Description

 SHW has been written up three separate times on VIC so I'd recommend going there for good background on the company and why it is such a great business. 

https://valueinvestorsclub.com/idea/SHERWIN-WILLIAMS_CO/6889635156#description, 

https://valueinvestorsclub.com/idea/SHERWIN-WILLIAMS_CO/5880793195, 

https://valueinvestorsclub.com/idea/Sherwin-Williams/2847386352), 

The opportunity today is that SHW shares are getting sold off on recession concerns and the likelihood that the 2020 home selling / painting season will be significantly disrupted by Coronoavirus. To be fair, shares were running hot earlier in the year, peaking at a hair under $600 (26x forward cash earnings vs. a 5 year average if 22x and an average of 18.5x since the beginning of 2006), so to some degree this retracement has been healthy. But at $420 (-30%), we think the prospects for a bad 2020 are more than priced in at the moment and investors get to buy a high quality business at a very reasonable multiple.  

So leading with the obvious, 2020 is going to be a bad year. Their architectural coatings business won't do as well because housing turnover won't be as good and it is likely that home improvement spending will be curtailed with everyone worried about what an unprecedented stopping of the global economy means for them. Their industrial coatings business will also suffer with a slowing economy. Whatever coatings volumes were being estimated a month ago, best to assume we miss them badly. I have to believe this is known right now.

So moving forward, what I think is being missed right now is huge margin tailwind SHW is about to receive from the OPEC price war. The beauty of the coatings is how much pricing power they have, and architectural coatings (in particular via SHW's company owned stores) are the best of the bunch. With resins/latex accounting for 43% of the cost of a can of paint, the significant decline in oil in the last few weeks is is a material benefit for companies with pricing power. 

Now this isn't going to save estimates in a year like 2020 but they do have the potential to supercharge the recovery in 2021 (assuming we aren't in global depression that has extended from 2020).Look at the margin trajectory for SHW stand-alone from 2011 - 2016. The combination of oil price inflation and a super cycle in TiO2 pricing drove SHW to take significant rate increases, but TiO2 peaked in 2012 and oil in late 2014, and you can see the impact on  gross margins for 2015 - 2016: 

To be clear, some of the benefit was mix because their stores outgrew the rest of the business and that business is highest margin, but even PSG segment operating margins expanded from 13.5% to 20.8% during this time. 

So when I think about 2021, we likely have a lot of deferred housing activity driving strong coatings demand (if you needed to paint your house in 2020 but didn't because of the economy, it gets harder to defer in 2021 too... same with wanting to sell) and the industrial economy kicking back into gear after a bad year, and margins should be structurally higher due to the drop in raw materials, which combined should drive significant earnings growth. Certainly relative to 2020 but potentially relative to the trend heading into this demand shock. Additionally, this is a business that generates healthy FCF and management is consistent about deploying cash flow for M&A and to buy back shares. Assuming no M&A, this company will assuredly be an active acquiror of their shares which will drive per share profitability even higher.

*Recession Modeling

Paint is a recession resistant business but not immune. Paint store group same store sales were decidely negative during the GFC, so it is important to think through downside scenarios in case my bullish view does not pan out. 

My stab at modeling recession earnings is: I take Sherwin sales per store in 2009 ($1.1mn), adjust up for 35% in pricing since then, and then use SHW and VAL numbers from 09 for rest of business (VAL numbers from 09 plus some M&A they did after). This is likely conservative because it embeds no pricing from rest of segments and doesn’t have exclusive LOW numbers in results. I then apply a margin (-100bps vs. last year b/c that is the decline they reported in 2009 and we already discussed how their raw material basket is a big tailwind), current year estimates for interest expense and taxes and get to a cash EPS of $12.64 (so ~33x P/E). This embeds no benefit from buybacks but once the dislocation eases I would expect SHW to aggressively be buying back shares just like they did in 2009.

Catalyst

Normalization after demand shock

Widening of profit margins with oil price declines