The Sherwin-Williams Company (NYSE:SHW) Q3 2023 Earnings Call Transcript

The Sherwin-Williams Company (NYSE:SHW) Q3 2023 Earnings Call Transcript October 24, 2023

The Sherwin-Williams Company beats earnings expectations. Reported EPS is $3.2, expectations were $2.77.

Operator: Good morning. Thank you for joining the Sherwin-Williams Company’s review of third quarter 2023 Results and our Outlook for the Fourth Quarter and Full Year of 2023. 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 2 hours after this conference call concludes. This conference call will include certain forward-looking statements as defined under the U.S. federal securities laws with respect to sales, earnings and other matters. Any forward-looking statement speaks only as of the date of 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 the session to questions. I will now turn the call over to Jim Jaye, Senior Vice President, Investor Relations and Communications.

James Jaye: Thank you, and good morning to everyone. Joining me on the call today are John Morikis, Chairman and CEO; Heidi Petz, President and Chief Operating Officer; Al Mistysyn, Chief Financial Officer; and Jane Cronin, Senior Vice President of Enterprise Finance. Sherwin-Williams delivered excellent third quarter results compared to the same period a year ago. These results follow our strong first half, and we are again increasing our full year guidance, which John will talk about in just a few minutes. But first, let me touch on a few third quarter highlights. Consolidated net sales were within our guidance range. Consolidated gross margin expanded significantly sequentially and year-over-year driven by pricing discipline and moderating raw material costs.

To reiterate our commentary from last quarter, we are committed to investing in and profitably growing the business at the same time. The high single-digit increase in SG&A over the prior year third quarter reflects those investments, which are deliberately being made at a higher level to take advantage of current market uncertainty and are aimed at driving the success of our customers and growth across all businesses. Operating margin expanded year-over-year and adjusted diluted net income per share grew by a double-digit percentage. EBITDA also grew by a double-digit percentage with adjusted EBITDA margin of 20.7% near the high end of our current 19% to 21% target range. In addition, we returned $566 million to our shareholders through dividends and share repurchases during the quarter.

Let me now turn it over to Heidi, who will provide some commentary on our third 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. Third quarter Paint Stores Group sales increased 3.6% against the challenging 21.5% comp. The increase was driven by continued effective pricing and higher Pro architectural volume, excluding New Residential. Segment margin improved sequentially and year-over-year to 25.9%, driven by pricing discipline and moderating raw material costs. Protective & Marine was the fastest growing in the quarter, driven by strong volume as sales increased by a double-digit percentage against the mid-teens comparison. Industrial flooring, infrastructure and oil and gas applications remain key drivers. In our Pro architectural end markets commercial sales were strongest, increasing by a high single-digit percentage versus a high teens comparison.

Residential repaint sales increased by a mid-single-digit percentage amid continued softness in existing home sales and against a 20% comparison. While this is a solid performance in the current environment, we are not satisfied, and res repaint continues to be our largest opportunity for growth. Property maintenance sales grew by a low single-digit percentage against a mid-20s comparison. New Residential sales were down mid-single digits with volume down high single digits against the mid-20s comparison. As we’ve previously noted, we anticipated New Residential would be challenging near term, given prior softness in single-family starts. We expect our continued share gains and new account wins to become more and more apparent as starts improve.

Our DIY business was down low single digits against a very difficult low 30s comparison. From a product perspective, interior paint sales were up low single digits and exterior paint sales were flat, both against double-digit comparisons in last year’s third quarter. Sales in our Consumer Brands Group decreased by 4% in the quarter, primarily due to the divestiture of the China architectural business and softer DIY demand in North America, which was partially offset by selling price increases. Sales in North America, our largest region, decreased by a mid-single-digit percentage against a double-digit comparison. The Pros Who Paint category continued to grow, while DIY demand remained muted by inflationary pressures on consumers. We continue to invest here with our strategic retail partners for growth.

