Sherwin-Williams: Brushstrokes of Success

Sector

Chemicals

Background

Todd Basnight is the Director of Equity Research at Aureus Asset Management. We cover how Sherwin-Williams became the the largest paint and coatings company in the world, why it's been such an effective compounder over a long period of time, and what it can teach us about the balance between returning capital to shareholders and reinvesting in growth.

Cover

Date

September 18, 2024

Episode Number

183

Background / Overview

Founded in 1866 by Henry Sherwin and Edward Williams, Sherwin-Williams has grown from a pioneer in ready-mixed paint to the world’s largest paint and coatings company. Headquartered in Cleveland, Ohio, the company employs over 65,000 people and operates in 120 countries. In 2023, it generated $23 billion in revenue, driven by its three primary segments: Paint Stores Group (architectural coatings for professional painters), Performance Coatings (industrial coatings), and Consumer Brands (DIY-focused paints and stains sold through third-party retailers). Sherwin-Williams has compounded earnings at 14% annually over the past 20 years, delivering a 26x return to shareholders compared to the S&P 500’s 5x over the same period.

Sherwin-Williams’ longevity (10 CEOs in over 150 years) and innovation (over 35,000 paint colors) underscore its ability to adapt while maintaining a focus on quality and service. Its iconic logo, featuring the Earth doused in paint with the slogan “Cover the Earth,” reflects the ubiquity of its products, though it humorously contrasts with modern ESG sensibilities.

Ownership / Fundraising / Recent Valuation

Sherwin-Williams is a publicly traded company (NYSE: SHW) with no recent private equity ownership or major fundraising events noted. The 2017 acquisition of Valspar for $11 billion, funded entirely with debt, was a transformative event that increased leverage to a target of 2-2.5x, aligning with a more efficient capital structure. At the time, Sherwin-Williams had a market capitalization of approximately $30 billion, and its stock price has since risen from ~$100 to ~$360.

Current valuation metrics suggest Sherwin-Williams trades at approximately 30x forward earnings, a premium to its historical 20x multiple and peers in the building products or chemicals sectors. This reflects growing market appreciation for its superior growth, high returns, and resilient business model, though it may temper future stock returns compared to historical outperformance.

Key Products / Services / Value Proposition

Sherwin-Williams operates three economically separable segments, each with distinct products, customer bases, and value propositions:

1. Paint Stores Group (~57% of revenue, ~67% of segment profit):
• Description: Sells premium Sherwin-Williams-branded architectural coatings (interior/exterior paints) exclusively through ~4,700 company-owned stores in North America, targeting professional painters (85% of sales) and some DIY customers.
• Value Proposition: Provides unmatched service, quality, and convenience for professional painters. Features include on-demand color mixing, delivery to job sites, and dedicated sales reps (~3,800) who act as business partners. The vertically integrated model ensures consistency in product quality, pricing, and service, saving painters time (estimated one day per month) and enhancing their profitability (labor is ~90% of a paint job’s cost).
• Volume/Price: In 2023, the segment generated ~$13 billion in sales, with ~$2.7 million per store. Prices range from $25-$100/gallon, with an average of $25-$30.
• Financials: High-20s gross margins, >20% operating margins, reflecting premium pricing and operational efficiency.
2. Performance Coatings (~25% of revenue, high-teens operating margins):
• Description: Manufactures and sells industrial coatings for diverse applications (e.g., automotive refinish, packaging, coil, appliances, infrastructure). Strengthened by the Valspar acquisition, which expanded scale and exposure to high-growth end markets.
• Value Proposition: Offers specialized, high-quality coatings tailored to fragmented end markets. In automotive refinish, it mirrors the Paint Stores model by serving local body shops with a focus on service and quality. In packaging/coil, it provides differentiated products for technical applications.
• Volume/Price: Grows at mid-single-digit rates, with margins improved from high-single-digits pre-Valspar to high-teens post-acquisition.
• Financials: Lower margins than Paint Stores due to higher competition and customer concentration in some subsegments, but scale and M&A potential drive growth.
3. Consumer Brands (~18% of revenue, mid-teens operating margins):
• Description: Sells non-Sherwin-Williams brands (e.g., Valspar, Cabot, Minwax, HGTV by Sherwin-Williams) through third-party retailers like Lowe’s (exclusive supplier since 2018), targeting DIY customers.
• Value Proposition: Leverages established brands and retail partnerships to capture DIY market share. Less service-intensive than Paint Stores, with focus on brand recognition and accessibility.
• Volume/Price: Low single-digit growth, reflecting slower DIY market dynamics. Prices are lower than Paint Stores due to retail competition.
• Financials: Mid-teens margins, volatile due to third-party retail dynamics and international exposure.

