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This is business breakdowns.
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Welcome back to business breakdowns.
This is Matt Russell.
And today we are breaking down the paint giant Sherwin Williams.
Sherwin Williams is a great example of a company where everyday consumers might not appreciate just how great of a business and stock this has been.
Over the last 20 years, Sherwin has compounded earnings at 14 % per year.
And over those 20 years, the stock has returned 26 times your investment, and that's compared to the S &P at five times your investment.
So you get the idea here.
This has been a incredible quiet compounder.
My guest today is Todd Bassnight, Director of Equity Research at Orius Asset Management.
Todd gets into what makes Sherwin such a special business.
It's founded back in 1866, so it has a long history in terms of becoming the giant that it is, but we get into the weeds in terms of the vertically integrated model, the focus on a particular customer base that is the pros, and a management team that's been thoughtful about capital allocation around
buybacks versus store growth versus the potential for M &A and some of the big deals they've done historically.
It's a really, really interesting business.
I would recommend that anybody that listens to this and enjoys it checks out our episode on AutoZone, which is similar in terms of the quiet compounder category.
And one last thing, before we jump to the conversation with Todd, we're making a final call for anyone interested in the founders and business breakdowns event in Austin at the end of September.
You can find the information at joincolossus .com slash events.
It's an excellent group of attendees, an excellent lineup of speakers and breakout sessions.
If you're interested, make sure to sign up today.
Now onto our business breakdown on Sherwin -Williams.
All right, Todd, excited to have you here to talk Sherwin -Williams.
This is a name that I think pretty much everyone in the U .S.
knows Sherwin -Williams.
I think to anybody in the investing world, the stock market, it's this really interesting quiet compounder that has this great backstory.
So there's this maybe disconnect between Main Street and Wall Street in terms of who Sherwin -Williams is.
So to start out, I think we could just keep it super simple in the easiest terms that you would describe them.
Who is Sherwin -Williams?
What do they do? Just a little bit of an overview for us.
Yeah, thanks for having me on.
I'm a big fan of the podcast.
Sherwin is the largest paint and coatings company in the world.
It's best known for its Sherwin -Williams paint brand sold exclusively through its Sherwin -Williams paint stores, which primarily sell to the professional painter.
Sherwin also sells non -Sherwin -Williams brands such as Valspar paint, Cabot and Minwax stains and Thompson's Water Seal at home centers and hardware stores, most notably at Lowe's, where Sherwin's their exclusive paint supplier.
And Sherwin's also one of the largest manufacturers of industrial coatings, which are applied to everything from food and beverage packaging, automotive refinish, appliances, furniture, infrastructure assets, heavy equipment, and so many other consumer and industrial products.
But most people probably do not appreciate how ubiquitous coatings are.
They are seemingly everywhere and on all things.
And in fact, in what has to be one of the least ESG friendly corporate logos, Sherwin's is the earth being doused with a can of Sherwin -Williams paint and the slogan, cover the earth.
Yeah, it is a very funny backstory and to bring listeners behind the scenes when we were talking about this episode, we talked a little bit about the history and there's not one huge name that sticks out.
It is a really long history.
But that was one thing that I came across that was an early logo decision.
And it did stand out to me in terms of, a little bit of head scratching there, but I do love it, it is humorous.
Can you walk us through what would be the key points or any background on the history of business that you think is relevant?
One thing is, it is a very old company.
So that is worth pointing out.
You're absolutely right.
Sherwin's been the business of selling paint for over 150 years.
It was founded by Henry Sherwin and Edward Williams.
Also, it was one of the first companies to sell ready mixed paint.
Previously customers bought paint ingredients that they were then mixed together themselves.
Since its founding, it's only had 10 CEOs, and yet it's created over 35 ,000 paint colors.
And today the company has more than 65 ,000 employees, operates over 5 ,000 paint stores, sells coatings in 120 countries.
And as of last year, generate over $23 billion in sales.
The company operates three business segments, the paint store segment, its largest segment, followed by performance coatings, which sells the industrial coatings that I referenced earlier.
And lastly, the consumer brands group, which sells those non Sherwin -Williams brands at home centers and hardware stores.
Yeah, I wanna get into the paint stores group because I think that's something that certainly stands out.
I can remember growing up and seeing the Sherwin -Williams store on one of the main roads in my town.
So it seems like a differentiator for Sherwin -Williams that I don't see for other paint brands, but maybe you could just introduce us to that piece of the business.
The paint stores group is the crown jewel of Sherwin -Williams.
This is its largest segment, representing over half of sales and two thirds of segment profit.
Sherwin operates over 4 ,700 dedicated paint stores in North America.
That's more than all the Home Depots and Lowe's combined.
It's also more than half of all the dedicated paint stores in the country.
And as I mentioned earlier, these paint stores are the exclusive distributor of the Sherwin -Williams paint brand.
You cannot buy Sherwin -Williams paint at any other retailer.
This distinguishes it from most other paint brands, which are sold in other stores.
The Sherwin -Williams paint store primarily sells what's known as architectural coatings or paint used for the interior and exterior of homes and buildings.
While we mostly think of paint as a decorative treatment for our home with its endless array of colors, it is also a protective coating from harsh weather outside or merely scuffs and markings inside.
So paint not only beautifies but protects what is many people's most valuable asset, their home.
Paint as a category has a number of other attractive attributes.
As I mentioned earlier, it is everywhere.
Applied to the enormous and ever -growing installed base of square footage in the country, regardless of its former place.
So whether we are building new homes in the South or apartments in the Northeast or data centers seemingly everywhere these days, they will all get painted initially and then again and again over time.
As of 2023, there's roughly 270 billion square feet of residential and non -residential space, and it grows consistently about 1 % per year.
Paint's also a low -cost high -value home improvement project.
Relative to a kitchen or a bathroom model or addition to your home, paint's a smaller ticket project.
It doesn't need to be financed.
And as everyone knows, just changing the color of one room or your front door can have a dramatic impact on the look and feel of a home.
Therefore, paint sales are less influenced by change in interest rates, and they tend to hold up better in downturns than many other home improvement categories.