In other regions, sales were up high single digits in Latin America and low double digits in Europe. Sales in China were down high double digits as we completed divestiture of the business on August 1. Adjusted segment margin was 13.8%, which was lower than a year ago, primarily due to lower sales volume and lower fixed cost absorption due to lower production volumes. Sales in the Performance Coatings Group decreased 1% against a low teens comparison. Volume decreased by a high single-digit percentage, but was partially offset by positive low single-digit contribution from pricing, FX and acquisitions. Adjusted segment margin increased to 19.1% of sales, primarily due to pricing discipline and moderating raw material costs. Sales in PCG varied significantly by region.

Sales were strongest in Europe and increased by a mid-teens percentage. Latin America sales increased by low single digits against a mid-teens comp. North America sales decreased mid-single digits against a 20% comp. Demand in Asia remained weak, with sales down double digits against high single-digit growth a year ago. From a division perspective, growth was strongest in our Industrial Wood business, which was up by a low double-digit percentage against a mid-single-digit comparison. This growth reflects our ICA acquisition, share gains and a potential bottoming of New Residential construction. We expect to gain further momentum in this business. As we closed October 1st on the previously announced acquisition of Germany-based specialized industrial coatings holding comprised of the Oskar Nolte and Klumpp Coatings businesses.

We are gaining share and seeing steady demand in Auto Refinish, where sales increased by a mid-single-digit percentage against a high single-digit comparison. Sales in Coil and General Industrial both decreased by low single-digit percentages against challenging comparisons and vary widely by region. Packaging sales were down by a mid-teens percentage against the high single-digit comparison. We anticipated this decline given the near-term destocking by brand owners that we described earlier this year. Packaging sales in the quarter were also slightly impacted by the fire at our Garland, Texas plant. Our business continuity team is executing our contingency plans to minimize customer impacts from this event near term. Longer term, we continue to feel very good about our position and growth prospects in this end market, and we expect to bring additional capacity online at our , France plant by early 2024.

With that, let me turn it to John for his comments on our outlook for the fourth quarter and the year.

John Morikis: Thank you, Heidi. Our team delivered another strong quarter in an environment characterized by ongoing uncertainty. My thanks go to our 64,000 employees for continuing to focus on our mission and for executing on our strategy. Their energy in serving our customers and providing them with solutions remains a true differentiator. On our July call, we described the anticipated second half demand backdrop across our businesses. The third quarter played out much as we expected, and we believe the environment remains largely unchanged in the fourth quarter. Paint Stores Group will face another strong year-over-year comparison. Demand in commercial, property maintenance, residential repaint and Protective & Marine remains stable with New Residential remaining soft as we expected.

We have now annualized prior price increases. In Consumer Brands, North America DIY demand remained soft. Europe demand has stabilized and Latin America markets remain mixed. Performance Coatings demand remains highly variable by end market and by region. We know we cannot defy gravity in terms of the macro environment. What we can do is aggressively pursue new account and share of wallet opportunities to drive market share gains, we are aggressively focused on doing just that. Moving to the cost side. We’re narrowing our full year raw material outlook. We expect cost to be down by a high single-digit percentage in 2023 compared to 2022. We expect other costs, including wages and other input costs to be up in the mid- to high single-digit range.

We also continue to see the current market uncertainty as an opportunity to press our advantages through greater investment in solutions for our customers that will drive their success and ours. Our SG&A spend in the fourth quarter will reflect these investments, leading full year SG&A to increase in the high single-digit to low double-digit range compared to last year. This approach has served us well many times in the past. We are highly confident and will again now resulting in continued above-market growth and strong returns. Now moving on to our specific guidance. We anticipate our fourth quarter 2023 consolidated net sales will be up or down a low single-digit percentage compared to a high single-digit increase in the fourth quarter of 2022, with volume flat to down slightly.

As a reminder, we’ve largely annualized previous price increases across the business. For the full year 2023, we expect consolidated net sales to be up a low single-digit percentage with volume down a low single-digit percentage. Our sales expectations by segment for the fourth quarter and the full year are included in the slide deck issued with our press release this morning. We are increasing our full year 2023 diluted net income per share to be in the range of $9.21 to $9.41 per share. We believe this increased range accurately reflects our strong third quarter performance, continued pricing discipline and moderating raw material costs while also acknowledging the ongoing uncertainty in our seasonally smaller fourth quarter. This guidance includes acquisition-related amortization expense of approximately $0.80 per share and restructuring related net expense of $0.09 per share.

