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

Good morning, everybody. This is Bob Koort from Goldman Sachs, I head up the U.S. equity research effort in the chemical space. Joining me from my team is Anthony Walker, who helps me cover PPG. And from PPG, in addition to John Bruno from IR, we've got Vince Morales, who is Senior VP and CFO. And Vince, I thought maybe we could start out -- I should also remind all the clients on the webcast, there is an opportunity for you to ask questions. There's a question box there, and you could submit those. We'll prioritize your questions first. But Anthony and I have a long list here that we'll ask if you guys don't ask them yourselves. Maybe first to start off, Vince, you guys are very big and broad and diversified consumer, industrial end markets global. Can you just give us a helicopter tour around the world as we sit here in mid-May of how they're developing around the world?

Sure, Bob and Anthony, thanks for having us. I think we've attended the Goldman conference for the last at least 10 consecutive years. It's a great conference. So I appreciate it. Again, joining me today is John Bruno, our Investor Relations Officer. Just quickly, Bob, I'll maybe speak for a minute or 2. But as we've seen this crisis progress, so starting in China at the end of January, February, move into Europe, U.S. and now Latin and South America, we're seeing it unwind in a similar fashion. In China, we are close to normal, back to normal, both from an operations perspective and based on recent data points, retail activity in China is resuming at near-normal levels pre-crisis. The most recent data point is I think last on the month of April, auto sales were actually up for a full month year-over-year versus 2019. All of our factories are up and running in China, have been for quite some time and are running at normal rates. And based on anecdotal evidence and feedback from our teams over there, the consumer has been out in force in following proper safety safeguards, but has been out in force in the major cities and miles driven has returned close to normal levels. So I think China has followed a path to recovery that we hope is emulated in other parts of the world. And again, that's both on our manufacturing or OEM side as well as consumer side. There's still some businesses that remain weak like air travel. I'm sure we'll get into some of those specifics momentarily. If we moved into Europe, which, again, was the next region that was impacted, we are starting to see probably 2 weeks ahead of the U.S. what I'd call measured startups country by country. Again, there's different enforcement actions or restrictions in place based on the country. We are seeing, as things start up, an initial surge of activity especially on the architectural side as there was projects probably in flight prior to the shutdowns. And now there's a certainly a willingness and ability to get those completed in short manner to help incite revenue for some of the painters. Car production is starting up in earnest. And so again, a similar pattern to what we're seeing in -- what we saw early on in Asia. And then people are probably more intimate with what's happening here in the U.S. But again, it's spotty at this point. Again, as things start up I think on the state, we do see certainly some activity. The major automakers are scheduled to start up next week. Again, they'll be starting up at reduced rates. And then we'll see, I think, some return to production based on demand. In Latin America, went into the crisis really in April, so they had a full first quarter. Again, the restrictions there are very spotty, depending on whether you're Latin or South America. But our estimation at this point is it will follow what happens in the U.S. by probably 2 or 3 weeks. So that's a quick walk. And I'm sure we'll have some questions around that.

Yes. And obviously, lots of end markets discuss and segments you guys have. But maybe before we get deeper into the dive, you guys pursued a strategic review last year. And I was just wondering if you could talk us through the portfolio you guys have to go to, what the virtues or challenges of having that diversified portfolio and sort of what the broader strategy is going forward.

Yes. I think from a portfolio perspective, Bob, we're certainly comfortable in all the businesses we're in. These businesses, some of them are typically over the course of a recession a bit more stable, some are a little bit more volatile. But you build a portfolio for the long term. And some of the more cyclical businesses typically have some kind of moat around them, typically, it's technology. That moat over the course of several number of years allows these businesses to have a more than adequate return profile, both in margins and return on capital. Some of the more stable businesses probably have a little less moat, a little more brand-centric but they don't have the same cyclicality in a traditional recession. We're seeing, in this recession, that be a little different. It would have been very difficult for anybody to predict miles driven to be down 50%, 60%. Would have been very difficult for people to predict a lot of the commercial businesses would be closed for a period of time, which would hurt architectural repaint. So again, I think we're building a portfolio for the long term. We favor businesses with high technology content. And some of those are a little more cyclical, some of those are a little more stable. So again, we're comfortable with the portfolio as it is today.

And how do you balance being opportunistic here when maybe some valuations have come in and there's a little anxiety in the markets versus maybe being more prudent around deploying the balance sheet? Maybe talk about your -- the tone of your M&A discussions or your excitement to do something near term versus waiting?

