PPG Industries, Inc. (PPG) Earnings Call Transcript & Summary

Good morning. Thank you all for holding. [Operator Instructions] And I would like to remind to all parties the call is now being recorded. If you have any objections, please disconnect at this time. And I would now like to turn the call over to Jeff Zekauskas. Thank you, sir. You may begin.

Good morning. This is Jeff Zekauskas, I'm the chemical analyst at JPMorgan. And I'd like to welcome everyone this morning to the JPMorgan virtual Industrials Conference. We changed the format of our 2020 conference to a virtual one in the interests of health and safety. And thank you very much for attending this morning. It's my pleasure this morning to introduce Vince Morales, the Chief Financial Officer of PPG. Vince has been CFO of PPG since 2017, though he's a 35-year veteran of PPG. Previously, he was the Corporate Controller and Treasurer as well as doing a long stint in Investor Relations. Vince will make some opening remarks, and then we will turn to a fireside chat format. Vince?

Jeff, thanks for the introduction, and really appreciate everybody's interest. And certainly, appreciate the conference, Jeff. Just first, joining me today from PPG, John Bruno, our Investor Relations Officer. John may be reached after this call or any time for any updates on PPG. Next and obviously most topical -- the most topical issue we have is the coronavirus. Most important to PPG is the safety of our employees. We continue with an abundance of caution in all facets of the company. As an example, we were one of the first companies to put travel restrictions in place, dating back to late January. From an overall business perspective, we're a truly global company and have all operations in all major global regions. As it relates to PPG and our customers, our China operations were impacted by corona for the first portion of the month of February, but we've been continually progressing with a safe and orderly start-up of our operations since that time period. I'll remind everybody that coatings is a batch operation. Coatings has very low capital intensity and has a high variable cost structure. As such, we have the capability of easily stopping and starting our operations without much operating cost penalty. We primarily make the customer demand, so we are typically not building inventory in our system when we're down. Just to give some context of the orderly start-up in China. About 3 weeks ago, our China operations were running below 30% capacity utilization. Today, we're approaching 80% capacity utilization, again, solely based just on customer pull. We've evidence most of our large major customers in China also conducting similar orderly start-ups. With respect to raw material supply basis feedback we've received from many of our suppliers, most of our suppliers, both within and outside of China, have continued running their factories for the entire year at near-normal capacities. So we have a strong belief there is, at a minimum, adequate raw material inventory in the system. To date, excuse me, we have not experienced any noteworthy customer demand effects outside of China, but we do expect some impacts towards the end of Q1 and into Q2 in the other major regions. This obviously remains very dynamic, and we intend to provide a comprehensive update on the impact to our financials during the Q1 earnings call. Just shifting to other important PPG aspects, just a quick recap. For 2019, many of our key -- some of our key objectives were to have a strong operating margin recovery and to deliver improved year-over-year cash flow continued with our aggressive cost management programs, deliver organic volume growth and remain disciplined in our use of our balance sheet with a focus on key shareholder value creation. Our scorecard for 2019 read fairly well with strong margin improvement, record operating cash flow and delivery above our targeted cost management goals. From a balance sheet perspective, we completed 7 acquisitions over the past 15 months or so, and we repurchased over $400 million of stock in 2019. We ended 2019 with considerable financial flexibility. And as we sit here today, the coatings acquisition pipeline remains active. We fell short of our organic volume growth targets, but we did deliver strong aggregate pricing of over 2% for the company, which is top-tier now that all of our peers have produced top-tier in our peer group. From a volume perspective, we continue to deliver above-market, in some cases well above-market growth in several businesses or regions driven by our innovation. This included strong performance in our Performance Coatings segment. However, we were impacted in the second half of the year by a noticeable step-down in general industrial demand globally, which impacted our Industrial segment. Finally, and looking at '20 -- looking ahead in year 2020, we will continue to drive the company's top line with a strong focus on innovation. If you look over the recent years, there are periods where we have notably outperformed the market in key technology-based coating sectors. For example, in our OEM, we outperformed with our compact process technology in automotive refinish, with our leading water-based product that's industry-leading today: packaging coatings with new interior can coatings, more recently, in protective coatings, including leading fire -- passive fire protection coatings; general industrial and aerospace with a variety of technologies in 2018 and 2019. In all these instances, we outperformed the market growth rates considerably and for an extended period of time on just volume growth, not including the benefits from the premium product mix. We've all outperformed regionally as well, including Latin America and more recently, Europe, albeit benign overall region. And second, as we are continuing to focus on our operating margin recovery, we expect to get to our previous aggregate operating margin high watermark in the second half of 2020. This includes continued strong cost management of our overall cost structure as well as continued targeted pricing actions. Finally, we remain disciplined in shareholder focus with respect to our balance sheet. And now I'll turn it back over to you, Jeff, for further questions.

