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

As Brian mentioned, we'll have a break after Axalta.

We just got to power right through.

All right. So next up, we have Axalta presenting. Axalta is a global manufacturer of coatings with over about 70% exposure to automotive refinish and automotive OE. In 2020, the company generated $760 million in EBITDA on $3.7 billion in revenue, 240 million shares at about $31, market cap was $7 billion and net debt of about $3 billion. Speaking with us today is Chris Mecray, VP of IR, Treasury and Strategy. Chris, thank you so much for speaking with us virtually this time. We're so -- we're happy to have Axalta.

Carolina, it's a pleasure to be back with you.

Great. So just -- a lot of people know the company, but I did want to start with a broad overview of Axalta and then maybe delve into the segments. But what you do, what do you sell and who your customers.

Yes. So just real quick, Axalta, $4-plus billion sales. We're a little suppressed in mobility today. But we're an old business that has been around for 150 years. If you go way back to some of the predecessor companies, we were carved out of DuPont in 2013. We've been public since 2014. And we operate essentially across industrial coatings verticals. So we are a pure-play industrial coatings company. We have a concentration in a couple of areas within industrial, refinish, automotive refinish. So the collision space comprises about 40% of our sales and a greater percentage of overall EBITDA as that's the highest profitability piece of the company. About 1/4 of the business is in light vehicle manufacturing, so new car plant manufacturing and the coatings and the vehicles there. Another 8% or so of the business is in commercial vehicles. Same thing, OEM, new production assembly lines for trucks and for other nontruck commercial vehicles. Tracked, wheeled anything that crawls or rolls, we will coat. In the industrial end market, we have a catch-all basket of other industrial verticals that we operate in, and that's $1.3 billion in total sales. And some of the bigger pieces of that include about a $250 million wood business. So that's architectural and furniture-related wood coatings, primarily in North America. We have about a $300 million business in powder coatings going, which really serve a broad array of industrial end markets. We have over $100 million business in electric motors serving markets like factory automation, HVAC and wind, but also increasingly electric vehicles. And then we have a basket of other industrial verticals that fall into general industrial liquids, which serve all kinds of things from sporting equipment skis, football helmets, guitars and all the way up and down the chain of industrial verticals from oilfield equipment to architectural, commercial industrial, commercial architectural and other aspects in industrial. So it's an industrial coatings business. We're -- we have some automotive concentration between the Light Vehicle and the Refinish business, but we're increasingly diversified, and it's a very good business with pretty high margins starting in Refinish and cascading down, but a pretty high-margin business, normally speaking, and a really good cash generator and we can get into the economics, if you like.

Great. Perfect. We will get into economics. But I did just kind of want to touch on the Refinish market, which we've talked about today. Can you kind of discuss the -- why your end customer or your body shop would pick Axalta and why you're important to the process.

Yes. So we operate as a leader in the refinish, automotive refinish space and have been so for quite a while. What drives that business, I mean, fundamentally, you have a fairly consolidated set of suppliers, just a handful, really, of top-end suppliers globally, serving a highly diversified set of ultimate end clients, which are the body shops spread around the world, and there are about 80,000 of them around the world. We are providing for them, obviously, one of the critical nodes of the process. So when you get your car fixed, there's a high labor component and a lot of that is just a technical component of changing out the parts that need to be changed. But the critical piece of that is ultimately painting and coating, the new parts that go on the vehicle to perfectly match the vehicle as it comes into the shop. And that ultimately is what's going to satisfy the end consumer and also satisfy the insurance carrier who selected that body shop for that work. So you really having to satisfy those 2 constituents. Because of the competitiveness of the insurance market, they have raised up the competitive standard and the quality standard of the body shop network out there. So for any of you who need to get a car fixed in recent years, you may have been struck by the quality of the service that you received, regular calls and updates from the shop on how things are going. And a pretty seamless process. And that's because that body shop has to satisfy the insurance client. The insurance client is highly demanding and only wants to work with a high productivity efficient body shops out there. So what we do for them, you may think, well, we sell the paint. Great. Okay, we do. But what we do for them is much more than that. Since we're dealing with the most labor-intensive, highest cycle time portion of the overall fix, we're really hand-in-hand with that client at the body shop level, working on and evaluating and improving their productivity as a shop. And that can be not only the shop setup, so leaning out the process of the shop itself but also making sure that they're handling the steps of the painting and coating process in an efficient manner so that they can take the total cycle time of the job down to a reasonable target level. And if they can accomplish that reasonable target level, they satisfy and make happy the insurance client, and the insurance client is, therefore, likely to feed them more business going forward. So they live or die by the cycle time of turning the repairs, which in making happy the USAAs and GEICOs of the world, they will then turn around and feed them more volume. So if you're a well-performing shop, you can really do very well. And these are small businesses where the business owner ends up having a nice boat in Florida or you could do very poorly and be out of business very quickly. So the sensitivity of a reasonably high-margin outcome and a losing-money outcome is quite sensitive and quite determined by how well and how cleanly they get through the coatings process of that job. It's not hard to put a bumper on a car, but putting the bumper on with exactly matching paint done in a reasonable amount of time dictates the economics of the job. So we're there providing that service to these shops not only in individual locations, but fully nationally in the U.S., fully across Europe and across many other regions in the world. We serve over 140 countries globally. And when you put that all together, we have a network and a capability and IP and everything else associated with it that's very hard to match and certainly would be hard to replicate.

