The Sherwin-Williams Company

Good morning. Thank you for joining the Sherwin-Williams Company's review of third quarter 2022 results and our outlook for the fourth quarter and full year of 2022. With us on today's call are John Morikas, Chairman 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 issue or direct via the internet at www.sherwin.com. An archive 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 up this session to questions. I will now turn the call over to Jim Jay.

Thank you, and good morning to everyone. Sherwin-Williams had an excellent performance in the third quarter, including high teen sales growth resulting in the first $6 billion sales quarter in company history, significant sequential and year-over-year gross margin improvement, record-adjusted diluted earnings per share, and strong cash flow. Demand remained strong in pro-architectural and North American industrial end markets, in contrast to continuing softness in Europe and China. While year-over-year cost inflation remained very significant in the quarter, we were encouraged by a modest sequential decrease in raw material costs. The industry supply chain also continued to stabilize, though conditions remained tight. with some previously noted specialty resins in particular remaining in limited supply. Throughout the quarter, our team continued to focus on growth initiatives, product innovation, customer solutions, pricing actions, cost control, supply chain improvements, and business optimization activities, while also taking actions and planning for a wide range of scenarios that could unfold next year. I'd like to go through just a few of the numbers at a high level and then turn it over to John, who will provide some additional color on the third quarter and our outlook. Comparisons in my comments are to the prior year period, unless stated otherwise. Starting with the top line, third quarter 2022 consolidated sales increased 17.5% to a record $6 billion. Pricing was in the low double digit range. Consolidated gross margin increased to 42.8 percent. This was an improvement of 120 basis points year over year and 110 basis points sequentially, reflective of our pricing actions. Gross margin improved sequentially month to month in the quarter, with September increasing 650 basis points year over year. SG&A expense decreased to 25.3 percent of sales. Consolidated profit before tax increased $265.7 million, or 43.5%. Diluted net income per share in the quarter was $2.62 per share versus $1.88 per share a year ago. Excluding Valspar acquisition-related amortization expense, third quarter adjusted diluted net income per share increased 35.4%, to $2.83 per share versus $2.09 a year ago. EBITDA in the quarter was $1.12 billion, or 18.6% of sales. Moving on to our operating segments. Sales in the Americas group increased 21.4%, driven by double-digit volume growth across all architectural end markets, and high single-digit price increases. Segment profit increased by $132.6 million, and segment margin was 21.2 percent, which was about flat with last year and up 30 basis points sequentially. Sales in the consumer brands group increased 8.5 percent, driven by a low double-digit price increase, which offset lower sales volumes primarily outside of North America. Continued tightness in alkyd resins impacted North America's stain and aerosol sales. Adjusted segment margin was 16.2%, up 150 basis points year over year and 500 basis points sequentially. Sales in the performance coatings group increased 13.7% and were driven by mid-teen price increases, partially offset by a less than 1% decrease in volumes. Mid-single-digit sales from acquisitions were offset by a mid-single-digit unfavorable FX impact. Adjusted segment margin increased 590 basis points to 16.4% of sales due primarily to higher selling price increases. Let me now turn it over to John to provide some additional commentary before we move on to your questions.

Thank you, Jim, and good morning, everyone. As we've indicated since the start of the year, we expected 2022 would be a year of two contrasting halves, and that's exactly what we're seeing play out. We delivered strong results in the third quarter, and I want to thank our entire leadership team and all 61,000 employees for their focus, their determination, and drive in what remains a challenging operating environment. We continue to have great confidence in our strategy. Before moving on to our outlook, let me provide some additional color on our third quarter. In the Americans Group segment, we delivered record sales and PBT. Mid-teens volume growth and high single-digit pricing drove sales, which were up by a strong double-digit percentage in every end market we served. The sales growth was led by DIY, which was compared to an extremely soft quarter a year ago, where we prioritized our pro customers given limited product availability. Sales growth was next strongest in our property management, followed by new residential, residential repaint, and commercial, respectively. Sales were also up by a double-digit percentage in protective and marines. but were dampened by the ongoing limited availability of alkyd resins. We are seeing strong effectiveness from the 10 percent price increase we announced September 6. TAG segment profit increased due primarily to double-digit paint volume growth and selling price increases, partially offset by increased raw material costs and higher SG&A costs related to continued investments in our long-term growth initiatives and our strategy. From a product perspective, exterior and interior paint sales were both strong, with exterior sales growing slightly faster and interior being the larger part of the mix. We've opened 32 net new stores year to date and expect to open 40 to 50 in the fourth quarter. We continue to invest in our management trainee program, expecting to hire more than 1,400 college graduates that will enter this program this year and who will be the future leaders of the company. We also added sales reps and territories in the quarter, along with ongoing growth investments in innovative new products, e-commerce, and