Think about it as the affordable luxury of the home improvement category.
And lastly, similar to a barista at Starbucks, who can whip up an endless array of drinks with just a few ingredients, coffee beans, water, milk, the paint store can whip up thousands of colors with also just a few inputs, a base paint, and the pigments necessary to make the color.
So unlike many other retailers, a paint store does not need to anticipate demand for certain colors or products and then hold their markdown unwanted inventory when they're proven wrong.
A can of paint's mixed up on demand in a matter of minutes.
Yep, it is an impressive process to watch when you bring them a color that you wanna match and then you see how it actually gets done in store.
And just in terms of Sherwin -Williams' specific paint, that which you are getting at their dedicated stores, can you categorize that in the market?
I should know a bit more about what is premium versus what is discount.
My mother -in -law tends to drive all those decisions in our house where she is very opinionated on the quality of certain paints.
So I'm not quite sure what the answer is, but can you just frame it just in terms of where it sits in the market?
It is certainly a premium brand.
If you look at Sherwin -Williams paint relative to a paint you might get at a home improvement center, a hardware store, this is preferred by professional painters and it does have a range of price points from low, medium to premium, but Sherwin -Williams is certainly a premium can of paint.
And I think you gave us some description of the industry as a whole, some of those growth metrics.
Can you just talk a little bit more about what it looks like in the U .S.
in terms of the size of the overall market where Sherwin -Williams sits in?
You mentioned off the top that they are the number one player, but anything else that you would describe the market as a whole?
Sure. So in 2023, the industry sold roughly 800 million gallons of architectural paint.
That comes out to about one gallon for each 300 square feet of space.
And while the price of a gallon of paint can range from $10 to $100, depending on whether it's for interior or exterior use, the brand, quality of the product, and who's buying it, if we assume the average price paid is about 25 to $30, then the industry was roughly $22 billion in sales last year.
Of course, this is just a drop in the bucket of the overall home improvement category where total spend is closer to a trillion dollars.
Paint's a highly consolidated industry, mostly by Sherwin -Williams, which controls roughly 65 % of the market, followed by Masco's Bear, PPG, and Berkshire Hathaway's Benjamin Moore.
But those next three players together represent less than half of Sherwin's sales.
And prior to the Valspar acquisition, I think it was 2016, 2017, did Valspar represent a big percentage of market share in the industry, or was that a small player as well?
Valspar was one of the players similar to Masco's Bear, or PPG, or Benjamin Moore.
So they were a smaller player compared to Sherwin -Williams, for sure.
Sherwin has long been the dominant player.
And when you think about the industry and annual sales year to year, I think something that was huge during COVID was the DIY boom.
It's generally big.
I do think about painting as one of those things where it is something that is DIY friendly.
It's at the intro level of the potential DIY projects.
Do you have any sense for Sherwin?
Do they break that out in terms of DIY versus professional painters?
What percentage of the business is represented by each?
They do. So by end market, roughly 35 to 40 % of paint projects are do -it -yourself, or DIY.
30 to 35 % is residential repaint.
That is the painting of existing homes by professional painters.
10 to 15 % is new home construction.
10 to 15 % is what they call property management.
That's painting associated with apartment turnover.
And 5 to 10 % is commercial, such as hospitals, schools, hotels.
Roughly 80 % of painting demand is driven by repaint activity of existing square footage.
And that's driven by a combination of factors, mostly home price appreciation and the resulting homeowners equity, which gives the homeowners the confidence to invest in their home.
The age of the housing stock, which is now more than 40 years old on average, also drives natural maintenance work.
And another important driver is existing home sale activity.
Since paint tends to double dip there, usually the seller will put on a fresh coat of paint, something neutral to sell the home.
And then the buyer will repaint the home with more color to make it their own.
The other 20 % of painting demand is new construction, two thirds of which is new residential.
It's a fun data point to think about with the existing home sales and the double dipping that you would see.
So the potential extreme exposure to that, but very interesting just to hear that 80 % is from existing square footage relative to 20 % from new builds.
It does make sense when you just consider the housing supply in the US and where we are from a country standpoint.
But these data points are always super, super interesting to me.
Going a level deeper just in terms of what the DIY painter looks like versus the professional painter.
Can you talk about the characteristics of that pro painter?
I would assume they're spending more on the paint, they're buying the more premium paint.
What other characteristics stand out?
And tell me if that is even true.
Yeah, so at a high level, a residential paint project is done by either a professional painter or an individual willing to DIY it, as you said.
Goes without saying, but only professional painters work on new home construction, commercial construction, and property management.
In the 80s, about 60 % of paint projects were DIY, while the other 40 % were done by a professional paint contractor.
Today, that percentage is more than flipped with about 65 % of paint projects now being completed by a professional painter.
There are many reasons for this shift.
First and foremost, greater appreciation for the quality of work done by a professional, more dual income household with sizable home equity, able to afford such a professional.
Older homeowners unable to do the work themselves, and perhaps younger homeowners less capable of doing the work.
I can say from a personal standpoint, my father was and still is incredibly handy, always able to fix something around the house, whereas in my house, my wife is horrified any time I attempt to tackle even the most basic home improvement project.
But you're right, this trend towards more work being done by professional painters has been a powerful driver for Sherwin's business since his paint stores network is designed to serve that professional painter who make up 85 % of Sherwin's paint sales.
Unlike the DIYer who paints infrequently, shops mostly for color and cares less about quality and more about price, for the professional painter, painting is their livelihood.
This is what they do day in and day out.
They care deeply about paint quality and performance and above all else, service.
And that's the case because a paint project is labor and time intensive.
There can be considerable prep work before painting even begins.
Most projects require multiple coats of primer and paint that they need to dry.
And lastly, there's touch -up work.
As a result, the cost of a paint job is roughly 90 % labor, while only 10 % of the cost is paint and other materials.
On larger projects, labor can represent 95 % of the total cost.
So for a professional painter, time is literally money.
These painters do not wanna be stuck waiting in line behind you or me at the paint desk of a home center.
