The Sherwin-Williams Company (NYSE:SHW) Q1 2023 Earnings Call Transcript

The Sherwin-Williams Company (NYSE:SHW) Q1 2023 Earnings Call Transcript April 25, 2023

The Sherwin-Williams Company beats earnings expectations. Reported EPS is $2.04, expectations were $1.78.

Operator: Good morning. Thank you for joining the Sherwin-Williams Company’s Review of First Quarter 2023 Results and our Outlook for the Second Quarter and Full Year of 2023. With us on today’s call are John Morikis, Chairman and CEO; Al Mistysyn, CFO; Heidi Petz, President and COO; Jane Cronin, Senior Vice President, Enterprise Finance; and Jim Jaye, Senior Vice President, Investor Relations and Communications. This conference 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 excellent first quarter results compared to the same period a year ago. Consolidated net sales grew by a high single-digit percentage, ahead of our expectations and were led by a mid-teens percentage increase in our professional architectural end markets. On the Industrial side of the business, sales increased in all regions except Asia Pacific. Gross margin significantly improved sequentially and year-over-year, driven by strong volume in the Paint Stores Group and effective pricing. Cost of goods sold includes higher inflation in wages and other employee-related categories, which were partially offset by a slight decrease in year-over-year raw material costs.

We expect to hold the majority of the pricing we have put into the market, given the ongoing investments we have made to drive innovation, enhance services and secure the talent that provides differentiated solutions to help our customers reach their goals and drive their success. Segment margin in all three reportable segments expanded sequentially and year-over-year. We also delivered strong double-digit growth in diluted net income per share and EBITDA. Additionally, we continue to execute on the portfolio realignment actions we announced late last year, including the divestiture of a noncore aerosol business, which closed on April 1, and our recently announced agreement to divest our China architectural business. I’d like to highlight just a few of our consolidated first quarter numbers.

Comparisons in my comments are to the prior year period unless stated otherwise. Starting with the top line. First quarter 2023 consolidated net sales increased 8.9% to $5.44 billion. Consolidated gross margin increased to 44.5%, an improvement of 340 basis points. SG&A expense as a percentage of sales was 31.1%, an increase of 140 basis points, driven by investments in the Paint Stores Group’s long-term growth initiatives and investments in our people across the company through year-over-year increases in compensation and other employee-related benefits. Our people remain our key differentiator in the marketplace. Consolidated profit before tax increased $153.7 million or 33.3%. Diluted net income per share in the quarter was $1.84 per share versus $1.41 per share a year ago.

Excluding Valspar acquisition-related amortization expense and costs related to previously announced restructuring actions, first quarter adjusted diluted net income per share increased 26.7% to $2.04 per share versus $1.61 per share a year ago. EBITDA in the quarter increased $185 million or 26.7% and was 16.1% as a percent of sales. Let me now turn it over to Heidi, who will provide some commentary on our first quarter results by segment. John will follow Heidi with comments on our outlook before we move on to your questions.

Heidi Petz : Thank you, Jim. I’ll begin with the Paint Stores Group, previously known as The Americas Group. We described this change on our last call and in this morning’s press release. There is no impact to prior year consolidated results related to this change. Current and prior year segment results have been restated to reflect this change. First quarter Paint Stores Group sales were ahead of our expectations and increased 14.8%, driven by high single-digit volume growth and continued effective pricing. Segment profit increased by $97.9 million and segment margin improved 120 basis points to 18.4%. Our Pro architectural sales grew by a mid-teens percentage in the quarter. All Pro market segments increased by double digits, led by property management and followed by commercial, residential repaint and new residential, respectively.

Sales in protective & marine and DIY also increased by double-digit percentages. 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. Moving on to results in our Consumer Brands Group, which again now reflects the addition of a Latin America architectural business in the current quarter and prior year. Sales were well ahead of our guidance and increased by 2.4% in the quarter. Performance was better than expected in North America, where sales were down less than 1%; and in Europe, where sales were down low single digits. In other regions, sales were up strong double digits in Latin America and down double digits in Asia. Effective pricing led by Latin America was partially offset by a mid-single-digit decrease in volume and low single-digit FX headwinds.