On an adjusted basis, we expect full year 2023 earnings per share in the range of $10.10 to $10.30. This is an increase of 16.8% at the midpoint compared to last year’s $8.73 adjusted earnings per share. We provided a GAAP reconciliation in the Reg G table within our press release. Our slide deck includes additional information on our assumptions for the year. As we begin the fourth quarter, we continue to expect choppiness by region and end market. More importantly, we continue to see opportunity amid uncertainty, and we are extremely confident in how well our various businesses are positioned. Our strategy is clear. It’s working, and it’s not changing. We’ll continue to provide our customers with differentiated solutions that drive their productivity and their profitability.

Our capabilities, products and services are unique. We remain on offense, growing new accounts and share of wallet in the right markets with the right customers. We also remain focused on developing and retaining talent and improving and simplifying our operations. We expect to finish the year with momentum that will carry us into 2024. I have the utmost confidence in Heidi, Al, our leadership team and our people. Together, we expect to continue outperforming our competitors and the market. This concludes our prepared remarks. And 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: [Operator Instructions]. Your first question is coming from John McNulty from BMO.

John McNulty: And first, John, congratulations on a great tenure in the CEO slot. And Heidi best of luck to you as you take on that role at the end of the year. So I guess the first thing I wanted to just touch on was the strength of the contractor market. Can you give us a little bit of color as to what you’re seeing, especially in the residential repaint area. It looks like it’s been maybe a little bit stronger than what we would have expected. So just curious your take on how to think about that continuing going forward.

Heidi Petz: Yes. I think you make a great point here. I want to take a minute before I jump right into res repaint, which I absolutely will and just put this a bit in perspective. You heard from some of our prepared remarks that when we look at our performance in general, and we’re posting some stronger results up against really aggressive comps last year. I think that’s an important piece that we anchor in as I get into the res repaints. repaint certainly New Res being up against over 20% comps here and still in this environment, continuing to post. So we’re really proud of the team to be able to overcome some of that. So I think if I just jump right into Res repaint, I’ll let you know that yes, we are gaining share in this market.

Demand does vary depending on a few variables. I think if you look at this and separate a bit, those contractors that are more established and well-known and are more experienced in marketing their business, they’ve got the scale and they’re confident in their backlog. I would say that’s more so true for them than those that have less experience being able to put that type of focus on in marketing their business. So I’d say there’s a bit of a variance there. But we look at this importantly. The adversity that these contractors are facing in this choppiness is also an opportunity where I believe that it makes our stores and our reps even more valuable as we’re helping them navigate through a lot of this uncertainty and helping to intercept what it is that they’re trying to accomplish in their business, whether it’s leads or making sure that we’re helping them finding ways to be more efficient in their process.

So I think if we’ve seen this movie before, we’re ready for what’s ahead. We’re putting investments in. John referenced earlier in the SG&A that you see, and I’ll take you back. We saw this coming in 2008 and 2009. And making sure that what came out of that was our desire to be well positioned and New Residential does recover, that we’ve got all the investments in place here to continue to drive res repaint. So this is an opportunity where, where and I would say when, our model stands out and when we’re able to gain a lot of share.

John McNulty: Got it. Fair enough. And I guess the second question is just around cost versus price. It looks like raws are coming down, but you’ve highlighted in the remarks that other costs are definitely still pushing higher and you’re also still investing in the business. So can you help us to think about the need for further pricing? I know you’ve taken a little bit of a pause recently as you normally do in the paint season. But I guess, how should we be thinking about the need for further pricing as you’re pushing into 2024?

Allen Mistysyn: Yes, John, this is Al Mistysyn. And we’re in that part of the year where we’re going through our operating plans. We’re reviewing really demand outlook with our suppliers. I know we’ve gotten a lot of questions about oil ticking up, and that has to be up for a period of time before we see that flow through our raw material basket. I think what you will see is the other cost input items increasing, I think merit increases will get back to a more normal level, but you’ve got health care, freight, some of the things going on with LTL carriers that are driving our overall costs up. So as we typically do, we push back and look for offsets as much as we can. And then when we can’t — don’t feel like we have an offset and we need to go out with price, we’ll tell this to our customers first and, then we’ll talk to the Street.