Unique Dynamics:

• Controlled Distribution Model: Sherwin-Williams’ Paint Stores Group is unparalleled in its vertical integration, controlling manufacturing, distribution (own trucking fleet and 3,300 delivery vehicles), and sales through company-owned stores. This contrasts with competitors like BEHR (sold through Home Depot) or Benjamin Moore (independent retailers), who outsource distribution and lose control over customer relationships and pricing.
• Professional Painter Focus: The Paint Stores Group’s design around professional painters (85% of sales) creates a sticky, high-margin customer base. Painters prioritize quality, service, and time savings over price, given paint is only ~10% of a job’s cost. Sherwin-Williams’ low employee turnover (<10% annually) and proactive sales force (3,800 reps) foster loyalty, with painters preferring Sherwin-Williams over Benjamin Moore by 5:1.
• On-Demand Customization: Paint stores mix colors on-demand, minimizing inventory risk and markdowns, unlike other retailers that must predict demand for specific products.

Segments and Revenue Model

Sherwin-Williams’ revenue model varies by segment, reflecting distinct customer needs and market dynamics:

1. Paint Stores Group:
• Revenue Model: Sells premium architectural coatings to professional painters through exclusive stores. Revenue is driven by volume (gallons sold), price (premium positioning), and share gains (outpacing competitors).
• Drivers:
• Volume: 65% of the U.S. architectural paint market (800 million gallons in 2023), with ~75% of the professional segment. Grows via new store openings (80-100/year) and share gains (1-2% annually).
• Price: Average $25-$30/gallon, with premium products up to $100. Pricing power stems from low price sensitivity (paint is ~10% of job cost) and controlled distribution, enabling rapid price adjustments.
• Mix: 85% professional painters, 15% DIY. End markets include residential repaint (30-35%), DIY (35-40%), new construction (10-15%), property management (10-15%), and commercial (5-10%). Repaint activity (80% of demand) is driven by home price appreciation, housing stock age (40 years), and existing home sales (double-dipping effect).
2. Performance Coatings:
• Revenue Model: Sells specialized industrial coatings to fragmented end markets, with revenue driven by volume growth, selective pricing, and M&A.
• Drivers:
• Volume: Mid-single-digit growth, tied to global industrial production and end-market expansion (e.g., packaging, coil). M&A adds inorganic growth.
• Price: Varies by subsegment, with higher margins in differentiated markets (e.g., automotive refinish) and lower margins in commoditized areas (e.g., auto OEM).
• Mix: Diverse end markets (automotive refinish, packaging, coil, infrastructure), with focus on high-growth, high-margin categories post-Valspar.
3. Consumer Brands:
• Revenue Model: Sells branded paints/stains through third-party retailers (e.g., Lowe’s), targeting DIY customers. Revenue grows slowly due to competitive retail dynamics.
• Drivers:
• Volume: Low single-digit growth, limited by DIY market saturation and competition.
• Price: Lower than Paint Stores due to retail pricing pressure.
• Mix: Primarily DIY-focused, with exposure to home improvement retail channels.

Revenue Splits and Mix:

• Segment Mix (2023): Paint Stores (57%), Performance Coatings (25%), Consumer Brands (~18%).
• Customer Mix: Professional painters dominate Paint Stores (85%), while Consumer Brands targets DIY (100%). Performance Coatings serves industrial clients (e.g., auto shops, manufacturers).
• Geo Mix: Primarily North America for Paint Stores, with Performance Coatings and Consumer Brands having international exposure.
• End-Market Mix: Paint Stores focuses on residential/commercial repaint (80%) and new construction (20%). Performance Coatings spans automotive, packaging, and infrastructure. Consumer Brands is home improvement retail.
• EBITDA Contribution: Paint Stores (67%), Performance Coatings (20%), Consumer Brands (~13%).
• Historical Mix Shifts: Paint Stores’ share of revenue and profit has grown due to faster growth (8% CAGR vs. 3-5% for competitors). Consumer Brands’ share stabilized post-Valspar, while Performance Coatings’ importance increased.