The tightness in alkyd resins impacting our ability to produce stains and aerosols, improved significantly during the quarter, and we expect this issue to be behind us by the end of the second quarter. Adjusted segment margin was 13%, up 120 basis points year-over-year. As Jim mentioned, we divested a noncore aerosol business at the beginning of this month, and we also entered into an agreement to divest our China architectural business. We expect these actions will benefit segment margin over time as we drive a return to our high teens, low 20s adjusted margin target. Onetime restructuring costs in the quarter were immaterial. Sales in the Performance Coatings Group increased 3.4% against a 20.4% comparison. The increase was driven by low teens pricing and mid-single-digit sales from acquisitions, partially offset by a low teens decrease in volume, which included the impact from discontinued operations in Russia and a low single-digit unfavorable FX impact.

Adjusted segment margin increased 390 basis points to 15.7% of sales. This is the fourth straight quarter this team has delivered year-over-year segment margin improvement, driven by execution of our strategy, including effective pricing. Sales in PCG varied significantly by region. In North America, sales increased high single digits against a nearly 30% comp. Latin America sales increased by double digits, also against a strong comp. Sales in Europe were up mid-single digits, while sales in Asia were down double digits. From a division perspective, growth was strongest in Auto Refinish, which was up by a mid-teens percentage, followed by Coil and General Industrial, which were both up mid-single digits. All three of these divisions grew against double-digit comparisons.

Industrial Wood sales were down mid-single digits as expected due to slowing in furniture, cabinetry and flooring related to new residential softness. Packaging sales also were down mid-single digits against a 30-plus comp with volume down about 1 point in the remainder due to our exit of Russia and unfavorable FX. We continue to feel very good about our position and growth prospects in this end market. With that, let me turn it over to John for his comments on our outlook for the second quarter and the full year.

John Morikis : Thank you, Heidi. I want to thank our teams for working hard to deliver a strong start to the year, especially the margin recovery we are seeing following the relentless cost inflation we’ve experienced the last two years. As we said in January, we expected to have a strong first quarter, and that’s exactly what our team delivered. We also indicated that we would not be updating guidance after the first quarter. We know we have work to do, and we’re under no illusions about the macro headwinds we’re likely to face as the year progresses. We’ll have a much better idea of how the year might unfold as we get deeper into the painting season over the next few months. As we enter the second quarter, we’ll remain focused on what we can control.

This includes leveraging our recession-resilient markets, growing new accounts and share of wallet, continuing appropriate growth investments in stores and sales representatives and managing price cost dynamics. We remain confident in our differentiated strategy, capabilities and product and service solutions, and we continue to expect to outperform the market. For the second quarter of 2023, we anticipate our consolidated net sales will be up or down by a low single-digit percentage compared to the second quarter of 2022, inclusive of a high single-digit price increase. 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 by segment for the second quarter and the full year are included in our slide deck and reflect the move of the Latin American architectural business from Paint Stores Group to Consumer Brands Group.

There is no impact on our sales guidance in the quarter or the year from the divestiture of the China architectural business at this time as the transaction has not yet closed. On the cost side, there is no change in our raw material outlook where we continue to expect costs to 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. We expect other costs, including wages and energy, to be up in the mid- to high single-digit range. The first quarter is typically our smallest, and we need to see second quarter trends and performance to better understand potential impacts on our second half outlook.

We expect to provide an update on our full year sales and EPS guidance following our second quarter. As a result, there is no change at this time to our guidance for full year 2023 diluted net income per share, which we expect 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 $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. There are also no updates to the additional data points and capital allocation priorities we provided on our January call.

I’ll also 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. All of these remain unchanged from our January call as well. Given the many variables at play, limited visibility beyond the first half, and the high level of uncertainty in the global economy, we continue to believe our current outlook is a realistic one. As we get through our second quarter and we see more information, the assumption we laid out in January could change. If those assumptions change for the better, we would expect to deliver stronger results. We’ve transformed our business in many ways since the last significant downturn, and we’re now a stronger and a more resilient company.

