NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for 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 (FCF) generation, and strong management team. Risk factors include lead-based paint litigation cases pending against SHW, volatile raw materials costs, the cyclicality of the company's end markets, and SHW's relatively aggressive growth strategy.
The Stable Outlook reflects the expected continued improvement in the overall U.S. construction market during 2015. The Stable Outlook also reflects the company's solid liquidity position and strong operating performance expected during 2015.
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 more than 4,000 company-operated paint stores and 576 company-operated branches as of Dec. 31, 2014. 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.
In December 2014, the company announced a partnership with HGTV and Lowe's Companies, Inc. (Lowe's) to sell HGTV HOME by Sherwin-Williams labelled paints through Lowe's stores nationwide and online, beginning in March 2015. This brand is also sold in SHW stores and is targeted to the DIY consumer segment. Fitch views this partnership positively as it provides SHW with a large platform to further expand its products directed to the DIY consumer segment.
The company estimates that about 75% of its sales are through its controlled distribution platform, with the remaining 25% through independent retailers.
SHW has a strong track record of adhering to a disciplined financial strategy, balancing capital deployed for growth opportunities and shareholder friendly activities. The company has a target leverage of about 1.0x as measured by debt to EBITDA, although SHW may be slightly above this level during certain periods when the company increases short-term borrowings to fund working capital. Additionally, the company's leverage may also go above this level if it makes a sizeable acquisition. However, as the company had demonstrated in the past, Fitch would expect SHW will return to its target leverage within a reasonable period of time if the company completes a large acquisition.
SHW's credit metrics remain appropriate for the rating level. Debt to EBITDA for the latest-twelve-months (LTM) ending March 31, 2015 was 1.6x compared with 1.1x at the end of 2014, 1.2x at year-end 2013 and 1.4x at the conclusion of 2012. Adjusted debt to EBITDAR was 2.8x for the LTM period ending March 31, 2015 compared with 2.5x at the end of 2014, 2.5x at year-end 2013 and 2.7x at the conclusion of 2012. The leverage levels for the LTM period are modestly higher due to increased short-term borrowings during 1Q15, which included short-term borrowings to fund $614.9 million of accelerated share repurchases. Fitch expects debt to EBITDA and adjusted debt to EBITDAR will be around 1.1x and 2.4x, respectively, at the end of 2015.
Interest coverage remains solid at 26.7x for the LTM period ending March 31, 2015 compared with 24.7x during 2014, 22.2x during 2013 and 29.4x in 2012. Fitch expects interest coverage will settle around 28x in 2015. FFO fixed charge coverage was 3.6x for the LTM period ending March 31, 2015 compared with 3.6x during 2014, 3.6x during 2013 and 3.7x during 2012. Fitch expects FFO fixed charge coverage will remain around 3.5x during the next few years.
LIQUIDITY AND CASH FLOW GENERATION
As of March 31, 2015, SHW had cash of $64 million and $258.7 million of unused capacity under its $1.05 billion CP program that is backed by a $1.05 billion revolving credit facility. In addition, Fitch estimates that the company has about $650 million of borrowing capacity under its various domestic and foreign revolving and letter of credit facilities.
SHW has no major debt maturities until 2017, when $700 million of senior notes matures. As of March 31, 2015, the company had $791.3 million of borrowings under the CP program and $575 million borrowed under its short-term revolving and letter of credit agreements. Fitch expects SHW will repay some of its short-term borrowings with FCF and term-out a portion of the balance during 2015. (In December 2014, SHW repaid $500 million of senior notes that matured with short-term borrowings.)
Cash flow generation remains strong with FCF totaling $672.9 million (6% FCF margin) for the LTM period ending March 31, 2015 compared with $665.7 million (6%) of FCF during 2014, $712 million (7%) during 2013, $569.8 million (6%) during 2012. Fitch projects SHW will generate FCF margins of 5.5%-6.5% during the next few years.
SHW repurchased $1.49 billion of its common stock in 2014 compared with $769.3 million in 2013, $557.8 million in 2012 and $367.4 million in 2011. During the 1Q15, SHW bought back $614.9 million of stock in an accelerated stock repurchase program. By comparison, the company spent $256.4 million on share repurchases during 1Q14. At the end of the first quarter, SHW had 3.23 million shares remaining under its share repurchase authorization.
Fitch is comfortable with the company's share repurchase activity given its strong FCF, solid liquidity position and management's track record of adhering to a disciplined financial strategy. Fitch expects SHW will remain disciplined with its capital allocation, balancing acquisitions and share repurchases.
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). During 2014, the company opened 95 net new stores (109 new stores opened and 14 stores closed). SHW currently plans to open around 100 net new stores this year.
SHW has spent over $1.5 billion for acquisitions since 2004 (none in 2014). In 2012, SHW entered into an agreement to acquire Consorcio Comex, S.A. de C.V. (Comex) for $2.34 billion. Comex has operations in Latin America, the U.S. and Canada. In September 2013, the company completed the acquisition of the U.S./Canada business of Comex for $90 million in cash and $75 million of assumed liabilities. In April 2014, SHW terminated the 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 acquisitions will remain a priority for excess cash flow and the agency expects SHW will continue to pursue acquisition opportunities, with primary focus on building its architectural coatings platform in the Western hemisphere as well as expanding its coatings business in emerging markets.
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 7.1% during 2015 after growing 5.4% in 2014 and 5.8% in 2013.
New housing metrics increased slightly in 2014 due to more robust economic growth during the last three quarters of the year, despite modestly higher interest rates, as well as more measured home price inflation. Housing activity is likely to ratchet up more sharply in 2015 with the support of a steadily growing economy throughout the balance of the year. Total housing starts are projected to expand 14% to 1.14 million as single-family starts advance 17% and multifamily volumes gain 7%. New home sales should grow 18%, while existing home sales rise 4.3%.
Fitch forecasts home improvement spending will increase 6% in 2015 following an estimated 4% growth in 2014. The continued improvement in the housing market, as well gains in home prices in 2013 and 2014, are likely to drive higher spending on home renovation projects in 2015.
Non-residential construction is also expected to grow modestly during 2015. Fitch expects private non-residential construction spending will improve 7% during 2015 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 Jan. 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.
Fitch's key assumptions within its rating case for the issuer include:
--U.S. construction spending increases 7% during 2015;
--SHW's revenues rise mid-single digits during 2015;
--EBITDA margins improve 50-100 bps during 2015;
--Debt/EBITDA at year end 2015 settles at around 1.0x, adjusted debt/EBITDAR is roughly 2.5x and FFO fixed charge coverage is at or above 3.5x;
--SHW generates FCF margins of 5.5% - 6.5% during the next few years;
--Excess FCF will be used to pay down debt and fund additional share repurchases.
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 2015/2016 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' (May 28, 2014);
--'Building Products: Ratings Navigator Companion' (Feb. 12, 2015).
Applicable Criteria and Related Research:
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage
Building Products: Ratings Navigator Reference File