Organic vs. Inorganic Growth:

• Paint Stores grows organically via store openings and share gains.
• Performance Coatings relies on organic growth and M&A (e.g., Valspar).
• Consumer Brands grows organically, with limited M&A expected.

KPIs

• Paint Stores Sales Growth: 8% CAGR (6% same-store, 2% new stores), outpacing industry’s low single-digit growth.
• Same-Store Sales Breakdown: 1-2% volume, 2% price, 1-2% share gains.
• Store Productivity: $2.7 million/store, comparable to top QSRs like Chipotle.
• Store Openings: 80-100/year, with runway to 6,000 stores.
• Gross Margin: ~50%, with 400 bps volatility during inflationary periods.
• Operating Margins: High teens overall; Paint Stores >20%, Performance Coatings high teens, Consumer Brands mid-teens.
• ROIC: >40%, up from mid-20s a decade ago.
• FCF Conversion: >100% of net income.
• Share Repurchases: 2% annual share count reduction, with opportunistic buybacks (15% retired post-GFC).

Trends: Accelerating market share gains (competitors like PPG and Kelly-Moore exiting/struggling), stable store growth, and improving margins post-COVID inflation.

Headline Financials

Revenue Trajectory:

• Paint Stores: $13 billion in 2023, 8% CAGR (6% same-store, 2% store growth). Driven by volume (1-2%), price (2%), and share gains (1-2%).
• Performance Coatings: Mid-single-digit growth, boosted by Valspar’s scale and M&A potential.
• Consumer Brands: Low single-digit growth, constrained by DIY market dynamics.
• Total: Mid- to high single-digit growth, with Paint Stores as the primary driver.

Cost Trajectory / Operating Leverage:

• COGS: ~50% of sales, primarily raw materials (85% of COGS: resins, latex, pigments, solvents). Volatile due to petrochemical feedstocks, but Sherwin-Williams passes through price increases rapidly (10% price hike adds only 1% to job cost).
• SG&A: ~30% of sales, high due to controlled distribution (store staff, sales reps, delivery vehicles). Fixed costs drive operating leverage, with incremental margins of 25-30%.
• EBITDA Margin: High teens, with Paint Stores >20%. Margin expansion occurs post-inflation as prices remain elevated while raw material costs subside.
• Volatility: Gross margins dipped 400 bps during COVID inflation but recovered quickly, setting new baselines.

Capital Intensity / Capital Allocation:

• CapEx: <2% of sales, low due to efficient store openings ($1M/store, $600K profit, rapid payback) and periodic manufacturing investments.
• NWC: 11% of sales, with a short cash conversion cycle due to on-demand production and low inventory risk.
• Capital Allocation:
• Organic Growth: 80-100 new stores/year, low capital intensity.
• M&A: Valspar ($11B, 2017) was transformative; future M&A likely in Performance Coatings.
• Shareholder Returns: 45 years of dividend increases, 2% annual share repurchases, opportunistic buybacks (15% retired post-GFC).
• FCF: >100% net income conversion, supporting dividends, buybacks, and M&A without excess cash hoarding.

Value Chain Position

Sherwin-Williams operates across the paint and coatings value chain, with a focus on manufacturing, distribution, and retail:

• Primary Activities:
• Manufacturing: Produces paints/coatings at its plants, controlling quality and cost.
• Distribution: Owns trucking fleet and 3,300 delivery vehicles, ensuring efficient logistics.
• Retail: Operates 4,700 Paint Stores for professional painters and sells through third-party retailers (Consumer Brands).
• Value Chain Position: Midstream (manufacturing) to downstream (retail). Paint Stores’ vertical integration (manufacturing to retail) is unique, while Consumer Brands relies on third-party retail (downstream only).
• GTM Strategy:
• Paint Stores: Direct-to-professional painters via company stores, supported by 3,800 sales reps and delivery services. Exclusive agreements with 23/25 top homebuilders and 17/20 property management firms enhance scale.
• Performance Coatings: Direct to industrial clients, with focus on differentiated subsegments.
• Consumer Brands: Retail partnerships (e.g., Lowe’s), leveraging brand equity.
• Competitive Advantage: Vertical integration in Paint Stores ensures control over pricing, service, and customer relationships, creating a moat. On-demand production reduces inventory risk, enhancing efficiency.

