Moody's Upgrades Sherwin-Williams (SHW) Unsecured Rating to 'A2'; Outlook Remains Stable

Moody's Investors Service upgraded Sherwin-Williams (NYSE: SHW) unsecured debt rating to A2 from A3 and its rating for commercial paper to Prime-1 from Prime-2 as a result of the reduction in adjusted debt due to changes in Moody's approach for capitalizing operating leases. The updated approach for standard adjustments for operating leases is explained in the cross-sector rating methodology Financial Statement Adjustments in the Analysis of Non-Financial Corporations, published on June 15, 2015. The upgrade also considers Sherwin-William's elevated margins, strong free cash flow generation and low balance sheet debt. The outlook is stable.

"The reduction in capitalized lease value reduces leverage by over half a turn, this improvement plus Sherwin-Williams' strong and relatively stable free cash flow has triggered the upgrade to A2," stated John Rogers Senior Vice President at Moody's Investors Service.

Ratings upgraded:

..Sherwin-Williams Company (The)

....Commercial Paper to Prime-1 from Prime-2

....Senior Unsecured Medium-Term Note to A2 from A3

....Senior Unsecured Notes to A2 from A3

RATING RATIONALE

SHW's A2 senior unsecured ratings reflect its size and market position in North America, elevated EBITDA margins, strong free cash flow and continued top line growth. The company's growth strategy includes organic growth from existing operations, small to mid-sized bolt-on acquisitions that are complementary to its existing businesses and potentially larger geographic expansions to increase the company's global footprint. The company uses its large free cash flow to fund planned acquisitions or buyback shares. Moody's expects that credit metrics will improve in 2015 due to lower raw material and distribution costs, which will more than offset the negative impact of a stronger US dollar. The company's LTM March 31, 2015 metrics include leverage (Debt/EBITDA) of 2.0 times, Retained Cash Flow/Debt (RCF/Debt) of 36% and Free Cash Flow/Debt (FCF/Debt) of 18%. The company's first quarter EBITDA was up by over 10%.

The company does have moderate risks associated with environmental matters and lead paint litigation. Moody's expects that SHW will be able to manage these contingent liabilities within its rating due elevated free cash flow.

The Prime-1 commercial paper rating reflect SHW's good liquidity, and is supported by modest cash balances but strong free cash flow generation, which is expected to be $700-800 million in 2015. Its commercial paper program is back-stopped by an undrawn $1.05 billion revolving credit facility that expires in July 2018. The company also has an additional $1 billion of bilateral facilities with $250 million maturing by the end of 2015. At the end of the first quarter of 2015, short term debt was elevated at $1.4 billion due to a $600 million accelerated share repurchase program and a seasonal working capital build. SHW had over $790 million outstanding under its commercial paper program at the end of the first quarter. Moody's expects this balance to be less than $100 million by year end 2015.

SHW sells paints, coatings and related products through company operated stores, large retail stores, independent retail stores (primarily hardware) and directly to customers (private label paints and industrial coatings). The productivity of the SHW's over 4,000 company operated stores is the highest in the industry and a significant advantage. The majority of SHW's sales are related to architectural paints and coatings. Hence, demand for SHW's products is tied to the housing market and correlates closely with existing home sales and remodeling expenditures in the US and Canada. Customer density, whether through its own stores, big-box retailers or independent retailers, keeps distribution costs low and enhances margins.

The stable outlook reflects improving financial performance and the expectation that short term debt will decline significantly by year end 2015. There is limited pressure for an upgrade due to the company's financial policies that are more consistent with the A2 rating. Moody's could upgrade the rating if management changes its financial policy such that the company maintains Debt/EBITDA below 1.5x and Retained Cash Flow/Debt (RCF/Debt) of over 40% on a Moody's adjusted basis. Moody's could lower the rating in the event of a large debt-financed acquisition or share repurchase program, which would keep leverage sustained at over 2.0x and RCF/Debt of less than 30%. Moody's adjustments add roughly $1.2 billion of additional debt-like liabilities, which is almost entirely from the capitalization of operating leases.

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