Axalta Coating Systems Ltd. (AXTA) Earnings Call Transcript & Summary

Good afternoon, everybody. This is Bob Koort. I am the GS chemical analyst that runs the equity research in the chemicals space. I've also got from my team, Anthony Walker on, who works with me on Axalta. And from Axalta, we've got Robert Bryant, who is the President and CEO; Sean Lannon, who is the Executive VP and CFO; and Chris Mecray, who is VP of Treasury, IR and strategy. Now the format, like the rest of our presentations today, Anthony and I will lead a Q&A session. We've got plenty of questions for Axalta. But as clients on the web portal here, you can also submit your own questions via that portal, and we will prioritize those and ask those questions on your behalf. Those are anonymous questions, so Anthony and I will direct those to the Axalta guys.

So with that, Robert, if we could start off, I thought maybe you could just give us sort of as we're going through the quarter here, around the world, look at what's happening in some of your geographies? And maybe if we're taking any cues from what's happened in China, who quarantined and came out first to what might happen in Europe and then in the U.S.

Sure, Bob. I'll be happy to. And pleasure to be on with you as well as everybody else who's dialed in. Think overall, if we look at our businesses in terms of just where we are currently and kind of the path here to recovery, I think overall around the world, we're looking at kind of 3 variables that we discussed. One is just the lifting of stay-at-home orders, and we expect that to result in our Refinish business starting back up a little bit more or coming back a little bit stronger, but more activity and then also new car sales, which would drive production, and of course, the purchase of automotive OEM paint. The second is really the pace of automotive OEM production beyond just testing supplier readiness. There are a number of OEM plants that are expected to come back up in the next couple of weeks here. And as they come up, whether it's for maintenance or cleaning or supplier readiness is kind of a first phase or do they actually go kind of directly into production? I think that's a question mark. And one thing that we'll certainly be watching out there. And then thirdly is just overall consumer confidence globally. We need consumers to be out there buying cars, driving the ones they have. And as we talked about buying and repairing and upgrading their homes, in particular, in terms of our industrial business. In Refinish, on a global basis, obviously, with fewer cars on the road, there's fewer miles driven, fewer accidents. So we need things to get back to normal here to kind of refill the pipe, you might say, with cars. Now we do think that there are some cars that are going in to be repaired that have had minor accidents or have just been involved in accidents more generally. And body shops are open, maybe not all of them open. Many of them have been idled or some of our customers have decided to cluster which shops are open and keep other ones down. But there are still cars being repaired. But just given the overall situation, there may be some sitting on the sideline. But I think we expect to see 2 -- kind of 2 inflection points there. The first inflection point could be as certainly Refinish distribution in North America and to a lesser extent, in Europe, see that things are coming back online and more demand pull from the end customer, we expect them to need to refill their inventory levels, which we currently believe are actually running -- are currently running quite low. And so as they -- as those inventories get replenished, we could see a pretty sizable uptick in purchases. And then secondly, as people get out on the road more and we see more accidents, that would be a second impetus, I think, in that business that we would expect to see globally. We talked about industrial, the overall demand drop has been lower than what we have seen in Refinish light vehicle and commercial vehicle, which, of course, have dropped down more. So the good news is it hasn't dropped as far. But when it does bounce back, the size of the bounce back will be smaller. But they're really segments out within the various industrial markets in terms of how they've reacted overall. In Light Vehicle, OEMs today are carrying -- of course, understandably, they're just in time. So they never really carry that much inventory to begin with. So we can -- we'll see the pull-through demand pretty quickly once they move beyond restarting their operations to test supplier readiness. And as we go forward here in the fall in the upcoming weeks as -- if the OEMs actually do bring their plants back online and begin producing vehicles again, that will be one important milestone; and then two, exactly how much -- how many vehicles they produce which will, in some part, be a function of consumer confidence and people getting back out and buying vehicles. And so we'll be watching, as I'd mentioned, kind of automotive dealer inventory levels as well as consumer signals pretty closely. Commercial Vehicle, not that much different on the heavy-duty truck side compared to light vehicle with the demand pullback, but we do expect to see Commercial Vehicle plants come back online, potentially a little bit more easily than some of the light vehicle plants just because there are fewer suppliers involved in the overall total number of suppliers to put together any given vehicle and also based on certain customer feedback that we've received in the marketplace. As far as your question on China, I think as we mentioned in our earnings call, we did see Refinish down about 46% in the first quarter given the impact of COVID and where it started in China. But in the month of April, we did see top line sales up some 14%. So that was pretty encouraging in terms of how quickly it can bounce back and by how much it can bounce back.

