The Sherwin-Williams Company (NYSE:SHW) Q4 2023 Earnings Call Transcript

The Sherwin-Williams Company (NYSE:SHW) Q4 2023 Earnings Call Transcript January 25, 2024

The Sherwin-Williams Company beats earnings expectations. Reported EPS is $1.81, expectations were $1.8. The Sherwin-Williams Company isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. Thank you for joining The Sherwin-Williams Company’s review of Fourth Quarter 2023 Results and our outlook for the first quarter and full-year of 2024. With us on today’s call are Heidi Petz, President and CEO; Al Mistysyn, Chief Financial Officer; Jane Cronin, Senior Vice President, Enterprise Finance; and Jim Jaye, Senior Vice President, Investor Relations and Communications. This call is being webcast simultaneously in listen-only mode by Issuer Direct 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 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 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 up the session to questions. I will now turn the call over to Jim Jaye.

James Jaye: Thank you and good morning to everyone. Sherwin-Williams delivered solid fourth quarter results that concluded a record year for the company, where sales grew 4.1% to $23.1 billion and adjusted earnings per share grew 18.6% to $10.35 a share. Sales in the fourth quarter increased by a low-single digit percentage against a tough comparison, and we generated significant year-over-year gross margin improvement. As we previously described, we also continue our deliberate and accelerated investments in the business as reflected by the low-double-digit year-over-year increase in SG&A in the quarter. These investments are being made to take advantage of current market uncertainty and are aimed at driving the success of our customers and above-market growth across all businesses.

Adjusted earnings per share in the quarter decreased by a mid-single-digit percentage related to higher non-operating costs. We maintained our disciplined capital allocation approach and returned $641 million to our shareholders through dividends and share repurchases during the quarter. Sales in all three of our reportable segments were within or better than our guidance. In our architectural business, commercial and residential repaint were the strongest performers, while DIY remained challenging. In our industrial business, growth was variable by division. Sales grew in Europe and Latin America with softness in North America and Asia. Let me now turn it over to Heidi, who will provide some commentary on our fourth quarter results by segment and a few full-year highlights before moving on to our 2024 outlook and your questions.

Heidi Petz: Thank you, Jim. I’ll begin with the Paint Stores Group, where sales increased 2.3% against a mid-teens comparison. Volume drove the increase as our previous price increase annualized in September. Segment margin improved 210 basis points to 19.3%. Protective & Marine, commercial and residential repaint drove the growth. Strength in these markets was partially offset by decreases in New Residential and property management. From a product perspective, exterior and interior paint sales both increased by low-single digit percentages. Exterior sales grew faster but were a smaller part of the mix. We opened 35 new paint stores in Paint Stores Group in the fourth quarter and a total of 76 new stores in 2023. We also announced a 5% price increase to our customers in the quarter effective February 1.

Moving on to our Consumer Brands Group. Sales decreased by 7.1% in the quarter, which was better than our guidance. Sales increased mid-teens percentage in Europe and Latin America. Sales decreased in North America by a low-double-digit percentage as customers managed their inventories lower due to soft paint demand, partially offset by an increase in the pro paint sales. Adjusted segment margin, which excludes acquisition-related amortization expense and impairment charge related to trademarks in Europe and the negative impact from the significant devaluation of the Argentine Peso in December was 10.8%. The decrease from last year’s fourth quarter was driven by lower volume and higher nonoperating costs. Sales in the Performance Coatings Group increased slightly with continued choppiness across each of our businesses and regions.

Acquisitions and favorable FX were offset by lower volume. Adjusted segment margin, which excludes acquisition-related amortization expense and the Argentine devaluation impact, improved to 17.3%. This is the fourth straight quarter this team has delivered year-over-year segment margin improvement. This performance reflects execution of our strategy, moderating raw material costs and the ongoing value we are providing customers. Industrial wood led the growth, including the impact of recent acquisitions. Coil and Automotive Refinish also delivered solid growth. Packaging was down as expected. General industrial was impacted by lower demand in all regions. PCG sales varied significantly by region with growth in Europe and Latin America and decreases in North America and Asia-Pacific.

From a full-year perspective, I’ll provide just a few highlights before turning to our 2024 outlook. At this time a year ago, you’ll recall an environment of tremendous macro uncertainty with single-family housing starts down an average of more than 20% for seven consecutive months, existing home sales down a similar percentage, soft PMI manufacturing indices in all regions and most economists predicting a hard recession. Against that backdrop, we provided guidance that we believed was appropriate. We also said that if conditions improved, our performance would be better than our initial guidance, and that is exactly what happened. I could not be more proud or thankful for the efforts of our 64,000 employees throughout 2023. On a consolidated basis, our team delivered record full-year sales, adjusted EBITDA, adjusted diluted net income per share and net operating cash.