Okay. Good. Thank you for that very nice summary, Vince. PPG is one of the companies that reports its 2019 earnings earliest. You assessed business conditions in mid-January, and you've said that what you'll do is you'll reassess your earnings prospects for 2020 when you do your first quarter earnings call. But all things being equal, I would imagine that your vision of 2020 is probably weaker now than it was when you assessed matters in the middle of January. Is that a fair assessment?

Yes. I think for the corona situation, Jeff, certainly, nobody predicted coming into the year this pandemic. It does have a transitory impact on businesses, regions. The open question is, what's the level of recovery? The only visibility we really have is we've been dealing with this in our Asia, specifically, our China operations. So approaching 8 weeks now, we do see that orderly start-up occurring. And hopefully, that continues, and the majority of what we experienced is transitory. There is, in some of our businesses, the opportunity to recover that lost time and certain other businesses that are more time-based. We would say those sales for that 6- or 7- or 8-week period would not be recoverable because they're time-based. It's too early to have any understanding of the impacts beyond what we're seeing in China.

Sure. In your opening remarks, Vince, you said that your utilization rates in the -- in China, which I imagine are primarily in the auto markets, were -- had risen from 30% to 80%. In the normal course of business, where are your utilization rates in China?

Yes. They're a little seasonal just because of the shape of the businesses there. We do have a full array of businesses there, so it's not just automotive. We have a big industrial business there as well, refinish, protective, aerospace. We're typically -- again, we're running the customer demand in all of our businesses. But we typically, in China, be over 90%. It's one of our regions where we have -- and we're adding more capacity because everything we had over there was typically fully utilized so, again, adjusting for seasonal demand trends.

Okay. What I'd like to do is turn to raw materials for a moment. What I hear sometimes is that there's inflation in China TiO2 prices, maybe in part from shortages in ilmenite or for other reasons, and that TiO2 prices in the west, in the United States and Europe, are more stable. Is that your general impression of the TiO2 market? Or do you have a different view?

Yes. I think, holistically, Jeff, we haven't seen an inflating TiO2 raw material basket globally. We haven't seen it in any specific region. The coronavirus -- the timing of the coronavirus coincided with Chinese New Year. So for the first part of January, we weren't experiencing inflation -- much inflation in terms of TiO2 or other raw materials, which you wouldn't expect because there was an intended shutdown around Chinese New Year. And then there was a delayed start-up following Chinese New Year specific around the virus. And at this point, it's just a matter of folks getting people, product in places, and we're not, at this juncture, experiencing inflation. We are experiencing modest logistics disruptions, but we're not experiencing what I would coin as structural inflation.

So TiO2 is -- and I would think that with chloride-based TiO2, Tronox now has more capacity available from Yanbu, and Lomon's got more in China. So in general, there seems to be plenty of titanium dioxide. Would you agree with that?

Well, we think it's more than sufficiently supplied based on the back half of 2019 and the reported capacity and volumes of the TiO2 base. In our experience, the chloride TiO2, that's the molecule -- that's the price-setting molecule. And again, I think both molecules at this point are sufficiently supplied.

Yes. Now oil prices have really dropped over a short period of time, and I would think that, that would make a difference to your raw material basket over the course of the year. Is that what you see as well?

Yes. Just a little more -- probably a little more framing, if you look at our mix of businesses, our performance-type businesses, distribution-type businesses, architectural, et cetera, typically have much less oil content or oil-derivative content than our industrial-type businesses. But we need a prolonged -- we need any dislocation of this nature to be prolonged before it rolls through any supply chain. We're several steps removed from oil. The only thing that's more closely correlated in timing would be freight, diesel cost, some solvents. But for this to have an impact, we need to see oil be at a much lower level year-over-year for a prolonged period of time, and it's too early to make that call.

Yes. I agree that it's too early to make that call. So what I wanted to do then is just give you a little bit of rough math. I don't want to dilute you with numbers. So PPG's cost of goods sold was about $8.7 billion last year, and maybe 80% of cost of goods sold are raw materials, so that's about $7 billion. And then you think how much of the $7 billion are oil derivatives, I don't know, maybe 30%, which is about $2 billion. And last year, Brent averaged $65 a barrel, and today, it's $35. So it's down almost 50%. And so if it did turn out that oil stayed at $35 per year, could that save you $1 billion in raw material costs? I mean, is that the order of magnitude? I realize that you buy derivatives, and there are different timing issues, but when you think about, I guess, solvent purchases or more straightforward oil derivatives, how big is that for PPG, if you can frame that?

