The Sherwin-Williams Company

Good morning. Thank you for joining the Sherwin-Williams Company's review of second quarter 2021 results in our outlook for the third quarter full year of 2021. With us on today's call are John Marikis, Chairman, President, and CEO, Al Mestician, CFO, Jane Cronin, Senior Vice President, Corporate Controller, and Jim Jay, Senior Vice President, Investor Relations and Communications. This conference call is being webcast simultaneously in listen-only mode by issuer direct and via the internet at www.sherwin.com. An archived replay of this webcast will be available at www.sherwin.com beginning approximately two hours after this conference call concludes. This conference call will include certain forward-looking statements as defined under U.S. federal securities laws with respect to sales, earnings, and other matters. Any forward-looking statement speaks only as of the date on which such statement is made and the company undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise. A full declaration regarding forward-looking statements is provided in the company's earnings release transmitted earlier this morning. After the company's prepared remarks, we will open this session to questions. I will now turn the call over to Jim Jay.

Thank you, and good morning, everyone. Sherwin-Williams delivered very solid results in the second quarter, We continue to operate in a very dynamic environment where demand was robust across the majority of our business, raw material inflation remained persistently high, and the effects of winter storm URI continue to have an impact on the entire industry supply chain and product inventories. Amid these challenges, we raised our sales expectations at our June 8th analyst day, and we delivered on those targets. Our gross margins were under considerable pressure in the quarter, given the sustained higher raw material costs. However, as we have demonstrated in past inflationary cycles, we are fully committed to offsetting these costs, and we announced additional pricing actions in the quarter, which will be realized as the year goes on. Despite the near-term gross margin compression, Adjusted diluted net income per share in the quarter grew by a double-digit percentage, and EBITDA expanded by a high single-digit percentage. Let me briefly summarize the quarterly numbers. All comparisons in our prepared commentary this morning are to the second quarter of 2020, unless otherwise specified. Starting with the top line, second quarter 2021 consolidated sales increased 16.9% to $5.38 billion. This is the single largest revenue quarter in the company's history. Supply chain constraints negatively impacted sales by approximately 3.5 percentage points, split evenly between the Americas Group and the Consumer Brands Group. Consolidated gross margin decreased 320 basis points to 44.8%. driven by raw material cost inflation outpacing our price increases near term and a return to a more normal mix. Gross margin increased 10 basis points compared to the second quarter of 2019. SG&A expense as a percent of sales decreased 130 basis points to 26.7%. Consolidated profit before tax increased $71.8 million. or 9.6%, to $819.2 million. The second quarters of 2021 and 2020 included $78 million and $75.1 million of acquisition-related depreciation and amortization expense, respectively. Excluding these items, consolidated profit before tax increased 9.1% to $897.2 million. Diluted net income per share in the quarter increased to $2.42 per share from $2.16 per share a year ago. The second quarters of 2021 and 2020 included acquisition-related depreciation and amortization expense of 23 cents per share and 21 cents per share, respectively. Excluding these items, second quarter adjusted diluted earnings per share increased 11.8% to $2.65 per share from $2.37 per share. EBITDA grew to $1.05 billion in the quarter, or 19.5% of sales. Net operating cash grew to $1.2 billion in the first six months of 2021. an increase of 11.8% compared to the same period in 2020. Looking at our operating segments, sales came in much as we anticipated, with very strong growth in our pro-architectural and industrial businesses and, as expected, a historically more normal DIY. Segment margin was under pressure in all three segments. primarily due to significantly higher year-over-year raw material costs. Our additional price increases, which are still being implemented, were not enough in the near term to offset the higher material costs. Sales in the Americas Group grew 22.6%. Segment margin decreased 30 basis points to 23.5% as operating leverage from the higher volume and selling price increases were offset by the higher raw material costs. Sales in the consumer brands group decreased 25.4%, including four percentage points related to the wattle divestiture. Adjusted segment margin decreased 680 basis points to 19.7% of sales, resulting primarily from lower sales volume and gross margin pressure related to higher raw material costs, partially offset by selling price increases and good cost control. Sales in the performance coatings group exceeded our expectations and increased 41.3%. Adjusted segment margin decreased 60 basis points to 13% of sales, as operating leverage from the higher volume and selling price increases were offset by higher raw material costs. Let me now turn the call over to John Marikis for additional commentary on the second quarter and our first half, along with our guidance for the third quarter and full year 2021. John?