We returned a total of $2.1 billion to our shareholders in the form of dividends and share buybacks in 2023. We delivered these results while reinvesting in the business by design and at an accelerated rate to drive continued above-market growth and enhanced profitability. In terms of CapEx, we invested $590 million, including approximately $205 million for building our future R&D lab projects. We expect to begin occupying these facilities by the end of 2024. We ended the year with a net debt to adjusted EBITDA ratio of 2.3x. Looking at our reportable segment on a full-year basis. Paint Stores grew sales by a high-single digit percentage and expanded its margin. Sales increased in all end markets except New Residential, which was down less than 1%.

This New Residential performance was remarkable given the state of the market and reflects our share gains. Performance Coatings also grew its top line while further integrating recent acquisitions and achieving a high teens adjusted segment margin. The full-year adjusted margin performance is the best since the Valspar acquisition in 2017. Consumer Brands had a challenging year on the top line with lower sales resulting from soft DIY demand, but adjusted segment margin expanded. We’re confident our aggressive portfolio adjustments completed during the year, including the divestiture of noncore aerosol product lines and the China architectural business, should result in improved future profitability. I am confident that we further separated ourselves from our competitors in 2023, and that’s exactly what we intend to do again in 2024.

Our success in 2023 stemmed from executing on our strategy, which remains unchanged. We provide differentiated solutions that enable our customers to increase their productivity and profitability and for which they are willing to pay and stay. These solutions center on industry and application expertise, innovation, value-added services and differentiated distribution. We also have momentum in the enterprise strategic priorities that are illustrated in our slide deck and I first described at our Investor Day last August. I am confident the continued execution of our strategy and our enterprise priorities will spur the next era of profitable growth for Sherwin-Williams. So turning to our outlook. We entered 2024 with confidence, energy and a commitment to seize profitable growth opportunities in our targeted end-market segments.

We expect to outperform the market just as we have in the past. And while the macro environment feels better today than it did a year ago, it still contains a number of uncertainties. On the architectural side, U.S. New Residential sentiment has improved. Single-family starts have been up year-over-year for six consecutive months. Mortgage rates are expected to begin moderating but will remain well above historic levels. In residential repaint, existing home sales drove a portion of our sales and have declined year-over-year for 28 straight months. The trajectory of recovery is not clear here, and the LIRA index is forecasting negative remodeling spend in 2024. However, there are numerous other drivers for repaint, and our investments and our model give us confidence that we will continue to grow share.

In new commercial, starts slowed considerably in 2023, which we expect will impact completions starting midway through 2024. Commercial lending standards have also tightened, and the Architectural Billing Index has been negative for five consecutive months. On the DIY side, we’ll remain in share gain mode as we do not currently see a macroeconomic catalyst driving meaningful improvement in consumer demand, though any improvement in existing home sales could be a tailwind. On the industrial side, the PMI numbers for manufacturing in the U.S., Europe and Brazil have largely been negative for multiple months with China being slightly better recently. We expect Automotive Refinish to be our most resilient business in this environment, and we expect to see ongoing benefit from recent share gains.

Industrial wood is likely to benefit from recovery in New Residential given the furniture, flooring and cabinetry end markets it serves. We expect Coil will grow driven by significant new account wins over the past year. Protective & Marine should continue to have momentum but will face challenging comps. We expect general industrial demand to remain choppy. In packaging, we expect industry volume for food and beverage cans to be flat to down in 2024. We will also see a negative short-term impact related to temporary volume shifts, which occurred as a result of our Garland production plant incident last August. We fully expect to recover this volume in stages in 2024 and 2025 while also winning new business. Longer term, we remain bullish on our packaging business and our differentiated non-BPA solutions.

Our Garland plant is fully back online, and we are bringing on additional capacity in other locations during the first half of the year. We continue to have excellent new account and share-of-wallet opportunities in every business and in every region. The continued growth investments we have made over the past year give us tremendous confidence in pursuing these opportunities and gaining share. Moving to the cost environment. Our outlook assumes our raw material costs will be down by a low-single digit percentage in 2024 compared to 2023. We expect to see the largest benefit occurring in the first half of the year as comparisons become more challenging in the back half, where the entire basket decreased low-double-digits. While raw materials will likely be a benefit for us, other costs, including wages, health care, energy and transportation are expected to be up in the mid- to high-single digit range in 2024.

