Here’s What To Do About Sherwin-Williams Co (SHW)’s Acquisition of The Valspar Corp (VAL)

Sherwin-Williams Co (NYSE:SHW) is the leader in the North American coatings (paint) industry. The company is the 3^rd largest coatings corporation globally.

Source:  Source: Sherwin-Williams Credit Suisse Presentation, slide 5

The company is not an overnight success.  Sherwin-Williams was founded in 1866.

Sherwin-Williams’ management has a long history of rewarding shareholders with rising dividend payments. The company has paid increasing dividends for 37 consecutive years. This makes Sherwin-Williams 1 of only 50 Dividend Aristocrats.

Among the investors tracked by Insider Monkey, Shervin-Williams registered a slight decrease in popularity during the fourth quarter and 43 funds reported long positions in the company, versus 45 funds a quarter earlier. However, the total value of their holdings increased to $1.91 billion from $1.61 billion and represented 7.90% of the company’s outstanding stock at the end of 2015. The largest shareholder of Shervin-Williams in the Insider Monkey database is Eric Mindich’s Eton Park Capital, which owns some 1.12 million shares. In addition, Eton Park owns 1.20 million shares in ‘Call’ options.

The company’s stock currently has a 1.2% dividend yield.  Despite its long corporate history Sherwin-Williams is still in growth mode.

This growth is reflected in the rise of Sherwin-Williams stock price over the last several years:

Source:  Finviz

The company is realizing growth by consolidating the fragmented coatings industry.

Sherwin-Williams took a big step forward in consolidating the industry with its latest announcement…

Sherwin-Williams is Acquiring Valspar

Sherwin-Williams Co (NYSE:SHW) announced it will acquire The Valspar Corp (NYSE:VAL) on March 20^th.  Sherwin-Williams will acquire Valspar for $11.3 billion (including Valspar’s debt).

The image below compares the size (using enterprise value) of Valspar and Sherwin-Williams.  Enterprise value for both businesses is post acquisition announcement.  This shows the impact the acquisition will have on Sherwin-Williams’ business.

The acquisition of Valspar by Sherwin-Williams is more than a small ‘bolt on’ deal.  The acquisition will significantly bolster Sherwin-Williams international operations and boost the company to become the largest coatings business in the world.

Valspar Overview

The Valspar Corp (NYSE:VAL) had a market cap of ~$5.3 billion before the acquisition.  Valspar has a long history of dividend increases (like Sherwin-Williams). The company has increased its dividend payments every year since 1992.

Compared to Sherwin-Williams, Valspar is less popular among the smart money investors followed by Insider Monkey. A total of 15 funds reported stakes worth $670.50 million as of the end of 2015, versus 19 funds with $531.03 million worth of stock a quarter earlier. Among these funds, David Cohen and Harold Levy’s Iridian Asset Management is the top shareholder of Valspar, owning 4.80 million shares.

Valspar operates in 2 segments:

– Coatings

– Paints

The Coatings segment generates 70% of the company’s EBITDA in fiscal 2015. The Paints segment generated 30% of the company’s EBITDA in the same year.

The image below further summarizes Valspar’s business:

Source:  Sherwin-Williams’ Valspar Acquisition Presentation, slide 4

Impact of Acquisition on Sherwin-Williams

The acquisition of The Valspar Corp (NYSE:VAL) will vault Sherwin-Williams to the #1 position in the global coatings industry.  The acquisition will very likely reach approval as it in no way creates a monopoly in the industry.

Source:  Sherwin-Williams’ Valspar Acquisition Presentation, slide 4

The acquisition will be especially impactful for Sherwin-Williams international operations. The company’s percentage of revenue generated internationally will increase substantially.

– 16% of company revenue generated internationally before acquisition

– 24% of company revenue generated internationally after acquisition

A large acquisition would not be complete without potential synergy talk. The Sherwin-Williams/Valspar deal is no exception.

Sherwin-Williams expects to realize $280 million in annual synergies by 2018. The company expects fully realized synergies to be around $320 million a year. Nearly 90% of synergy benefits will come from selling, general, and administrative expenses as well as from reductions in raw material costs.

The overall impact of the acquisition will be positive for Sherwin-Williams. The company believes the deal will be immediately accretive to earnings-per-share (not counting acquisition costs).

The deal makes strategic sense as it gives Sherwin-Williams’ international operations a ‘jump start’. The deal also increases the size and scale of Sherwin-Williams’ operations which will likely result in higher margins through greater economies of scale.

Did Sherwin-Williams Overpay?

The coatings industry is cyclical.  There are two primary factors that impact earnings for the coatings industry:

1. The strength of the global economy (especially housing and construction)

2. The price of oil

When the global economy is strong, the coatings industry tends to do well. Sherwin-Williams has compounded its earnings-per-share at 20% a year since the worst of the Great Recession in 2009.

But the company did see earnings-per-share decline 20% from 2007 to 2009 during the Great Recession. Sherwin-Williams remains profitable during recessions, but the company is far from recession resistant. The same is true of much of the coatings industry.

Oil prices also effect profitability for the coatings industry. Oil is one of the primary input costs of most coatings.  High oil prices reduce margins, while low oil prices increase margins. Ultra-low oil prices have been a powerful tailwind for Sherwin-Williams.

What does all of this mean for the Valspar acquisition?

It means Sherwin-Williams is buying Valspar when everything is going just right. As a result, the company is paying far more than it would if it waited to purchase Valspar during a recession or a period of high oil prices (or preferably, both).

With that said, Sherwin-William is purchasing Valspar for a price-to-earnings ratio of around 20. Sherwin-Williams itself trades for a price-to-earnings ratio of nearly 26.

The acquisition is not timed well. It is also being done for a fairly reasonable price-to-earnings ratio. Sherwin-Williams is not drastically overpaying for Valspar.

What Should Shareholders Do?

Shareholders of Sherwin-Williams Co (NYSE:SHW) should continue to hold this high quality dividend growth stock.  There’s no reason to bail on Sherwin-Williams. The company will very likely be larger a decade from now than it is today. The company will very likely also continue to pay rising dividends.

Investors looking to get exposure to the coatings industry would likely be better served waiting to make a purchase until either (or both):

1. Oil prices rise

2. The United States housing and construction market slows significantly

These events will create a more favorable time to purchase shares of Sherwin-Williams.  Sherwin-Williams currently does not rank particularly well using The 8 Rules of Dividend Investing due to its above-average price-to-earnings ratio and low dividend yield.

Valspar shareholders are likely dancing in the streets due to the large premium the company is being acquired for.  They are the biggest benefactors of the announced deal.

Disclosure: None