Fitch Ratings affirms A- rating for Sherwin-Williams, driven by company's leading market position in coatings industry, unique distribution platform, breadth and depth of product offerings, solid free cash flow generation, notes Stable rating outlook
May 12, 2014
– Fitch Ratings has affirmed the ratings of The Sherwin-Williams Company (NYSE: SHW), including the company's Issuer Default Rating (IDR) at 'A-'. The Rating Outlook is Stable. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings for SHW incorporate the company's leading market position in the architectural coatings industry, its unique distribution platform, the breadth and depth of its product offerings, solid free cash flow generation, and strong management team. Risk factors include lead-based paint litigation cases against SHW, volatile raw materials costs, and the company's relatively aggressive growth strategy.
The Stable Outlook reflects the expected continued improvement in the overall U.S. construction market during 2014. The Stable Outlook also reflects the company's solid liquidity position and strong operating performance during 2013 and so far in 2014.
LEADERSHIP POSITION WITH UNIQUE DISTRIBUTION PLATFORM
SHW is the largest coatings manufacturer in the U.S. and the third largest worldwide. SHW has a network of 3,908 company-operated paint stores and 582 company-operated branches as of Dec. 31, 2013. The company is unique in that most of its competitors distribute their products through 'Big Box' retailers, hardware stores and mass merchandisers. The networks of competitor paint companies that distribute through company-owned stores are not as extensive as that of SHW. Fitch views this as an advantage, as the company can directly control marketing, merchandising, service, and price decisions at its stores. Additionally, SHW also distributes through 'Big Box' Home Centers and mass merchandisers, primarily reaching the do-it-yourself (DIY) customer segment. The company estimates that about 75% of its sales are through its controlled distribution platform, with the remaining 25% through independent retailers.
The company seeks to expand its distribution platform by opening new stores and pursuing acquisition opportunities. In a solidly expanding economy, management plans to expand the store base at an average of 3% per year (100+ stores annually). However, the pace of store expansion has been slower over the past six years as demand slowed and the company closed redundant stores from previous acquisitions. Management plans to open between 80-90 net new stores this year.
In September 2013, SHW completed the acquisition of the U.S./Canada business of Consorcio Comex, S.A. de C.V. (Comex) for $90 million in cash and the assumption of liabilities valued at about $75 million. In April 2014, SHW terminated the stock purchase agreement to acquire the Mexico business of Comex after the Federal Competition Commission of Mexico twice rejected the proposed acquisition due to concerns that the transaction would reduce competition in the Mexican paint market.
Fitch believes that the company will continue to pursue acquisition opportunities to grow its business. The acquisition of the U.S. and Canadian operations of Comex last year added 306 company operated paint stores to the company's network, increasing SHW's store presence in key markets. This acquisition will contribute about $450 million to total revenues this year.
SHW has a long track record of adhering to a disciplined financial strategy and Fitch expects this to continue. The company's leverage has been slightly above it long-term target of 1x debt to EBITDA due to the pre-funding of $1 billion of debt in December 2012 meant for the Comex acquisition. Fitch expects the company will return to its leverage target by the end of 2014 enabled by EBITDA growth and some debt reduction later this year.
The company has historically used excess FCF to repurchase its stock and/or fund acquisitions. SHW repurchased $769.3 million of its common stock in 2013 compared with $557.8 million in 2012 and $367.4 million in 2011. During the first quarter of 2014, SHW bought back $256.4 million of stock. At the end of the first quarter, the company had 10.85 million shares remaining under its current share repurchase authorization.
SHW's credit metrics remain appropriate for the rating level. Debt to EBITDA at the end of the March 2014 quarter was 1.3x compared with 1.2x at year-end 2013 and 1.4x at the end of 2012. Adjusted debt to EBITDAR was 2.6x for the March 31, 2014 LTM period compared with 2.5x at the end of 2013 and 2.7x at year-end 2012. Fitch expects debt to EBITDA and Adjusted debt to EBITDAR will be 1.0x and 2.4x, respectively, at the end of 2014.
Interest coverage remains solid at 21.2x for the LTM period ending March 31, 2014 compared with 22.2x during 2013 and 29.4x in 2012. Fitch expects interest coverage will settle around 23.0x in 2014. FFO fixed charge coverage was 3.6x for the LTM period ending March 31, 2014 compared with 3.6x during 2013 and 3.7x during 2012. Fitch expects FFO fixed charge coverage will be approximately 3.5x during 2014.
LIQUIDITY AND CASH FLOW GENERATION
SHW maintains solid liquidity with cash of $366.5 million and no borrowings under its $1.05 billion commercial paper program that is backed by SHW's $1.05 billion revolving credit facility. SHW also has three U.S. revolving and letter of credit facilities totaling $1 billion, a 95 million Euro credit facility and a C$150 Canadian credit facility. The company has $500 million of debt coming due in December 2014, which is expected to be repaid from cash on hand, short-term borrowings and FCF.