And they don't wanna be stuck in their car in traffic, driving many miles to that one independent paint store to pick up another gallon of paint because they misordered.
They wanna be serviced by a dedicated paint dealer who knows them, knows their projects and can serve them effectively and efficiently with the best products.
And for that to be the case, wherever their projects might take them.
Sherwin's built their store model to do just that.
As I mentioned earlier, Sherwin's unique in the paint business as it's truly the only player of significance that operates a controlled distribution or near vertically integrated business model.
Almost all of their paint brands are sold in other stores by others employees, whether it's Masco's Bear at Home Depot or Buffett's Benjamin Moore famously sold mostly through independently owned paint and hardware stores.
On the other hand, Sherwin manufactures the paint at its plants, ships it via its own trucking fleet, sells and delivers it exclusively through its own stores and delivery vehicles and services its customers with its own inside store managers and outside sales reps.
Annual employee turnover at stores is less than 10%, which is remarkably low for a retailer and highlights the quality of the service a painter can receive at Sherwin paint stores.
In fact, the previous two CEOs, Chris Conner and John Marikas both came up through the ranks of the paint stores group.
One time John Marikas told me a story that when he was a young sales rep, he would go to local lunch spots and sift through the business cards in the fishbowl waiting hoping to get picked for the free lunch.
He was looking for painters he hadn't yet met to sell them on using Sherwin Williams paint.
When he'd find the business card and walk out, the owner would scold him because the painter would miss out on the free lunch and Marikas would ensure, once I find this guy, I'm gonna buy him lunch.
While corporate culture is always hard to steal and describe, I believe it's that same aggressive pursuit of new business and a relentless approach to customer service that still defines the culture of the paint stores group today.
So Sherwin's entire business model is designed to make pro painters more productive and therefore more profitable.
As a result, professional painters are extremely loyal to Sherwin preferring it over the number two brand Benjamin Moore by a margin of five to one.
Wow. The point on the outside sales reps, what does that look like just in terms of the pro -activeness?
It sounds like they're actually out there in the field looking to win business.
I mean, my imagination was everything's coming to you in a store and that's basically how you're gonna make the sale and it's gonna be some marketing effort, but it sounds like I might have that wrong.
So can you describe a little bit in terms of how they're going about this?
Is Salesforce a big function there?
Sherwin says we don't open the door and wait for business to come through.
We go out and bring it to the store.
So Sherwin has 3 ,800 outside sales reps.
That's nearly one per store.
And they are out there canvassing the market, looking for painters they haven't yet met or encouraging them to do more of their business with Sherwin Williams.
They're out there helping them bid on projects, select the right type of paint.
They're very much a business partner.
Very interesting. And I can imagine that you can look up the painters in the area.
Does that extend to when there are new builds, you're getting in touch with the builders as well?
I'm just trying to imagine this finding the painters and more professional painters to use them, where would you find them on jobs, I assume, but they don't just have like a paint hangout.
Is there anything else to it that you would point out?
Because it does feel like we talk about the secret sauce of these businesses.
That's something I just wouldn't have ever considered as being a piece of this business.
Absolutely. Sherwin's controlled distribution model is particularly valuable to larger paint contractors, home builders, large property managers, and really any other large scale commercial customers who do business on a regional or a national scale.
Sherwin's able to secure exclusive agreements with these customers to supply paint, often with its own 3 ,300 delivery vehicles from any of its 4 ,700 stores, ensuring consistency of paint quality, color, price, service, and speed for any of their projects around the country.
It would be operationally and cost inefficient for these larger customers to buy paint from smaller scale disparate retailers all over the country.
So as a result, Sherwin dominates the larger end of the paint market.
It has exclusive agreements with 23 of the top 25 national home builders and 17 of the top 20 property management companies.
Overall, I estimate that Sherwin might control about 75 % of the professional paint market.
Good market to have that control over.
Were there competitors that tried a similar model with the dedicated stores?
I can only think of Sherwin or the home depots and the lows of the world, but was there any competitor that tried to attack what seems to have become this moat that Sherwin has built?
Most competing paint brands sell paint through other stores.
As I mentioned, from the DIY segment, they're sold through the large home centers.
Benjamin more famously sells through local independent paint and hardware stores.
PPG has always been a bit of a tweener.
They've owned some company stores that somewhat resemble Sherwin's business model, albeit on a much smaller scale.
But they've also then sold their paint through independent paint stores and all through the home centers.
So they've always taken this omni -channel approach, but really Sherwin is the only one that operates this controlled distribution, vertically integrated business model.
In your experience covering the industry, was it ever a threat that someone else would try to come up with this type of plan or adjust their strategy?
I can actually understand the Benjamin Moore style of we're not gonna have to take on the overhead costs, the infrastructure build out, all the capital spend.
So there's probably some efficiency just in terms of the return profile.
But has it ever been a threat?
It really hasn't. Sherwin has just relentlessly continued to open stores and gain share.
And I think that's discouraged competitors from trying to keep up with them.
Makes sense. I wonder when you have the big players like Lowe's and Home Depot, and then a Sherwin in town, it seems like it would be difficult to gain share and build out there.
In terms of the opportunity set that still remains in the paint stores group, just in terms of runway, you mentioned the store count that they have, which is in context to it being more than Lowe's and Home Depot combined, was an eye -popping number.
But is that something that still has a lot of runway, there's still a lot of opportunity to introduce new stores?
So when Sherwin had 3 ,000 stores, they said their target was to get to 4 ,000.
When they got to 4 ,000, they said their target was to get to 5 ,000.
They're coming in on 5 ,000 now.
And I imagine they're gonna talk about opening stores to level of 6 ,000.
So there's still considerable runway, even though their market share is becoming quite large.
I think they're still targeting that last 35 % of the paint market, or 25 % of the professional paint market.
So I think they've still got room to run.
And a lot of new store growth is also just relieving pressure on existing stores that are handling so much volume.
So yes, the runway has been fairly consistent for decades, opening 80 to 100 stores per year.
It doesn't consume that much capital.
So there's a lot of excess cash flow from the business.
And for the stores and the pro relationship, is everything still going to the stores and the pros are coming to pick up the paint in -store?
