Great Stock, Great Company, Great Evaluation? – Sherwin-Williams Company (SHW)

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The chart of coatings and paint company Sherwin-Williams Company (NYSE: SHW) has been a thing of beauty over the last year. One look at it reveals all you need to know about the progression of sentiment over the US housing market in 2012. A recovery has been a long time coming, but it looks to be finally here and SHW is doing all the right things by making acquisitions and expanding store rollouts. So is now the time to buy the stock?

Sherwin-Williams Company (NYSE: SHW) a Year of Beating Estimates

It’s funny how much difference a year makes. SHW entered 2012 on a price of around $90 and guided to $5.52 in earnings. Meanwhile, the market was still highly skeptical of a rebound in housing after having seen a couple of false dawns before. Fast forward one year and SHW left 2012 priced at around $150, having hit earnings of $6.49. That’s some difference.

Sherwin-Williams CompanyLet me put it another way. Entering 2012, the market was willing to pay 16.3x forward earnings but now in 2013 it will pay 21.9x forward earnings (based on the mid-point of SHW’s guidance i.e. $7.45) for the stock. Is a recovery fully priced or is there upside to come?

Looking at this chart you could make the case that the evaluation is justified if we are heading for a multi-year recovery in US housing but on the other hand it was never this high even going into the expansion from 2002-07.

The Case for Sherwin Williams

I can understand why the market loves the stock. The company is doing all the right things, and there are significant upside drivers here. Indeed market estimates for 2013 earnings are at $7.81, significantly higher that SHW’s guidance of $7.35-7.55.

Some of these factors below:

1). The purchase of Mexican coatings manufacturer Comex for a couple of billion should add to earnings (assumptions were not included in SHW’s guidance) and create synergies in an economy that is doing very well at the moment.

2). A multi-year recovery in the US housing market (new build included) starting from a low base

3). New store rollouts and the opportunity to expand further. SHW plans to get to 5,000 stores in North America, including around 300 from Comex plus the 78 planned for 2013 will still see it have less than 4,000 stores.

4). Industry consolidation: PPG Industries, Inc. (NYSE: PPG) is buying Akzo Nobel’s US household paints division, and I think this might cause some firming of margins in the industry.

5). Pricing: The last pricing increase was in February 2012, and with a stronger housing market (and no pricing increases included in this year’s guidance) there is the potential to push through more.

These points are powerful arguments in favor of SHW but they come with a number of caveats.

Why I’m Not so Sure

Firstly, as noted above the evaluation of SHW does leave investors exposed to significant risk of any kind of change in sentiment on housing. Similarly, recall that its expansion plans are predicated on an improvement in US housing. I think it makes sense and I’m bullish on housing, but an investor needs to understand the risk/reward calculation. There is a long way down with SHW if I’m wrong about US housing and I could be.

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