Yes. Again, I think we're -- we have a very strong balance sheet, a lot of liquidity. It's a good position to be in, in times like today. If there is an opportunity to create shareholder value, we'd certainly look at that. But our focus right now is on liquidity, maintaining a strong balance sheet as we still don't have a lot of what I'd call midterm business visibility. The coating space is a little unique, Bob, in that we don't find a lot of distressed assets like you would find in some other industries. So we're not expecting an uptick in activity. I would actually say, we expect more of a pause of activity just because it's a good cash flow business. Most of the smaller companies can hunker down. This is a batch process, you're able to really drop your operational costs along with demand. And in prior cycles, we didn't see -- we actually saw a pause in M&A as opposed to an increase in M&A. There'll probably be a few folks out there who, just due to nuance, maybe over extended, they may have built a plant or something right before the crisis. But I would call those more on the edge as opposed to the norm. So again, our expectation is there'll probably be a pause here in M&A activity. Again, we would look at something if it came across our desks, but I would say that's probably more unlikely side as opposed to a likely side, which would be the case in other industries.

Vince, it's Anthony Walker. I thought you provided some extremely helpful slides with the first quarter earnings. And in particular, we and I think a number of clients really focused on the chart that you provided that related to the expected pace of recovery across your various end markets. Maybe just talk through some of the variables underpinning the expectations that you have across the segments. And I think in particular, given the comment that you made around miles driven returning back to normal levels in China, what informs a view of having auto refinish at the slower end of the spectrum in terms of what you expect going forward?

Yes. Sure, Anthony, hope you're doing well. Well, first of all, John Bruno deserves credit for the slides. I won't take any credit for that. But now, if you look at our -- these were our prognostications. This is a different crisis than we've seen in the past. There is certainly different drivers at play today. If you look at the chart, it's in our slide deck on our website, but we said that we expected the longest lead -- longest recovery to occur in aerospace. I think people can understand that. The passenger miles on planes is well down. That will come back, in our opinion, over time. And hopefully, there's a vaccination to come back earlier, but we were not betting on that. So we expect that to moderately return, but again, with a normal consumer precaution. Auto refinish was the second business we said turns the longest lead time. And this really is a reflection of our view at that point and still today, it will take some time for work from home to subside and people to fully go back to work. We are seeing that in China. Our China -- for example, our China offices are open, everybody's coming in. But we think it's going to be a little longer in other parts of the world. And more importantly, there's this question of how much will return back to the office over the midterm. Again, we've seen miles tick up in China. We are seeing folks shy away from public transportation, which is natural. That's, I think, if that continues to be a harbinger for good OEM sales and good miles driven. But what we really need in order to drive collision rates, this is a little bit unknown at this time, is the density of cars during rush hour. Most accidents occur during rush hour. So as miles driven come back, it has to be during those peak periods in order to drive collision rates. Again, we think that will take some time. We hope it does come back. And then beyond that, we know that the inventory for refinish paint did spike up heading into what was expected to be a peak season, so heading into Q2. So we have to work through some inventory. That is a distribution channel of business so there is some inventory in the channel, which, again, is some reason for the elongation of the recovery.

Got it. And then maybe just think through some of the variables on the architectural side. Bob and I have been remarking over the last several weeks and the month that every time we pass by a Lowe's or a Home Depot, the parking lot is absolutely full. And so how do we think about the variables and the trade-offs between DIY and professional painting? And how, within the U.S., that specifically affects PPG's business?

Sure. Sure. I'll let John give the stats on our size of DIY and trade in a minute. But look, this is no different than what we saw in 2008, 2009. As unemployment goes up, there's a shift from trade to DIY. As unemployment comes back down, so go back to 2-wager families, there's a shift back. So we've said for the last 4 or 5 years, part of the shift to trade was because unemployment was so low in the U.S. And so again, this is just a normal ebb and flow of those kind of 2 end markets. We expect trade to continue to be a solid market in a normal state of affairs, continue to gain share, but we need to see unemployment number come back down before that happens. We agree with you. The DIY business has been strong, very strong since the inception of the kind of stay-at-home edicts. And the trade business, some of that's cannibalized trade. And John, maybe you can give some of the numbers for PPG specifically.

Yes, absolutely. So in the U.S., DIY is around 45%. We do get a benefit by having a good presence in the independent dealer channel as well, and their DIY volumes have been robust in the past couple of months. And as everybody probably knows, the most hardware stores have been deemed essential in those states so they remained open. In Europe, our DIY is closer to about 1/3, so 35% of our volume activity.

