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Valspar Costs Overshadow Sherwin-Williams' Revenue Gains

By Dan Caplinger – Jul 20, 2017 at 9:46AM

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A long-awaited acquisition promises longer-term benefits, even if shareholders aren't focusing on that today.

A strong economy makes homeowners more willing to spend money to do work on their homes, and Sherwin-Williams (SHW -1.49%) has been a beneficiary of that favorable trend for years. Not only has the paint specialist grown its own network of stores and products organically, but it has also made key strategic moves, buying rival Valspar to improve its position within the industry.

Coming into Thursday's second-quarter financial report, Sherwin-Williams investors were expecting the company to keep growing revenue and net income at a healthy pace. The paint-maker largely delivered on that front, with record quarterly sales results. Yet acquisition-related costs weighed on Sherwin-Williams' bottom line, and a drop in guidance related solely to those one-time costs affected investor sentiment negatively even as the company looked forward to stronger long-term prospects. Let's take a closer look at Sherwin-Williams and what its latest results say about its future.

Sherwin-Williams products.

Image source: Sherwin-Williams.

Sherwin-Williams posts record sales again, but earnings are another matter

Sherwin-Williams' second-quarter results were mixed. Sales soared 16% to $3.74 billion, again setting an all-time high for the company and topping the 14% growth rate that most investors had expected. Yet net income fell by more than 15% to $319 million, and even after taking into account extraordinary items related to the Valspar acquisition and other issues, adjusted earnings of $4.52 per share were just shy of the consensus forecast among those following the stock for $4.57 per share.

Looking more closely at the company's results, Sherwin-Williams saw a wide range of performance in its key segments. The paint-maker combined its paint stores and Latin America coatings segments into a new Americas group, and that unit saw sales rise 9% on strength in the architectural paint category. Same-store sales in the U.S. and Canada were up 4.9% from the year-ago quarter, while Latin America sales were up a slower 1.2%. Segment profit rose by nearly 7% as Sherwin-Williams was able to offset higher raw material costs by boosting sales prices.

Sherwin-Williams' other segments saw even bigger gains in sales, but the news wasn't as universally good on the bottom line. The consumer brands division saw a 16% boost in sales due largely to having a month's worth of Valspar sales included in the mix. However, segment profit fell by about a quarter from the year-ago period, as lower organic sales volumes and higher raw material costs combined with acquisition-related charges to pull down earnings. Similarly, in the performance coatings group, Sherwin-Williams had a 48% jump in sales, but the division's bottom line fell by almost 12% amid accounting adjustments related to the Valspar purchase.

Sherwin-Williams CEO John Morikis was happy to have all the work on the merger vindicated. "It is gratifying to finally report a quarter that includes results from Valspar," Morikis said, and he believes that "the combination of these two companies forms a world class brand portfolio, expanded product range, premier technology and innovation platforms, and an extensive global footprint" for future growth.

Can Sherwin-Williams build up positive momentum?

Sherwin-Williams isn't pausing in the aftermath of closing its Valspar deal. The CEO sees integrating Valspar as crucial, but Morikis also sees the importance of "strengthening the performance of our core businesses." In that light, Sherwin-Williams hopes to boost sales through all of its retail channels and work at passing through higher costs to customers.

The Valspar acquisition will continue to have a big impact on Sherwin-Williams' financials over the rest of the year, both in terms of added revenue and acquisition-related costs. For the third quarter, the company expects earnings of $3.70 to $4.10 per share, which will include $0.40 to $0.60 per share of incremental earnings from Valspar but also $1.10 per share in Valspar integration costs. For the full year, Sherwin-Williams cut its adjusted earnings guidance to a range of $12.30 to $12.70 per share. Costs of $2.50 per share due to the acquisition will wipe out the $0.75 to $0.95 in incremental earnings from Valspar's operations throughout the full 2017 year.

Sherwin-Williams investors weren't happy with that news, and the stock fell more than 5% in pre-market trading following the announcement. Yet once all the Valspar-related costs are over and done with, the boost to earnings over the long run should more than make up for the short-term pain that the paint-maker is having to endure in order to move forward as a combined powerhouse in the paint industry.

Dan Caplinger has no position in any of the stocks mentioned. The Motley Fool recommends Sherwin-Williams. The Motley Fool has a disclosure policy.

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