I’m highly confident in our leadership team, which is deep and experienced and has been through many previous business cycles. We anticipate that 2023 would be challenging. We 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 become an even more valuable partner to our customers, while we’re also earning new ones. The bottom line is we expect to outperform the market and our competitors in 2023 and for years to come. That 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.

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Q&A Session

Operator: Your first question for today is coming from Vincent Andrews at Morgan Stanley.

Vincent Andrews : Could I ask in TAG in the quarter, just was looking at the incremental margins, obviously, you had a very strong sales performance. And I know there was about 5% carryover pricing in there. So it seems like the volume was quite strong. So was there just a lot of investment spend in the quarter ahead of store openings or just some of your initiatives and that if you could sort of bridge as to what the underlying total company SG&A expense was in the quarter and whether that is a good number to run with as we move through the balance of the year?

Allen Mistysyn : Yes, Vincent, this is Al Mistysyn. And let me start with consolidated SG&A was up 14%. Paint Stores Group was just over 2/3 of that increase, and excluding acquisitions, was approximately 80% of the increase year-over-year. And this is due to the increase in new stores and additional sales reps, which probably represented about 2/3 of the increase. And then in addition, employee-related costs were higher year-over-year due to multiple merit increases beginning in the second half of last year and into the first quarter of this year.

John Morikis : Yes. Let me just jump in here before you carry on there on the investments of our employees, I think it’s absolutely critical to understand in a controlled distribution model, particularly, we see the value of the retention of our employees as a key element of our strategy. We want to build relationships with our customers. We want to make sure we have the right talent that they’re trained, that they’re developed and that we retain them. And so the investments that we’ve made beginning actually about midyear last year, we are clearly seeing the benefits of that. Now there’s some benefit in the market as the economy has taken its course. And clearly, that’s had an impact on some employees and employers. But our relationship with our customers — our employees has improved dramatically.

And I would point to our retention. We’ve often boasted about our turnover rate down in the 7% to 9% range. And we’re proud to say that we’re back in that range of employee turnover. So our retention is back to a historic low. We think that’s an important element and an important investment that we make because we want to make sure that those employees are there when our customers are walking into our stores. So let me turn that back over to you.

Allen Mistysyn : Yes. The only thing I’d add to that is, Vincent, as we discussed in January, we’re going to continue to manage our G&A expenses tightly and adjust other discretionary marketing and other spending as we get a better outlook on demand in the second half. I would say I would expect a smaller year-over-year increase in our second quarter as we annualize the merit increase from last year. We start realizing more cost reductions from the restructuring activities. . Typically, we see a slight uptick in SG&A in our Paint Stores Group as it ramps up staffing and service to increase seasonal architectural demand uptick. Acquisitions will be slightly less than what we saw in our first quarter, which is a low single-digit impact.

And then we’d expect those to annualize and not see much in our second half. So as the year goes on, my second quarter, I’d expect a lower percent of sales because of the seasonally higher architectural sales, but then the year-over-year change gets tighter as the year goes on as we annualize some of these things.

Operator: Your next question is coming from Jeff Zekauskas at JPMorgan.

Jeffrey Zekauskas : The SG&A increase of 14%, I understand that it should moderate from that level. But this year, with everything you’re considering, are we going to be up more than 10% as a base case year-over-year?

Allen Mistysyn : No, Jeff, I’d expect — if you look at how Paint Stores Group, in particular, SG&A rolled out as the year went on last year, it ramps up as we get into our second half because we added more stores, but the merit increases happen in our second half. So the comp gets higher, so the percent change gets lower as we go through the year. I would say the other groups have done a really nice job of managing their SG&A. Consumer, Paints, PCG would have a similar impact with the merit increases, but they’ve been managing their SG&A very tightly. And then in admin, we’ll continue to invest in system upgrades and things like that, but we’re going to manage it tightly. So I would not expect that high of a percentage increase for the year.

Jeffrey Zekauskas : Okay. And then secondly, your new residential business seems to have held up reasonably well, given market conditions. When we get to the fourth quarter or the first quarter of next year, as a base case, what do you think those volumes are like year-over-year in new residential in the Paint Stores Group?

