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

Hi, good morning. I'm Jeff Zekauskas. I analyze chemicals for JPMorgan. This morning, it's my pleasure to welcome you to the 2021 JPMorgan Virtual Industrials Conference. Our conference is virtual in the interest of health and safety, and we very much appreciate your attendance. For today's fireside chat, if you have a question, please e-mail me at [email protected] or submit questions online through the JPMorgan conference website through the ask question feature. It's my pleasure this morning to introduce Vince Morales, who's the Chief Financial Officer of PPG. Vince has been CFO of PPG since 2017, and is a long-time PPG veteran. Also with Vince is John Bruno, who runs the Investor Relations function at PPG. I think Vince will make some opening remarks, and then we'll move to a fireside chat format. Vince?

Jeff, first of all, thanks for having us. One of our marquee conferences every year. Really appreciate the event and appreciate people attending virtually this year. Just a few opening comments. We won't take very much time. I know you want to get to current events. But I just want to rehearse a little bit about what happened in 2020. So 2020, we obviously dealt with some very challenging conditions globally, not only professionally, but personally. We have, obviously, a difficult Q2, as most companies did, but we really, as you would expected us to do, aggressively managed through the situation. We had very good results in Q3 and Q4, both up about 20% on an adjusted EPS basis versus 2019. We had exceptionally strong cash performance throughout the year as we worked internally on our working capital and with our customers. We really came into 2021 with some good solid momentum -- recovery momentum, still not back to where we were pre-pandemic in many of our key markets. But financially, very sound position. We also -- towards the latter part of 2020, we're able to put some of our balance sheet to work. We announced 4 acquisitions. We've subsequently closed 2 of those. I'm sure we'll talk about that today and expect to close the other 2 here in a couple of months. So coming into 2021, we think in good position. We're still not fully recovered. We still have some end markets that are significantly impacted by the pandemic, others that have partially recovered and again, I'm sure we'll get into some of that today. So I appreciate the opportunity and I look forward to the call here today.

Okay. So the coatings industry, Vince, has so many different cross currents in that raw materials are moving up, prices are moving up. Particular sectors are quite weak, others are stronger. As you look at the first quarter and the year for PPG, do prospects seem very different than they were when you spoke about them late in January? Are they better? Are they worse? The same?

No. I think, Jeff, when you look holistically, every year, there's always opportunities and challenges. When you look to our -- we're -- we match the coatings market globally. We're a fully fledged, full grown coatings company with very good positions everywhere, all the verticals and everywhere in the world. And when you look at that holistically, we feel good about the coatings prospects this year. If you look at our industrial-type businesses, those businesses have very strong demand patterns, most of that is still in recovery state. If you look at the performance-type businesses, these are more distribution-type businesses that would include architectural coatings, both DIY and professional. Trends in those businesses still look very promising. We still have some businesses that are still challenged, as you point out, like aerospace. But even there, we're starting to see, we think, early signs of recovery. So the demand profile looks positive. There could be, as there is every year, dislocations. But overall, when you look at it over a 12-month period, the demand profile looks promising.

Part of PPG's core strategy is to acquire. And this year, you made a bid, or you've recently made a bid for Tikkurila. Why was that an asset that you thought would be important to PPG?

Yes, Jeff, when you look at that particular asset, for us, it has very strong brand positions in a key part of Europe and Russia. #1 positions throughout most of Scandinavia. In Russia, we're talking about decorative or architectural positions, long-standing brand recognition, multiple decades. And those assets typically are scarce, where you have a #1 position for many, many, many years that the consumers truly value and understand. And that's what made that an attractive asset commercially. Financially, this is a business that is really in the early stages of, what we call, professionalization. This was a family-run business for many, many years. They brought in a professional management team 2 or 3 years ago. That professional management team is very capable, have started to move that business performance metrics, financial metrics up to -- closer to median, still not there yet. So we think we're going to be able to take advantage of that with that professional management team as well as bring our acquisition synergies on top of that.

Do you look at Russia as a meaningful opportunity for PPG over the next 5 years?

Yes. We -- again, we're a global coatings company. We play in all the key global economies. Russia is a key global economy. We, at present, Jeff, have a lot of industrial and automotive activity there. This will bring us some decorative or architectural exposure as well. And again, leading position in deco.

So in order to buy it, Akzo was the other bidder, and they kept bidding, and you kept bidding. And you finally purchased it at a price materially above what you originally -- where you originally started. why do you think other companies -- or why do you think Akzo wanted that business so much? And why was it important for PPG to pay out, to get it?

