Due to a recent yet rare negative earnings pre-announcement, PPG—a world class coatings business—is now trading at a historic discount to its main peer and the market at large. I believe this is a good entry to an equity-value compounder that is pricing in a more dire scenario than the market at large. PPG is a mid-to-high-teens ROIC business that grows earnings from mid-single to mid double digit rates depending on where we are in the economic cycle. Since 2005, the earnings CAGR here has been 11%.
I believe PPG will earn around $10/share by 2020 without adding to balance sheet leverage which is already low with leverage at ~1x ebitda and ~20x interest coverage. It won’t happen but if I were on the board, I’d recommend borrowing $7.5bln and buying back ~30% of the company around these levels…This company can probably borrow in Europe at less than 1% for 7- 10 years.
The basic earnings algorithm here is:
Volumes: global industrial production
Price: modestly outpaces inflation
Balance sheet deployment
So figure ~1-4% global industrial production + 1% price + 25% incrementals = low to mid single digit EBIT growth. Balance sheet and free cash deployment leads to high single to low double digit eps growth. This should at least trade in line with the market---usually has traded a premium but the recent dislocation provides the opportunity.
The thesis has the following key tenets:
Roughly 25-40% of the business is operating at below mid-cycle levels suggesting cyclical earnings upside in a meaningful part of the business mix or, at least, less downside that the shares reflect.
The cash conversion is very high as free cash tends to hover around net income creating earnings optionality from investing free cash into value-accretive M&A and buybacks. This is a capital light business with 2-3% capex as a percentage of sales.
Cycle over cycle earnings stability is higher than ever given the shedding of commodity businesses that used to be the swing drivers to PPG earnings.
PPG is a very diversified manufacturer of paint and coatings. It now reports in 3 segments: Performance, Industrial, and Glass.
Performance Coatings is the largest segment and this is where the company reports its (1) refinish, (2) aerospace, (3) protective and marine, and (4) architectural businesses. (1) The refinish business basically is cars/trucks (repair and refurbish), light industrial coatings and is sold through independent distributors. (2) Aerospace coatings include coatings for commercial, regional, and military aircraft. It does this on an OE and aftermarket basis and does so through its own distribution network and direct to customers. (3) The protective and marine coatings business sells to hard core industrial production end markets (metal fabricators, heavy duty maintenance contractors, and ships, bridges, and rail cars). It does so through its company-owned stores, independent distributors, and directly to customers. (4) Architectural coatings basically sells paint for residential and commercial structures. This is the direct comp to SHW core business and products are sold through company-owned stors, home centers, and other retailers. PPG has 920 stores in North America, 685 stores in EMEA, 40 in Australia, and 100 on central America. In addition, they sell coatings to 4000 stores that are operated as franchisees in
The Industrial Coatings segment houses the automotive OEM, packaging coatings, and other specialty coatings end markets that have industrial end markets. A large number of the products here are formulated specifically for the customers’ needs and application methods. Most sales are made on a direct basis.
By geography, PPG has 44% exposure to the US and Canada, 29% to EMEA, 17% to Asia Pacific, and 10% to Latin America.
The transformation the business has under-gone is represented in the slide above which shows that the higher multiple coatings business is basically the entire business now.
Despite this, here is a Bloomberg shot of the company’s relative PE multiple. Equally notable is PPG vs SHW going back a decade. This 2nd picture below is a relative price graph that shows
how differently the companies are being valued right now. N.B. SHW + VAL is a lot more like PPG than legacy SHW vs. PPG