for a follow-up, I think you had aspired to a 45% gross margin in Q4 and came in closer to 43%. Was that due to volumes being weaker than expected or another factor?

You're directionally right. Excluding one-time items and acquisitions, we were about 43.1%. It was mainly TAG coming in below its guided range; TAG is our highest-margin business. Some other segments were double-digit growth but below their guided ranges. Weather around Christmas also had an impact as it caused some to take time off, though January sales are back to expected levels.

Thanks so much.

Your next question is coming from Mike Sison from Wells Fargo. Your line is live.

One quick question: at the midpoint of your guidance, you said the first half will be better than the second half. Is volume flat in the first half or down? How much more front-end loaded is the year?

Mike, from a volume standpoint we expect architectural volume, specifically TAG, to be up low single digits in the first half and then moderate in the back half. New residential slowdown is expected to begin materially mid-second quarter and accelerate into the third quarter, with recovery lagging starts by three to four months. That's why the second half is expected to be more negatively impacted. We expect more price in the first half as price increases annualize and more acquisitions will tailwind the first half. Raw material decreases are a bit heavier in the back half. So the first half benefits from pricing carryover, acquisitions and more favorable comps.

Got it. Any help on the EPS cadence?

As volume is stronger in the first half, it will flow through and support better operating leverage in the first half.

Thanks.

Your next question is coming from Vincent Andrews from Morgan Stanley. Your line is live.

If the back half comes in worse than you anticipate across segments, what are the key risks to watch for that could make the back half worse than anticipated?

Vincent, the thing we're watching is within TAG and new residential. Timing of a potential slowdown isn't exact; the homes' completion timing impacts our sales the most. As we work with national homebuilders and get a clean line of sight, that affects TAG new residential and also impacts industrial businesses like cabinets, flooring and furniture. Those dynamics will be the main drivers of whether the second half is stronger or weaker than our current outlook.

Follow-up: In Consumer Brands and Performance Coatings, are there any shelf space issues we should know about? Any notable share gains or losses?

There's no shelf restriction impact on consumer that we're calling out. There's a huge amount of market share gain opportunities in our industrial businesses across the board. We don't have 100% market share in any business, segment or region, and we plan to march aggressively to gain share in 2023.

Your next question is coming from Arun Viswanathan from RBC Capital Markets. Your line is live.

There's been a lot of discussion about the new housing market slowdown. Permits are down significantly year-over-year. There's a correlation between architectural gallons and existing home sales, which also have a lag. Could you comment on your outlook for existing home sales and how that ties into your guidance? Is there a risk the low end of your guidance is not low enough if existing home sales get worse?

Arun, existing home sales drive a portion of our res repaint business, but other factors also drive repaint. We have been investing in more stores and reps to pursue repaint. While existing home sales have been down for 16 straight months, other factors — home price appreciation, aging housing stock, baby boomers aging in place — can offset some weakness. Combined with share gains, we have a good outlook and high expectations for res repaint next year.

Res repaint is our fastest-growing segment, our largest segment, and our largest opportunity for market share growth. That's the focus of our TAG team with dedicated stores and reps for repaint.

Compared to the last slowdown, we entered this period with more stores and reps — about 1,200 more stores since 2010 — and a stronger positioning. That gives us confidence that we will grow share during this period and benefit as conditions normalize.

Over the last 10 years we've added stores and improved our market position. Competition has closed stores while we've been adding them, creating opportunity. We're adding a new store on average about every four days and are confident in our long-term strategy and near-term execution.

Okay. Thanks. One more: you invest mostly organically, but are there inorganic opportunities in a downturn? What areas might you pursue for M&A?

We've been investing via acquisitions, primarily in Performance Coatings. We've added industrial businesses in Germany, industrial wood in Italy, and flooring businesses. We integrate acquisitions into the company and leverage technology and capabilities across the platform. We're not buying small positions; these are investments we will leverage worldwide. There remains opportunity to better leverage acquisitions as we go forward.

Your next question is coming from John McNulty from BMO Capital. Your line is live.

A cleanup question on pricing: in the deck on Slide 8 you showed consolidated pricing carryover with a range of low-single-digits to mid-single-digits. What drives that range? Is it just carryover from where you ended Q4?

John, similar to raw material ranges, market dynamics create the range. TAG had five different price increases over two years. We fully expect to maintain the majority of our price. Slight movement within the range doesn't impact the overall fact that we will maintain most of the price. This is similar across industrial and consumer businesses. We consider the total input cost basket when assessing price and are focused on bringing gross margin toward long-term levels of 45% to 48%. We've kept investing even during margin contraction and now that margins are improving, we continue those investments to drive growth.

Pricing isn't a stand-alone discussion; it's the result of the value we provide every day. Value goes beyond product to services, project help and digital convenience. We're confident in our ability to hold price because we're adding customer value.

Got it. Follow-up: your stores have a higher service component and labor inflation is significant. Do you have enough levers to offset labor cost beyond price, since competitors might not have to raise price as much?

John, we drive higher-quality products that make contractors more efficient, allowing them to do more jobs with the same number of painters and improve their bottom line. When you innovate the high end of the good-better-best continuum, that good gets replaced over time and drives higher margin. That's a major lever for continuing to expand margins.

Got it. Thanks for the color.

Your next question is coming from John Roberts from Credit Suisse. Your line is live.

Historically DIY paint is not price elastic, but do you think demand weakness here is because prices got too high?

