|Shares Out. (in M):||240||P/E||18.1x||13.3x|
|Market Cap (in $M):||13,297||P/FCF||33.0x||16.0x|
|Net Debt (in $M):||1,817||EBIT||1,173||1,452|
Upside/Downside: 4/1 with expected return of 40%.
Business Description and Background:
Akzo Nobel is the largest producer of paint and coatings globally with a #1 market share in Europe, #2 in the US and #2-3 in Asia. The company also has a leading specialty chemical business serving general industrial, ag, energy, marine and pulp and paper markets. Akzo Nobel has a market cap of €11 bn and a TEV of €15bn. The company trades at a 3x discount to peers on P/E and 2x discount to EV/EBITDA.
Despite having excellent assets, Akzo has been a perennial underperformer (300 bps lower operating income margins) largely due to subpar management execution and poor M&A integration. Akzo acquired Imperial Chemicals Inc. in 2008 paying >12x EBITDA (significantly overpaid). The acquisition expanded the decorative paint and chemicals segment by 50%; however the businesses were not well integrated - eg limited site closures, layoffs or bulk buying. In late 2011 (4 years after the acquisition) the company has finally hired a new (far superior) CEO to restructure the business. Upon his arrival, the company announced a €500 mm cost savings program (25% of EBITDA).
Paint is a strong business with significant pricing power as the cost of a paint job is 90% labor and 10% paints/coatings (high value for low price). The paint market is bifurcated to “Do-It-Yourself” (DIY) and contractor. In the case of the DIY buyer this is a one-time expense and the customer is not highly price sensitive. The contractors are able to push paint price increases through to the end customer. The quality of the paint is more important to the end customer as they do not want to pay for a second paint job down the road as the labor costs will be very high.
The relative pricing power is impacted by the distribution channel's used (owned retail has the strongest pricing, independent retailers next and big box retailers lowest). Akzo's distribution is strong in Europe and Asia and weak in the US. While Sherwin Williams and Benjamin Moore have concentrated retail foot prints that allow them to gain local economies of scale in distribution and good pricing (as there is no middle man), Akzo mostly distributes through 3rd parties (only 300 stores in the US that are not concentrated) which has caused them to be lag the market. In fact, Akzo was the bad actor and traditionally undercut the market on price in the US, however their strategy recently changed as Akzo pushed through a price increase in 2011. This was a critical sign to the industry who all followed suit. Despite ~€700 mm of revenue and a #2 market share, the US has traditionally been a loss maker for Akzo (€50 million loss in 2011). Buchner’s turnaround plan will change this significantly as the company cuts costs, improves distribution and maintains/grows prices. In Europe, Akzo has a much stronger distribution channel with in Asia and is building its own retail footprint in Asia.
Volumes in the paint industry are linked to new home sales, commercial building and renovation spending. As mentioned above, paint volumes in the EU are down 23%. Eurostat publishes this data monthly which allows you to track inter quarter swings. The latest data suggests EU volumes have turned. In Asia, Akzo continues to take share and volumes continue to increase. 1/3 of Akzo's businesses exposed to faster growing emerging markets.
Valuation: Akzo trades at a 20-30% discount to peers on P/E and EV/EBITDA as the company has been an underperformer since its ICI acquisition. While Sherwin, Valspar and PPG have all seen significant stock returns over the past decade, Akzo has largely been flat. I believe that the turnaround will close the gap and that sentiment will improve as margins expand and earnings continue to grow. To that end I apply a 16x multiple to my 2015 P/E to get to a base case price target of €75 or +40% with the dividend. This implies an EV/EBITDA of 6.8x 2015E EBITDA. The 16x is a discount to the best in class peer Sherwin Williams and PPG that trade at 17/18x. One could argue that Akzo (once turned around) should have better margins and pricing power as it is the largest paint producer in the world and will have significant economies of scale, but I have not assumed this in the base case.
Base Case: I have assumed that pricing is flat and volumes at 5% a year through 2015 in decorative paints. For Performance Coatings and Specialty Chemicals I have assumed price flat and volume growth of 5%. I assume incremental margins of 37.5% which is below where management is guiding (40-45%). I have assumed incremental cost savings will compensate for inflation. This implies earnings of €4.70, a stock price of €73 (+ the dividend) or 21% higher than consensus.
Bull Case: I have assumed volumes at +7% a year through 2015 in decorative paints. For Performance Coatings and Specialty Chemicals I have assumed volume growth of 7%. I assume incremental margins of 40%. I have also assumed cost savings initiatives offset inflation. This implies earnings of €5.24, or 35% higher than consensus. I use a 17x “best in class” multiple, implying a price of €89 for upside of 63%.
Bear Case: I have assumed that flat pricing and volumes at -2% a year through 2015 I assume decremental margins of 30% I have also assumed $50m of inflation in excess of cost savings initiatives. This implies earnings of €2.70, or 30% below consensus. I use a 14x multiple (a 20% discount to current comps) which implies a downside of 16%.
The four major risks to the thesis are as follows:
Earnings announcements: The company will continue to beat expectations as they strive for their long-term guidance . Cost savings plans will continue to improve earnings power, FCF and returns on capital. Pension expenses will decline as the company has now made significant top up payments which will allow them to increase the dividend (3%+).
Early 2014 Capital Markets Day: This will be the first time that the new heads of the business divisions addresses the buy and sell side. They will provide an update on restructuring plans and I believe there is significant potential for them to pull forward the timing and increase the size of the plan.
EU volumes continue to rebound...this is the Key Investment Factor and should be watched closely
|Entry||11/25/2013 08:01 PM|
Hi thanks for the write up. I have two questions.
1: what do you think they do with the specialty chemicals business longer term? is there any push from shareholders to divest the business? it doesn't seem to fit with the core business.
2: do you think there is a structural margin gap between their paint businesses and US peers due to the different distribution networks? if so, can this ever get to a US peer multiple on normalized earnings?
|Subject||RE: two questions|
|Entry||12/01/2013 05:51 PM|
1. I think that longer term the CEO will divest Specialty Chemicals if they can get appropriate value. Totally agree the two businesses provide little synergy. They company disposed to US Deco (~$1bn), German O&O stores, Specialty Pakistan (~$100m) and the Building Adhesives businesses ($300m) in the past year so they clearly are focused on shedding non core assets.
2. I think there is a structural margin gap on some pieces of the business, namely where they have lower market shares like Germany. In the UK, Netherlands and France they should be able to achieve similar margins. In EM markets (Latam, China) they should also be able to achieve similar or possibly even better margins as the pricing power is better in these markets due to less branded competition. Taken together I think they should be able to achieve margins that are close to US peers over at 2-3 year period.