Is there anything that actually goes all the way to a customer site or a customer job?
Absolutely. As I mentioned, Sherwin has 3 ,300 delivery vehicles with 3 ,000 drivers.
So it is almost like the Amazon of paint.
You can buy online, pick up in -store, call it in, pick up in -store, call it from the job site, they can deliver it to you.
In fact, Sherwin estimates that they save their painters one day per month by delivering paint to the job site.
Because again, time is money.
So anytime the painter does not have to spend driving to the store, driving somewhere else, saves them a lot of time and therefore a lot of money.
Yeah, I was missing that.
I was thinking it was just within the network, but that seems like an incredible value add.
It's very interesting to see what they've built around the paint stores, and that seems to be the core piece of their business.
But I know the consumer brand segment, the Valspar acquisition has been an evolution of Sherwin.
So maybe you could talk about something around that segment, how it is positioned within the business, how you view it as an investor.
Just kick us off with an introduction to that.
So in order to better understand the next two segments, consumer brands and performance coatings, it makes sense to discuss Sherwin's 2017 acquisition of Valspar.
This was far and away Sherwin's largest acquisition in its history, and it transformed both of these segments, allowing Sherwin to capture an even greater share of the DIY market, and also build a scale platform and performance coatings.
Prior to the acquisition, Sherwin's business was comprised of the dominant paint stores group, and these smaller, good but not great consumer brands and performance coating segments, which at the time represented about 30 % of sales and 25 % of profits.
Prior to the Valspar acquisition, the consumer brands group sold non Sherwin -Williams brands such as HDTV by Sherwin -Williams and Dutchboy Paint, Minwax, Thompson's WaterSeal, Krylon, and Purdy Paintbrushes at home centers and hardware stores.
This business more closely resembled the way many of Sherwin's competitors sold their paint in other people's stores with other people's employees, and the business had modest sales growth but healthy high teens margins and low capital intensity.
Valspar had a sub -scale decently profitable consumer brands business, which sold Valspar paint and cabot stains to home improvement retailers, most notably at Lowe's, where it had a long -standing partnership, much like Bare Paint does at Home Depot.
So this business was quite similar to Sherwin's own consumer brand segment.
A few years prior to the Valspar acquisition, Sherwin had begun selling paint at Lowe's under this newly created HDTV by Sherwin -Williams brand, whereas Masco's Bare Paint is the dominant paint brand at Home Depot.
The Lowe's paint department was a bit of a jump ball, with Valspar, PPG's Olympic brand, and Sherwin's HDTV brand.
Not less than one year after the Valspar deal closed, Sherwin and Lowe's announced an agreement whereby Sherwin would become the exclusive paint supplier to Lowe's, effectively booting PPG from Lowe's' stores.
Therefore, whereas Sherwin's paint store group was already the dominant paint supplier to professional painters, the Valspar acquisition allowed Sherwin to capture an even greater share of the DIY paint market, and thus the overall paint market.
While the DIY market is not as attractive as the professional paint market for the reasons we discussed earlier, every additional gallon of paint that Sherwin can produce comes through at high incremental margins, so it is a creative and strategic move.
I would not expect much more than low single digit sales growth from this division going forward, and Sherwin has been rationalizing the portfolio, selling off subpar brands and geographies.
I also would not expect Sherwin to commit much more capital this segment going forward, whereas that's not the case at the performance coatings group.
On that Lowe's deal, it's such an interesting strategic move which you mentioned with the jump ball and then winning that business.
Do you have any sense of what that looked like from a financial perspective, whether there was some type of an agreement on price or some type of sacrifice made on the margin just because you know you're gonna see significant volume if you are the exclusive provider to Lowe's?
Was there any context given just in terms of what that looked like?
Sherwin never discussed particular financials related to something like that, but I think it really was a win -win.
As I mentioned for Sherwin, obviously they captured even more share of the DIY paint market and additional paint gallons, but Lowe's now then got the best paint retailer in the country and the best paint manufacturer exclusively selling paint in their paint stores, debt using their own staff, helping
them sell paint. So it really did benefit Lowe's as well to have a singular partner controlling their paint department.
Whereas in most hardware stores, you're gonna have competing brands.
So you're not only trying to get one customer in the door to sell paint, you're then trying to sell them on which paint to buy.
So it results in a little bit more confusing sale.
And you mentioned that there's a difference here between the DIY side of the business and maybe the opportunity set there versus performance coatings, which could be more of an opportunity.
Just describe more what performance coatings is.
I'm picturing my outdoor furniture, which could require a coat of some type of paint and special stain, but let me know if there's more to it than that and maybe some more examples would be helpful.
Yeah, as I joked earlier about the ubiquity of coatings, it really shows up here in the industrial coatings industry where the end markets are incredibly diverse.
Coatings on planes, trains, automobiles, ships, beverage cans, furniture, floors, appliances, metals, oil and gas and infrastructure assets, and on and on.
And unlike the US paint market, the global industrial coatings market is far more fragmented with many smaller players.
However, industrial coatings categories vary significantly by quality, some great, some good, some close to commodities.
It really depends on customer concentration, the price versus cost mix that we talked about with a professional painter, and then also the specifications of the paint.
I imagine it can be an incredibly lucrative or highly specialized market to what you describe.
So where does Sherwin fit into that?
Are they considered a real player in some of these sub segments?
Would you say they're still very much getting their feet wet?
Just position them there.
Prior to the Valspar deal, Sherwin's performance coatings segment sold industrial coatings to various end markets, such as automotive refinished, general industrial OEM, and industrial wood.
At that time, the business was subscale, growing low single digit, mid single digit sales, and had less than 10 % segment margins, less than half that of the paint stores group.
So Sherwin is really just another player in the industrial coating space.
At that same time, Valspar had a large and highly profitable performance coatings business, specifically in attractive higher growth end markets, such as packaging and coil, where Sherwin did not have exposure.
Therefore, the acquisition allowed Sherwin to gain significant scale in performance coatings, expand into other end markets and geographies, and become one of the largest industrial coatings companies globally behind only PPG and Axo Nobel.
