July 10, 2008
Fitch Affirms Sherwin-Williams’ IDR at ‘A'; Outlook Stable
Robert Curran, +1-212-908-0515 (New York)Robert Rulla, CPA, +1-312-606-2311 (Chicago)
Brian Bertsch, +1-212-908-0549
(Media Relations, New York)
Fitch has affirmed the ratings of The Sherwin-Williams Company (NYSE:SHW) as follows:
--Issuer Default Rating (IDR) 'A';
--Senior unsecured debt rating 'A';
--Revolving bank credit facilities 'A';
--Short-term IDR 'F1'.
--Commercial Paper 'F1';
The Rating Outlook is Stable.
The ratings and Outlook for SHW are based on the company's leading market position in the architectural coatings industry, 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 free cash flow generation and strong management team. Risk factors include lead-based paint litigation cases against SHW, the effects of the sluggish housing market on the company's architectural paint segment, increasing raw material costs and the company's relatively aggressive growth strategy.
On July 1, 2008, the Rhode Island Supreme Court overturned a February 2006 verdict wherein a Rhode Island (R.I.) jury found that SHW and two other companies (NL Industries and Millennium Holdings) were liable for creating a public nuisance in a lead-based paint lawsuit brought by the State of Rhode Island.
The decision of the Rhode Island Supreme Court is important because it reverses the first successful public nuisance claim against the paint industry, and, for that matter, the first successful lead-based paint lawsuit of any kind against the paint industry. While the February 2006 jury verdict against SHW and the other defendants opened the possibility for new lead-based paint cases across the country, the reversal of the jury verdict by the R.I. Supreme Court may potentially discourage other states from suing paint manufacturers or, more specifically, suing and using public nuisance theory as the basis for potential lawsuits. Since the February 2006 lower court ruling against the three paint manufacturers, Ohio is the only other state that has sued. While the reversal of the R.I. jury verdict was based on R.I. law, the decision could influence court opinions in other jurisdictions where lead-based paint lawsuits are pending. In addition to the state of Ohio, a case is also pending in Santa Clara, California.
The decision of the Rhode Island Supreme Court follows favorable rulings for SHW and other paint companies in other court cases in 2007. In June 2007, the New Jersey Supreme Court reversed an earlier decision by the Appellate Division and reinstated the dismissal of the public nuisance claims brought by counties and cities of New Jersey. This decision concluded the case in favor of SHW and the other defendants. During the same month, the Missouri Supreme Court affirmed summary judgment for the defendants, which concluded the public nuisance case in favor of SHW and the other defendants. In June 2007, a Milwaukee, Wis. jury concluded that although the presence of lead paint in Milwaukee is a public nuisance, the defendant, NL Industries, was not at fault for the public nuisance. (Note: Mautz Paint, which was previously acquired by SHW, was also a defendant in the Milwaukee case but the trial court entered an order severing and staying the claims against Mautz Paint.) The City of Milwaukee is appealing the jury verdict and the trial court's denial of the City's post-trial motions. Finally, in November 2007 a Milwaukee jury sided with the defendants (SHW, other former lead pigment manufacturers and the Lead Industries Association) in a personal injury case (Thomas v. Lead Industries Association, et al.) in Wisconsin. The plaintiff filed post-trail motions for a new trial, which were denied by the trial court. On March 4, 2008, final judgment was entered in favor of SHW and the other defendants. The plaintiff has filed an appeal of the final judgment.
The company is operating in a very difficult housing environment. Existing home sales increased 2% to a seasonally-adjusted annual rate of 4.99 million homes in May from a level of 4.89 million in April, but are 15.9% below the 5.93 million-unit pace in May 2007. Based on Fitch's forecast, existing home sales are projected to decline by 14.5% in 2008 after falling by 12.8% in 2007. Total housing starts for the January to May 2008 period fell 30.6% and are projected to decline by 29.4% in calendar 2008. New home sales for the first five months of 2008 declined 37.3% and are projected to fall by 26.1% in 2008. Among the factors contributing to these market conditions are: excess inventory, tightening credit standards, and negative buyer psychology. During the first quarter of 2008, U.S. architectural coatings volume declined 6.2% compared to the same period last year.
During the first quarter of 2008, SHW's margins were negatively affected by higher raw material prices and this trend is expected to continue for the remainder of the year. Higher crude oil and natural gas prices over the past several months have driven up the costs of some basic raw materials and suppliers have responded by raising prices. Management projects that the paint industry will realize 9- 14% annualized year-over-year raw material price increase in 2008 (up from an earlier projection of 4-8%). While the company has implemented several price increases to offset the higher costs, the severity of the raw material price increases as well as the lag in its selling price implementation will cause margins to decline in 2008.
SHW seeks to expand its distribution platform by opening new stores and pursuing acquisition opportunities. Management plans to expand its store base at an average of 3% per year (100+ stores annually). The company expects to open 100 new stores in 2008, although it is also accelerating the closure of 60-80 redundant stores during the year. The company was active with acquisitions in 2007, completing 7 acquisitions for a total investment of $282 million. During the first quarter of 2008, SHW spent $15.8 million on acquisitions.
SHW has a network of 3,325 company-operated paint stores and 469 company-operated branches. 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. Additionally, SHW also distributes through 'Big Box' Home Centers and mass merchandisers, primarily reaching the do- it-yourself customer segment. It is estimated that about 75% of SHW's sales are through its controlled distribution platform, with the remaining 25% through independent retailers.
SHW's strong brand and captive distribution network should give the company a competitive advantage in the growing professional contractor market. Within the industry's architectural coatings segment, it is estimated that sales to professional contractors accounted for approximately 61% of the unit volume in 2007, compared to 58% in 1997 and 49% in 1987. Fitch expects the professional contractor channel to continue to grow at a faster rate than do-it- yourselfers given the anticipated increase in 'do-it-for-me' work as the U.S. population ages. In recent years the company has also been successfully growing its stores' sales to do-it-yourselfers.
SHW has a strong balance sheet and typically generates solid free cash flow. SHW's debt to capitalization was 45.1% at March 31, 2008 compared to 35.1% at December 31, 2007. SHW is targeting gross debt to capitalization in the 35%-45% range. The company generates significant free cash flow (over $450 million for each of the last three years and $572 for the latest twelve months LTM) from March 31, 2008), which has allowed the company to fund certain acquisitions and stock repurchases. SHW maintains ample liquidity with cash of $20.1 million and $468 million of availability under the commercial paper program that is backed by the company's $910 million revolving credit agreement. Over the past few years, SHW also improved its liquidity with an additional $1 billion in revolving and letter of credit facilities and a $500 million accounts receivable securitization facility. SHW has $500 million outstanding under certain of its revolving and letter of credit facilities.
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 last 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.
Founded in 1866, The Sherwin-Williams Company 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 three business segments: the Paint Stores Group (62% of 2007 sales), the Consumer Group (16%), and the Global Group (22%). The Paint Stores Group is the exclusive North American distributor of Sherwin-Williams branded paints and related products. The Consumer Group sells paints, coatings and related products under various branded names (Dutch Boy, Pratt & Lambert, Martin-Senour, Thompson, Minwax, etc.); licensed products (Martha Stewart); and private labels (Wal-Mart, Sears). The Global Group develops, manufactures, distributes and sells a variety of paint and coatings products worldwide
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