John Morikis : So Jeff, we’ve said that the single-family housing starts are expected to be down year-over-year in the range of 20% to 35%. And our expectation would be that in our business, we’d be better than the market. So our expectations would be that it would be down in the 10% to 20% range. And we’ve also talked openly about the fact that we expect some of our more recession-resilient segments to pull heavier during that period of time. So as we saw the quarter unfold, we saw exactly the sequential trend that we — that you just described. So year-over-year, January, we saw high teens percentage increase; in February, low double-digit increase; and then mid-single digits in March. So we expect that type of a trend to continue through the balance of the year. If you look back 90 days, 120 days and you see the number of starts in comparison to previous quarters, you can see the downturn and then the impact on our new res sales as it unfolds.

Operator: Your next question for today is coming from Christopher Parkinson at Mizuho.

Christopher Parkinson : John, can you sit on a little bit more on what you’re hearing from your customers and contractors in terms of backlog, specifically in the resi repaint market, property maintenance and then perhaps just hit a little bit on what you’re seeing in protective? It would be greatly appreciated.

John Morikis : Yes, Chris, I’d start with the fact that our Paint Stores Group is our largest business, as you know. It’s a $12 billion portion of the company. 90% of our Paint Stores Group is made up of professional sales. And as Heidi mentioned, PRO sales in total grew by a mid-teens percentage with every one of our professional segments growing double digits. So these are large segments growing double digits. So we’re growing real market share in absolute dollars. And I’ll give Justin Binns and his team a lot of credit for the new account and share of wallet initiatives that are clearly working. To your question specifically on residential repaint, we probably best would describe the bidding activity as having returned to a more normalized bidding market, where in the past 12 to 18, maybe 24 months, it was difficult to get a painter to even come out and give you a bid because they were so busy and so backlogged.

I would say that it’s likely best described as a more level or more normalized bidding activity. If you look at the LIRA or the NAHB remodel index, both are positive, but clearly some deceleration in what they’re projecting. Our double-digit quarter this year was on top of a mid-single-digit performance last year. So I’d say that we have confidence in what we’re doing. We have confidence in our ability to continue to grow and grow at our competitors’ expense. We have product back in our store. We just talked briefly about the people in our stores. We think that’s a very important element in what it is that we do. So the retention of our people, we believe, has a direct correlation to the retention of our customers. And we continue to introduce new products.

We can get into some of those details, perhaps later, if we like. But we’re introducing new products to help keep that residential repaint customer not only successful in what they’re doing, but also growing in new segments as well. Talk a little bit about new res there a moment ago after Jeff’s question, but I will say that our ability to work with our builders and help to drive their business and their efficiency, we believe, has been an important element in our ability to retain the relationships that we have, and in fact, grow those relationships. We’re introducing in the face of an adverse market here in the diversity of new residential, we’re introducing new products that will help our customers high build products that will help hide imperfections and improved durability, and that’s helping us to grow our new residential business, and we expect that to continue to grow.

We expect to come out of this time here of some challenges in the market with absolute new and greater market share. On the Commercial side, you asked about this was one of the markets that clearly came in with stronger-than-expected results for the quarter. Our position in this segment is very good, strong and growing. We’ve been long investing in reps, products, specifications and the fact that we have local stores and local reps is an important element in growing this segment. Again, we’ve introduced a number of innovative products here as well. When you think about labor, we often talk about that labor represents, on average, about 85% to 90% of the cost of goods for a painting contractor. The cost for a commercial contractor is likely higher than the average, perhaps in the 90% to 95% as many of the commercial contractors are either union or applying paint in the metro markets, which are higher cost.

Our model, therefore, is even a greater value to these customers. Our ability to collaborate with the architects, work with the designers, work with these contractors is absolutely paying dividend. And we’re excited about this business. The commercial side, there’s a lot of work that’s still coming out of the ground, and we expect to continue to grow with this market and at the expense of our competitors. Property maintenance, you asked about as well, is another segment that grew stronger than expected. Occupancy and rents are returning to more normal rates, and growth here is driven by not only our continued share gains but capital improvement projects as well as an increase in turns. So the Pro side by segment is really going well, and we’re going to continue to put fuel in this tank and feel really good that while we’re growing share, the only expectation we have for our team is to grow it even faster.