Thank you, Jim, and good morning, everyone. Let me begin by framing my comments with some key themes. First, demand is very strong across the majority of our business, and we are aggressively pursuing growth opportunities. Two, While industry supply chain constraints are continuing to impact production and sales, nobody has more assets and capabilities than Sherwin-Williams to keep their customers in paint and on the job. Three, we are aggressively combating raw material inflation with significant price actions across each of our businesses. We will continue to do so as necessary. And last, we've seen this movie before. There's no better or more experienced team in the industry to manage through the current environment. We remain extremely confident we will emerge from these current challenges a stronger company with stronger customer relationships and with continued strong value creation for our shareholders. My deep thanks goes to all 61,000 members of our team who are doing an amazing job in some pretty challenging circumstances right now. Jim did a nice job of framing up the second quarter at a high level. And in a moment, I'll get into some additional color for each of our segments. But first, I'd like to make a comment on our first half. Given the impact of the pandemic on our results in the second quarter a year ago, 2021 first half consolidated sales increased 14.7%, or $1.29 billion. Adjusted PBT increased 23.5%, or $303.3 million. Adjusted PBT margin was up 120 basis points to 15.9% of sales. And adjusted diluted net income was $4.71 per share, an increase of 26.6%. This is a very strong performance, especially in light of the much higher than anticipated raw material inflation we've seen and the supply chain challenges we've described. Now, returning to segment performance in the quarter. In the Americas group, second quarter sales increased 22.6%. The impact of unfavorable currency translation was not material. Same-store sales in the US and Canada were up 19.3%. We generated strong double-digit growth across all of our pro-end markets in TAG in the second quarter. Residential repaint, TAG's largest business, was the fastest growing, and we expect this momentum to continue. Contractors are reporting solid backlogs, and interior and exterior work were both strong. Our commercial business was the next fastest growing and is gaining momentum as we expected. Projects continue to resume at varying paces, and comparisons are favorable over the remainder of the year. Property maintenance is also gaining momentum. Apartment turns, a return to travel and office, and a favorable comparison all contributed to our growth. We expect to see continuing improvements as the year progresses. New residential remained another area of strength for us. New housing permits and starts have been trending very well since last summer, and customers are reporting solid order rates. We're also encouraged by growth in our protective and marine business. We saw a return to growth with oil and gas customers and continued strength in flooring, bridge and highway, and pharmaceutical applications. And finally, As expected, our DIY business was down significantly after five consecutive quarters of double digit growth. Notably, all TAG architectural businesses delivered growth over the second quarter of 2019. From a product perspective, sales in both interior and exterior paint were up by double digit percentages, with interior being the larger part of the mix. Additionally, this is the fourth consecutive quarter spray equipment sales increased by double digits. This continues to be a very healthy sign of recovery as contractors typically invest in this type of equipment in anticipation of solid demand. We realize nearly 2.5% of price in the second quarter resulting from our February 1 price increase. Given the persistent raw material inflation we are experiencing, TAG announced an additional 7% price increase last month that will be effective August 1. We would expect the combination of these February and August price increases to result in a mid-single-digit percentage of price in the third quarter, and better than that in the fourth quarter, putting our full-year price realization for TAG in the mid-single-digit range. We will continue to evaluate additional pricing actions as needed. We opened 23 net new stores in the quarter, and have opened 34 net new stores year-to-date. Along with these new stores, we continue to make investments in sales reps, management trainees, innovative new products, e-commerce, and productivity-enhancing services to drive additional growth. To provide a fuller picture of how this business is performing, I'll close out my TAG discussion with a few comments on the first half. Sales are up 15.9% versus the first half of 2020, and segment margin is up 110 basis points, 21.6% of sales. A metric we pay very close attention to is the number of new accounts, which are up nearly 30% in the first half. This is a clear indicator of terrific opportunities ahead. On a two-year stack basis, sales are up 14% compared to the first half of 2019, or an average of 7% annually, well above market growth. Segment margin expanded 240 basis points over the same two-year period. Moving on to our consumer brands group. Sales decreased 25% in the quarter, including a positive impact of 1.5 percentage points related to currency translation and a negative impact of 4 percentage points related to the Waddle divestiture. Pricing was positive. As expected, our DIY business returned to more normal levels driven by consumers returning to work and difficult comparisons to the prior