Yes. We typically don't get into the buckets. We have a dozen or so major buckets of raw materials, again, differing by business. The numbers are a little lofty that you stated. The $7 billion of raw material basket would be more than we have. But again, we're several steps down the chain from oil, Jeff, really with -- sometimes, when oil moves down or up, that is tempered by supply/demand in the system, and it's being several steps removed. And also, there's regional effects. There's also more -- equally importantly, oil is traded and typically traded in U.S. dollar around the world. So there's currency effects. I think a straight pass-through, as you're describing, we haven't seen in our basket of raw materials, it can either up or down with oil. That would be -- that's too much of a straight pass-through.

Yes. Well, PPG is plainly a specialty company, but in the environment that we're in, investors really are concerned about what the rate of volume decrease might be under various scenarios. And they're also aware that the effects of some of those volume issues are mitigated by lower raw material costs. Your EBITDA last year was $2.6 billion. Like do you have a rough idea of your trough EBITDA if it turned out that 2020 was pretty -- almost like a tough demand year and raw materials came in? Or is it really too difficult to frame that?

I honestly -- I'm not trying to not answer that. First of all, I want to say I appreciate we are a specialty company. We're a company that's truly based on innovation. And our customers understand that, and we get paid only because our customers value the products and services that we provide. And I will go back to my opening comments. We're a variable cost structure. So volumes are certainly important for us, but we do lose a big piece of the costs. If there's no volumes, we're able to easily, on a daily basis, start and stop our plants. We don't incur the raw material costs that you've inferred, we don't incur freight costs if we're not producing or selling. So that variable cost structure, I think, has positioned PPG in the entire coating space well, certainly in times that are dynamic like today. We don't -- it's too early to frame what this means. Again, our only indications, what's happened so far in China, that's been about an 8-week period from early detection through, again, an orderly start-up. We do expect some impact, obviously, in Europe and the U.S. We can't understand the time line to those periods. Some of this, as we -- as I alluded to, some of this we feel is transitory and will return, some of this demand because it's time-based that we lost. Again, it's too early to predict any of that, and there is an offset with respect to what happens in the cost buckets.

So the cost buckets have been things that PPG has really gone after. And I think that in 2020, you expect to save something like $75 million or $80 million net year-over-year. But you -- but in your most recent 10-K, I think what you've said is that you still have maybe $225 million to spend in cash outlays having to do with restructuring programs. So does that mean that it's probably the case that after you achieve your $75 million in 2020, there's probably another -- a comparable amount in 2021 and 2022, given that level of spending?

Yes. The numbers you said, Jeff, are certainly accurate, as I would expect. We do expect $75 million or so in 2020 of restructuring benefit. As we mentioned, when we announced our program in May of last year, this was more -- this was an elongated program for PPG because it involved a variety of our manufacturing footprint and operations. So included in -- embedded in the cash outlay number you cited includes some capital spending. As we're moving production around, we will have certainly some carryover benefit into 2021. Some of those manufacturing footprint adjustments we're making are -- have either just started in earnest or haven't started yet. So they'll carry into 2021 as well that spending. As you're fully aware, if you're moving production around, there's a sequencing process that has to take place, which is you've got to build the gap, build the capacity at the existing facilities that are going to remain. You've got to then pilot the product and get the customer acceptance, and then you could start to move on the restructuring actions. So that's why this program, as we again earmarked last year, would be a prolonged one, 3 years instead of our 2 -- traditional 2-year program. So you're exactly right. There'll be some spillover into 2021. We'll itemize that at the appropriate time.

Okay. So in a world in which volume growth is difficult to come by, is your employee base exclusive of the employees that come to you through acquisitions? Is your employee base growing? Or is it staying flat? Or is it shrinking?

It really differs by business and region. We have some businesses that have been growing. Our aerospace business, our protective business last year grew mid-single to high single or even larger by region. There's other businesses that are modest or contracting. Our way of managing that is through attrition. We -- every one of our functions and businesses who manages attrition basis with -- what we believe to be the demand environment. And net-net, I would say, with the demand environment that existed in 2019 ex acquisition, we're down slightly. That's again primarily via attrition.

