A Dividend Aristocrat Painting High Returns

Sherwin-Williams (SHW) has annually increased dividends since 1979 and outperformed the market by nearly 14% per year over the last decade.

Watching paint dry has been quite rewarding with coatings producer SHW, but past performance is not necessarily indicative of future results.

As we review SHW for potential inclusion in our Top 20 Dividend Stocks portfolio, we will be paying close attention to the factors that have contributed to the company's historical success and assess the likelihood of these factors persisting far into the future.

Business Overview

SHW has been in business since 1866 and is the largest producer of paints and coatings in the United States (80% of its revenue) and third-largest worldwide. The company primarily serves the needs of architectural and industrial painting contractors and do-it-yourself homeowners through a network of more than 4,000 company-operated stores, but it also sells some industrial coatings, automotive finishes, and protective and marine coatings (around 20% of sales in 2014).

Business Analysis

SHW's biggest competitive advantage is its controlled distribution model. The company operates over 4,000 retail stores, about as many as Home Depot and Lowe's combined and four times as many as PPG Industries (PPG).

Controlled distribution accounts for 75% of SHW's total sales and provides the company with greater control over its brand image, in-store product experience, pricing, customer relationships, and inventory.

The majority of SHW's customers are contractors, and many of them prefer to deal with dedicated paint specialists rather than working with big box stores like Home Depot. SHW can offer the best range and quality of paints, and its higher quality paints are more valued by contractors, which tend to be less price sensitive than consumers. Contractors know that SHW's paints can help them complete jobs faster because of their higher quality (e.g. faster dry time, less coats required, etc.), which means more money in their pockets.

SHW is also likely to have a convenient location for contractors almost anywhere around the country – more than 90% of the population lives within a 50-mile radius of a SHW store. As contractors continue taking market share from do-it-yourself consumers, SHW's business should continue to benefit.

As a result of SHW's large network of stores, long operating history, strong brands, and direct in-store relationships with customers, it has built up number one brands in architectural paint, stain & protective finish, aerosol paint, auto specialty paint, painting tools, and wood sealers.

In addition to strong pricing power, SHW's margins also benefit from the company's vertical integration. Big box retailers must pay wholesale prices for their paint inventory, but SHW produces its own coatings, resulting in higher profits. The business also requires little capital, helping SHW consistently generate excellent free cash flow:

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