year. We're encouraged by growth in our European and Asia Pacific businesses. which were both up double digits in the quarter. And in our pros who paint category, though these areas of strength were not enough to offset lower North America DIY demand. While it was a challenging quarter for sure, it's constructive to look at this business over the first half, given the unusual DIY dynamics related to the pandemic over the past year. Adjusting for the divestiture of Waddle, the business is only down low single digits compared to the first half of 2020. Encouragingly, the first half of 2021 is up mid single digits compared to the first half of 2019 and adjusted segment margin is up 180 basis points over the same period. We think the comparison to the first half of 2019 better indicates the progress we're making in growing this business and improving its performance. As you know, our global supply chain organization is managed within this segment. This team continues to do incredible work in navigating the industry-wide raw material supply chain disruptions caused by winter storm Yuri. We are working collaboratively across our business to support our customers and keep them painting. Last, let me comment on second quarter trends in Performance Coatings Group. The industrial recovery appears to be in full swing. The momentum we've seen since the third quarter of 2020 continued and accelerated in the year's second quarter. Group sales increased by more than 40%, including a currency translation tailwind of 6% in the quarter. Price was positive, and all regions and all divisions generated growth. Regionally, sales in the quarter grew fastest in Europe, followed by Latin America, Asia Pacific, and North America. Every division in the group grew by a strong double-digit percentage, driven by robust underlying demand, New customer wins, share wallet gains, and favorable comparisons to last year's second quarter. I'll start with the industrial wood division, which again had the highest growth rate in the group. This is the third consecutive quarter of double-digit growth in this business, and sales were positive in every region. New residential construction continues to drive robust demand for our products in kitchen cabinetry, flooring, and furniture applications. General Industrial, the largest division of the group, posted its second consecutive quarter of double-digit growth, and sales were positive in every region. Our customers are reporting the growth they are seeing is being driven by true end-market demand rather than temporary inventory restocking. Sales were strong across our customer segments, including heavy equipment, building products, containers, and general finishing. Automotive refinish sales increased by a strong double-digit percentage. Miles driven and collision shop volume remained below pre-pandemic levels. New installations of our products and systems in North America remained very strong. This is a good indicator of further momentum in our business. Our coil coatings business remains a consistent performer. Sales grew by a strong double-digit percentage and were positive in all regions. This team continues to do an excellent job at winning new accounts in all regions. Construction and appliances led the growth. Our packaging team generated double-digit growth against a high single-digit comparison last year, and sales were positive in every region. Demand for food and beverage cans remains robust, and our non-BPA coatings continue to gain traction with existing and new customers. As I did in the other two segments, let me speak to performance coatings' first-half performance. where sales were up 26.4% versus the first half of 2020. Adjusted segment profit increased $81.3 million, or 25.7%. Adjusted segment margin was basically flat, which is encouraging given that this group has seen the highest level of raw material inflation in the company year to date. On a two-year stack basis, PCG first half 2021 sales were up 15% compared to the first half of 2019, or an average of 7.5% annually, again, well above market growth. Adjusted segment margin is down just 40 basis points over the same two-year period. Encouraging performance given this business has faced the most significant raw material inflation year to date. Before moving on to our outlook, let me speak to capital allocation year to date. We have returned a little over $1.9 billion to our shareholders in the form of dividends and share buybacks. We've invested $1.6 billion to purchase 6.4 million shares at an average price of $257.12. We distributed $297.7 million in dividends, an increase of 21.2%. We also invested $151.4 million in our business through capital expenditures including approximately $17 million for our Building Our Future project. We ended the quarter with a debt-to-adjusted EBITDA ratio of 2.4 times. Turning to our outlook, we expect robust demand in all North American pro-architectural end markets to continue through the second half, though comparisons become more challenging, and continued tightness in the supply chain will remain a headwind. We expect DIY demand to continue to moderate as consumers return to work and comparisons will remain challenging into 2022. We expect industrial demand will remain strong over the rest of the year. As we described last quarter, we've been highly proactive in managing the supply chain disruptions to provide product to our customers. We expect to be in a make and ship mode until the seasonally slower fourth quarter when we expect to begin building inventory. We see the current challenges as an opportunity to drive even greater engagement