Right. And it seems as if those services have helped you take share over the last few years or last while. The other topic that often comes in mind when we've ad Boyd Group kind of presenting here before, just the consolidation in the market, but also those big MSOs using Axalta over maybe someone that doesn't provide those services. So can you talk about the consolidation and MSOs?

Yes. So the insurance market itself has been, as I described, kind of driving higher service levels and expectations of productivity out of the body shops that they work with. And by only working with the shops that meet their expectations, they in turn have driven a process of consolidation at the shop level. So there are body shop owners who, in some cases, own 2 or 3 shops. In other cases, will own 5 or more shops, and we then classify them as a multi-shop or multisite owner. It's just a term we came up with to describe people who are broader in the market and are working for scale instead of just a single location. And now there are network owners like Boyd Group and some other names you may or may not know, Service King, Caliber, who own hundreds of shops and have gradually consolidated the market. Now look, the market is still fairly unconsolidated. So of 30,000 body shops in the U.S., only maybe 3,000 of those are owned by the top handful of MSO players. So it's still a pretty unconsolidated market, but it's gradually moving in that direction. We benefit from that quite simply because we sell some of the most highly productive coatings in the market. And so we have a very good selling proposition to those owners who are trying to put more and more cars through a location. If you coat 50 or 60 or 100 cars a week, productivity matters a great deal. And if you're going to get those cars to the shop, you need a productive solution. We provide that to people. So what we found is that as that consolidation trend has moved forward, we've picked up incrementally more share along the way. So we're highly indexed to that particular theme.

Great. And then just talking more about your growth opportunities. This last quarter, you saw about 9% growth in this end market. Can you talk about that in relation to COVID and then miles driven and what you're kind of seeing at your end customer repair shop?

Yes. So again, Refinish -- this is focused on Refinish, again, 40% of our sales base, just to be clear. We have -- we were severely impacted by COVID. The first time in automotive history that people literally were sort of stuck at home and unable to drive in any full way. So we saw a dramatic drawdown of miles driven, and therefore, collisions, and therefore, business for us in the second quarter of 2020. It did come back fairly strongly thereafter. But we're still working at about a 10% or 12% gap right now in body shop activity relative to normal. And that's largely attributable to a combination of lower congestion on the roads in typical rush hour period. So a little bit less miles driven in historically traffic dense times of the day. And further by a shortage of labor. Like you've seen everywhere, shortage of labor exists in the body shop level. So they're having a hard time getting cars done in a timely manner. And then compounded by a shortage of parts, getting the parts that they need when they need them at the body shop. So the cycle time of getting cars done has extended fairly dramatically, and that's leading to lower overall painting activity relative to normal. So these are addressable things. The miles driven part, the actual car usage is coming back strongly. We need to get through the labor and logistics and supply chain challenges to get that business fully back to normal, which we hope will happen in a relatively near-term basis. We'll see. But it's certainly on a recovery path this year and should continue into next year.

Terrific. And looks like we have a question from the audience.