And that gap in margin, it's interesting to hear, is that largely just determined by having certain subsegments which are very fragmented?
Do you have a lot of competition versus others where it's highly specialized and there's less competition?
Is there anything else that's driving the margin difference between the two?
Yeah, if you think about what makes the architectural coatings business such a great business on the Sherwin -Williams side, you have this extremely fragmented end customer base in the form of hundreds of thousands of professional painters across the country.
You also have this extreme labor versus cost mix where the service element is so crucial.
So therefore, the professional painter's willing to pay up for superior brand, superior service, and that results in the higher margins you see on the architectural coating side, not to mention the immense scale that Sherwin has.
When you move to the performance coating side, the margin profile really will depend on that end market customer concentration, that mix between labor versus cost, and also how highly technical the paint is, or the coatings are, it really does depend.
In many instances, the coating suppliers are working closely with the manufacturers.
They're almost specced in on the performance of the products.
In some instances, these things are closer to commodities.
Since the Balspur acquisition, Sherwin has been clear that they are interested only in end markets and customer groups that value differentiated products and services, much like how the professional painter does in the paint stores group.
So I would expect to see more M &A from Sherwin in this space in the future, but I also expect management to be disciplined as well.
Would something like automotive be commoditized in terms of the providers?
I think of that as being a natural, interesting market.
It's big, there's obvious differences between what you see there versus elsewhere.
But how would that fit in that description that you just gave?
Auto OEM is certainly close to the description you just described.
There are consolidated customer bases.
There are consolidated manufacturing bases.
The labor versus cost mix is far more excused to the cost of paint.
So the price of paint and coatings matters a lot more.
But if you're talking about automotive refinish, which is where Sherwin is involved, that business looks a bit more similar to the professional paint market.
Cars all over the country getting into accidents, having to be refinished at local auto body shops.
So that business actually looks more similar to the professional paint business.
Fragmented and customers, more of a labor versus cost mix.
And also the service element is a more crucial component.
It's funny you bring that up.
I've always wondered about the auto refinish market because it is so challenging.
It's not like you nicked something on your wall and you could just paint over DIY.
This requires a lot more.
When you start to put all this together, I think we've described the segments, but when you put Sherwin together, can you just give some overview of how you think about top line just as a whole today?
And I think you hit on growth rates a little bit, but if you have some type of equation for how you think about that volumes times price equation or anything else, that will be helpful to hear as we move into the financial model.
So in 2023, the paint stores group generated nearly 13 billion in sales.
As I mentioned earlier, that represents roughly 65 % of the total US architectural paint market and perhaps closer to 75 % of the professional paint market.
Over the last 10 years, the paint store group has compounded sales growth at 8 % per year.
And that breaks down as roughly 6 % same store sales growth and 2 % annual store growth.
Sherwin's 8 % annual sales growth compares to the rest industry growing at a low single digit rate.
And that Sherwin same store sales growth breaks down as roughly one to 2 % volume, 2 % price and one to 2 % share gains.
And those 4 ,700 stores generate about 2 .7 million in sales per store.
So these are highly productive stores comparing favorably to some of the best QSRs.
I mean, for context, last year Chipotle did about the same in sales per store as a Sherwin paint store.
When you consider that a paint store cost about a million dollars to open, makes $600 ,000 in annual profit per store, the payback and returns are very attractive.
So Sherwin's been opening about 80 to 100 stores per year for decades.
And the runway for growth is still quite long as we discussed.
And it's always growing as New Square Footage is constantly added.
And those share gains have been consistent over many years as Sherwin relentlessly outgrows the competition.
He's mostly tied to other stores.
While Sherwin adds new stores and sales reps every single year.
Sherwin does not have a store base.
It has a store network, drawing in painters with over 3 ,800 sales reps, nearly one per store, serving them with long tenured store managers, sales reps and delivery drivers.
So as Sherwin's store network continues to grow, the value of the entire store network to pro painters also increases.
This in turn draws in more painters and more of their spend and retains them with Sherwin's relentless focus on customer service.
As a result, it leaves little incremental demand for competitors.
Sherwin used to say for every two stores they opened, they forced the closure of three independent pain stores.
And that stat bears out.
Prior to the housing downturn, Sherwin had 3 ,000 stores out of 12 ,000 dedicated pain stores.
When it had 4 ,000 stores in 2015, the rest of the market shrunk to 9 ,000 stores in the aftermath of the housing recession.
And now as Sherwin closing in on 5 ,000 stores, the rest of the market is maybe around 8 ,000.
In fact, earlier this year, PPG announces intention to sell its US and Canadian architectural coatings business.
Despite being one of the larger and more tenured competitors in the industry, PPG revealed that its architectural paint business has been shrinking for years and is essentially break even.
This compares to Sherwin's pain stores group margin of over 20%.
Also this year, another smaller paint manufacturer and retailer, Kelly Moore filed for bankruptcy.
So it does feel like we're reaching a tipping point in the industry where it is Sherwin and no one else, at least as it relates to serving professional painters.
Would Sherwin ever buy the PPG portfolio?
Given their size in the market, I don't think it would be realistic from an antitrust standpoint.
But that being said, I don't think Sherwin needs to buy PPG.
Given their store base, given their employee base, they discuss on the call that they're going out and targeting all of that business that they know is now up for grabs.
Yeah, they're doing this charade where the rest of the market is shrinking and Sherwin's just replacing it, which is interesting.
And I guess they could do with PPG as well.
Certainly interesting to track that development there.
And on the actual store count itself, it sounds like the trend line has just gone in one direction.
I'm curious during the housing crisis, was there any type of pullback in the store count specifically where they actually had a net decrease in the number of stores, or has that ever happened over the history where there's been a prolonged shrinkage of the footprint?
No, even during the great housing recession, Sherwin kept opening stores, kept adding sales reps.
So it really took advantage of the downturn and took advantage of weekend competitors.
So really, it's never been nothing but constant new store growth.
I guess during that recession too, if you're not gonna buy a new house, you wanna repaint your existing house.
So you can always make the case for more paint.
