|Shares Out. (in M):||247||P/E||0||0|
|Market Cap (in M):||6,511||P/FCF||0||0|
|Net Debt (in M):||2,954||EBIT||0||0|
We recommend purchasing shares of AXTA at today’s level of $26.32. Intrinsic value is $36, or 37% higher.
Axalta was purchased by Carlyle in Q1 2013 from DuPont. The stock went public at $19.50 a share in November 2014. Berkshire Hathaway (Combs and/or Weschler) purchased a stake from Carlye around $28 in the spring of 2015, and the stock broke $36 in June 2015. Berkshire is the largest holder with slightly under 10% ownership. The stock cracked to $20 in Q1 2016, and now trades around $26.
AXTA has been written up before on VIC. I refer you to those writeups for a good overview of the business. Since then, the company has executed well and continues to pay down debt.
Axalta is a leading global manufacturer, marketer, and distributor of high performance coating systems. The company generates 90% of its revenue in markets where it holds the #1 or #2 global market position, including a #1 position in its core automotive refinish end-market with approximately a 25% global share. The company has 2 reporting segments: Performance Coatings and Transportation Coatings. Each reporting segment has two sub-segments, and while we have revenue for all four sub-segments, we have EBITDA only for the reporting segments. This is a high quality business with strong returns on capital, low capital expenditures, and EBITDA margins around 23%.
Performance Coatings provides high-quality liquid and powder coatings solutions to a fragmented and local customer base. Axalta is one of only a few suppliers with the technology to provide precise color matching and highly durable coatings systems. The end-markets within this segment are refinish and industrial.
Based on 2015 sales, the segment breaks out as 71% refinish and 29% industrial. By geography, the breakout is 34% NA, 35% EMEA, 18% Asia Pacific, and 13% Latin America.
The refinish end-market is driven by the number of vehicle collisions and owners’ propensity to repair their vehicles. Refinish coatings are a small portion of the overall vehicle repair cost, but they are critical to the vehicle owner’s satisfaction given their impact on appearance. We spent a significant amount of time speaking to body shops and they are mostly focused on performance, reliability, and service. Unsurprisingly, Axalta and PPG both come away with strong recommendations here. We also learned that a significant amount of time and capital went into developing color match technology and the thousands of vehicle color formulations. Axalta’s color match technology provides Axalta-specific formulations that enable body shops to accurately match colors regardless of the vehicle’s brand, color, supplier, or age.
In the industrial end market, the company focuses on general industrial, electrical insulation, architectural, transportation, and oil & gas. Uses include the following:
General industrial: coatings HVAC, shelving, appliances, electrical storage components, as well as specialized coatings for the interiors of metal drums and packaging.
Electrical insulation: coatings to insulate copper wire used in motors and transformers and coatings to insulate sheets forming magnetic circuits of motors and transformers.
Architectural: exterior powder coatings typically used in the construction of commercial structures, residential windows and doors, as well as liquid interior and exterior house paint.
Transportation: coatings for vehicle components, chassis and wheels to protect against corrosion, provide increased durability and impart appropriate aesthetics.
Oil & gas: powder products to coat tanks, pipelines, valves and fittings protecting against chemicals, corrosion and extreme temperatures.
Transportation Coatings provides advanced coatings technologies to OEMs of light and commercial vehicles. These customers are becoming more global and require a high level of technical support coupled with cost-effective, environmentally-responsible coatings systems that can be applied with a high degree of precision, consistency, and speed.
2015 sales by end market in this segment break out as 77% light vehicle and 23% commercial vehicle. By geography, it is 39% NA, 28% EMEA, 17% Asia Pacific, and 16% Latin America.
Axalta has had two 2 cost saving programs underway: “Fit for Growth” and “Axalta Way.” Both will be completed by YE 2017. The Fit For Growth program is largely complete ($92 million out of $100 million in cumulative savings achieved by YE 2016). Fit For Growth has been focused primarily on Europe and involves right-sizing staffing levels, wage/benefit restructuring, rationalizing manufacturing and logistics, and investing in automation.
Axalta Way ($57 million out of $100 million in cumulative savings achieved by YE 2016) is implementing lean tools to enhance productivity and ROIC. Near-term opportunities include procurement and SG&A reduction.
Net leverage was 5.6x LTM EBITDA at the time of the LBO and is now 3.3x. The company’s target leverage ratio is 2.5-3.0x, which will be achieved in 2017. Given that over 50% of the company’s profits are from the stable refinish business, leverage is not a concern at all for us. Axalta has recently taken its average cost of debt down closer to 4% now versus 4.7% previously.