Customers and Suppliers

• Customers:
• Paint Stores: Professional painters (85%), DIY (15%). End markets: residential repaint (30-35%), DIY (35-40%), new construction (10-15%), property management (10-15%), commercial (5-10%).
• Performance Coatings: Industrial clients (e.g., auto body shops, manufacturers in packaging/coil).
• Consumer Brands: DIY consumers via retail channels.
• Suppliers: Raw materials (resins, latex, pigments, solvents) from petrochemical and commodity feedstocks. Sherwin-Williams’ scale enables bulk purchasing, but COGS volatility reflects upstream price fluctuations.
• Customer Stickiness: High in Paint Stores due to service, quality, and time savings. Professional painters’ loyalty (5:1 preference over Benjamin Moore) and exclusive agreements with large clients (homebuilders, property managers) reduce churn.

Pricing

• Contract Structure: Paint Stores negotiate with large clients (homebuilders, property managers) for exclusivity, ensuring consistent pricing and volume. Smaller painters pay premium prices due to low price sensitivity.
• Pricing Drivers:
• Premium Brand: Sherwin-Williams’ reputation and service justify higher prices ($25-$100/gallon vs. $10-$30 for competitors).
• Low Price Sensitivity: Paint is ~10% of job cost, enabling rapid price pass-through (10% hike adds 1% to job cost).
• Controlled Distribution: Instant price adjustments at company stores, unlike competitors haggling with retailers.
• Rational Industry: Consolidated market and low demand elasticity prevent price wars.
• Inflation Dynamics: Price increases during inflation are retained post-cost declines, driving structural margin expansion (e.g., post-2010s and post-COVID).

Bottoms-Up Drivers

Revenue Model & Drivers

• Paint Stores:
• Revenue Model: Volume x Price. Volume grows via store openings (80-100/year), share gains (1-2%), and market growth (1% annual square footage increase). Price grows 2% annually, with flexibility for pass-through.
• Volume Drivers: New stores, share gains from competitors’ exits (e.g., PPG, Kelly-Moore), and repaint demand (80% of market). Repaint is driven by home equity, housing age, and existing home sales (double-dipping).
• Price Drivers: Premium branding, low price sensitivity, and controlled distribution. Inflation pass-through is rapid and sticky.
• Mix: Shift toward professional painters (65% of projects vs. 40% in 1980s) boosts margins. Repaint focus ensures stability.
• Performance Coatings:
• Revenue Model: Volume x Price, with M&A adding inorganic growth. Volume grows via end-market expansion and organic share gains.
• Volume Drivers: Growth in high-margin subsegments (e.g., packaging, coil) and M&A. Cyclicality tied to global industrial production.
• Price Drivers: Varies by subsegment; higher in differentiated markets, lower in commoditized ones.
• Mix: Shift toward high-growth, high-margin end markets post-Valspar.
• Consumer Brands:
• Revenue Model: Volume x Price, constrained by retail competition.
• Volume Drivers: DIY market growth (low single-digit), retail partnerships (e.g., Lowe’s exclusivity).
• Price Drivers: Limited pricing power due to retail dynamics.
• Mix: Stable, with focus on branded products.

Absolute Revenue:

• Paint Stores: $13 billion (57%), growing 8% CAGR.
• Performance Coatings: ~$5.75 billion (25%), mid-single-digit growth.
• Consumer Brands: ~$4.25 billion (18%), low single-digit growth.
• Total: $23 billion, mid- to high single-digit growth.

Mix Shifts:

• Paint Stores’ dominance grows due to faster growth and competitor exits.
• Performance Coatings’ share increases via M&A and end-market expansion.
• Consumer Brands’ share stabilizes, with rationalization of low-performing brands.