Yes. Chris, Brian Sponheimer here. I'm curious, you mentioned supply chain before. We've talked about it in the last few days, whether the experience over the course of the last year is leading to some thought within the company of rethinking how they think about sourcing product or sourcing raw materials, where from dual sourcing, et cetera, as we've obviously seen issues, not necessarily from your business, but on the OE side, with suppliers, with the GMs, the Fords, et cetera, all going through various 1-, 2-, 3-week shutdowns and the lack of predictability within the OE side. I'm just curious how that's impacted Axalta and maybe your thoughts on that.

Sure. So crosses over a couple of topics, but it's all interrelated. So first of all, in terms of raw materials and inputs that go into our business, which are basically a set of different chemicals and materials that go into a mixture, we have certainly seen tightness in the markets that we buy from. So everything from solvents to resins and monomers and additives and pigments that we buy that go into the can, they've been very, very tight in part because of supply chain difficulties, also in part because of force majeures, plant outages, hurricane impacts from Ida, the winter storm effects from last winter. You can add it all up. It's a very, very tight market. So we've seen significant inflation in the materials that we buy as well as challenges in procuring enough material to meet our needs. We have not -- essentially, we haven't shut anything down or we haven't shut any customers down because of material shortages. We have been able to get enough product on the inbound that we can make enough coatings to keep our customers going. Now we have had enough issues that some of the inventories on hand that our customers are drawn down so that the buffer stock is lower than it would have been, and we're a little bit more hand to mouth than we'd like to be. So we have materials that we're waiting for that delivery to come this week or else has been an issue as recently as September. So certainly tightness in raw materials, but not to the point where we're shutting any customers down or anything. Now having said that, if OEM were running full steam today and all the businesses are running full steam, it is possible that we would be in a worse shape, but the fact that volumes are down, maybe helping avoid that kind of outcome. But I do think things are getting easier. I think that some of the plants are coming back on. The capacity in the Gulf Coast and the chemical chain is getting a little easier. So we may be getting further away from that critical point right now on the supply side. In terms of customers and where they are, we're clearly -- Axalta has been dramatically affected by the semiconductor and supply chain problems at auto OEMs. So now -- and that's dramatically affected only in the 1/4 of our business that serves that particular area. So just to be clear, about 25% of our sales serves auto OEMs. And we are essentially painting cars for every car that goes down the line and we get paid per car down the line. So that business is perfectly correlated to car production and has been perfectly impacted by the drawdown of car production. Now we hope, obviously, that we've hit the bottom there. And there's certainly signs that the chip availability will be improving as we get into next year. And I guess, I don't know if you've talked about it directly, but it sounds like about a 10% improvement in total global production is anticipated next year. And that's probably just a starting point. And it won't be correct, but at least that's kind of what we're hearing from Ford and others in the last week. And that's encouraging for us. We should expect our sales on a baseline level to increase by that amount accordingly. We have been disproportionately affected in North America relative to other regions. So that has not helped the outcome for our business, which is -- tends to do a little bit better in that region than others. But yes, this has been a fairly severe issue in 2021. And in the last quarter, just reported our mobility business, which includes light vehicle, was essentially at a breakeven level as a result of this fairly dramatic effect this year.

Great. And 2 questions just to go along with those. First, you're seeing the inflationary pressures, but can you just talk about any price pass-through that you've been able to do and just your end customer willingness to take those prices?

Yes. So the inflation environment this year has been severe. We have witnessed what we expect to be about 15% overall inflation in 2021, and that's back-end-loaded since there wasn't that much in the first quarter. So a little bit worse than that, closer to 20% in the back half. It's -- when I say that, it's hard to believe I'm even saying it, 20% inflation in a year, right? I mean it's kind of madness. But we are in a good position as a company. Coatings in general is a good business, us and our peers, in terms of being able to pass on price as needed to cover inflation. In some of our businesses, we can be on top of that within weeks and cover it within a quarter or 2. In a few other businesses, it takes a little longer. But we do have a track record of overcoming and passing through inflation in the channels that we operate with. And we are -- we just reported a quarter with about 4.5% overall net price, which is good. I mean it puts us on track to largely offset inflation exiting the year. We won't quite get there. There's a gap still exiting the year, but sometime in the first part of '22, we expect to have offset '21 inflation on a run rate basis. Now there may be incremental inflation next year as well, which we'll then have to go out and cover with incremental price. But that's the story for the inflation that we've seen in '21. And we're in a happy place there generally. It's not easy to go and get price ever, and it's hardest in the OEM channel, as you would imagine. But we do have index contracts for a good portion of our cost structure with OEMs. We have new products that get introduced continuously each year, which get repriced. And we have new contracts that roll over 25% to 30% of those a year. So within a year or so, we can largely address or at least discuss pricing related to inflation with customers.