As mentioned earlier, the company first intends to pay down debt, and then focus on M&A. If attractive M&A opportunities are not present, the company has said it will repurchase shares if the shares are cheap. If the shares are not compelling, then Axalta will return capital via dividends. This year the company has done some tuck-in M&A. These acquired businesses include a refinish business in Southeast Asia, a light-vehicle business specializing in interior coatings based in North America, and 51% of a controlling interest in an industrial business specializing in coil and spray coatings.
Our estimate of 2016E EBITDA is $881 million which is net of stock compensation expense. The company expects to achieve another $52 million of run-rate synergies on top of this achieved by the end of 2017 which we give them credit for since the team has executed well on synergies to date. We use a maintenance capex number of $100 million which is much higher than management’s estimate. And then we hit them for $140 million of interest expense and a 25% tax rate to arrive at $520 million of FCF. Ex-cash, this translates into a 9% yield. This compares favorably to a stock market trading around 19x P/E. At $36, this would be slightly above a 6% yield, more in line with fair value. Keep in mind that while I am giving them credit for synergies, I am using 2016 #s, not 2017. The CEO Charlie Shaver will be giving 2017 guidance later this week and I expect it to be good. Charlie made public comments earlier this month and my guess is that he is going to guide to around 3-4% organic growth ex-currency for 2017 which is solid in this environment.
Our DCF also gets us to $36. It assumes a revenue CAGR slightly below 3% and an EBITDA CAGR slightly below 5%.
The company has significant long-term competitive advantages:
--Government regulations determine VOC limits. Axalta has completely compliant portfolios for both refinish and OEM.
--OEMs seek continuous productivity improvements. Axalta's technology enables OEMs to reduce capital, footprint, headcount, and energy.
--OEM vehicle light-weighting. Axalta has broad substrate coating applicability for next generation materials.
--Growth in MSOs (multi-system operators). Axalta's waterborne technology improves MSO productivity and the company's national coverage enables high service levels.
--More complex colors. Axalta has integrated itself with OEMs and is constantly growing its color library. Advanced color matching technologies are critical to body shop supplier selection.
Axalta market growth and drivers
The global coatings industry is forecasted to grow at a 4% CAGR for the next several years.
Drivers for refinish market: car parc, miles driven, and collision rates. The car parc is growing globally. Keep in mind that light vehicles per 1,000 people is 743 in the U.S., 263 in Central & Eastern Europe, 230 in Mexico, 129 in Brazil, 61 in China, and 19 in India. In emerging economies you have rapid growth of the middle class, increased vehicle penetration per capita, and elevated collision rates vs developed markets.
Drivers for light vehicle: emerging economies and middle classes; ongoing consumer strength in developed markets.
Commercial vehicle: Global consumer, infrastructure growth.
Industrial: Global GDP and industrial production.
The auto production cycle has peaked in NA and Europe. This is probably true for this part of the cycle, however the car parc will still grow in emerging markets, and heavy duty truck is already in a meaningful downturn. I have modeled a continued decline in the OEM and heavy duty truck markets, and this is offset by continued growth in refinish and industrial. So even with a downturn in the OEM and heavy-duty markets, I arrive at $36 for today’s value. In terms of cyclicality in refinish, sales were down 14% in 2009 which was much higher than in a normal recession, and one has to keep in mind that material costs were down as well. As vincent975 mentions in his writeup, there is a chart in the bond offering memo which shows this. The company goes a good job preserving margins given the variable cost nature of the business. I also think that current management would manage a downturn better than the previous DuPont management, which leads to the next point.
One of the questions cnm3d asked in the previous posting of AXTA was “why was AXTA sold to cheaply to DuPont?” While DuPont is not stupid, the DuPont employees which ran DuPont Performance Coatings were incredibly complacent and in most cases incompetent. It is clear that the coatings division never received nearly enough attention from management, and hence the complacency and low-hanging fruit which Carlyle focused on. And remember that this was always a small piece of DuPont, a $60+ billion market capitalization company.
Autonomous driving. This has been discussed on previous threads on multiple posts, so I am not going to rehash the discussion. I think it will take a long time (15 years) before a meaningful number of self-driving cars are on the road. The technology has to improve and become affordable, and then it has to work its way through the global car parc. And time will tell how it will work in terms of regulations. A meaningful number of autonomous cars will need to be on the road to bring down accident rates, and I think many people are going to still want to control their driving for many reasons, the most obvious of which is to exceed the speed limit. But it is undeniably a long term risk factor, and one can perhaps think of various hedges.
Currency. This is unfortunately a real headwind as 66% of Performance Coatings sales and 61% of Transportation Coatings sales are outside of North America.