Cost Structure & Drivers

• COGS (50% of sales):
• Variable Costs: Raw materials (85% of COGS: resins, latex, pigments, solvents). Volatile due to petrochemical prices, but pass-through mitigates impact.
• Contribution Margin: High due to premium pricing and low variable costs (on-demand production minimizes inventory).
• Gross Margin: ~50%, with 400 bps volatility during inflation. Structural increases post-inflation (e.g., post-COVID).
• SG&A (30% of sales):
• Fixed Costs: Store staff, sales reps, delivery vehicles, and facilities. High SG&A reflects service investment, driving loyalty and margins.
• Operating Leverage: Fixed costs yield 25-30% incremental margins as revenue grows.
• R&D: <1% of sales, focused on incremental paint/coatings improvements (e.g., faster-drying products).
• EBITDA Margin: High teens, with Paint Stores >20%. Margin expansion driven by price stickiness and fixed cost leverage.

Cost Analysis:

• % of Revenue: COGS (50%), SG&A (30%), R&D (<1%), other (20%).
• % of Total Costs: Raw materials (42.5%), labor/service (25%), facilities (15%), other (17.5%).
• Adjustability: Variable costs (raw materials) are managed via pricing. Fixed costs (SG&A) are strategic, supporting the moat.

FCF Drivers

• Net Income: High teens operating margins drive strong profitability.
• CapEx: <2% of sales, primarily for store openings ($1M/store) and manufacturing. Low maintenance CapEx enhances FCF.
• NWC: 11% of sales, with efficient cash conversion cycle (on-demand production, low inventory).
• FCF: >100% of net income (~$2.3 billion), supporting dividends, buybacks, and M&A.
• Cash Conversion Cycle: Short due to rapid inventory turnover and stable receivables/payables.

Capital Deployment

• Organic Growth: 80-100 new stores/year, low capital intensity, high returns.
• M&A: Valspar ($11B, 2017) added scale in Consumer Brands and Performance Coatings. Future M&A likely in Performance Coatings.
• Shareholder Returns: 2% annual share repurchases, 45-year dividend growth, opportunistic buybacks (15% post-GFC).
• Leverage: Post-Valspar, targets 2-2.5x leverage, balancing growth and stability.

Market, Competitive Landscape, Strategy

Market Size and Growth

• U.S. Architectural Paint Market:
• Size: ~800 million gallons in 2023, ~$22 billion at $25-$30/gallon.
• Growth: Low single-digit, driven by 1% annual square footage growth and stable repaint demand (80% of market).
• Volume: 1-2% growth, tied to repaint and new construction.
• Price: 2% growth, with inflation pass-through.
• Global Industrial Coatings Market:
• Size: Larger and more fragmented than architectural, with diverse end markets.
• Growth: Mid-single-digit, tied to industrial production and M&A.
• Home Improvement Market:
• Size: ~$1 trillion, with paint as a small but resilient category.
• Growth: Mid-single-digit, with paint less cyclical than other categories.

Industry Growth Stack:

• Population growth (~0.5%).
• Real GDP growth (~2%).
• Inflation (~2-3%).
• Square footage growth (~1%).
• Home equity and existing home sales drive repaint demand.

3 KDs of the Industry:

1. Repaint demand (80% of market, stable).
2. Professional painter shift (65% of projects, growing).
3. Vertical integration (Sherwin-Williams’ moat).

Market Structure

• Architectural Paint: Highly consolidated, with Sherwin-Williams at ~65% market share, followed by BEHR (Masco), PPG, and Benjamin Moore (combined <50% of Sherwin-Williams’ sales). Competitors like PPG and Kelly-Moore are exiting or struggling, reinforcing Sherwin-Williams’ dominance.
• Industrial Coatings: Fragmented, with Sherwin-Williams, PPG, and Akzo Nobel as leaders. Subsegments vary from commoditized (auto OEM) to specialized (packaging).
• MES (Minimum Efficient Scale): High in architectural paint due to store network and service requirements, limiting competitors. Lower in industrial coatings, allowing more players.
• Industry Traits: Low regulation, stable demand, rational pricing due to consolidation.