And then I'll just add one more thing. We're not only seeing DIY up in the U.S. We're seeing DIY up in Europe, although it's a smaller market there. We're seeing DIY up in Australia as well. So all the mature regions where there's a strong existing DIY presence, the same phenomenon exist.

And John, since you were accredited with the slide Anthony referred to earlier, can you give us some insight into why that trade market in Europe would come back faster than the U.S.?

Yes, Bob, I think the one anchor we see in the U.S. is commercial maintenance. Commercial is about 30% of the U.S. market. And if you think about hotels, restaurants, retailers in general, most of these guys aren't even open today, they're all trying to preserve cash. So we're just concerned that they're not going to be painting or prioritize painting in the near term. Now that will ultimately come back. But in Europe, it's a different maintenance cycle. They have different kind of priorities, and we would expect that to come back quicker than it does in the U.S.

Maybe shifting over to some of the other end markets. Obviously, the auto OEM markets crushed in the very short term. But what have you seen in terms of China opening back up from an auto OEM standpoint? And then what do you expect to see in Europe and the U.S. there?

Yes. In China, in China auto market was shut down basically, first 2, 3 weeks of February. We -- then the industry went through a measured startup. I would almost call it linear, it started at maybe 10%, 15%, 20%, and then it's ramped up. And if you look at the month of April, the entire month, so 4 weeks of data, the industry actually had increased year-over-year auto sales, as I mentioned. So for the full month, sales were up for the first time in almost 2 years versus the prior year. Production was not up as much as sales were. But production was also good for the month of April, and that's continuing as we enter into May here. So again, natural startup. We do see in China probably now 2 dozen individual government incentives to help incite additional auto sales. Some of those are license tax -- or excuse me, taxes. Some of those are license, freeing up licenses. Some of those are EV-driven. So again, we're seeing a lot of incentivization around automotive production, which again happened in 2008, 2009 in a lot of parts of the world. Europe -- U.S. is starting up next week. Europe is starting up as well. Again, everybody is starting at a low base, probably for the next couple of weeks. We have to see what the consumer does as there are dealerships are opening up in the U.S., et cetera. So it's -- the jury is still out, but we do expect a bump of activity here, and then it's going to be based on what consumer demand is.

It's Anthony again. As you think about the aerospace business, that's another area that's seen some pretty significant headwinds here, I think, in the near term. And we're starting to hear more about MAX cancellations, in particular for Boeing, which comprises a decent amount of the forward order book. Just maybe talk about your outlook for that business coming off, what were particularly strong in 2018 and 2019 periods from a volume perspective?

Yes. Yes. First, kind of the composition of our business, and we did a deep dive on aerospace almost a year ago today, and it's on our website so there's a just a plethora of slides and details out there about our business and the industry in general. But if you look at our business, 30% of our business is military. That remains very solid as an end market, and we expect to outpace what is a growth market in 2020 for military. The remaining important part of our business is equally split between commercial OEM, commercial aftermarket. The aftermarket business, obviously, is down. It's not down as much as the normal indicators would lead you to believe. Normal indicators are passenger miles, which are down considerably. We care about planes being flown, so whether a plane has 140 people on it or 1 person on it, doesn't matter. The maintenance of that plane has to occur on a normal interval as required by FAA and equal bodies around the world. So we care about planes in the air. Now those are still down a lot, but not as much as passenger miles. Again, the return, as I said earlier, that is still in question. But we do know that over the last 2 weeks or so, the airlines have returned. The airlines took about, I think, 17,000, 18,000 planes out of service. They've returned about 2,500 planes of service over the last 2 weeks. So again, there's more planes being flown, which should temper somewhat the declines in the aftermarket, although there'll still be declines. In terms of the OEM book, totally agree that the back end of that book is certainly being truncated. There's still enough activity for the next several years as they work to start back up we do expect that obviously to be paced based on the backlog and based on the -- as visibility clears up. Most of these new planes are going to Asia. And again, we expect -- hopefully, some return on normalcy, hopefully, a vaccine. And if that's the case, we expect growth to resume at some point because there's still a -- I think the stat we gave last year was only 5% of people in China have ever been on a plane. And so there's still a significant amount of opportunity for growth over the long term.