That's terrific. I have a bunch of questions on the businesses, but to honor my comment about giving clients first pass. There's questions about the evolution of the exploring all options strategy and your conclusion to stay the path. Can you give us any more detail about what was considered or why the conclusion was to keep on with the existing strategy?

Well, I was saying that we had a strategy in place that we were executing against. And then when I became CEO in late 2018, we did a complete strategy review and a reboot at that time and worked through the strategy that we're currently executing on internally. Unfortunately, we started this review of strategic alternatives. So we didn't really get a chance to talk much about that -- about the new strategy with the broader investor community out there. But what I would say is, in the strategic review process, we went through and really did an exhaustive review of all of our businesses and all of our regions and looked at growth potential, margin trajectory, competitive dynamics, risk of substitution, technical trends. We looked at pretty much every aspect of the business during the strategic review and looked at what we thought we could do organically, what we thought we could do inorganically, areas of the business where it might make sense to form an alliance of some kind or a joint venture with the business, perhaps with another party to accelerate growth, kind of everything was on the table. And then certainly, from a capital allocation perspective, all options were on the table, and we looked at that. And so I think we were pretty exhaustive in terms of the approach. Unfortunately, in light of the dislocation in the global markets caused by COVID-19, the Board ultimately decided that concluding the strategic review at the end of March was in the best interest of shareholders. I do think we have a lot to say regarding the direction of the company, in particular in terms of top line growth opportunities as well as further value creation through adjusting the company's business model and cost structure. And as we come out of COVID at some point and the focus shifts from being around balance sheet strength and liquidity and more focused on growth trajectory and how COVID-19 -- what dislocations it may have created in the markets and what opportunities that creates for us. As we get on the other side of that, we're very much looking forward to talking about that with the investment community, and we have a lot to say about that.

That sounds like a good teaser for an Investor Day.

We're right now on the Goldman Sachs Industrial Materials Conference. Maybe you could share your insights.

I tell you, if we could -- if the timing were different, it'd be a great platform, Bob. We'd love to do that.

Well, let's start going through the businesses a little bit. We've written a little bit more assertively about Axalta this past week. And part of our lead story was just that the Refinish markets could see a relatively quick rebound as people start getting back on the road and driving again and that amongst all the paint end markets and businesses, Refinish is definitely one of the strongest. I was wondering if you could help us understand, one, is that true? And why is it true? And then can you frame Axalta's position within that Refinish ecosystem? What do you guys do better, best, worse? Where are there opportunities? Sort of what's the direction and secret sauce to your Refinish operations?

Yes. So let me start perhaps in -- a little bit in reverse there. As you know, we are the #1 leader -- #1 player globally in the Refinish market. A lot of that market position is -- it's based on a multitude of factors. One is we have the most productive water -- high premium waterborne coating system in the world. So it allows body shops that are focused on specifically maximizing their productivity. It allows them to achieve that better than any other paint system out there. So particularly with the multisite operator segment, larger body shops, people that are spraying waterborne have a certain amount of breakeven volume or above that to spray waterborne and make the investment in waterborne spray booths and other equipment and training and so forth. We have the best product out there to be able to do that. Our technical sales and service support is bar none the best in the industry. We have the ability to diagnose quickly any of the potential issues or problems that any of our body shops encounter. And we're also working continuously with our body shops to provide education, technical training and pretty much any support they need not only in the painting aspect of the body shop but also just overall body shop management and administration, we're able to help our customers a great deal. And then in certain markets, we have a distribution model that we feel is favored and allows us to really have, in the case of the U.S., a national distribution system, which is so important for certain of our customer segments. So all those things together allow us to have the market position that we do. That being said, we're not resting on our laurels, and we have a number of products in development in the Refinish space, both in waterborne as well as in solventborne, to continue to keep us at the forefront of the industry. We're certainly not resting for a moment and thinking that our competitors aren't trying to catch up there. But we intend to maintain our lead. In terms of the bounce back of the market, I think, Bob, we have -- we also have a favorable outlook on the bounce back of the Refinish business. But it will largely be dependent upon how -- when people are actually able to begin circulating again and when some of the stay-at-home orders are lifted. China gave us an interesting data point in terms of the bounce back that can occur in the markets. So we think that, that will be a favorable dynamic for us. And we also expect to see -- if you look at the segment of the population that travels via public transport, some people that use public transportation do so for financial reasons. It's what they can afford, and they can't necessarily afford to drive a car. Other people can afford to drive a car, but they choose to take public transportation for convenience because it's a lower commute time to work or other factors. And we certainly do think that coming out of COVID-19 that things won't necessarily go back to normal for some time in terms of people's willingness to be as close to other people as before. So we do think that, that could result in people being willing to engage in longer commute times or do more of their errands and other activities, taking kids to school, et cetera, using their own vehicles. So that would, of course, be more miles driven, potentially more accidents and a better -- more revenue for our business there. But again, the pace of that potential recovery is entirely dependent on the stay-at-home orders being lifted and kind of the overall pace of that recovery.