productivity-enhancing services. Our consumer brands group had a much improved quarter, led by sales that exceeded our guidance. Sales in North America increased by a double-digit percentage, driven largely by price. DIY paint demand remained sluggish as inflation continued to pressure consumers, while continued tightness in alkan resins impacted our ability to produce stains and aerosols. On a positive note, the pros-who-paint segment, again, grew by a strong double-digit percentage. Sales in China were down by a double-digit percentage, due mainly to the COVID-related lockdowns. Europe was also down double digits due to the slowing macroeconomic environment. Segment margin improved significantly, primarily due to selling price increases and good cost control, partially offset by lower sales volume, increased raw material costs, and higher supply chain costs. The performance codings group followed a very good second quarter with another strong performance in the third. Sales were up mid-teens, including mid-teens pricing and a mid-single-digit benefit from acquisitions, partially offset by a very slight decrease in volume, and a mid-single-digit impact from unfavorable effects. For the second straight quarter, this team delivered year-over-year segment margin improvement, driven by execution of our strategy, including effective pricing action. The 16.4 percent adjusted margin in the quarter was the highest for the segment since the acquisition of ALSPAR, and excluding the impact of acquisitions closed over the last 12 months, adjusted segment margin was 17 percent in the quarter. Although we're pleased to have reached the low end of our expressed margin target of high teens, low 20s, we know there's a significant amount of opportunity ahead. I'm proud of our team's efforts to reach this goal and know they understand the high expectations we have for continued improvement. Sales varied significantly by region. In North America, sales increased double digits against a challenging comp and included low single-digit volume growth. Latin America sales also increased by double digits against a strong comp. Sales were up high single digits in Asia, driven by price as COVID lockdowns continued to impact demand. Sales in Europe were backward mid-single digits against a double-digit comparison and continued economic slowing. Every division in the group grew, led by coil and followed by packaging, auto-refinish, general industrial, and industrial wood. We're also pleased by what we're seeing so far from the recent acquisitions we've announced in this segment. Again, these businesses added mid-single-digit growth in PCG sales in the quarter, though this was nearly all offset by unfavorable effects. Earlier this month, we announced an agreement to acquire IKA, a high-quality European business focused on innovative wood coatings. Before moving to our outlook, let me speak to capital allocation in the quarters. We returned approximately $203 million to our shareholders in a quarter in the form of dividends and share buybacks. We invested $48 million to purchase 200,000 shares in an average price of $237.81 per share. We distributed $155.8 million in dividends. We also invested $175 million in our business through capital expenditures, including $125 million in core CapEx and $50 million for our Building Our Future project. We closed three acquisitions in the third quarter for approximately $440 million. We ended the quarter with a net debt to EBITDA ratio of 3.1 times as we increased short-term borrowings to fund our recent acquisitions. We'll drive the ratio to our long-term target of 2 to 2.5 times range in 2023. We'll use cash in the fourth quarter of 2022 to manage debt, and share buybacks will be done to offset option dilution. Turning to our outlook, we expect to deliver a very solid fourth quarter, resulting in our second-half sales increasing by a low double digits to mid-teens percentage, and second-half diluted earnings per share increasing by 35% at the midpoint of our guidance. Within the Americas group, Demand is strong across all of our pro-architectural markets, including new residential, despite higher interest rates, with customers reporting strong backlogs that will take them through the end of the year and likely longer. We also see a unique opportunity to continue winning new business as our competitors transition their pro-contractor business models, and our differentiated model has never been more on display in value than it is today. Within the consumer brands group, we expect the North American DIY consumer to continue to face inflationary pressures, and Europe and China remain challenging. Within the performance coatings group, demand remains strongest in North America, our largest region. European demand slowed in the third quarter, and we expect continued softness in the fourth quarter. In Asia, the pace of recovery from prior COVID lockdowns in China. and prospects for additional lockdowns make it difficult to assess demand trajectory. From an industry supply chain perspective, we're largely getting the raw materials we need, though the availability of alkyd and some specialty resins remain choppy and is impacting certain product lines within consumer brands and performance coatings. While we continue to push hard, we don't expect meaningful improvement in the availability of these resins until the first quarter of next year. Some near-term inefficiencies remain in our own supply chain as we continue to take steps to overcome industry issues and serve our customers. On the cost side of the equation, our full-year raw material inflation guidance remains in the high teens. We expect to see further sequential decline of raw material costs in the fourth quarter, though they will remain elevated year over year. We expect the trajectory of raw material costs to continue trending favorably as we exit the year, although the pace and level of potential relief next year is difficult to project. Additionally, along with the highest inflation rate we've seen in 40 years, we're also experiencing significant higher costs in other elements of our cost