And combining that with the other segments or looking at the other segments and their potential growth rates, how did those fit and do they add juice or dilute the growth rate of the overall business?
The paint stores group will likely continue to be the fastest growing segment, growing at a mid to high single -digit rate.
Performance coatings should grow at about a mid -single -digit rate, albeit with more volatility, given that many of the markets are linked to global industrial production, which can be more cyclical.
But this is also the segment where Sherwin has the most white space to grow organically and also via M &A.
So I would expect to see acquisitions add to overall sales growth here.
And the consumer of brands is likely a low single -digit grower, growing below the rate of overall home improvement spend, given that exposure to the DIY categories.
So adding all up, I would expect Sherwin to continue to grow sales at a mid to maybe high single -digit rate, barring any economic or housing downturn.
And you mentioned M &A a few times.
Beyond Valspar, have they been highly acquisitive over their history?
Is that part of their DNA?
With the exception of the large Valspar acquisition, Sherwin has grown mostly organically with small tuck -in acquisitions from time to time.
But as I mentioned earlier, I would expect most future M &A to be in that performance coding segment, with Sherwin looking to gain greater scale in existing categories or geographies, or perhaps buy into a new attractive end market.
Yeah, it seems like when there's an opportunity to do it, they have done it, but it's not necessarily the only route to growth.
There's a huge organic history here.
On the margin profile of the business, can you talk about how much it actually does fluctuate, how quickly they can pass on that pricing to customers, and anything else you think is relevant in terms of the margins?
Comedy gross margins are nearly 50%, which more closely resemble margins for some of the best -known consumer brands, rather than a building products or a chemicals company.
And it speaks to painters' willingness to pay up for Sherwin's superior brand and service.
85 % of cogs are raw materials, such as resins, latex, pigments, additives, solvents, and other products derived from various upstream petrochemical and related commodity feedstocks.
So Sherwin's cogs can be volatile.
As a result, there tends to be a lot of focus on this raw material basket, especially from sell side analysts, many of whom cover the materials or chemicals industries.
I believe Sherwin's shown time and time again that it has the ability to quickly and successfully pass through cost increases when necessary, because paint represents only 10 % of a painting project, price increases do not have a meaningful impact on the total cost of a project.
I mean, even a sizable 10 % price increase only adds 1 % to the total cost of a job.
Whereas other paint suppliers need to haggle with their retail partners over price increases, Sherwin can just, with the press of a button, instantly change prices at its stores.
Now, price negotiations with larger customers are not as simple as that.
But since Sherwin's entire business model is dedicated to helping these paint contractors save money on the other 90 % of a project, that is their own time and labor, Sherwin's earned the right to pass through price when necessary.
So Sherwin truly has pricing power.
And since paint represents a small percentage of a paint project, when raw materials fall, there's little incentive for any one supplier to cut price because it'll have little impact stimulating demand for new paint projects.
Therefore, the industry, already highly consolidated, is also quite rational when it comes to pricing.
And actually, highly inflationary cost environments tend to be catalysts for Sherwin to move gross margins structurally higher after cost inflation subsides.
In such time periods, you'll usually see gross margins decline initially, as higher costs are realized, followed quickly thereafter by price increases from Sherwin, which stabilize and begin to recover gross margins, and then inevitably, raw material increases subside, if not outright decline, while
Sherwin then never lowers the price of a can of paint, allowing gross margins to rise even higher and set new baselines.
This happened in the previous two inflationary environments in the 2010s, and it's what's happening right now after the latest highly inflationary environment during COVID.
And that volatility, obviously the trend line is still moving up and to the right.
But from a 50 % as the baseline, how much of a swing do you see?
Is it 45%, is it sub 40?
Whether it's year to year, quarter to quarter, I know there's gonna be a lot of noise, but how much volatility is there?
There can be considerable volatility.
If you look during the more recent COVID period, gross margins declined by about 400 basis points from peak to trough.
And now they're recovering that and likely will march even higher.
So the volatility in this line can be quite volatile, but it tends to correct fairly quickly over shorter periods of time.
And then as you get into EBIT margins, profit margins, we've talked about R &D a bit here.
I am curious about R &D.
How much is there going on in paint?
How much has paint evolved over the years?
I know there's chemicals, there's all types of things, but how much is actually going on behind the scenes here?
Is it a big budget?
And how core is R &D to this story?
It's a relatively small part of total sales.
There is always R &D going on, improving paint performance, coatings performance.
They're always coming up with new paint products that save time for professional painters, get them off the job sooner, make their projects look nicer.
But really, when you think about the differences between paint, if you talk to a professional painter, some like Sherwin -Williams, a little better for this.
Some like Benjamin Moore, a little better for that.
When you think about them preferring Sherwin -Williams by a margin of five to one, it's not because the paint is that much different.
It's because the service is that much different.
That makes sense, yeah, I think.
A five to one difference, I don't know what the paint would have to do, but it would have to be pretty amazing.
So I think that's one of those lines that I can certainly see the case for that.
Anything else from a cost perspective or just general capital intensity, it sounds like new store build -outs are a big piece of this.
What does it look like when you actually flow everything through the business and look at free cash flow and returns for Sherwin?
Well, SGA as a personal sales is around 30%, which is high relative to many peers.
And that's because of Sherwin's control distribution model and its willingness to invest heavily in service for his professional painters.
But these costs and investment are what distinguishes Sherwin from its peers, generates the intense loyalty from professional painters, and forms a mode around its business so it's money well spent.
As a result, total company operator margins are in the high teens, with the paint stores group being the most profitable at over 20%.
The performance coding segment is next highest in the high teens.
And if you recall, this segment pre -valce bar had margins in the high single digits.
So Sherwin's benefit tremendously from increased scale, exposure to higher quality end markets, as well as synergies between the two businesses.
And they think this business can also have 20 % margins as well.
And lastly, margins at the consumer brands group have been more volatile, hovering around the mid teens due to the fact that they sell through other stores with weaker sales growth and greater national exposure.
Over time, total incremental margins have averaged around 25 to 30%.