Competitive Positioning

• Sherwin-Williams: Premium brand, vertically integrated, dominant in professional paint (75% share). Focuses on service, quality, and scale.
• Competitors:
• BEHR (Masco): DIY-focused, sold through Home Depot. Lower margins (~mid-30s gross, high teens operating), slower growth (3% CAGR).
• Benjamin Moore (Berkshire Hathaway): Premium, sold through independent retailers. High teens margins, <10% share, limited growth.
• PPG: Omnichannel (company stores, independent retailers, home centers), but shrinking architectural business (breakeven).
• Matrix Positioning: Sherwin-Williams leads in price (premium), service, and professional market share. Competitors focus on DIY or fragmented channels.

Market Share & Relative Growth

• Sherwin-Williams: 65% of architectural paint, 75% of professional segment. Grows 8% CAGR vs. industry’s low single-digit.
• Competitors: BEHR (15%), PPG (10%), Benjamin Moore (~10%). Shrinking share due to Sherwin-Williams’ store expansion and competitor exits.
• Relative Growth: Sherwin-Williams added $7 billion in Paint Stores sales over 10 years vs. <$1 billion for BEHR and Benjamin Moore.

Competitive Forces (Hamilton’s 7 Powers)

1. Economies of Scale: Sherwin-Williams’ 4,700 stores and manufacturing scale drive cost advantages, enabling aggressive store openings and pricing power. Competitors struggle to match MES, leading to exits (e.g., PPG, Kelly-Moore).
2. Network Effects: The store network’s value increases with scale, attracting more painters and reinforcing loyalty. Each new store enhances service consistency for national clients.
3. Branding: Sherwin-Williams’ premium brand and 5:1 preference over Benjamin Moore command higher prices and loyalty.
4. Counter-Positioning: Controlled distribution model is superior to competitors’ outsourced models, deterring imitation due to high capital and operational costs.
5. Cornered Resource: Exclusive agreements with 23/25 homebuilders and 17/20 property managers secure high-value clients.
6. Process Power: On-demand color mixing, low employee turnover (<10%), and delivery services create operational excellence competitors cannot replicate.
7. Switching Costs: Professional painters’ reliance on Sherwin-Williams’ service, consistency, and relationships creates high stickiness.

Porter’s Five Forces:

• New Entrants: High barriers (scale, capital, brand, distribution) deter entry. Sherwin-Williams’ store network and agreements lock out competitors.
• Substitutes: Low threat; wallpaper is a minor risk for interior repaint (~33% of market), but adoption is limited.
• Supplier Power: Moderate; raw material volatility impacts COGS, but Sherwin-Williams’ scale and pass-through ability mitigate risk.
• Buyer Power: Low for professional painters (fragmented, low price sensitivity). Higher for large clients, but exclusive agreements secure volume.
• Industry Rivalry: Low in architectural paint due to consolidation and rational pricing. Higher in industrial coatings due to fragmentation.

Strategic Logic

• CapEx Bets: Offensive store openings (80-100/year) capture share, with low capital intensity ($1M/store, $600K profit). Defensive manufacturing investments maintain scale.
• Economies of Scale: Achieved MES in Paint Stores, with no diseconomies due to focused operations. Performance Coatings seeks similar scale via M&A.
• Vertical Integration: Controls manufacturing, distribution, and retail in Paint Stores, reducing costs and enhancing service. Competitors’ outsourcing limits flexibility.
• Horizontal Expansion: Valspar added DIY and industrial coatings scale. Future M&A targets Performance Coatings end markets.
• Geo Expansion: North America focus for Paint Stores, with international growth in Performance Coatings.
• BCG Matrix:
• Cash Cows: Paint Stores (high share, high margin, stable growth).
• Stars: Performance Coatings (growing, M&A potential).
• Question Marks: Consumer Brands (low growth, stable margins).
• Dogs: None; rationalized low-performing Consumer Brands.

Valuation

Sherwin-Williams trades at ~30x forward earnings, a premium to its historical 20x and peers (building products/chemicals at 15-20x). This reflects:

• Superior Growth: 8% CAGR vs. peers’ 3-5%.
• High ROIC: >40%, driven by low capital intensity and strong margins.
• Resilience: Paint’s low-cost, high-value nature and repaint focus (80%) reduce cyclicality.
• Moat: Controlled distribution, scale, and loyalty create defensibility.