And then since you -- it does sound like 2 stories, right, in terms of OE versus Refinish. Did you -- do you provide the percentage of the business on the OE side that is indexed or will be rolling over where we won't see that same type of pressure?

So of the 25% of light vehicle business, about 1/4 of that customer base is on indexed contracts today, and it's increasing. We just started doing that a few years ago. And so at least 1/4 of those customers are largely indexed for the -- certainly the volatile elements of the cost structure, which is great. Another quarter or more are contracts that roll over each year. And then a good portion of the remaining consists of products that get rolled into new products in subsequent years. So that leaves 25% to, call it, 40%, somewhere in that zone of the business that gets direct negotiated on the basis of agreed upon inflation and deflation that occurs depending on where you are in the cycle.

Great. And then just because I said there's 2 stories here because when I looked at your Refinish results this past quarter, given the 15%, 20% inflation we saw, the margin was actually very impressive. Just talk about some of the price pass-through that you did there.

Yes. So in the Performance Coatings business, which is Industrial and Refinish, but in Refinish, certainly, we're able to increase prices. We've done so repeatedly during 2021, and we will be successful in offsetting the inflation this year through price increases. And we saw -- we've seen it in the mid, even mid-single digits or even higher in terms of price pass-through of that market, which has been quite successful. And so that -- so the margins in that business are really as good as ever. And although they are squeezed a little bit short term this year, we're seeing those lift. And then frankly, if we do get a reversal here, if we get a little bit deflation and calming down of pricing out there, then that business will essentially hang on to the price that we do pass through successfully, and it will be a margin expander. So we like to tell people, and thanks for the tee up because I think it's a key point to understand, that for coatings through the cycle, it is not unhelpful or it is helpful to see inflation to the degree that we can pass through pricing because if the average pricing level's lower than whatever peak inflation we're seeing, then it can be a margin expander for the company as a whole. And so when we think about the fact that we put out 2024 financial targets or 4-year targets back in May, it could actually help us get there. You're seeing this inflationary cycle, even though short term, in '21, it's a margin -- a net margin down arrow because of the businesses that haven't yet passed it through.

Perfect. And then you also mentioned the transportation -- or mobility segment is tied to global production rates, but it does seem like you're doing better than some of those forecasts. Can you talk about the results in that line, business retention and contracts.

Yes. We're doing very well in mobility. And Robert, our CEO, noted on the last call that we've actually picked up some incremental business this year. He made the point that we won about 1/3 of the business that we bid on this year, which actually adds in the $100 million kind of range of incremental sales once fully rolled out. And I should qualify that it's once fully rolled out at normal full production rates, not at maybe current rates and whatever those plants are. So getting through the semi thing and looking at normal rates, what we won, would expect to gain significant revenue. And that's really coming directly as a result of a management change that we made in that business. We have a new segment leader in Light Vehicle and Mobility. He brought in a number of people. The depth of relationships that these new folks have had in automotive is impressive. And the value proposition that we're selling and services that we're bringing to the table have been very, very successful in picking up some share this year. So I wouldn't trump at that because we're not doing that at the expense of price, but we have been successful with the new team and going after new business and I guess winning a disproportionate number of the contracts that we've been on this year.

Great. And since during the opening remarks you had, you did mention electric vehicles. It's been a big topic here. Can you just talk about your exposure there and where you plan to go in the future?