Pricing. There is always a risk of pricing concessions/givebacks as commodity prices decline. Also, insurance companies limit the allowable cost of repairs charged by body shops. Our work has shown that insurance company limits have not impacted refinish pricing, especially since refinish is a small part of the overall repair. The refinish side does take more pricing than the OEM side since the body shop customer base is very fragmented. Axalta does an excellent job improving the productivity of body shops with its coating systems, and this creates meaningful value for the body shop.
Potential acquisition candidate
As I mentioned, this is a Berkshire Hathaway position initiated by Todd Combs or Ted Weschler. In 2015, the stock reached my estimate of today’s intrinsic value, so presumably Berkshire has more aggressive assumptions than I do. While speculative to guess, it would make sense for Berkshire to simply buy this today at $36+. The coatings market globally is very fragmented and Berkshire could meaningfully accelerate M&A in the refinish and industrial markets. The industrial coatings market is a terrific market and incredibly fragmented, and Charlie has mentioned his interest in making this segment much larger. And of course there are ample consolidation opportunities in their other markets.
There could be strategic purchasers down the road as well. While there may be antitrust issues to deal with, someone like PPG could be a natural buyer of AXTA. Prior to 2016, I would not have suggested Sherwin Williams as a potential buyer, but Sherwin is getting into industrial coatings with its purchase of Valspar, and Sherwin has no presence in auto refinish. Sherwin would need to digest its Valspar acquisition, but I think an acquisition by Sherwin would make sense. While Axalta does not have a big presence in architectural coatings like Valspar, Axalta has better technology than Valspar and it is much easier for Axalta to continue to make progress in industrial coatings than it is for Sherwin/Valspar to make headway in automotive.
You may have noted that Lou Simpson took a position in Axalta in Q3 2016 and shows up as one of the larger holders. Lou ran GEICO’s portfolio for Buffett and had a terrific long-term track record while part of Berkshire. The track record at his new shop, SQ Advisors, was marred by a large Valeant position which he sold out of this year. One would think buying VRX would be a younger man’s mistake, especially since Munger went on a anti-VRX rant at the 2015 BRK annual meeting, so it was interesting to see Lou get caught by it.
Meryl Witmer, who I think highly of, recommended Axalta at the beginning of the year.
The interview is somewhat misleading since the Barrons.com editor opens by saying “Wouldn’t it be nice to find a stock which is recession resistant?” Meryl mentions that the business is mainly driven by the refinish business, but keep in mind that ~45% of profits are from more cyclical, non-refinish segments. She is right that AXTA was neglected and milked for cash when part of DuPont. The stock was at $25 when she gave the interview in January 2016 and her target was $38, slightly above mine.
Continued debt paydown. Once AXTA reaches its target leverage level, it will consider share buybacks.
Continued accretive M&A.
Achieving all the planned synergies.
Acquisition by industry competitor or Berkshire Hathaway.
|Subject||Re: Re: Clarification|
|Entry||12/14/2016 09:53 AM|
I’ll defer to Wavelet, but imo the worldwide adoption of driverless vehicles will take a very long time to play out.
AXTA is a global business and most of the growth will come from developing countries. Off the top of my head, I think the U.S. has 700 or 800 vehicles per 1000 people while in places like China it might be 100. For the out years of the DCF cash flows will be more heavily weighted towards developing countries as their car parcs grow. People in developing countries first need to be able to afford any vehicle before they can afford a vehicle with the technology to be driverless. I don’t know what driverless vehicle hardware will cost (and of course there will be price deflation over time), but any serious solution will involve multiple cameras and perhaps radar and/or sonar as well plus a bunch of GPUs and more.
A good parallel to think about is the adoption of automatic transmissions in heavy vehicles. Allison Transmission sells an automatic transmission for trucks that is clearly superior to a manual, but penetration outside of North America is very low because the extra few grand is more than people are willing to pay (even when the TCO might be equivalent).
|Entry||12/14/2016 10:03 AM|
You mention autonomous cars as a risk, which is true - but isn't the greater risk the increasing penetration of ADAS like auto-braking and other crash avoidance? Unlike autonomy, this is happening right now and has an impact not only on the installed base, but also on the vehicles that installed base would have crashed into - so the impact on collisions should be ~2x the penetration change (at least in early days).
How might this affect AXTA's business? Have you attempted to quantify this?
|Entry||12/14/2016 09:01 PM|
Very good write up Wavelet. I've looked at it as well, deeply, and haven't bought the stock. Here's my take on it.
AXTA trades at 10x LTM EBITDA. The Refinish business (~50% of EBITDA) is probably a consistent ~5% EBITDA grower, driven by pricing.