with our customers. We're leveraging all of our assets, including our store platform, our fleet, our distribution centers, and more, to let us come up with unique and creative customer solutions that others simply can't. On the cost side of the equation, raw material inflation has not moderated, driven by continued supply chain issues and surging demand. As a result, we are raising our raw material inflation expectations to be in the mid-teens for the year, an increase from our previous range. We anticipate year-over-year inflation in the third quarter to be higher than it was in the second quarter with only slight improvement in the fourth quarter as demand remains high. We continue to have great confidence we will offset these higher costs with the incremental price increases we announced in all businesses during the second quarter. We are prepared to implement additional increases should they be necessary. We recognize the timing of price realization will continue to put pressure on margins in the near term. Over the longer term, we expect margin expansion. Against this backdrop, we anticipate third quarter 2021 consolidated net sales will be up by mid to high single digit percentage compared to the third quarter of 2020. We expect the Americas Group sales to be up by a mid to high single digit percentage, with pro sales at or above the high end of this range, and DIY sales returning to a more historic level. We expect consumer brand sales to be down by a mid to high teens percentage, including a negative impact of approximately five percentage points related to the wattle divestiture. And we expect performance coating sales to be up by a high teens to low 20s percentage. We expect raw material availability to continue to improve throughout the quarter. Embedded in our guidance is a slightly smaller impact from raw material availability than we experienced in the second quarter. For the full year 2021, we expect consolidated net sales to be up by a high single to low double digit percentage. We expect the Americas Group to be up by a low double digit to mid-teens percentage, consumer brands group to be down by a mid to high single-digit percentage, including a negative impact of approximately four percentage points related to the wattle divestiture, and performance coatings group to be up by a low 20s percentage. We expect diluted net income per share for 2021 to be in the range of $8.01 to $8.31 per share, compared to $7.36 per share earned in 2020. Full year 2021 earnings per share guidance includes acquisition-related amortization expense of $0.80 per share and a loss on the wattle divestiture of $0.34 per share. On an adjusted basis, we expect full year 2021 earnings per share of $9.15 to $9.45, an increase of 13.6% at the midpoint. over the $8.19 we delivered in 2020. Let me close with some additional data points that may be helpful for modeling purposes. We expect to see slightly more gross margin contraction in our second half compared to our first half due to higher raw material costs, product and customer mix returning to more normal levels, and a more difficult comparison year over year partially offset by additional selling price increases implemented across all of our businesses in the second half of the year. We expect to see some contraction in full year gross margin, given the lag between pricing realization and the rapid and greater than expected increase in raw material costs. As we capture price and inflation abates, we expect to see gross margin recover and then expand over time, just as it has in previous cycles. We expect to see some contraction in our second half operating margin due to the contraction in gross margin partially offset by leverage on SG&A due to the strong sales growth. We expect our full year adjusted operating margin to be approximately flat with 2020, with a nice improvement compared to 2019. The level of operating margin performance compared to last year will depend on where in the range our consolidated sales perform and where raw materials trend through the second half of the year. We will continue making investments across the enterprise that will enhance our ability to provide differentiated solutions to our customers. We expect to return to our normal cadence with around 80 new stores opening in the US and Canada in 2021. We'll also be focused on sales reps, capacity, and productivity improvements, systems, and product innovation. We also plan additional incremental investments in our digital platform and the home center channel. These investments are embedded in our full year guidance We expect foreign currency exchange to be a tailwind of approximately 2% for the full year. We expect our 2021 effective tax rate to be in the low 20% range. We expect full year depreciation to be approximately $280 million and amortization to be approximately $310 million. The CapEx and interest expense guidance we provided last quarter remains unchanged. We have $24 million of long-term debt due in 2021. We expect to increase the annual dividend per share by 23.5% per share for the full year. We expect to continue making opportunistic share repurchases. We'll also continue to evaluate acquisitions that fit our strategy. We delivered an excellent first half, and despite considerable supply chain and inflationary headwinds, we are maintaining our previous full-year guidance and expect to deliver another very strong year. We remain highly focused on providing solutions to our customers. That concludes our prepared remarks. With that, I'd like to thank you for joining us this morning, and we'll be happy to take your questions.