Fitch Downgrades Sherwin-Williams' IDR to 'A-'; Outlook to Stable

Fri May 10, 2013 11:48am EDT

(The following statement was released by the rating agency) CHICAGO, May 10 (Fitch) Fitch Ratings has downgraded The Sherwin-Williams Company's (NYSE: SHW) ratings, including the company's Issuer Default Rating (IDR) to 'A-' from 'A'. Fitch has also removed SHW's ratings from Rating Watch Negative. The Rating Outlook is Stable. A complete list of rating actions follows at the end of this release. Fitch had originally placed the company's ratings on Watch Negative in November 2012 following SHW's proposed acquisition of Consorcio Comex, S.A. de C.V. (Comex) for $2.34 billion, including assumed debt, in an all cash transaction. The transaction is expected to close during the latter part of the second quarter of 2013. KEY RATING DRIVERS The ratings downgrade reflects SHW's high leverage following the acquisition of Comex and integration risks associated with this large transaction and takes into account normalized leverage post integration. While the company has successfully integrated smaller acquisitions in the past (i.e. Duron, Purdy, M.A. Bruder), there is greater risk as the Comex acquisition is significantly larger and also involves meaningful operations in foreign jurisdictions (Mexico and Canada). Leverage as measured by debt to EBITDA is projected to peak at around 2.4-2.5x at the end of the 2013 second quarter, once the acquisition of Comex is completed (without any contribution from Comex). Lease-adjusted leverage (adjusted debt to EBITDAR) is projected to be roughly 3.5x-3.75x. This compares to debt to EBITDA of 1x and lease-adjusted leverage in the 2x range prior to this acquisition. Fitch expects SHW will reduce its debt levels in the next 24 months and will lower its debt to EBITDA to below 1.5x at year-end 2014 and will further reduce this ratio to roughly 1.2x by the end of 2015. Similarly, lease-adjusted leverage is forecast to decline to 2.7x at year-end 2014 and 2.5x at year-end 2015. The ratings also incorporate the company's leading market position in the architectural coatings industry, the company's unique distribution platform, the breadth and depth of its product offerings, the company's focus on painting contractors and property maintenance managers, solid free cash flow generation, and strong management team. Risk factors include lead-based paint litigation cases against SHW, volatile raw materials costs and the company's relatively aggressive growth strategy. The Stable Outlook reflects the expected continued improvement in housing (new and existing), home improvement and commercial construction markets in the U.S. during 2013. The Stable Outlook also reflects the company's solid liquidity position and strong performance during 2012 and so far in 2013. COMEX ACQUISITION Comex is a privately held business with operations in Latin America, the U.S. and Canada. In 2011, the company had $1.4 billion of sales, 66% of which was generated in Mexico and the remaining 34% in the U.S. and Canada. Comex manufactures and sells architectural and industrial coatings in Mexico through 3,300 points of sale operated by 750 independent concessionaires. In the U.S., Comex sells paint and coatings products under a variety of brand names through 240 company-operated paint stores. In Canada, the company markets multiple brands of paint and coatings through 78 company-operated paint stores and approximately 1,500 independent paint dealers. The proposed acquisition has good strategic rationale for SHW. The acquisition augments its current business mix and provides the company with a meaningful controlled distribution platform in Mexico, the western U.S. and Canada, where its store count is currently low. The acquisition also improves SHW's scale throughout Latin America and provides the company with strong brand names in that region. LIQUIDITY AND CASH FLOW GENERATION SHW maintains ample liquidity with cash of $613.9 million as of March 31, 2013 and no borrowings under its $1.05 billion CP Program (that is backed by SHW's $1.05 billion revolving credit facility). SHW also has three revolving and letter of credit facilities totaling $1 billion, a EUR95 million five-year Euro credit facility and a C$150 Canadian credit facility. Cash flow generation remains strong with free cash flow (FCF) totaling $624.1 million for the LTM period ending March 31, 2013. FCF totaled $569.8 million in 2012, $428.6 million in 2011, $425 million in 2010, $605.3 million in 2009, $593.9 million in 2008, and $546.3 million in 2007. Fitch expects SHW to generate $450 million to $500 million of FCF during 2013. MANAGEMENT DISCIPLINE SHW has a long track record of adhering to a disciplined financial strategy and Fitch expects this to continue. The company has also demonstrated in the past that it can successfully delever its balance sheet following major acquisitions. In 2004, SHW completed two large acquisitions totaling $640 million, which resulted in its debt to EBITDA ratio increasing from 0.7x for the LTM period ending June 30, 2004 to 1.25x for the LTM period ending March 31, 2005. The company quickly reduced its leverage to 0.7x by the end of 2005. The company has historically used excess FCF to repurchase its stock and/or fund acquisitions. SHW's share repurchases totaled $557.8 million in 2012, $367 million in 2011, $375 