Light Vehicle Coatings (~27% of EBITDA), as you mentioned, is facing topping cycles in the U.S. and Europe. The good news is auto cycles tend to flat-line near peak levels for a few years before turning down. So I expect this business to not grow, but not shrink either in the medium term. The thing is, what multiple are you going to put on peak earnings? The cycles will turn down eventually. This segment may be worth 6x current/peak EBITDA.
Industrial Coatings (17% of EBITDA) is facing a slowing macro economy, but AXTA is a small player who is gaining share. This segment probably has modest EBITDA growth.
Commercial Vehicle Coatings (9% of EBITDA) is declining as the U.S. heavy duty truck cycle has turned down. Fortunately, this is their smallest segment. But the top-line pressure you're seeing in this segment today will be seen in Light Vehicle Coatings, which is 3x bigger, at some point in the future...and Industrial Coatings as well.
Add FX pressure to the mix and AXTA likely has 0% to LSD EBITDA growth in the current environment. As you spelled out, their cost cutting programs still have a lot of fat to cut, so my guess is they can sustain MSD EBITDA growth through expense cuts.
The problem is this isn't high-quality growth. And it isn't sustainable. They probably have another 2-3 years of cost cuts to keep EBITDA growing at ~5% with no macro tailwinds, but beyond that it likely becomes an aggressive assumption to keep modeling that out.
A blended 10x EBITDA multiple seems fair to me. Refinish is worth more, but the cyclical businesses are worth less as we're at peak earnings for some of them.
So I basically see a stock at fair value given the current environment. It can rise in line with cost-cut-driven EBITDA growth of ~5%, but it would be hard to argue for multiple expansion.
Carlyle sold its position very quickly. From the IPO in November 2014 to their final secondary offering in July 2016 (where they sold a whopping 18% stake for $1.2 billion at $28.25) it seems like they wanted out of this investment rapidly. While I'm well aware that private equity firms don't hang on to public stakes for long, the speed with which Carlyle (likely the best PE investor in the industrial sector) exited is worth noting. There's nothing of concern at AXTA. Management is terrific and the businesses are #1 or #2 in most areas. I think Carlyle is concerned about where we are in the various cycles (i.e., the late innings).
Finally, I haven't read a solid bear case on AXTA anywhere. Since I always consider the "earthquake risk" to a stock, I'll spell out the bear base here. While it is a low-probability event, there is a scenario where the cyclical businesses turn down in tandem and the stock's multiple goes lower. The downturn in the cyclical businesses could mask the steady performance of Refinish, and you'd be able to buy Refinish at a very attractive implied multiple in this scenario.
Maybe I'm dead wrong here...and let me know if you think I am...but I see a stock with a 5% CAGR on the upside and far more downside risk if you get unlucky and more of its cyclical end markets do what Commerial Vehicle Coatings is doing now.
Personally, I'd rather keep this one on my screen and wait for a better price. My guess is Carlyle did not want to be exposed to the possibility of the scenario I laid out, as they made 4x their money on AXTA. So, I don't see a table pounding risk/reward.
Finally, you looked at FCF after maintenance capex, but AXTA is investing in growth and actual FCF is lower. You get to a 9% FCF yield after maintenance capex, and I'd argue that that's fair, as without growth capex they won't grow much. A 9% FCF yield for no/low growth with exposure to cyclical businesses near peaks seems fair to me.
|Entry||12/14/2016 09:14 PM|
Just read your write up again and am confused by something. You said, ex-cash the FCF yield is 9% (after maint. capex), but AXTA has a net debt position of just under $3 billion. How are you looking at FCF yield?
|Entry||12/15/2016 08:57 AM|
How far above normal do you (or anyone else) think light vehicle production is in the U.S. and Europe? I think US production is above normal but Europe is at replacement demand. On just released guidance, which seems to be based on 1-2% global auto production growth (where AXTA says ‘modest market outgrowth based on company specific opportunities’), the fcf yield using their guidance is 7.4% but >8% if you use maintenance capex and >9% if you back out a working capital use (imo closest to economic earnings). If the U.S. were the only region above normal, we would be talking about ~30% of the sales in Transportation Coatings, which itself is ~40% of total sales at slightly lower profitability. If only 12% of the total were above normal on an 9%+ FCF yield the stock is cheap, especially since some of this FCF can be reinvested at good returns.
|Subject||Re: Re: Re: Valuation|
|Entry||12/15/2016 12:48 PM|
Cool thanks for your views on production rates. I used a working capital outflow (which sounds like it won't happen) but I didn't include the cost saving cash outflow... so basically a wash. Do you have a view on what could ultimately be achieved with productivity enhancements beyond the current programs? They are talking about it more but it's tough to know what is possible. It's also tough to benchmark against PPG b/c their disclosures aren't great.