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Media Talk

Sherwin Williams Successfully Integrating Valspar Acquisition

Sherwin Williams (SHW) reported solid 4Q17 results slightly above consensus sales and earnings estimates. Heading into 2018, SHW expects earnings per share between $18.80 and $19.30 excluding Valspar acquisition-related expenses of $3.45. Importantly, SHW noted that most of the remaining costs to achieve the estimated $385-$415 million of annual acquisition synergies will be booked in 2018. The integration of Valspar appears to be going well, with both the overall size of expected synergies and the estimated time to achieve those benefits better than initially planned. Northlake continues to expect SHW to move toward $450-$500 in the coming years as earnings per share climb toward $25 by 2020.

From a business segment perspective, retail sales to “do it yourself” customers remain slower than hoped, offset by strong demand from contract painters. The strong housing cycle has been a nice tailwind for SHW, but there is a risk that rising mortgage rates will begin to offset that benefit as fewer consumers are able to afford home loans. Industrial markets also remain strong for SHW and Valspar. The primary challenge for the industrial segment in 2018 will be inflation in raw material prices, which will limit profitability to the extent that SHW is unable to pass through price increases to customers. Specifically, SHW expects an average increase of 4-6% in 2018 for key raw material inputs such as crude oil, propylene, and Titanium Dioxide (TiO2). SHW has historically demonstrated the ability to manage inflation risk by effectively implementing price increases as needed while maintaining strong customer relationships and delivering valuable products.

SHW currently has substantial debt on the balance sheet, partly due to financing for the Valspar acquisition. The company plans to use free cash flow to pay down excess debt in 2018. Once SHW reduces debt to normalized levels, free cash flow will likely be shifted towards other beneficial uses such as further investments in growing the business organically or via acquisition, or returning excess capital to shareholders through share buybacks.

In summary, Northlake expects SHW will move toward $450-$500, equating to roughly 20x 2018 to 2020 EPS. A backdrop of strong overall demand from contract painters and industrial customers should continue for the foreseeable future. While there are inflationary risks to the long-term outlook, they appear to be manageable. Once SHW has completed the Valspar integration and reaped the benefits, the combined company will be in a strong position to continue consolidating the industry while returning capital to shareholders.

SHW is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.  SHW is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.

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