million in 2010 and $530 million in 2009. Following the Comex acquisition, Fitch expects the company will lower its share repurchases relative to previous years and use excess FCF to pay down debt. IMPROVEMENT IN SHW'S U.S. END-MARKETS Fitch's ratings on SHW take into account the cyclicality of the company's end markets. Residential, commercial and industrial construction are each cyclical and can be influenced by economic trends. The housing recovery should advance this year with a continued, somewhat below-trend-line, cyclical rise off a very low bottom. In a slowly growing economy with somewhat diminished distressed home sales competition, less competitive rental cost alternatives, local permitting delays, labor imbalances, developed lots less readily available, and new and existing home inventories at historically low levels, 2013 total housing starts should improve about 18% 925,000, while new home sales increase approximately 22% to 448,000 and existing home sales grow 7.5% to 5.01 million. Fitch currently projects home improvement spending will increase 4% in 2013. Growth patterns in the intermediate term are likely to be below what the industry experienced during the previous housing boom and the early part of the past decade due to the slower expansion in the U.S. economy and only moderately better housing market conditions. Non-residential construction is also expected to grow slightly during 2013. Fitch expects private non-residential construction spending will improve 5% during 2013 while public construction spending is forecast to increase 2% this year. SOLID FINANCIAL RESULTS SHW reported strong financial results during 2012 and so far in 2013. During 2012, revenues grew 8.8% compared with 2011 and gross margins increased 140 bps year-over-year (YOY). The company's EBITDA margins also showed meaningful improvement, advancing 160 bps to 13.2% during 2012. This trend continued during the first quarter of 2013 despite difficult YOY comparisons due to favorable weather conditions during the first quarter of 2012. Total revenues increased 1.4% during the first quarter of 2013, although the company's paint stores group reported better results, with sales growing 4% (3.2% on a same-store basis) during the quarter. Gross margins and EBITDA margins each improved 180 bps during the quarter. Fitch currently expects sales to grow in the mid-single digit percentage range (without Comex) and EBITDA margins to increase 50-75 bps this year compared with 2012 levels. LEAD-BASED PAINT LITIGATION RISKS The company (and other companies) are or were defendants in legal proceedings seeking recovery based on public nuisance liability theories, among other theories, brought by the state of Rhode Island, the city of St. Louis, Missouri, various cities and counties in the State of New Jersey, the state of Ohio and various cities in the state of Ohio, the city of Milwaukee, Wisconsin and the county of Santa Clara, California and other public entities in the state of California. Except for the Santa Clara County, California case, all of these legal proceedings have been concluded in favor of the company and other defendants at various stages in the proceedings. The trial for the Santa Clara case is set to begin in June 2013. The potential liability related to this legal proceeding cannot be determined at this time. RATING SENSITIVITIES The company's ratings are constrained in the near term because of the high leverage levels following the Comex acquisition. Nevertheless, a positive rating action may be considered if SHW's financial performance is meaningfully above Fitch's current expectations, leading to improved profitability and FCF, and lease-adjusted leverage ratio below 2x. Negative rating actions may be considered if the company performs in line with Fitch's 2013/2014 stress case forecasts, including Fitch-calculated EBITDA margins falling to between 11% - 12% and lease-adjusted leverage consistently exceeding 3x 12-18 months following the completion of the Comex acquisition. Additionally, Fitch may consider a negative rating action if there is an adverse decision against the company related to outstanding lead-based paint litigation cases wherein the judgment will lead to higher debt levels and lease-adjusted leverage above 3x. Fitch has downgraded SHW's ratings as follows: --Long-term IDR to 'A-' from 'A'; --Senior unsecured notes to 'A-' from 'A'; --Unsecured bank credit facilities to 'A-' from 'A'; --Short-term IDR to 'F2' from 'F1'; --Commercial Paper (CP) to 'F2' from 'F1'. The Rating Outlook is Stable. Contact: Primary Analyst Robert Rulla, CPA Director +1-312-606-2311 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60602 Secondary Analyst Robert Curran Managing Director +1-212-908-0515 Committee Chairperson Megan Neuburger Senior Director +1-212-908-0501 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Additional information is available at www.fitchratings.com. Applicable Criteria and Related Research: --'Corporate Rating Methodology' (Aug. 8, 2012); --'Evaluating Corporate Governance' (Dec. 12, 2012); --'Liquidity Considerations for Corporate Issuers' (June 12, 2007). Applicable Criteria and Related Research Corporate Rating Methodology here Evaluating Corporate Governance here Liquidity Considerations for Corporate Issuers here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.