Yes, Jeff, I think it's, again, the value of these brands that have existed in this important part of Europe for quite some time. Our -- we had the advantage on our initial bid that there was no other bids on the table, and that initial bid came in well less than traditional coatings multiples, if you will. Certainly, Akzo did put in a bid. They didn't raise their bid. They only put in 1 bid. And that put it, I think, on an equal footing with other coatings multiples. But again, we're going to provide some more details once we close this transaction. Still -- we're still in an open tender process. We certainly hope to close the transaction in the next couple of weeks or 1 month or so. And when we do that, we'll provide out what our synergy capability is on this particular property. And again, for us, this is going to be shareholder value-creating and, again, a very good property from a commercial perspective.

What was behind your Wörwag acquisition? If that's the way you pronounce it.

Yes. Yes. Wörwag is a German company. Again, another acquisition that's pending. We certainly hope to close in the next couple of weeks or so. This has really been a technology play for us. They have certain specifications and technology in the automotive space. That's technology that we've been working on developing, but they're, frankly, a little bit further ahead, including some water-based coatings on plastic parts. So again, a niche -- a real good niche company with real good customer relationships. We typically find these acquisitions, Jeff, where they've developed a good technology, but they're small and they have a hard time going global. And we think we're able to exploit that technology on a global scale, especially with some of their customers in China.

And I guess, finally, you bought Ennis-Flint in the United States. What intrigued you about that asset, Vince?

Yes. This is a company we've been following for quite some time. Again, none of these companies are a surprise to us. We know the space very well. Ennis-Flint primarily is a pavement marking company. So exceptionally stable demand profile as we look at road markings. The road markings have come under much more prominence as of late, especially with driver-assisted safety options and eventually autonomous. These road markings play a key role in identification for the car systems. Some of the road markings in some of the states are becoming more prominent. They're actually expanding them from maybe a 4-inch to 6-inch strip, so a 50% increase in volume. And we expect that to continue. It plays into our mobility activities work we have around automotive. And again, very stable profile, spec positions. Each state has different specifications so you need to be specified individually by state. And this company has done a great job, over the years, building up that spec position.

It's funny, Vince. When I think of the Ennis-Flint acquisition, and I think of your new products and -- then that serve the electric vehicle market, and of course, you're the leader in automotive OEM coatings. This acquisition seemed more thematic, or it seemed that there was direction strategically that PPG wanted to go in. Is that the case?

Yes, Jeff. I think if you look at our recent history here, as you mentioned, we've been a leader in automotive for decades. But if you look -- we put a mobility team together to really understand some of the key customer gaps, as we talked about in autonomous, in electric vehicles, that mobility team has been in place 4 to 5 years. One of the things we've learned early on, so we're talking circa 2017, is the importance of these road markings in that mobility space as a, whether -- again, driver-assist or autonomous, these road markings have played a much more prominent role. So we certainly were looking at that as well as the other coatings on electric vehicles that are enablers for additional powered batteries, et cetera. So this definitely was within the scope of what we are looking at as something for the future theme around this improved mobility capability in the automotive space.

My understanding is that Ennis-Flint is largely a domestic company. Are any of its technologies or approaches to the market, something that you can globalize or learn from in being able to sell these kinds of paints more globally?

Yes. You're correct, Jeff, as usual. Ennis-Flint is primarily domestic. We do have opportunities to cross-sell this in other places. Again, typically, the U.S. is the leader in specifications in terms of technology, the U.S. Department of Transportation in the States. So stuff that happens here is typically carried forward to other places. We are looking at cross-selling this in Mexico where we have adjacent and immediate distribution capabilities. They already have positions already when we bought them in the U.K., Australia, Argentina. So they're not just domestic. But again, we'll look to exploit this product line elsewhere where it makes sense. And certainly, again, this autonomous and driver-assist is where we would see the best opportunities.

Can you describe your approach to the electric vehicle market over a longer period of time? And how do you think that you stand versus your competition in serving the market for those coatings?

Yes. I'll let John talk about a few of the products. But again, I do want to go back to the fact that we started this as a critical project, reporting to Michael McGarry, our CEO, about 5 years ago. So for us, we think we have a considerable head start in this space. We're working on next-generation stuff. So the stuff that's out there today, the hybrid technology is not as prominent with our technology, but the next wave of stuff we think we're working on and getting commercialized. And maybe John can talk about some examples.

Yes. And it's important to remember that we're shifting from a largely hybrid model to a more powerful, isolated pure EV model. So those batteries are going to have a lot more energy and require some things that the hybrids didn't require. They're going to require more fire protection, because they're so powerful that they have higher risk of catching on fire. So PPG, in its protective business, has a fire passive protection product, which is gaining a lot of acceptance and qualifications right now. It's actually the only product right now that we know that it's been approved under recent Chinese law for this kind of fire protection. In addition, we have products that are enabling the battery to have longer driving range, which is a key issue with today's batteries and why not as many electric vehicles are purchased. So our products are replacing not coatings, but other applications today that just cannot fulfill the need for higher driving range and safety that exist.