Rob, it's Anthony Walker. And I was particularly struck by the comment of demand in China going from down 46% to plus 14%. I think it is indicative of the type of snapback, which you can potentially see. But I also wanted to follow-up just on the longer-term trends for the business. If I think about miles driven in some of the more developed markets, it's been at plus or minus 1% for years. And the growth has really come from the continued growth of car parks in the emerging regions. So maybe just walk us through the differences in your business and your technology as it relates to the Asian markets, the demand for premium products in those areas and also waterborne coatings in Asia as well?

Yes. It's a good question. I think -- and just let me touch on kind of developed markets first. As you said, you've seen sort of miles driven at lower rates in the past several years in the more mature markets. And so what that really has necessitated, and I think we've been responding to well is that we expand the definition of what business we're in. And if you were to go back to this business when it was owned by DuPont, they would have told you this is a premium Refinish business. And if you limit yourself to strictly the premium segment, then you're only going to have a certain amount of growth. We've expanded our definition to include the mainstream and even the economy segment in some markets. And so that will and should give us some additional growth that we might not have had otherwise. The other element from a definition of the business is exactly what business we're in. And it's a lot more than just selling -- than selling Refinish paint. There's a whole cadre of services and other elements that we provide. And I think constantly looking at how we define the business and how we actually charge for our products and services is something that is part of ongoing discussion. Now in Asian markets, as I think you all are aware and we've talked about before, kind of 60% to 65% of coatings demand over the next 10 years is expected to come from China, Southeast Asia and "emerging markets" in general. But it's predominantly China, India and Southeast Asia, where the majority of that growth will come from. But there's going to be an outsized amount of growth that will come in the Refinish business from those markets, just given demographics and the relative size and growth rates of middle classes in those markets. And so the key thing there is not only the premium and the mainstream and economy offerings, it's having not only waterborne products but also solventborne products that meet people's needs. And the increasingly demanding -- more demanding environmental regulations that we see in markets, especially like China, really demand that we continue to innovate not only in waterborne, but especially in solventborne products. So we've actually been able to develop some very good products in solventborne coatings that actually meet the VOC requirements or limits that are being put in place by governments across Asia. And why is that important? It's important because not every body shop should spray waterborne coatings. They're more expensive, requires a higher skilled painter, requires a greater investment in spray booths and overall maintenance of the waterborne coating business for a given body shop, waterborne painting is a higher kind of cost of maintenance than solventborne. So the important thing is to have good solventborne products that meet those environmental requirements, which we do. So if we execute on those, then I think we will be -- continue to be very well positioned and grow in emerging markets.

One -- asking you to put your crystal ball hat on again. One potential impact from COVID-19 is the stress that could potentially come from smaller players in the market not having the liquidity and the ability to maintain their operations and stay in business. And so within the Refinish segment, how do you think about the potential for consolidation amongst the body shop customers that you serve? And what, if any, impact that could potentially have on your business?

