Streetwise

Lauren Rudd

Sunday, February 17, 2013

Professional Success Does Not Guarantee Investment Success

How unfortunate it is that wealth derived from achieving professional success does not bestow a comparable level of investment expertise. Alas, neither does eligibility for Social Security. To the detriment of the gullible, enviable returns are offered up by pseudo experts with a supposedly elite understanding of market trends and psychology.

It is no real surprise that the promised returns are rarely, if ever, forthcoming. Yet a cornucopia of quality investments is readily available to virtually everyone. A good example is Sherwin-Williams (SHW), the nation’s largest paint manufacturer, known for its slogan that it covers the world.

Founded in 1866, Sherwin-Williams is a global leader in the manufacture, development, distribution, and sale of coatings and related products to professional, industrial, commercial, and retail customers. The company manufactures products under well-known brands such as Sherwin-Williams, Dutch Boy, Krylon, Minwax, Thompson's Water Seal, and many more.

The Company’s branded products are sold exclusively through more than 4,000 company-operated stores and facilities, while the company's other brands are sold through leading mass merchandisers. The Sherwin-Williams Global Finishes Group distributes a wide range of products in more than 109 countries.

When I last wrote about the company a year ago the shares were trading at $99.80. My 12-month projected share price was $112 pegged to estimated 2012 earnings of $5.45 per share. Earnings came in at $6.49 per share and the shares recently closed at $165.45 for a one-year capital gain of 65.8 percent.

Annual sales for 2012 increased 8.8 percent to $9.53 billion, with acquisitions accounting for about 0.9 percent of the increase. An unfavorable exchange rate environment reduced sales by 1.8 percent and lowered net income by $.13 per share. This was partially offset by a stock buy-back 4.60 million shares during 2012.

Net operating cash flow was $887.9 million, while the Company’s working capital ratio (accounts receivable plus inventories less accounts payable divided by sales), excluding acquisitions, came in at 10.7 percent as compared to 10.9 percent a year ago. The annual cash dividend for 2012 was $1.56 per share.

The balance sheet is well positioned for the anticipated closing of the Comex acquisition. Sherwin-Williams borrowed approximately $1.0 billion during the fourth quarter at an average rate of 2.1 percent.

Some of the factors favoring Sherwin-Williams going forward are the purchase of Comex, a Mexican coatings manufacturer, a recovery by the housing market, and new store rollouts for a total 5,000 stores in North America, including 300 from Comex plus the 78 planned for 2013.

PPG Industries is acquiring Akzo Nobel's U.S. domestic household paints division, which in turn, could raise industry profit margins. Sherwin-Williams last price increase was in February 2012, and with a stronger housing market price increases are both possible and probable.

In its forward looking guidance for the first quarter of 2013, Sherwin-Williams anticipates net sales will increase at a low-single digit percentage rate, while net income for the first quarter is expected to be in the range of $1.03 to $1.13 per share.

For all of 2013, the Company expects net sales to increase above 2012 levels by a mid-single digit percentage, generating net income of between $7.45 and $7.55 per share, excluding any effects from the proposed Comex acquisition.

The intrinsic value of the shares using a discounted earnings model, with an earnings growth rate of 15.56 percent and a discount rate of 15 percent is $184 per share. The more conservative free cash flow to the firm methodology yields an intrinsic value of $179 per share.