Yes. I mean it's a really good news story for us that I don't think is appreciated by the market at all today, I mean really truly. We are on that list of companies that has more -- much more content per vehicle on an electric vehicle against an ICE vehicle. And in our case, we would plan to come out and provide some more information on this and maybe some more granular information about where exactly we operate and what we generate revenue potential. But for starters, we coat and have the majority market share in automotive motors. So the 1, 2, 3 motors that go on an EV have multiple coatings on and within them. But the most value-added portion is an actual resin protective coating that goes on the copper wind in a motor, which provides both energy stability or heat stability as well as conductivity, improves the conductivity by keeping the copper wire slightly separated, which improves both the energy efficiency of the motor and the life of the motor over time. And that's a critical -- really critical functional aspect of the motor, and we have good market share there. That provides a significant increment to an EV versus an ICE cable that has none of those motors in them, of course. We also have some content on the battery and battery-related componentry, and that will provide incremental share as well. And then we're working on a set of new coatings technologies that will seek to get access on some of the other components on the skateboard of that EV. In total, the opportunity for coatings as a whole, I mean you can easily double or more the content per car in an EV versus an ICE vehicle. And in our case, we're aiming to do just that. We're not quite there yet at that level, but I think by the time we've fully introduced the set of products that we're either in with customers with or evaluating and developing, we should be there over the next few years.

Great. And then just to touch on a couple more strategy questions. You have gone through a strategic review. You then have -- you had COVID, but there was a strategy rollout after your strategic review. Can you just talk about kind of big item company decisions, where Axalta is going in the future?

Yes. So we have a pretty robust growth strategy. And the changes that were made in the last couple of years start with some significant changes in the management team. When Robert was appointed CEO, he wasn't able to enact those immediately because we did do a strategic review in '19 and into '20. Since that time, he's both changed out the majority of the senior leaders of the business, which is really I'd characterize as like a freshening. I mean you have new blood and new thoughts and new ways of doing things. And it's been very invigorating for the growth rate and object -- some of the objectives that we've put out for growth in the business. We have a lot of opportunities to refine the growth model and accelerate the growth model. And one aspect of that is investing incrementally and wiser in innovation. So lots of significant innovation investment going in, which then drives the rate of commercialized new products higher in the system. So that's ultimately driving growth, particularly in the industrial segment of the business where we're broadening the business and deepening our penetration into other industrial verticals that we haven't previously operated in. That's a success story, and we're looking at a significant high growth rate, an industrial high single digit, at least, type of growth rate in that business over the next 4 years. In Refinish, we have a bunch of new innovations as well as new business models that we're going after to both broaden the business, and that's introducing a broader product set as well as deepen it. In other words, go into more countries and more geographic verticals to cover the globe with our services even more than we have been. And then in the Light Vehicle, we've talked about taking share in that business by offering a broader and deeper set of products, and we've really proven that out again this year, and we'll see that going forward. So we've set out a range of financial targets back in May at our Investor Day, but the punchline to that was that, organically, before any acquisitions, before any capital allocation, we expect to generate at least $3 of earnings in 2024. It would clearly be higher than that if you start playing with scenarios around capital allocation in M&A and share buyback. So that, at our current multiple, which has been the lowest we've seen since we came public, creates an interesting value story, for example.

Great. Yes. And just one quick question. We had seen some interest in Axalta from some large competitors or in some of your segments. What do you think about consolidation going forward? Is that something we should factor into our thinking?

Coatings is a consolidating sector, has been for a long time, actually. And it's created runway for a number of companies. The Valspar Corporation, for 20 years before it sold to Sherwin-Williams, was a coatings roll-up kind of story. A lot of that in architectural, but also some in industrial. PPG's done a whole series of acquisitions over a 20-year period. Going back quite a ways, many of you know that team very well. Axalta is a newer story to the fold in terms of being independent, external from DuPont. But we've picked up a theme, and we've done 23 acquisitions since we took over the business. Many of those being smaller companies, so maybe not a fair number to really gauge us on. But we've done a handful of substantive deals, including 2 this year. And there are quite a few targets out there. So consider us a coatings consolidator. We are highly cash generative. We have plenty of ability to go and do those. In terms of large strategic combinations, yes, I mean there's certainly a rationale for combining certain companies with others at a larger, higher level. It just takes 2 to tango. You got to get everybody's priorities aligned and get deals done to make those happen. The bigger you get, the harder is to get those things done. But there are combinations that could happen and could make sense. For every larger-scale consolidation deal out there, you then create a whole new set of opportunities from that. So yes, I do expect consolidation, big, small and in between, to continue for some years to come.

Great. Well, we have run up against the half hour. Chris, thank you so much for joining us again this year. It's always great to hear from you. Once again, thanks again.

It's a pleasure, Carolina. Thank you so much.

We will take a 30-minute break for lunch and return with the final 3 presentations at 1:00 Pacific Time.