And I would expect Sherwin to continue to drive margins higher over time as it's done in the past.
And then when you look at that margin profile profitability, what does the capital intensity look like for this business?
The capital intensity of the business is rather low, with CapEx under 2 % of sales.
CapEx is primarily for new store openings, which are about 80 to 100 per year, and also periodic expansion of manufacturing capacity.
Networking capital is around 11 % of sales.
So with strong margins and low capital intensity, the business generates attractive tangible returns on invested capital at over 40%.
And that's up from the mid 20s, 10 years ago.
So incremental returns on invested capital have been attractive.
And free cash flow conversion has averaged over 100 % of net income over time.
Impressive to have that.
And I think when you were describing the new store openings and what the average store does in terms of cost versus profitability, it speaks to that.
There's more to the business than that, but I think it's a very good proxy for it.
On the margins point that high teens, how does that look versus competitors?
Are they sacrificing a bit on margin, but obviously having the market share gains from that?
I'm just curious if you have context on where they rank versus peers.
If we stick with architectural coatings and look at Masco's decorative architectural group, that is bare paint sold exclusively at Home Depot.
On the surface, the margins don't look too different.
Masco has high teens operating margins, which compares to Sherwin's paint stores group in the low 20s.
And Masco has equally low CAPX, of course, without even the need to open stores.
Although we get to the operating margins in a different way, with lower gross margins for Masco in the mid 30s, versus over 50 % at Sherwin's paint stores, because Masco is selling paint through someone else's store.
But of course, lower SG &A is a percent of sales for Masco because they don't have to operate their own stores with their own employees.
So the end result in terms of operating margins doesn't look too different.
And actually, the last time we got a look at Ben Moore's financials prior to Berkshire acquiring them, they also had high teens operating margins by selling paint through other stores.
But I think this is where a simple comparison of some financial metrics has tripped up investors in the past.
The margin profiles aren't that different.
Capital intensity is similarly low.
They both sell paint.
It's a mature industry.
How different could the growth rates possibly be?
Why not just buy the one trading at the cheaper valuation?
Well, the key missing point is what we've discussed today, Sherwin's controlled distribution model, which allows it to control its brands, its customer relationships, pricing, and the pace and place of its stores and employees.
So while the margins and even returns look somewhat similar, the growth rates have been anything but similar.
As I mentioned earlier, Sherwin's paint stores have CAGR sales at 8 % for a decade, whereas Masco has grown at 3%.
But even a CAGR understates those share gains over time.
In those 10 years, Sherwin has added almost 7 billion in sales, whereas Masco has added under 1 billion.
That's a seven X difference in 10 years.
When Bendmore went private in 2000, it had under a billion dollars of sales compared to 3 billion at Sherwin's paint stores.
Over the next 20 plus years, Sherwin's paint stores have had 10 billion in sales versus what appears to be less than a billion dollars at Bendmore.
So a 10 X difference over the second most preferred brand by professional painters.
So similar margins for Sherwin's peers, but much different growth rates.
Yeah, interesting to see what the trade -offs are and obviously much less capital intensity, but I'm surprised.
I mean, 2 % of sales for CapEx is incredibly impressive.
It suggests that there's not a ton that has to go into store maintenance and new store openings.
Obviously you're doing that on a much larger store count.
So impressive free cash flow conversion, begs the question, what happens with that free cash flow?
Is it coming back to shareholders, dividends, buybacks?
What's the general philosophy for the business?
In terms of the use of free cash flow, with the exception of the large ballast bar acquisition, Sherwin's grown mostly organically with small tucking acquisitions from time to time.
As I mentioned earlier, I would expect most future M &A to be in the performance coding segment.
With Sherwin looking to gain greater scale in existing categories or geographies, or perhaps buy into a new attractive end market.
After M &A, Sherwin's always had a consistent policy that it will not hold excess cash, choosing to return it to shareholders and the formable dividends and buybacks.
Sherwin's raised his dividend each of the past 45 years.
And Sherwin's also been a consistent repurchaser of its own shares, with share account declining by 2 % per year on average.
And it's also showing the ability to be more opportunistic at times.
During the post GFC housing recession, Sherwin retired roughly 15 % of its shares over a three year period.
Share of cannibals we love on this podcast.
So very interesting to hear.
And on the ballast bar acquisition general M &A, when they're doing that, are they taking out a lot of leverage to acquire these business?
Are they using cash on the balance sheet?
Sounds like they haven't made a ton of huge acquisitions.
So maybe there's not a specific philosophy, but what would you point to there just in terms of their willingness to add leverage to the balance sheet?
So one of the noteworthy attributes of the ballast bar deal was that it also led to a more efficient capital structure at Sherwin -Williams.
Prior to the ballast bar deal, Sherwin always managed a balance sheet with less than the turn of leverage, below that of industry peers, which frustrated many investors and analysts who thought the business could support more leverage given the superior quality and consistency of its cash flows.
While they're not wrong per se, I think management always knew there was a potential to acquire a ballast bar, and didn't want to issue highly valuable equity in such a transaction.
And rightfully so, Sherwin was able to purchase ballast bar for over $11 billion entirely with debt.
When you consider that Sherwin was a $30 billion market cap company at the time, this was a substantial deal to complete without having to issue stock.
And lo and behold, not long after the deal, Sherwin committed to a more appropriate capital structure with leverage targets of two to two and a half times.
And of course, it didn't have to issue equity, which at the time was worth about $100, and today is closer to $360.
So this was a clear sign that management is long -term focused, willing to be patient and ignore the market short -term demands in order to create substantial long -term value for shareholders.
I respect that. Yeah, that's an impressive number.
Impressive willingness to take on leverage and navigate through that and re -architect the capital structure there.
Shifting a little bit, talked about the runway.
There's obviously this historical precedent of how this business is run.
It is a name that I think is loved, a cult compounder for many investors.
When you think about approaching valuation as an investor, it's always tricky with these names where there's these long histories, but the valuation can just jump off a screen in terms of feeling expensive.
So what's your general philosophy without having to take a view on the actual stock itself?
How do you think about it for a business like Sherwin?