I will remind you that these categories also inflated in 2023. Working with our customers, we delayed additional Paint Stores price increases last year given the pricing actions that we took in 2021 and 2022. We cannot however ignore these escalating costs indefinitely. As I mentioned earlier, Paint Stores Group is implementing a 5% price increase effective February 1st. The Performance Coatings and the Consumer Brands Group are also likely to have some targeted pricing activity in 2024 though at a more modest level than Paint Stores. As for our specific outlook, the slide deck issued with this morning’s press release includes our expectations for consolidated and segment sales for the first quarter of 2024. The deck also includes our expectations for the full-year, where consolidated sales are expected to be up a low to mid-single-digit percentage and diluted net income per share is expected to be in the range of $10.05 to $10.55 per share.

Excluding acquisition-related amortization expense of approximately $0.80 per share, adjusted diluted net income per share is expected in the range of $10.85 to $11.35, an increase of over 7% at the midpoint compared to 2023’s adjusted diluted net income per share of $10.35. We’ve provided a GAAP reconciliation in Reg G table within our press release. Let me provide some additional data points and an update to our capital allocation priorities. Given incremental 2024 pricing, raw material deflation and Paint Stores Group, our largest and highest gross margin segment, growing sales faster than the other two segments, we would expect full-year gross margin expansion. We expect SG&A dollars to increase by a more typical level and increase by a mid-single-digit percentage in 2024, a moderation from the low-double-digit percentage increase we reported in 2023.

We expect the investments we made last year and those we plan to make this year will enable us to grow at a multiple of the market. We plan to control costs tightly in noncustomer-facing functions. And we have a variety of SG&A levers we can pull, depending on a material change to our outlook up or down. We expect to open 80 to 100 new stores in the U.S. and Canada in 2024. We’ll also be focused on sales reps, capacity and productivity, system improvements and product innovation. Next month, at our Board of Directors meeting, we will recommend an annual dividend increase of 18.2% to $2.86 per share, up from $2.42 last year. If approved, this will mark the 46th consecutive year that we’ve increased our dividend. We expect to continue making opportunistic share repurchases.

We’ll also continue to evaluate acquisitions that fit our strategy. We have a manageable $1.1 billion of long-term debt due in 2024 and expect to refinance the debt at higher rates. We expect to be within our current long-term target debt-to-adjusted EBITDA leverage ratio of 2x to 2.5x. 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. Our team is operating with great confidence as we begin 2024. We are extremely well positioned to continue delivering shareholder value. And I want to thank John Morikis for the incredibly strong foundation he leaves with us as he moves into his role as Executive Chair.

I’m also grateful for the outstanding executive leadership team surrounding me. Given that there is still a considerable amount of uncertainty in the global economy, we believe our initial 2024 outlook is an appropriate one. Should the demand environment prove to be stronger than we are currently assuming, we would expect to do better than the guidance we are laying out today. Our first quarter is a seasonally smaller one. For that reason, we will not be making any updates to full-year guidance until our second quarter is completed and we have a better view of how the painting season is unfolding. Our strategy is clear, our priorities are focused, and our people are ready. We will continue to win by providing innovative solutions that help our customers to be more productive and more profitable.

We expect to deliver meaningful earnings growth in 2024. 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.

Operator: At this time, we will be conducting a question-and-answer session. [Operator Instructions]. Your first question for today is coming from Vincent Andrews with Morgan Stanley.

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Q&A Session

Vincent Andrews: Thank you and good morning everyone. Heidi, I’m wondering if you could sort of break down the Paint Stores Group top line guidance for I see low single to mid-single-digits, and maybe there’s 3% of net pricing there. And I guess, what I’m really trying to get at is where do you think that sales guidance would be if you hadn’t made the significant growth investments in 2023. What are you anticipating you’re going to get from that this year?

Heidi Petz: Well, I’ll tell you right now — I’ll start this off, and then I’ll hand it over to Al to give some color commentary as well. I would start by, you said this beautifully. As you look at kind of the drivers of what’s making us effective in the investments that we’re laying in, we’ll talk to this in a minute, but we’ve made some very significant choices relative to some of these segments. And I’ll start with Residential Repaint. We talked about despite some of the choppiness out there, we are continuing rather to take share based on some of these investments that we laid in. It’s interesting, in this environment, there’s a lot of people that are out there talking about market share gains. And I would say that no one’s really posting the mid-single-digit gallon gains that we’re seeing versus our mid-teen comparison last year.

So not everyone will be able to grow share. I’m confident that we are. And I would also say, given some of these investments, no one is better positioned in the market than we are to help these contractors. Specific to residential repaint and some of these investments, we’re really able to demonstrate our model. We’re interacting with these contractors that are looking to move beyond just painting but becoming business owners. So if you can imagine some of the investments that are allowing our teams, our reps to help them in real time in terms of marketing, customer acquisition, even as they look to expand into different substrates. We launched our Gallery Series last year, helping these contractors move from just walls into other surfaces in the home while they’re there, kitchen cabinets being a great example.