So we’re going through that process, and we need a little more time to figure that out, and we’ll let our customers know and then we’ll come back and let the street know.

Operator: Your next question is coming from Vincent Andrews from Morgan Stanley.

Vincent Andrews: Wondering if I could just dig into the SG&A a bit more. Understand completely and appreciate what you’re doing this year. But how do we think about that into ’24, both in terms of what level of increase is realistic for next year, presumably SG&A is not going to go down, but should it grow a lot less than normal just given the big step up this year? And then how do we think about from the outside over the next couple of years measuring the return on that? Is it simply going to come through the volume line in Paint Stores Group, or do you think it’s going to be about margin or both? As we — we’re here 2 years from now, and we do a look back, what do you want us to see specifically in the P&L?

John Morikis: Yes, Vincent, let me start with that last piece because I think it’s really important. And again, I want to reiterate the confidence that we have in our strategy and the fact that we’ve seen this movie before. The investments that we’re making, you will see in the P&L, and you will see in market share growth. Our teams are invested in executing on these areas. But I think another important area that’s crucial that you won’t be able to measure on our P&L is the success that we’ll bring with our customers as well. So if you go back to the strategy that we employ, it’s focused on driving the success of our customers. And these investments that we’re making will clearly help our customers in achieving what it is that their trying to do. And so I think as you look forward, the expectation should be increased market share and outpacing the market in volume and profitability as well.

Allen Mistysyn: Yes, Vincent, I would say certainly, as we annualize costs or the investments in our long-term growth initiatives, you’re going to see that in the first part of the year. But I’d highlight, if you look at our SG&A sequentially second quarter to third quarter, even though we kept investing in Paint Stores Group and reps, Performance Coatings Group sales and tech service reps and you have investments in the Pros Who Paints. We saw those offset by reductions in our G&A costs or admin SG&A so that we’re trying to figure out ways to continue to drive G&A down to offset the incremental cost of those investments. And yes, we will absolutely measure the return. But as we get into 2024, we’re going through our budgeting plan. We’re going through key initiatives across each of our functional areas, and we’ll keep driving both those costs lower to help pay for the incremental investments.

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

Jeffrey Zekauskas: I know that the year-over-year price comparisons are less positive than they’ve been. But when you look at sequential pricing from the second to the third quarter, were your prices down sequentially in any important product area?

Allen Mistysyn: Yes, Jeff, if you look at our pricing because you annualize pricing throughout each of the segments as we’ve gone. I know we’ve talked about Performance Coatings through basically, at some point, through on a 90-day cycle. So price was still up in the quarter, in the third quarter, up low single digit. But if you look at that compared to our second quarter, price would have added a mid single-digit percentage in the second quarter. So — and as you get into our fourth quarter, you’d be at a lower single-digit impact on our fourth quarter. So that’s just annualizing the price increases we’ve taken throughout ’22. But I would argue and say, we have not given that price back. And you can see that in our gross margin performance in the second quarter, up — 440 up in the third — third quarter of 490 basis points, and we expect to be up again in our fourth quarter, along with the moderating raw material cost sequentially.

Heidi Petz: Jeff, I would add to that as well. I think our effectiveness is at a record high, and I give the team a lot of credit because it’s not just about holding it, it’s about demonstrating that value every single day with our contractors.

Jeffrey Zekauskas: Okay, great. And your raw materials were down high single digits. I would imagine they would be down low double digits in the fourth quarter, if you’re going to be down high single digits for the year. And maybe the fourth quarter is sort of the bottoming of raw materials for the industry in general. Is that fair?

Allen Mistysyn: Jeff, I don’t know I’d go that far. As I mentioned earlier, I think we have to look at the — market is still demand, supply driven. We’re working with our suppliers to develop what does industry demand look like across each of the regions. And I think that’s going to be a bigger driver of raw material pricing as we get into 2024. I think as we mentioned on our second quarter call, we expected our third quarter to be our biggest year-over-year change in raw material costs, but certainly, they’re going to be down in our fourth quarter as well.

Operator: Your next question is coming from Greg Melich from Evercore ISI.