Sherwin's always been a bit of a tweener.
It's either viewed as a building products company or a chemicals company.
I think both of those industries contain a lot of average to below average businesses.
So when viewed through either one of those lenses, Sherwin's always seem quote unquote expensive relative to those peer groups, having traded around 20 times earnings for most of the last 15 years since the housing bust.
I'd often hear, yeah, it's a better business, but it's value is such.
Investors can tend to homogenize things they don't totally appreciate.
As a result, I think those comparisons have grounded Sherwin's multiple a bit and discounted the superior quality and durability of its growth and returns.
Therefore, paying a modest premium to the market or peers for far superior growth and returns with less risk, that seemed like a bargain.
And as such, Sherwin stock has compounded well in excess of the market and those peers over time, suggesting that it's quote unquote premium valuation was actually a discount.
Today, I do think the market has developed a greater appreciation for some truly superior businesses such as Sherwin.
And as such, perhaps future stock returns may be more modest given a higher starting point with regards to valuation, which is now close to 30 times earnings.
Yeah, funny when you mentioned the 20 times being the premium, it feels like so long ago where that was the case.
So it's a much different time now, but much different time for the overall market and always interesting to hear.
It's very hard to put a multiple on these businesses that are premium in nature because of the way that they operate and some of the financial characteristics.
So I thought that was well laid out just in terms of your own philosophy and always interesting to hear from investors on how they think about things.
Talking on the risks of this business, I guess just to start out the housing exposure in general, you've talked in a few different ways, whether it's new builds, whether it is existing home sales, but how much of a driver is just housing and how correlated is Sherwin to just the housing market in general?
Yeah, so for all the reasons we discussed earlier, I think the competitive position of the pain stores group is close to unassailable.
So you're right, the greatest risk factors for Sherwin are those outside of its control, most notably the overall health of the US housing market, given the importance of the pain stores group to the overall company, as well as similar exposures within the consumer brands and performance codings group.
With housing related companies, you don't have to look too far back to consider a worst case scenarios in the form of the post GFC housing bust.
So from peak to trough 2007 to 2009, Sherwin's pain store sales declined by 15 % and pain store profits dropped by 20%.
Total company profits dropped by closer to 30%.
But as we discussed earlier, because there's a sizable maintenance element to the massive installed base of homes and buildings, and also the low cost, high value nature of paint projects, paint tends to be a more resilient home improvement category.
So to put the paint stores 15 % sales decline in context, Home Depot sales, which are a better barometer of overall home improvement spend declined by roughly 25 % over a similar period of time.
Many other building products companies saw sales declines of 50%.
And of course, home builders saw sales declines by 75 % of the average.
So in the context of the 100 year flood for housing, Sherwin results were fairly resilient from an overall housing standpoint.
However, I do think Sherwin benefit from outside share gains during that period, as it was able to continue to invest throughout the downturn, taking advantage of weakened competitors.
Given that share of the professional paint market has become so large, at some point its results will start to more closely mirror that of the broader paint market.
While I think the long -term outlook for new home construction and home improvement spend is positive, as others have discussed in previous breakdowns of DR Horton and Home Depot, we are in a bit of a soft patch at the moment, and to the extent we just see continued softness in the broader housing market,
or a more severe downturn, Sherwin would not be immune, but I think it would once again improve more resilient than many other housing categories.
That certainly makes sense.
And are there other things beyond housing that you look at as risks for the business?
What stands out to you?
Yeah, outside of the housing market, could there be some substitution risk in the form of wallpaper making a comeback?
It would only be a risk for the interior portion of residential repaint.
So it'd be confined to a third of the market, and of course, they'd only recapture a small share of it.
So its overall impact would be modest.
And lastly, while I don't see this as a risk necessarily, and it might be just as much of an opportunity, but I do think it's something that bears watching, there is new management at Sherwin.
As I mentioned earlier, the prior two CEOs who managed the company for the last 20 years not only came from the paint stores group, but came up through the ranks of the paint stores group.
Sherwin's newly appointed CEO not only does not come from the paint stores group, but comes from outside the company, having joined from the ValSpar acquisition.
With the paint stores group already so dominant and a well -oiled machine at that, the hiring of someone not from the paint stores group likely signals to me that a bit more of management focus and capital allocation will be directed towards performance coatings, where I mentioned there's more white
space in terms of organic and inorganic investment.
And while I do not think incremental returns and performance coatings are as high or as much of a sure thing is opening another paint store, Sherwin's shown that it can still be attractive and a creative shareholder value, but this is something investors should monitor.
Yeah, it's at least an interesting evolution for the business.
And to your point on wallpaper, the Russell household has certainly leaned into the new wallpaper trend that is going on, but to your point, definitely not a DIY project, or if it is a lot more room for error than paint.
So it feels like it would be small, but I certainly hear a point on it being a substitutable product.
This has been great, Todd.
We close these conversations out, as you know, with the lessons that you can pull away.
Feels like there's quite a few for Sherwin, but I wonder what stands out to you as an investor in terms of lessons that could apply elsewhere.
So Boeing has been in the news a lot the last few years as the poster child for what can go wrong when you outsource too much of your business to others, among other things.
Unlike all of Sherwin's competitors who have also taken an outsourced approach, selling their paint through other stores with other's employees, Sherwin's willingness to own and operate all critical aspects of its business through its controlled distribution model, with all of the associate operating
capital expenses that come with it, shows that operators should think carefully about what aspects of their business they outsource to others.
While it might make a business more profitable and or less capital intensive in the near term, you might be tying the fortunes of your business to others more than you appreciate.
Sherwin's business model has always allowed to control its own destiny.
And I think that's been one of the most important factors in success over time.
Great answer. Honestly, I've been looking for a counter example to Boeing and I just sat through this conversation and had it come to it, but it has become so popular to outsource, and I think vertical integration has become less and less popular, conglomerates less and less popular for obvious reasons,
but we have a great example here of what the long -term view can do.
So thank you for pulling that lesson out.
Thank you for sharing the knowledge on Sherwin.
It's been a pleasure.
Matt, thanks for having me.
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