Our residential repaint business is strong. Regarding DIY consumers, while prices have risen, consumers remain aware of inflation and make choices. Painting remains a relatively inexpensive, impactful investment. We continue to see stickiness in higher-quality products. I don't think we've reached substantial demand destruction; consumers are making choices and there is still willingness to pay for quality when it reduces long-term costs and increases durability.

We saw differences in Q2 between retail channels and our stores. Retail channels were more impacted by inflation in energy and food than our store channel. So there is nuance between channels.

On elasticity, consumers may purchase less frequently and become more value conscious, but we've introduced products that encourage trading up due to increased durability. Consumers paying every five to seven years have shown willingness to pay for longer-lasting products.

Okay. Heidi, you mentioned coil was a stronger end market. Isn't that appliances and sheet metal for construction? Why did that outperform?

Yes, coil is tied to appliances and sheet metal. We have a nice coil business, but we're starting to see a reset in appliances as inventories normalize, which has impacted coil in certain areas. Overall, though, coil growth was strong over recent quarters.

Your next question is coming from Josh Spector from UBS. Your line is live.

On the China architectural and aerosol restructuring, it seems like a significant amount of sales might be rationalized. Are you past the point of monetizing that business, or is there still ability to monetize?

Josh, we continually review portfolio businesses, brands and customer programs for midterm and longer-term performance. We evaluate options: run for cash, run for growth, or monetize. Each option is considered. The short-term reality is China architectural is under heavy pressure, and we took appropriate actions to adjust to market conditions.

Okay. Follow-up on resin and raw materials: if demand weakens more than you expect in the back half, would raw material costs drop and provide relief into next year? Are there any long-term contracts that would prevent you participating in that deflation?

If demand deteriorates more than expected, raw material costs would likely drop. We don't have long-term contracts that prevent us from participating in market deflation.

Your next question is coming from Greg Melich from Evercore ISI. Your line is live.

Two questions. First, could you remind us how much larger residential repaint is compared to new residential?

Greg, today res repaint is about twice the size of new residential, roughly 2:1. Prior to 2008-2009, it was closer to 1:1. Both segments have grown at low double digits since 2010, but repaint started from a higher base.

Fair enough. Second, on gross margin progression: 45% to 48% is still the target. If volumes this year are flat or slightly up, would you be back in that range this year, or are there other factors?

Directionally, yes. If volumes are better — particularly in TAG, our highest gross margin segment — combined with maintaining price, raw material improvements, and continuous improvement initiatives across manufacturing and distribution, that helps move gross margin toward the 45% to 48% target. But volume through TAG is a key driver.

Would it be fair to use Q4 as a proxy for operating leverage? It looks like volume was lower than expected and gross margin was lower; am I thinking about that correctly?

You're directionally accurate.

Thanks and good luck.

Your next question is coming from Steve Byrne from Bank of America. Your line is live.

Following up on your comments about home center partners and Pros Who Paint: are home center partners trying to replicate delivery or digital services that you provide? Does that have any impact on your stores?

We're supporting our partners and their strategies to serve customers. Cannibalization between home centers and our stores is minimal; there may be a few small accounts. We'd gladly accept those to expand into a largely untapped market for us. Painters who visit our stores daily have expectations best served by a specialty paint store. The real target is attracting customers who prefer the home center experience; we're comfortable supporting both channels and pursuing the larger opportunity together with our partners.

Thanks. How much visibility do you have into contractor backlog, and are there differences in backlog across segments like residential repaint, commercial and property management? Any recent shifts?

We work closely with customers and have good visibility. There's variability: commercial and industrial contractors generally have longer lead times due to project scope, while residential repaint has shorter visibility. We have seen bid activity temper a bit, but lead quality and scope are increasing. Our guidance reflects shifts we've observed. Importantly, we're aggressively pursuing opportunities and expect to take share as competitors pull back. As conditions improve, we expect a strong rebound.

I would add that our customers and teams have become better planners and partners. That stickiness and collaboration improve our visibility and planning.

Thank you.

Your next question is coming from Garik Shmois from Loop Capital. Your line is live.

Thanks. On the SG&A guidance range, what factors will you consider when deciding to press growth initiatives versus pulling back? Is it a function of how demand tracks, and when would you need to make that decision given the wide SG&A range?

Garik, we'll assess this as we progress through the first half. We'll maintain G&A tightly through the first half and manage discretionary spend like merchandising and advertising based on demand outlook. We'll continue to invest in long-term growth initiatives such as stores and reps, packaging and industrial market share opportunities. So we'll be conservative on non-customer-facing spending and continue long-term investments we believe in.

Okay. On store openings in 2023, given the pickup in Q4, should we expect a more linear pace or will it still be backloaded?

We've tried to spread openings more evenly, but for many reasons they get backloaded. We have good visibility on numbers and locations. I hope they are less backloaded than last year, but we do expect some leaning into the back half of the year.

Okay. Thanks and best of luck.

That concludes our Q&A session. I will now hand the conference back to Jim Jaye for closing remarks.

Thank you, and thanks, everybody, for joining our call today. As we've discussed, we're very confident in our strategy and in our people, who are deep and experienced. Given market conditions, our outlook is a realistic one starting this year. Even in that outlook, we're going to continue to gain share and invest in the business to grow. As Al said, we'll control G&A tightly. We expect to outperform the market as we have in the past. As always, I'll be available along with Eric Swanson for follow-up calls. Have a great day. Thank you.

This concludes today's event. You may disconnect at this time, and have a wonderful day. Thank you for your participation.