TEXT - S&P rates Sherwin-Williams notes 'A'
Overview -- Cleveland, Ohio-based coatings producer Sherwin-Williams Co. plans to issue $750 million in notes due 2017 and 2042. -- We assigned our 'A' issue rating to the company's proposed $750 million notes with 2017 and 2042 maturities. -- We affirmed all existing ratings and removed them from CreditWatch, where we placed them on Nov. 13, 2012. -- The outlook is negative. Rating Action On Dec. 4, 2012, Standard & Poor's Ratings Services affirmed all of its ratings on Sherwin-Williams Co., including the 'A' corporate credit rating, and removed them from CreditWatch, where we placed them with negative implications on Nov. 13, 2012. The outlook is negative. We also assigned an 'A' issue rating to the company's proposed $750 million notes due 2017 and 2042. The company will use proceeds from the notes issue to fund a portion of the Comex acquisition. The November CreditWatch placement followed the company's agreement to acquire Mexico-based Consorcio Comex S.A. de C.V. for about $2.34 billion, including assumed debt, in an all-cash transaction. The company expects to complete the acquisition--which is subject to certain conditions and customary regulatory approvals--in the first quarter of 2013. Rationale The affirmations and CreditWatch removals followed the completion of our review of Sherwin-Williams' business and financial risk profile, proforma for the acquisition of Comex, which it recently agreed to acquire for $2.34 billion. The affirmation reflects our view that Sherwin-Williams should be able to restore its credit metrics to appropriate levels by 2014. Our belief is by discretionary cash flows prioritized for debt reduction and steady earnings growth. We revised the company's financial risk profile to "intermediate" from "modest", as this acquisition will stretch Sherwin-Williams' financial risk profile in 2013. However, our expectations are for underlying business and macroeconomic conditions to continue to strengthen so that the financial profile can be steadily improved. In addition, we do not expect additional major acquisitions or shareholder initiatives in the near term that add pressure to the financial profile. Comex is a privately held business with operations in Latin America, the U.S., and Canada. In 2011, Comex had total annual sales of $1.4 billion, 66% of which were generated in Latin America. We believe the acquisition of Comex would solidify Sherwin-Williams' strong business risk profile by expanding its geographic footprint in architectural coatings, particularly in Latin America. The ratings on Cleveland, Ohio-based Sherwin-Williams Co. combine its "strong" business risk profile as the leading North American coatings producer and its "intermediate" financial risk profile reflected in stable operating margins and strong discretionary cash flow. The company continues to perform well in a mature and consolidating industry. The ratings and outlook reflect Standard & Poor's Ratings Services' view that the U.S. housing market has stabilized and is gradually recovering. Ongoing litigation regarding lead paint represents a risk that we believe should not represent a serious threat to credit quality. With 2011 proforma sales of over $10 billion, Sherwin-Williams manufactures paints and coatings and distributes them through company-owned stores and other retail outlets. The majority of sales are to architectural end markets (primarily repainting, as opposed to new construction), but industrial, marine, and infrastructure markets are also important. Although sales are heavily weighted to domestic markets, the company has a growing international presence that will benefit from the Comex acquisition (it will double the size of the company's Latin American business). Sherwin-Williams' sales model of company-owned stores (which cater primarily to professional contractors) is one of its key business strengths. Other business attributes include strong product innovation and leading brands (including Sherwin-Williams, Minwax, Krylon, Thompson's WaterSeal, and Dutch Boy). Professional contractors tend to value product quality more than participants in the do-it-yourself market and are, therefore, generally receptive to Sherwin-Williams' high-end products. A knowledgeable sales staff, a high degree of customer service, and low employee turnover support this business model. Sherwin-Williams also sells branded and private-label paints, stains, varnishes, and other products to mass merchandisers, home centers, and other retailers. Improved earnings in the first nine months of 2012 reflect volume growth and price increases to pass through raw material cost inflation in resins (like propylene) and pigments (for example, titanium dioxide), compared with the corresponding period in 2011. We expect sales and earnings to continue to benefit from a gradual recovery in demand, and new store openings. EBITDA margins have been relatively stable over the past few years, and we expect this to continue. Pretax return on capital, currently about 25%, remains robust and in line with the rating. We expect the company to achieve synergies related to the acquired Comex operations of about 5% of sales, and consolidate the two companies' brands in the U.S. With good profitability and low capital spending requirements, Sherwin-Williams generates strong free cash flow. At Sept. 30, 2012, the company's credit measures were above par with funds from operations (FFO)-to-total adjusted debt at 52%. We adjust debt to include roughly $1 billion in capitalized operating leases and after-tax environmental and underfunded postretirement liabilities. Following the Comex acquisition, debt leverage will increase in 2013 to a level beyond what we consider consistent with the current ratings, with FFO-to-total adjusted debt deteriorating to about 30% in 2013. However, based on management's long standing financial policy objectives, we believe that Sherwin-Williams will apply discretionary cash flows primarily to debt reduction in order to improve to its financial profile with FFO-to-total adjusted debt improving to the appropriate 40% to 45% range by the end of 2014. Sherwin-Williams' financial policy is a key factor in maintaining the rating. We expect management to maintain annual dividend outlays but reduce the level of share repurchases and limit additional acquisitions in the next few years. Although some high-profile lead paint lawsuits have been resolved in the company's favor, it remains involved in lead paint litigation. The ratings and outlook reflect our expectation that pending cases will not result in additional material liabilities for Sherwin-Williams. Liquidity Sherwin-Williams has "adequate" liquidity, and we expect liquidity sources and discretionary cash flow to remain ample to meet all foreseeable cash needs, including seasonal working capital fluctuations, annual capital spending, dividends, and likely low pension and postretirement funding needs. At Sept. 30, 2012, the company had $55 million in cash and equivalents and ample availability under its $2.05 billion revolving credit facilities with maturities in 2015, 2016, and 2017. Commercial paper outstanding was $260 million at Sept. 30, 2012. Other relevant assumptions in our assessment of the company's liquidity profile include: -- The company's liquidity sources (including cash, FFO, and credit facility availability) over the next two years will exceed its uses by more than 1.2x; -- Even if EBITDA declines by 15%, sources would exceed uses of cash, and -- Minimal debt maturities until December 2014, when about $500 million in debt matures. Outlook The outlook is negative. Sherwin-Williams' commanding market position, strong discretionary cash flow, and prudent financial policies support the rating. We could lower the ratings if the company makes another large debt-financed acquisition during the next 24 months, if an economic setback reduces demand for architectural and industrial coatings, or if litigation requires major cash outlays that would cause FFO-to-debt to fail to improve toward the appropriate 40% to 45% range. We could revise the outlook to stable if credit measures improve to appropriate levels, as the company successfully integrates the Comex acquisition, and the housing recovery gains momentum. Related Criteria And Research -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012 -- Key Credit Factors: Business and Financial Risks In The Commodity And Specialty Chemical Industry, Nov. 20, 2008 Ratings List Ratings Affirmed; CreditWatch/Outlook Action To From Sherwin-Williams Co. Corporate Credit Rating A/Negative/A-1 A/Watch Neg/A-1 Sherwin-Williams Co. Senior Unsecured A A/Watch Neg Commercial Paper A-1 A-1/Watch Neg New Rating Sherwin-Williams Co. $750 mil. senior unsec nts due 2017 and 2042 A