Maybe just wrapping up performance. I think one of the brightest spots of the quarter was the success that you continue to have in terms of pricing. Obviously, volumes here in the second quarter and for the balance of the year could be a little bit pressure, but talk about your success and your ability to continue to get price despite the volume headwinds that you're experiencing?

Yes. I think we came into the year saying we'll get price. We announced a variety of different price increases in different regions and businesses. For the company in total, we had almost 1.5% of price in Q1, with the lion's share of that in the Performance segment, as you indicated. We expect the Performance segment pricing actions to stick for the balance of the year. We have going with a little more targeted pricing in the Industrial segment, and that's been really reflective of the lack of demand there. So we may not see the same absolute level of pricing in industrial just because demand is down. We're still expecting some very modest price and holding all the prior price that we accrued last year.

Even on the -- I'm sorry, Anthony. On the other side of the gross margin equation is the raw materials. It seems like maybe the paint -- or sorry, the TiO2 guys have been semi successful in stabilizing price there. So wondering, is there any hope in scope for some pressure, downward pressure? And then the rest of your raw material basket that's got some oil-related derivatives, I know you guys have talked about slowing production so maybe it doesn't get into the inventory and cost of goods line for a while. But what would be the cadence to start to see if we retain these lower petrochemical prices, some relief at the gross margin line?

Yes, Bob, actually, there's 2 factors at play here. One being the commodity prices drifting down and oil coming down dramatically. And again, that typically, in a normal environment, would take three, 6, 9 months to flow through depending on the particular supply chain. The second thing at play though is this is a supply/demand environment. All the commodities we buy are supply/demand-driven. We do know -- we said last year, in many of the markets, including TiO2, there's excess supply that's typically an important indicator with respect to the forward look on our prices. Now in this environment, we think there's actually even more supply. So we do see some suppliers certainly trying to lock in some volume for Q3 and beyond, reflective of the environment. I think we'll take, as you said, some time to roll through our P&L, our balance sheet to the P&L. And -- but we do expect some unwinding of what's been a multiyear inflationary cycle. We're still above 2016, 2017 pricing in certain markets. With respect to TiO2, again, I think we were pretty clear in the call, it's at a minimum sufficiently supplied, likely oversupplied globally. We are taking more -- much more product out of China, not just PPG, but the entire industry. Exports out of China have been up in consecutive months for several months now. And pricing in different regions is -- pricing is flat at best. And in different regions, it's going down, reflective of the oversupply.

And one market that had quite a bit of a spurt in the last couple of years has been packaging with the non-BPA coatings and now maybe with folks buying more groceries and whatnot. Can you give us an update on what's happening in that market, maybe scale how important that is for PPG and sort of what the outlook is from here?

Sure. John, do you want to take this one?

Yes. Sure. Sure. So it's still a relatively smaller business for PPG. It's a little under 5% of total revenue for the company. But it is a good business. We're seeing good growth in it. We had double-digit growth in U.S. and Canada in 1Q. Really, the only thing holding it back right now is -- are shutdowns of factories. Otherwise, the underlying demand is very positive. We would expect that to continue. Just as a reminder, last year, the food segment, which PPG has a good representation of, was down because of harvest issues both in Europe and the U.S. So if those don't repeat, those are both positives from a comp standpoint this year as well. And we're continuing the BPA-NI initiatives, still have good representation there. And the other thing is that the bev side, we still see the potential for more structural change on the bev side where maybe there's more of a movement from plastics to cans, metal cans. And as our customers add capacity, we see PPG getting their fair share of additional capacity.

Vince, John, it's Anthony again. Aggregating some of the commentary on price raws and also thinking about some of the costs that you're taking out this year and that you've taken out over the last several years, it seems to us that the opportunity for margin expansion, once volumes get back to more normalized levels, could be fairly significant. Maybe for both the Performance segment, Industrial and then on a total company basis and possibly overlaying the backdrop of '08, '09, how do you think about margins coming out of the downturn and where sustainably things should be going forward?

Yes. Again, this crisis is a little different, Anthony. But I do think a lot of the comments you made we also believe are accurate. We've done a tremendous amount of work on our overall structural cost the past couple of years. Even with the downturn in trade activity, for example, in March, in our U.S. architectural business, we made more money this year than last year just because we took a tremendous amount of cost out of that business. Same holds true across some other kind of region businesses as well. Again, we've been battling inflation for several years now. And hopefully, the fever is broken on that. So I do think similar to '08, '09, late '09, we had to maybe 2.5 quarters of down segment earnings. And then by the third quarter, we were at record levels, just reflective of some volume recovery on this lower cost base. And we do have the capability of -- some of the discretionary costs we took out, we have the capability of only adding those back when we need them. So I think the industry structure sets up well for that. I think some of the things that happened in the past couple of years like this inflation cycle have been moved to the back burner, at least for the time being. So we agree with the thesis.