Risks:

• Housing Market: 15% sales decline in Paint Stores during 2007-2009, less severe than peers (Home Depot -25%, homebuilders -75%). Current softness may impact growth.
• New CEO: Shift from Paint Stores veteran to Valspar outsider may redirect focus to Performance Coatings, with lower ROIC.
• Substitution: Wallpaper is a minor risk for interior repaint.

Valuation Outlook: The premium multiple may limit future returns vs. historical 26x, but superior fundamentals justify a modest premium. Investors must weigh growth durability against macroeconomic risks.

Key Takeaways and Dynamics

1. Controlled Distribution Moat:
• Sherwin-Williams’ vertical integration (manufacturing, distribution, retail) in Paint Stores is unique, enabling control over pricing, service, and customer relationships. Competitors’ outsourced models (e.g., BEHR at Home Depot) sacrifice flexibility and loyalty, allowing Sherwin-Williams to capture 75% of the professional paint market.
• Dynamics: Low employee turnover (<10%), 3,800 sales reps, and 3,300 delivery vehicles create a service-driven flywheel, saving painters time and reinforcing loyalty (5:1 preference over Benjamin Moore).
2. Professional Painter Focus:
• Targeting professional painters (85% of Paint Stores sales) aligns with a high-margin, sticky customer base. Painters prioritize quality and service over price (paint is ~10% of job cost), enabling pricing power and rapid pass-through.
• Dynamics: Shift to professional painters (65% of projects vs. 40% in 1980s) drives margin expansion. Repaint demand (80%) and exclusive agreements with homebuilders/property managers ensure stability.
3. On-Demand Production:
• In-store color mixing minimizes inventory risk and markdowns, unlike competitors predicting demand. This enhances efficiency and margins.
• Dynamics: Low capital intensity (<2% CapEx) and short cash conversion cycle boost FCF (>100% net income).
4. Valspar’s Strategic Impact:
• The $11 billion Valspar acquisition (2017) scaled Consumer Brands (Lowe’s exclusivity) and Performance Coatings (high-growth end markets), diversifying revenue while maintaining Paint Stores’ dominance.
• Dynamics: Performance Coatings’ margins rose from high single-digits to high teens, with M&A potential for further growth. Consumer Brands stabilized DIY share but grows slowly.
5. Pricing Power and Margin Resilience:
• Sherwin-Williams’ ability to pass through price increases (10% hike adds 1% to job cost) and retain elevated prices post-inflation drives structural margin expansion (~50% gross, high teens operating).
• Dynamics: Consolidated market and low demand elasticity prevent price wars, while fixed costs (30% SG&A) yield 25-30% incremental margins.
6. Capital Efficiency:
• Low CapEx (<2% of sales) and high ROIC (>40%) reflect efficient store openings ($1M/store, $600K profit) and manufacturing scale. FCF supports dividends, buybacks (2% annually), and M&A.
• Dynamics: Opportunistic buybacks (15% post-GFC) and debt-funded Valspar deal demonstrate disciplined capital allocation.
7. Market Consolidation:
• Sherwin-Williams’ 65% market share (75% professional) grows as competitors exit (PPG, Kelly-Moore). For every two stores opened, three independent stores close, reinforcing dominance.
• Dynamics: Store network scale and service create a winner-takes-all dynamic, with runway to 6,000 stores.

Conclusion

Sherwin-Williams exemplifies a quiet compounder, leveraging a vertically integrated, service-driven model to dominate the architectural paint market and expand in industrial coatings. Its Paint Stores Group’s controlled distribution, professional painter focus, and on-demand production create a formidable moat, driving 8% CAGR, >40% ROIC, and >100% FCF conversion. The Valspar acquisition diversified revenue, while pricing power and capital efficiency ensure resilience. Despite a premium valuation (~30x earnings), Sherwin-Williams’ superior growth, margins, and defensibility justify its status as a best-in-class business. Investors should monitor housing market risks and the new CEO’s strategic shift, but the company’s fundamentals remain robust.

Transcript