Yes. It's a great question. I'd say it partially depends on the duration of COVID-19. So I think if we see COVID-19 able to resolve itself here in the next few months -- and again, I'm kind of being pretty forward-leaning here in terms of offering a view. But if we see that resolved in the next few months, right, you've got a number of smaller body shops and body shop operations that are essentially on the sidelines and many them have idled their operation. They temporarily furloughed their workers or taken pretty dramatic pay cuts. And I think they're able to kind of wait out taking those actions. They're able to kind of wait this out. If we were to see a COVID-19 situation that lasted materially longer than that, then I think you could see some of the smaller body shop players be forced to sell. And to the extent that some of the larger players in the market had enough liquidity, they could step in and acquire some of those body shops and you could see some consolidation. My personal view though is that, is that an additional 5% of the market that's consolidated? Maybe. I don't think it's an additional 20% of the market that's consolidated or something of that magnitude.

That's great. And then maybe just rounding out kind of thoughts on Refinish. As you think about the competitive landscape and the manner in which you go to market, there have been, it seems, some differences and expectations around where inventory levels in the channel sit at present. So can you maybe just walk us through kind of what gives you confidence in your inventory levels amongst the distributors that you're working with being somewhat lean as we exit this crisis and think about the potential for recovery across other markets outside of China?

Yes. So understandably, I mean, if you were in the paint distribution business today and you were in the situation we're in and distribution business is, by its very nature, a thin margin business and a working capital-driven business, you're going to try and limit your purchases in order to maintain cash flow. And I think it's -- whether it's in the U.S. or whether it's in Europe, in markets where distributors play a bigger role or in some markets in ASEAN or I should say in Asia as well, where it's an importer or a distributor model, we've seen that across the globe. Distribution fundamentally lower or stop the amount that they're purchasing right now because activity is just so low at this point in time. So you see the -- those levels drop. Well, that really only becomes -- that only becomes an issue if at the body shop level, you see activity, demand, accidents really pick up. And then you've got distributors that don't have enough inventory and they can't service those body shops. So I think overall, globally, we have seen a reduction in inventory levels at distribution, which makes complete sense given the market we're in. And hence, my earlier comment about the 2 inflection points. One, when there's a clear signal that we're going to start back up and distributors need to restock in order to meet minimum service levels for their customers, I think that's one big jump up in demand that we'll see. And then the next one is really to kind of filling the pipe, as I call it, where people begin to get out and drive and have accidents and you get more of a steady flow, and you burn down some of that initial inventory restocking. I think that's another inflection point.

Robert, it's Bob again. Maybe just one last Refinish question. You mentioned the waterborne coatings, Refinish and there's high solids and those sorts of things. Where are we in terms of that sort of new product or alternate product penetration globally? How much have we gone? And how much is left ahead of you where you can leverage that technology?

So from a waterborne perspective, in terms of -- if you look at Europe, it's predominantly a waterborne market. If you look at the U.S., it's a mixture of waterborne and solventborne. If you look at Asia, it's predominantly a solventborne market with pockets of increasing amounts of waterborne. I think in terms of the major shift that we've seen going from solventborne to waterborne coatings due to environmental regulation and also just preferences of body shops that are at a high enough level of activity to actually justify the investment and realize the efficiencies, I think in terms of the major paradigm shift that we've seen that. What you will continue to see from us though is continued improvement of the waterborne products. And then also, it's important to remember that when we talk about waterborne, waterborne is really the base coat. When you look at clear coats and when you look at primers, for the most part, clear coats and primers are still predominantly solvent-based products. And from a technological perspective, our goal is to have both of those layers being waterborne as well, so that we have a truly 100% waterborne system. So I think that's an important point that from a technological development perspective and trajectory, we're working on having all of the layers be water-based, not just the base layer.

Got you. Maybe shifting over to OEM. Can you talk about your competitive positioning in each of the major geographies and any particular trends, maybe like those environmental trends that are driving business, if at all?

Yes. I mean, as you know, we're one of the top 2, 3 coatings players in the Light Vehicle business -- Light Vehicle OEM business globally. Very strong player in that market, well positioned in both the U.S., Europe and Asia. Haven't really seen too much change in terms of the overall competitive landscape in that business. The main thing I think we're all watching, of course, is to see the signals from the OEMs in terms of when they actually restart. And then when they say restart, what does that actually mean in terms of actually getting back and producing vehicles at a certain level? That's kind of, I think, what everybody is watching. We continue to invest in that business heavily from a research and development perspective. And we also continue to invest in our consolidated systems platform, where we are the leader in the industry in terms of removing one of the paint steps from the painting process in Light Vehicle plants and, therefore, saving valuable plant investment, equipment investment, labor and energy for our Light Vehicle customers. So we continue to innovate in that business.