And then from a balance sheet perspective, obviously, you guys have maintained a clean balance sheet over the last several years, and it certainly lends itself well to the current downturn. As you exit this period where you suspended share buybacks, how should we think about PPG's first uses of capital? Understanding you've been doing a number of small bolt-on deals over the years, but what's the appetite for something sizable and more strategic potential?

Yes. Again, we need way more business visibility. Our focus now is maintaining ample liquidity for kind of the midterm. And we'll continue to take actions to optimize our balance sheet based on the needs of the crisis, assuming the dust clears and things, we see a clear path to normalcy in the economies. We -- historically, I spoke of earlier, M&A has been very accretive to the business models for coatings. There's a -- these are low-risk type transactions because you do get embedded synergies in most of these with very little cash outlay by the acquiring companies. So if you look over the mid or longer term, we're certainly interested in continuing to consolidate the space. Again, I don't think you'll see many distressed assets come out from our industry like other industries. But I do think mid, longer term, there'll be more consolidation in the space.

Vince, it's Bob again. Can you talk a little bit about what your U.S. paint store company-owned store strategy is and how that's changed at all over time? And what you guys are seeing in the current market in terms of the restrictions and how you operate those stores?

Yes. Yes. In the U.S. and Canada, we've seen, I think everybody knows, different retail restrictions by state. Some of that's being lifted. We've been able to, for the most part, continue with either curbside or delivered to the job site. And again, I think over the next, hopefully, couple of weeks and months, we go back to kind of an all clear with the proper safeguards in place. Our strategy, we're following other retailers. We do -- we haven't seen what I would call a digitization of the paint industry yet from a retail perspective. We are believers it's coming. Certainly, my kids or my grandkids are not going to buy paint the way my parents did and the way we do. And we've been preparing for that digitization not only from a kind of an intermediate perspective, but really end-to-end, so from consumer through the completion of the paint job. So we're not just trying to optimize the supply chain. We're trying to optimize the purchase from continuum -- the full continuum. And with that digitalization, that would, in essence, say there's -- in our opinion, much less need for bricks-and-mortar -- the density of bricks and mortar, unlike other retail. You still need distribution hubs city by city. But again, there's not as much cost in bricks-and-mortar in that model. Specific to PPG, we've had both company-owned store model as well as a separate dealer model serving kind of the mom-and-pop hardware stores. What we're trying to do now is mold those 2 together, optimize those 2 to make sure there's not overlap and cannibalization among the 2. So we've, in some places, sold our -- some of our stores, our dealers. In other places, we're doing more. We're growing our stores. For example, Houston, Dallas, we're growing stores where we don't have as much of a dealer network. And again, the full focus of that is much more delivery anyway. And then this crisis, actually, the whole industry has moved to the model we're subscribing to, which is more delivery, more digitization. So this could act as a catalyst to that to move quicker to that business model.

And can you explain why paint won't become a victim of Amazon? What is it about the paint market and digitization that prevents it from being outsourced?

Yes. With paint, there's both a -- or 3 things. There's the product, which can be an Amazon product. But what keeps it from being an Amazon product, is a specific color. It's not a widget. You're trying to -- color selection process, which is probably the most important process for a consumer, doesn't lend itself well to that. And then the second piece of that is there is the service element to it. So not only once you pick a product, then you need to have it delivered, which can be Amazon. Then you have to have -- how is it going to get served in order for the paint to be applied to the wall. And the third element typically is even though you have the product delivered in your DIY, you typically need other things like rollers and brushes. And so we're trying to bundle all that together, but there's -- it's not just a one item selection. It's a multifaceted selection. So that's why I think it's been slower to develop. Paint bought electronically, based on what we can see, is still only 1% to 2% of the market. But it's gone up triple digits since March in both Europe and the U.S. in terms of how much paint is being procured online. And some of that will add back when restrictions are lifted, but we think some of that will stay in. As people get more comfortable buying, we think, again, it will be more electronic.

Excellent. Unfortunately, that goes to the end of our time. Vince, John, really appreciate it. I hope you guys stay safe and enjoy the rest of the day.

Thank you.

Thank you.