Last week I was trying to figure out why Sherwin-Williams (SHW) stock was so strong. I caught the analyst presentation, and within a few minutes I found why.
In terms of millions of gallons, sales of the U.S. architectural coatings market (i.e. paint) has rebounded sharply after having bottomed out in 2009. From just under 600 million gallons in 2009 to an estimated 671 million gallons in 2013, the market is recovering nicely. Furthermore, based on past sales, the architectural-coatings market still has a ways to go in its recovery. Typically the industry sells between 740 million and 760 million gallons of paint a year -- and nobody is watching the paint dry over at Sherwin. Some sources estimate the market could grow to more than 800 million gallons by 2015. Who knew architectural coatings could be so exciting?
It's just not architectural coatings, either. The rest of the business is picking up: protective coatings, automotive, marine, and aerospace -- you name it. In fact, if Sherwin-Williams can hit the consensus revenue estimate, sales will have risen 43% since the number bottomed out in 2009. Right now, the Street is estimating fiscal 2013 revenue of $10.16 billion and $7.79 per share in earnings. Next year the company is expected to grow revenue 6% to $10.8 billion, and to earn $9.17 per share.
Sherwin-Williams faces some serious competition in the coatings business. Specialty-coating companies RPM (RPM) and PPG Industrial (PPG) have turned the competitive heat up. PPG recently acquired the North American architectural-coatings business of AkzoNobel. The business is best known for its Glidden brand of paints. With the acquisition, PPG is the largest paint seller in North America.
Despite the competition, Sherwin-Williams has been the best-performing specialty-coatings stock over the last five years.
But here's my problem with the stock. A lot of good news in built in. Year to date, the shares are up about 21% vs. a 15% climb for the S&P 500. The 2013 consensus gross-margin estimate is 45.17%, which is just 83 basis points from the all-time high. Also, selling, general and administrative costs are only 140 basis points from their all-time low, which means it's going to be tough to expand operating margin much further. Last year, the company had operating income of 9.9%, which is just 60 basis points from its 10-year average.
Can things get even better? Sure. 2007 was the best year in a decade for Sherwin-Williams, and to stay bullish on the stock you have to assume the business is headed toward another 2007-type record year. To me that's a stretch. In my opinion, Sherwin-Williams in fully valued, and investors who buy in now will get shellacked.