And all of these areas are really our sweet spot. So in this environment, while we’re laying these investments in and we’re clearly posting results, I’d also say and characterize this as the residential repaint contractor has never been more receptive to all that we can bring them in terms of our consistent store-to-store experience as they’re traveling and growing, access to our highly trained reps that are helping them not just plan work, but helping them in real time to troubleshoot. So the accessibility, that’s really important. So there’s a list of items here that are really paying off. I’m going to hand it over to Al to give a little bit of specific color on the numbers.

Allen Mistysyn: Yes, Vincent. This is Al Mistysyn. Yes, when you look at the 2024 volume number, up low-single digits. If you go back to — coming out of the second quarter of 2023 and looking at the indicators that we were, we were talking about our volumes really being flat. And as John and Heidi like to say, we got to influence the numbers. So with our line of sight being better than — or better, the investments we made in Res Repaint and what you’ll see is we expect Res Repaint to be at the high end or above the high end of that range. In the fourth quarter, you saw a low-single digit volume growth. And again, our Res Repaint volumes were up mid-single digits. So even in the short term, we’re seeing the benefits of those investments, and we fully expect to realize those benefits in 2024 to accelerate our volume growth in Res Repaint.

Operator: Your next question is coming from John McNulty with BMO Capital Markets.

John McNulty: Yes, good morning. Thanks for taking my question. So there’s a lot of focus on the SG&A jump and administrative jump. And I guess, when you think about the roughly $300 million of the 20% investment that you had there or growth that you had there, I guess, how would you break it out in terms of just general inflation versus investment for growth versus management comp? Because primarily, the team did pretty darn well this year. So I guess, how would you break that out? And can you help us to think about on the growth investment side, the types of investments that are, I guess grabbing those costs or grabbing those dollars?

Allen Mistysyn: Yes. John, if you look at the adjusted — I’ll use the adjusted increase in SG&A. Almost 70% of that is attributed to our operating segments with the majority of that being in Paint Stores Group. And as Heidi mentioned in her opening remarks, we added 35 new stores in the quarter, 76 new stores for the year as well as additional reps, which with the additional investments that we’ve made in the second half, our rep count is up a multiple of that. The remaining increase is evenly split between our Consumer Brands and the Pro Paint reps increases and also with our Performance Coatings Group sales and tech service reps. And John, I believe the teams have done a really good job at driving the metrics and monitoring the metrics to make sure we’re going to get a return for those.

And then as you mentioned, the remaining portion of the increase is really related to the admin segment and primarily compensation, including stock-based comp, which as you know is typically heavier in our fourth quarter. It’s really driven by the stock price. We had some deferred comp and wage inflation. But I’d say those are the primary drivers of the SG&A. And I’d just add one more comment to that. Those will annualize in our first half next year. But we do expect, as Heidi mentioned in the opening, to be back to more typical investments and SG&A investments in 2024. So we’ll see a bigger increase in our first half and at or below the range in our second half to get to that mid-single-digit range for 2024.

Heidi Petz: John, one thing I would add to that, too, I think when you’ve got significant points of differentiation and you believe in your strategy, you’re going to invest in them. So while we’re growing faster than the market, then we’re confident, as Al pointed out, on the return we’re going to get here. Our heads are not in the sand. We absolutely know that it’s an expense, and we expect to get a return. There’s no doubt about that. But we do see this also as an investment to make sure that we continue to outpace the market.

James Jaye: Thank you, John.

Operator: Your next question for today is coming from Jeff Zekauskas with JPMorgan.

Jeffrey Zekauskas: Thanks very much. In your remarks, you said that your raw materials, I think in the second half of 2023 were down more than 10%. And that makes sense. Your cost of goods sold in the fourth quarter was down 10%, you have higher people costs. But next year, in the first quarter, you have your easiest raw material comparison. The second quarter is pretty easy, too. So if the first quarter continuing the pattern we’ve seen is down again low-double-digits and the second quarter is down high-single digits, shouldn’t your raw material base case for next year be down mid-single-digits rather than low-single digits?

Allen Mistysyn: Yes, Jeff. The way we have the raw material benefit rolling out in 2024, about 85% of that benefit is in our first half. And the assumption we’re making is that we’re not going to see another material drop as the year goes on. So essentially, we’re annualizing the benefits that we saw through the second half of 2023. That being said, the market is driven by supply and demand, and the raw material costs are driven by supply and demand. And as we see how demand unfolds, certainly, there’s plenty availability of supply in the market. That may change. But that’s based — our low-single digit outlook is based on the indicators we see today.