basket, including labor, transportation, and fuel and other costs. We will continue to monitor these costs, fight hard to offset them, and respond with additional pricing if necessary. So specifically for the fourth quarter of 2022, we expect our consolidated net sales will increase by a high single to low double-digit percentage, inclusive of a low double-digit price increase. We expect the Americas Group to be up high teens to low 20%. we expect consumer brands to be down a mid to high single digit percentage. And we expect performance coatings to be flat to up a low single digit percentage. We expect North America, which is the largest region within PCG, to be up a low teens percentage. For the full year 2022, we expect consolidated sales to increase by a low double digit percentage, inclusive of a low double digit percentage price increase. We expect the Americas Group to be up by low double digits to mid-teens percentage. We expect Consumer Brands Group to be down a low single-digit percentage, and Performance Coatings Group to be up by a low double to mid-teens digit percentage. Given the many variables we've noted, we left our diluted net income per share guidance for 2022 unchanged and in the range of $7.65 to $7.95 per share. Full-year 2022 earnings per share guidance includes Valspar acquisition-related amortization expense of approximately 85 cents per share. On an adjusted basis, we expect full-year 2022 earnings per share of $8.50 to $8.80, which represents mid-single-digit percentage growth from 2021 at the midpoint. in what continues to be a challenging macro environment. This guidance implies a second-half adjusted diluted net income per share of $4.63 per share at the midpoint, an increase of 35% over the same time period last year. In addition, we provided updated guidance on several of our full-year data points in our slide deck, including our expectations for FX, CapEx, interest expense, depreciation, and amortization. We expect our full-year tax rate will remain in the low 20% range. While we're not prepared to provide any specific guidance on 2023 at this time, I would like to comment on demand trends and actions we're taking that will impact our 2023 outlook that we will provide in January. We expect slowing new residential demand with elevated interest rates and other costs that are impacting new single-family home permits and starts. However, multifamily production has maintained strong momentum. It's also clear that macro headwinds are likely to continue and potentially worsen in Europe and China. Our base case in this environment remains to prepare for the worst and hope for the best. I'm highly confident in our leadership team, which is deep in experience and has been through many previous business cycles. We've transformed our business in many ways since the last significant downturn, and we are now a stronger, more resilient company. We know what to do. To this end, we've been evaluating multiple options available to us based on a wide range of scenarios, and we are prepared to take appropriate actions beginning this quarter. These include the following. We've continued to review our portfolio of businesses, brands, and customer programs to ensure that they are adding above-market growth and long-term shareholder value. As a result of this work, we are announcing action plans to simplify our operating model and portfolio of brands in consumer brands group and to reduce costs in all regions in performance codings group, consumer brands, and administrative segments. These actions, once finalized, could include one-time costs or charges in the range of $160 to $180 million over the next four quarters and could result in annual run rate savings of approximately $50 to $70 million once fully implemented. Additional details on these planned actions are outlined in the slide deck issued with our press release this morning. We will call out significant one-time charges and update our progress on run rate synergies on future quarterly earnings calls. We remain committed to our strategy of providing innovative solutions that help our customers to be more productive and profitable. In challenging environments, we have the opportunity to become an even more valuable partner to our customers. We will continue to focus on new account growth and share of wallet initiatives. We will leverage our strength in recession resilient end markets, including residential repaint, property management, packaging, and auto refinish, all of which are larger than they were in previous cycles. We will continue to invest in growth initiatives, including adding stores, sales reps, and innovative products and services. We will continue to invest in our people, including our management trainee program I previously mentioned. along with ongoing training that positions our people as one of the most significant amongst our many points of differentiation. We will continue implementing appropriate pricing actions across the company to offset persistently higher input costs with a focus on regaining our gross margins back to our long-term target range of 45% to 48%. We will continue investing in acquisitions that can accelerate our long-term strategy and top-line growth, and expand our operating margins, including our most recent announcement of European wood coatings leader, Eco Group. We will maintain our disciplined capital allocation philosophy. We will not hold cash while investing appropriately in capex, paying a dividend, targeting acquisitions that accelerate our strategy, and absent M&A, buying back our stock. In sum, We expect to deliver a solid fourth quarter to complete a very strong second half of 2022. And we're also taking actions to get ahead of what could be a challenging 2023. We don't expect to be immune from any number of potentially difficult scenarios. But what we do expect is to outperform our competitors and the market. We will do this by leveraging the best team in the industry. We remain committed to creating shareholder value over the long term. And that concludes our prepared remarks. At this time, we'll be happy to take your questions.