I've got an investor asking, does it make any difference to you the evolution of EVs in terms of your product demand?

Actually, it does. At the margin, for every electric vehicle that's developed, we have a very large -- besides a little business and a business in which we've won a lot of innovation awards, as you all have probably seen from our press releases over the last couple of years in our Energy Solutions business, which is predominantly electric motor coatings. And we have a full suite of products that go on all aspects of electric motors. So if we see more of a shift to -- away from combustion engines to electric engines, that's actually very good for us. It's more content per vehicle and could enable some interesting -- further synergies between our Energy Solutions business and our Light Vehicle OEM business. So I think that's something that as we continue to see the market develop, it would be favorable for Axalta.

Robert, switching gears. It's Anthony, again. I was curious just on price raws. It's obviously been a material headwind really from '16 through parts of '18 and even into '19. And -- but we've seen oil prices retreat pretty significantly over the past 6 months. How should we think about the timing of that potential benefit and also the magnitude that we could see flowing through your P&L, I would assume, mostly impacting the back half of the year?

Great question.

Robert, I'll take that. Let me take that, Robert.

Sure, Sean. Go ahead.

This is Sean Lannon. Yes. Certainly, we saw raw material headwinds really peak in the back half of '17, throughout '18 and even into 2019. We've started to see some marginal benefit year-over-year in, I think, September of 2019. But 2019 clearly was a headwind when you look at the full year. When we think about price raw recapture, as a total company, when we got into third, fourth quarter, we were largely caught up, and it was probably a little bit -- we were definitely behind on the transportation side. But performance was making up the difference to get to us on net breakeven. When we think about the dynamics that we're in right now, the uncertainty around the benefit accruing to our P&L is really a feature of the demand outlook. Certainly, if we were to be buying raw materials today at current prices, there's clearly a benefit versus prior year. But given we don't know what that demand environment is, it's hard to know exactly when we're going to be buying those materials and when they're going to be turning into the P&L. The other thing to simply put it, we have $600 million of inventory sitting on the balance sheet, so 2 to 3 months' worth of inventory. So by the time we actually start buying it and then for it to fully flush through the balance sheet, it's a few months down the road. So there was a handful of questions on the earnings call. It's just hard to see that turning in the second quarter. If demand recovers, you could see a benefit in third quarter, but likely not into the fourth quarter. And to be able to give you a tangible box, it's just really difficult given the environment we're in right now as far as what that benefit would be.

Guys, maybe one last one here before we run out of time. You -- in response to some of the COVID weakness, you announced some pretty aggressive cost containment efforts. From the outside, we always thought you're already fairly lean and mean. So can you talk about exactly where you're achieving those cost savings? And then how many of those -- how much of that is temporary that comes back then as the business recovers?

Yes, this is Rob. I'll take that. But Sean, if you want to go ahead?

Sure. Yes. So we called out $100 million in cost actions. And the majority of those are temporary. So we've done hiring freezes. We've tried to reduce third-party spend. We've tried to reduce contractor spend. And then there's a big portion inherently with the virtual world we're living in, travel and entertainment has essentially come to 0 as well as we've put in a number of temporary labor reductions, which is inclusive of 20% salary reductions for 4 months for the executive team, furlough programs, short work week, reduced hours. And all that in the aggregate has amounted to about $100 million, which, again, the majority is going to be temporary. I think we all are learning a lot and how to navigate this virtual world. So the hope is we'll be able to structurally hold on to some of these savings. But again, by and large, the $100 million is largely temporary. And the other incremental actions above and beyond the $100 million, we put in a number of discrete actions around generating additional cash flow. And we quantified above $125 million. And that's across a number of areas, the largest being CapEx. We chopped our guidance from $160 million in the beginning of the year down to $80 million. So we're looking under every rock from a cash flow perspective, making sure that we maintain a really good liquidity position.

Excellent. Well, we really appreciate you guys participating. Hopefully, next year, we can do it live and in person. Robert, Sean, and Chris, thanks so much, and you guys have a great day.

I appreciate the invitation. We also look forward to the opportunity to be able to do it in person, Bob, and spend some more time together. So thanks, again, for everybody's time today.

Cheers.