Cash flow generation remains strong with free cash flow (FCF) totaling $718.2 million for the LTM period ending March 31, 2014 compared with $712 million of FCF during 2013 and $569.8 million of FCF during 2012. Fitch projects SHW will generate between $500 million and $550 million of FCF during 2014.
IMPROVEMENT IN SHW'S U.S. END-MARKETS
Fitch's ratings on SHW take into account the cyclicality of the company's end markets. Residential, commercial and industrial construction are each cyclical and can be influenced by economic trends. Fitch expects total U.S. construction spending will increase 7.9% during 2014 following a 5.0% improvement during 2013. The growth will be driven primarily by continued strength in the new residential construction sector.
Housing comparisons are challenging through first-half 2014, and so far this year most housing metrics seem to have defied expectations and fallen somewhat from a year ago. Though the severe winter throughout much of North America has restrained some housing activity, nonetheless, there is an absence of underlying consumer momentum this spring, perhaps due to buyer sensitivity to higher home prices and finance rates and the slowing of job growth at year end. Fitch has recently tapered its forecast to reflect the subpar spring selling season. Single-family starts are now projected to improve 15% to 710,000 as multifamily volume grows about 9% to 335,000. Thus, total starts this year should top 1 million. New home sales are forecast to advance about 16% to 500,000, while existing home volume is flat at 5.10 million, largely due to fewer distressed homes for sale.
Fitch forecasts home improvement spending will increase 6% in 2014 following a projected 5% growth in 2013. The continued improvement in the housing market, as well as strong home price appreciation seen last year and so far this year, are likely to drive higher spending on home renovation projects in 2014.
Non-residential construction is also expected to grow modestly during 2014. Fitch expects private non-residential construction spending will improve 5% during 2014 while public construction spending is forecast to increase 3% this year.
LEAD-BASED PAINT LITIGATION RISKS
SHW and other companies are or were defendants in legal proceedings seeking recovery related to lead-based paint litigation cases. On Dec. 16, 2013, a California Superior Court judge ordered SHW and two other companies (ConAgra Grocery Products Co. and NL Industries) to pay $1.15 billion into a fund to be used to clean-up hazards from lead-based paint in homes in the state of California. The Santa Clara County, California proceeding was initiated in March 2000 by 10 counties and cities in the state of California and asserted a claim for public nuisance, alleging that the presence of lead products for use in paint and coatings in, on and around buildings in the plaintiff's jurisdictions constitutes a public nuisance. The court entered final judgment on January 27, 2014, holding the defendants jointly and severally liable to pay $1.15 billion into a fund to abate the public nuisance.
On March 28, 2014, the company filed a notice of appeal to the Sixth District Court of Appeal for the State of California. The filing of the notice of appeal effects an automatic stay of the judgment without the requirement to post a bond. Management believes that a decision by the Court of Appeals will take approximately 2-3 years.
Aside from the potential liability associated with the abatement costs, there is also increased possibility that the California decision could have broader ramifications by encouraging similar legal actions from other state and/or municipalities. Following the February 2006 jury verdict against SHW and other defendants in the State of Rhode Island in a similar public nuisance case, the State of Ohio and several cities in Ohio individually initiated proceedings in state court in 2006 and 2007 against SHW and other companies asserting claims for public nuisance. Those actions in Ohio were subsequently voluntarily dismissed by the plaintiffs after the Rhode Island Supreme Court reversed the public nuisance judgment against the company and the other defendants in 2008.
Positive rating actions may be considered if the company's credit metrics improve meaningfully from current levels, including lease-adjusted leverage consistently below 2x and FFO fixed charge coverage at or above 4x.
Negative rating actions could occur if the company performs in line with Fitch's 2014/2015 stress case forecasts, including EBITDA margins falling to between 11%-12% and lease adjusted leverage consistently exceeding 3x. Additionally, Fitch may consider a negative rating action if there is an adverse decision against the company related to lead-based paint litigation cases wherein the judgment will lead to higher debt levels and lease-adjusted leverage consistently above 3x.
Fitch has affirmed the following ratings for SHW with a Stable Outlook:
--Long-term IDR at 'A-';
--Senior unsecured notes at 'A-';
--Unsecured bank credit facilities at 'A-';
--Short-term IDR at 'F2';
--Commercial Paper (CP) at 'F2'.
Additional information is available at www.fitchratings.com.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology -- Effective 12 August 2011 to 8 August 2012
Fitch Ratings, Inc.
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