Via attrition, yes. I was looking at your 10-K, and I was looking at the financial returns of the industrial business and the performance business, your 2 large segments. And after I adjusted for the goodwill that's embedded in the assets in each of the segments, it seemed to me that the returns were relatively comparable. That is the return on assets. Is it the case that PPG's financial returns by business are pretty comparable rather than there being a couple of businesses that really have above-average returns? Where does it turn out that there are particular pockets of way above-average profitability of PPG in your businesses? Can you give us just a general sense of where the money is made at PPG?

Yes. I think it's a great question, Jeff, because we do get a lot of questions regarding our portfolio, and I think you hit the nail right on the head. Most of our businesses produce similar returns for different reasons. The industrial businesses, which would be automotive, general industrial, packaging, those are very heavy technology-led businesses. Customers pay you and reward you for bringing them technology. Certainly, operational excellence is a key, and they reward you for that as well. Being global is important to them. They want a global supply, consistent product and service, and that comes through with commensurate returns in that business. Conversely, our performance businesses, heavy distribution nature, they are more inventory-centric, having the right product at the right time. There certainly are some technologies deployed there as well. But if you look across our entire portfolio, returns, absent volume and other dislocations or growth, on a steady-state basis, returns in the coating space are generally comparable, but, again, for different reasons. And you can see that, if you look, as many of our peers have a different slant in terms of a preferential business structure. But if you look across most of our peers, even though there's dramatic differences in their business content to different verticals, you can see that returns are generally comparable.

Okay. I want to turn to the auto OEM business of PPG. In very rough terms, how do your revenues divide between North America and Europe and China in an average year?

Yes. On an average year, where it's -- it's almost even, honestly, Jeff. It's probably just below 40% in U.S. and Europe and above 20% in Asia. So not -- it's pretty well spread around. It's a truly global business. We're agnostic as to where cars are made as long as they're made.

Right. And the business performance in China, I would imagine, has been tough in the first quarter in that. I think Chinese auto production was maybe down 20% in January and maybe down to 80% in February. So all things being equal, China auto production maybe will turn out to be down, I don't know, 40%, 50% in the first quarter. Is that your view? Or it's harder to know?

Yes. Jeff, this is John Bruno. Jeff, those numbers are directionally correct. We rely on a third party in China who forecasts builds in China, and they're forecasting about 45% decline in 1Q.

Yes. Can you describe a little bit as to what happens in a market when your volumes -- when your customers essentially shut off? Do the pricing structures stay in place? Is it easy to get raw materials? Do you wait until they start up again? How have you coped with the business conditions in China? Has it been easy for you?

Well, again, I'd go back to what I said at the outset that we are traditionally an industry that has the capability of stop-start on a dime. We -- fortunately, again, this impact occurred following Chinese New Year, so everybody was already stopped in terms of production. It's just a matter of delaying the restart. We restarted in accordance with our customer production schedules. Again, for us, that's not very penal. We started with maybe 1 shift or 3 days a week, 2 shifts, 5 days a week. Those are things we're able to easily do and manage. That high variable cost structure helps us. We have no issue getting raw materials, so we've had no issue getting raw materials to start up. So for us, it was just managing around the customer needs. Again, fortunately, coatings is a high value add in an automotive assembly plant. Starting and stopping the coatings line is problematic. And so we're -- our technicians are in high demand when there's not a continuous process at an automotive assembly plant. So for us, our customers had a high need for us to be up and operational, and that's the value add we provide. That's why this is a value-add product for them.

In your European auto OEM business, my understanding is that there are some newer emission standards in Europe that may affect auto production. Can you describe what's going on in that area and how that might affect you?

Yes. We saw new emission standards come into place at the turn of the year. We knew this would be a choppy first half of the year just because we felt there was some prebuy by having those emission standards. This is on the heels of emission standards that came into place, I don't know, 18 months ago or so. So the landscape in Europe's been a little more difficult to predict what the run rate has been. We still expected Europe to have a fairly decent automotive year production, plus or minus 1% or 2%. Again, that'll have to get reshaped based on what's happening. But we didn't expect the new emissions to have a dramatic impact. That was well-known in advance. Again, there were some prebuy ahead of that in the auto companies, and we believe the consumers were prepared for that. So we didn't -- other than some month-to-month volatility, we didn't expect it to have a big impact on the full year.

What's your opinion about the United States? Do you think -- where do you think auto production will be this year relative to 2019?

Well, we came in the last several years believing it was going to be really consistent year-over-year. And that's been the case, and we held that belief out coming into 2020 as well. We did feel -- we do feel we're kind of around the replacement rate at this point, and I think there's been the last several years from the equity markets a bit more concern, and we've had around the production on a year-to-year basis. From -- really from 2017 forward, we felt we were kind of at that replacement rate level, and that's held the form.

