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Fitch Assigns Initial Sr Unsec Debt Rtg of 'A' to The Sherwin-Williams Company

Published on 2004-10-12. Author : SpecialChem

NEW YORK -- Fitch Ratings initiates a rating on The Sherwin-Williams Company (SHW). Fitch assigns an 'A' rating to SHW's senior unsecured debt. This rating applies to approximately $505 million in outstanding senior notes as well as the company's revolving credit agreement. The Rating Outlook is Positive.

The rating and Outlook for SHW are based on the company's leading market position in the architectural coatings industry, the attractive characteristics of the residential home improvement market, the company's unique distribution platform, the breadth and depth of its product offerings, the company's focus on painting contractors and property maintenance managers, solid net free cash flow generation and strong management team. Risk factors include sensitivity to general economic trends, as well as the cyclicality of residential, commercial and industrial construction, increasing raw materials costs, lead paint litigation cases against SHW and possible integration/financing issues related to its active acquisition program.

SHW has a strong balance sheet and generates solid free cash flow. The company's gross debt-to-capitalization ratio has improved to 25.4% at the end of the 2Q04 from a high of 38.7% at the end of 1997. SHW is targeting gross debt-to-capitalization in the 35% range. The company generates significant net free cash flow (EBITDA-capital expenditures-cash interest-cash taxes plus change in working capital). SHW realized over $425 million in net free cash flow for each of the last three years, which has allowed the company to fund acquisitions, dividends and stock repurchases, while paying down debt. SHW maintains ample liquidity with cash of $233.5 million and a new $650 million five-year revolver.

Credit statistics at the end of 2Q04 improved relative to the close of 2003. Interest coverage improved from 17.3 times (x) for 2003 to 19.3x for LTM June 30, 2004. EBITDA margins improved 20 bps to 12.6% for LTM June 30, 2004 from 12.4% for 2003.

SHW has a network of 2,961 company-operated specialty stores (including the recently acquired Duron outlets) in the U.S., Canada, Virgin Islands, Puerto Rico and Mexico and 194 automotive branches. SHW is unique in that most of its competitors distribute their products through 'Big Box' retailers, hardware stores and mass merchandisers. For paint companies that distribute through company-owned stores, their network is not as extensive as that of SHW. (SHW has more company-owned paint stores than the next ten competitors combined.) Fitch views this as an advantage, as the company can directly control marketing, merchandising, service, and price decisions. Additionally, SHW also distributes through 'Big Box' Home Centers such as Home Depot, Lowe's and Menards and mass merchandisers such as Wal-Mart, Sears, and K-Mart, primarily reaching the do-it-yourself customer segment. Management estimates that 69% of its sales are through company-owned stores, with the remaining 31% of sales are realized through independent retailers.

SHW's captive distribution network caters largely to painting contractors and property maintenance managers. Within the industry's architectural coatings segment, sales to professional contractors have increased over the past 20 years, accounting for 60% of the unit volume in 2003 compared to 51% in 1993 and 42% in 1983. Fitch expects that the sales to professional contractors will continue to advance at a faster rate than do-it-yourselfers. SHW is well positioned to capitalize on the trend favoring contractor growth within the home improvement sector. Also, in recent years the company has been successfully growing its stores' sales to do-it-yourselfers.

SHW seeks to expand its distribution platform by increasing the rate of new store openings and pursuing acquisition opportunities in the highly fragmented industry. Management plans to expand the store base at an average of 2 1/2-3% per year. Despite already meaningful market penetration, Fitch is comfortable with this strategy as Fitch believes that the company has considerable room to further expand its store base domestically. Individual stores do not require significant capital and the expansion program can and will be moderated as the situation requires. SHW has been an active consolidator in the coatings industry. Most recently, SHW completed the acquisitions of Duron, Inc. (the fifth largest specialty paint retailer in the U.S. and a major manufacturer of coatings) and Paint Sundry Brands (a leading marketer and manufacturer of high quality paint brushes and rollers). These acquisitions will provide the company with a broadened, controlled distribution platform (231 Duron stores) as well as recognized branded products (Purdy brushes and rollers) in the marketplace.

SHW supplements its extensive distribution platform and diverse product offering with 1,400 sales representatives who are out in the field (they are not in-store staff) constantly visiting contractors and having job-specific dialogues with end-users. The company's team of knowledgeable field representatives is able to provide end-users, particularly professional contractors and property managers, with local service and personalized expert advice. Fitch views this as an essential element to SHW's strategy of catering to painting contractors and property managers and as a distinct competitive advantage.

Fitch's rating takes into account the cyclicality of SHW's end markets. Residential, commercial and industrial construction are each cyclical and can be influenced by economic trends. SHW showed during the recent recession that it is capable of managing working capital and lowering expenses to generate strong cash flow. Fitch expects the company will be inclined to follow the same practices and build up cash during future periods of economic pressure. Sales for the company's architectural coatings remain strong as the home improvement industry continues to enjoy the benefit of a growing economy, the positive effects on consumer spending from a high level of mortgage refinancings in recent years, and a favorable U.S. housing market supported by historically low interest rates. Sales of existing and new homes are projected to be down modestly in 2005 from record 2004 levels, yet are expected to post the second best levels ever. Additionally, the company's industrial maintenance and product finishes segments have displayed stronger results over the past two quarters and could benefit from a cyclical pick-up in manufacturing and industrial production during the next few years.

SHW is still exposed to possible future liability arising from lead paint litigation cases filed against the company. To date, the company has had less than 100 lead litigation cases filed since 1987. About 85% of those cases have been dismissed, none have ever been settled, and only one case (brought by the State of Rhode Island) has ever come to trial. Most recently, the litigation filed by the State of Rhode Island against former lead pigment manufacturers, including SHW, was postponed to April 2005. The initial Rhode Island trial was declared a mistrial when the jury could not reach a decision on whether or not lead paint constituted public nuisance. SHW has not accrued any amounts for losses on such litigations.

The cost of raw materials for a typical coatings product (container, solvents, resins, titanium dioxide (TiO2), pigments, fillers) represents approximately 50% of the wholesale selling price. Higher crude oil and natural gas prices have driven up the costs of some basic raw materials and suppliers have responded by raising prices. Management projects that the industry will realize a 4%-6% annualized year-over-year raw material price increase in 2004. Fitch anticipates that the company can offset much of these raw material price increases with manufacturing efficiencies, implementation of newer low cost technologies, tight expense control, as well as selective price increases.

Founded in 1866, SHW is one of the world's leading companies engaged in the manufacture, distribution and sale of coatings and related products to professional, industrial, commercial and retail customers. The company is structured in four business segments: Paint Stores (64.1% of 2003 Sales), Consumer (22%), Automotive Finishes (8.4%), and International Coatings (5.3%). The Paint Stores Segment is the exclusive North American distributor of Sherwin-Williams branded paints and related products. The Consumer Segment sells paints and coatings and related products under various branded products (Dutch Boy, Pratt & Lambert, Martin-Senour, Thompson, Minwax, etc.), licensed products (Martha Stewart), and private labels (Wal-Mart, Sears). The Automotive Finishes Segment manufactures and sells a variety of motor vehicle finish, refinish and touch-up products primarily throughout North and South America, the Caribbean Islands, and Europe. The International Coatings Segment distributes a variety of paints and coatings products worldwide.

The noted ratings were initiated by Fitch as a service to users of its ratings.

Source: Fitch Ratings


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