Let's turn to auto refinish for a moment. Is the distribution of your auto refinish sales similar to the distribution of your auto OEM sales? That is, I don't know, larger in the United States and somewhat smaller in Europe and then smaller still in Asia?

No. It has generally the same shape, 40%, 40%, 20%, and the growth market, obviously, is the emerging regions, so Latin America, Asia.

Is auto refinish a deferrable expenditure if you're a consumer? Or you -- or is auto refinish sort of more necessary? That is if economic conditions get tough, do people really defer their auto refinish needs? Or they really can't, in your opinion?

Typically, if you go back to more difficult times like 2008, 2009, the effects you see in refinish, really our inventory destocking, Jeff. Typically, if someone has an accident, the car is out of service. They're in a -- sometimes, they're in a rental car in the U.S., and there's a high expectancy for a quicker repair because there -- the insurance companies are incurring costs for the rental car. Those costs can be minimized by a quicker repair. So there's not a -- there's certainly capability if it's a small blemish on a car to defer that, but most of the repairs that occur were centered around cars that are out of service and incurring other costs. So what you see when there's dislocations is, first of all, such as in China, no one was on the road driving in the month of February, so there are obviously less accidents. The secondary effect is because this goes through 2-step distribution, there can be a drawdown of inventory. But I think on a -- for a normal consumer, if their car is out of service, they'd like to get that repaired and then get out of the rental car, and the insurance company has the same catalyst.

The tenor of that business over time has been volumes. It's difficult to grow volumes, but it's not so difficult to grow prices. Is that the way you view 2020?

Yes. We would classify this as a GDP minus business in terms of volume. This is a business that the customer base, through the insurance company, values technology, innovation and speed of the body shops, and that has a heavy impact on the total cost of the repair. So you do get -- for the major global producers, you do get rewarded for innovation and technology in terms of value. And that algorithm's been in place for many years. You've seen a significant improvement in takt time in the body shops to make repairs go quicker, and that has, again, a very good effect on the total cost of repair for the insurance companies. We've just introduced a new product called MOONWALK in -- primarily in Europe right now, but certainly coming to the U.S. in pilot stages. And it has a further significant efficiency effect in terms of body shop productivity that -- it's an automatic mixing system that allows the most precious person in the body shop, the painter, to be much more efficient. And again, we'll get -- the body shops will recognize that and provide value for that.

In your Mexico paint business with Comex, that was a business that, if I remember correctly, had maybe a little bit of negative volume growth in 2019, but you're more optimistic about it in 2020. Is that correct?

We feel -- the Mexican economy struggled in 2019 and this is certainly a consumer-facing business. Volumes were down slightly in Mexico. We do have, with our model there, our variable cost structure. As we -- as you know, Jeff, we go through what we call concessionaire model, which is a kind of franchisee model in many ways. So we're not sitting on heavy fixed costs. So even though volumes were down slightly, it had de minimis impact because of that high variable cost model we have in Mexico. We do expect the economy to improve modestly because of what we know today. But again, I think, for us, keeping our variable cost model is important.

Are you encouraged about paint in North America in 2020, in that, certainly, the housing numbers have really sharply improved in the fourth quarter and in January? Some of your competitors have increased price in their stores business. Are you looking forward to a good year in paint in North America?

Yes. Again, I agree with everything you said. I think if you look at one of the markets that improved throughout or towards the tail end of 2019, it was the housing market. Both resales as well as new home mortgage interest rates, as we sit here today, are at very low levels. That typically has an impact, not immediately, but within 3 or 4 months. So I think the dynamics, as we sit here today, the foundational dynamics are in place for a solid year, and we still need to see the effect of corona around the world on consumer sentiment. That's the one piece of information that remains outstanding, is what's -- how is the consumer going to react over an extended period of time. We're certainly watching that very closely in China. What happens with consumer sentiment, consumer buying, that will be a leading indicator for us, and that will hopefully give us some insight into what happens in the other regions. But right now, I would say, the statistics you cited, we agree with.

Okay. I think that our time is up, and I very much appreciate you guys being flexible and doing a virtual meeting with us, and we hope to see you in person next year.

Jeff, certainly appreciate your time and the conference and appreciate your flexibility as well.

Okay. Good. Take care of yourself.

Thanks, Jeff.

Thanks, Jeff.

Bye.

And this does conclude today's conference. You may disconnect at this time.