And if I could conclude that, Jeff. As we look out, certainly a longer adoption window here, everybody has a different viewpoint of when EVs will be more mainstream, but, today, we have about $100 of content on a traditional gas combustion engine vehicle. We think the opportunities for EV -- a fully fledged EV with all of our content on it, would be an incremental $100 to $300, depending upon the a la carte that, that particular EV has of our products. So significant for us. I think we've got a jump-start here technology-wise, and hope to maintain that leapfrog advantage.

Not to dwell on it too much, Vince. But when you look -- you guys are so close to the auto manufacturers. When you look at the different models that your coatings will be on, in general, do you see the electric vehicle market as really having a very strong growth pathway over say, the next 3 years? Or do you think people overestimate the rate of growth?

Yes. Time will tell, Jeff. We're seeing very good adoption in China and Europe. And in some cases, incentive by the governments. I've seen different forecasts. So it depends on what forecast you're working out of. I think the -- we follow the money here. And if you look at all the investment that's going in, not only by the automakers, but by the battery makers, the tier 1s, tier 2s, there's significant amount of investment. And again, the trajectory of acceptance and adoption will be different by region and certainly different basis, availability of charging stations, et cetera. But we definitely know it's a trend that's going to continue. We're working off an assumption. There'll be 7 million to 8 million vehicles by 2025. I think that's -- there was about 1.5 million to 2 million last year. So it's not a vertical -- a complete vertical, but it is certainly a significant growth over a 3- or 4-year period. Most of that we expect to be in China and Europe.

I guess, if we can just swivel a little bit back to the presence in automotive. Normally, automotive production moves down in the first quarter versus the fourth quarter. Is that the typical pattern that you're seeing? And is there some -- I guess, do have lower expectations for the auto OEM business in the first quarter, given difficulties in finding automotive electronics or other factors?

Yes, Jeff. When we announced our earnings in January, we were fully aware of the chip issue. We talked a lot on our earnings call about this is more of a first half -- our predictions for automotive are more first half-based than first quarter-based. Just didn't know when things were going to fall. It is a tight market. The product is sold out all the way through the consumer. So they're running as hard as they can, basis their supply chain. We do feel this is going to be a good demand year, not only first half, but second half, especially relative to last year. So we're comfortable with the demand profile. When it falls throughout the year, we don't control, but it is a very tight market. And I think when you look -- when you pull back and look at it from 30,000 feet, putting this natural governor on this industry that has oversupply is not a bad thing. They're going to keep -- it's going to keep the profitability, we think, strong in the industry for longer. And again, it's going to keep inventory of used cars -- excuse me, new cars tight, which is a good thing longer term.

So automotive coatings have a higher petrochemical content and petrochemical prices continue to move higher. Is this an area where you feel that it's important to keep pushing on price in order to offset some of the raw material inflation you might be feeling?

Yes. We saw petro prices move up, obviously, the back half of last year off of a very low level. So we expected some inflation coming into 2021 in that cost bucket. We are working to price that effectively. We saw obviously another, we think, more of a transitory move up following the weather events in the Gulf Coast a couple of weeks back. Again, we expect some transitory inflation from that. We'll price that accordingly, but don't expect that to be long term. Definitely, working with our customers and suppliers on the most effective way to manage this. Again, the majority of this, we expect to be very short-term in nature.

Can you talk about what's happening in the auto refinish markets? Are you beginning -- it was obviously a very, very tough area in 2020. Now that COVID conditions seem to be changing a little bit in the United States, can you perceive that in your volumes? Or is it too early?

So Jeff, if you look at the back half of 2020, we were down -- the industry was down anywhere between, let's call it, mid-teen percentages in volume. And that progressively got slightly better. We're still certainly nowhere near 2019 levels. There's been some offsets. Obviously, the weakest part of the equation has been less congestion around rush hours, as there's not as many people, obviously, coming to the office. It's been partially offset, though, with more driving during the day and on the weekends in the suburbs. We actually do see more people moving from the city to the suburbs, at least on a temporary basis. So activity in the suburbs is up. So we're seeing some improvement as we progressed from late Q3, early Q4, into Q1. It's still going to be down probably close to double digits. And again, not recovering until we see a better prognosis on vaccinations, et cetera. But there is a very lean supply chain. So as folks do get into accidents, as other regions come back, we're seeing an immediate uptick in activity. In Europe, we've seen a much more quick return. Most European folks, when there is an opportunity to go back to the office. We've seen China closer to 90%, 95% of congestion levels. Less public transportation being used in both Europe and the -- or Europe and China, excuse me. So you're seeing some offsets, but it's still going to be down a little bit as we -- until we get much further along in the vaccination process.

So it sounds like in the United States, there's some incremental improvement. Is that correct, in demand, Vince?

There certainly had been from Q3 to Q4, and we expect some from Q4 to Q1. And obviously, that's dynamic changing based on the shape of the pandemic. But certainly, things feel better.

How about aerospace? Obviously, that suffered so much in 2020. But it seems people are flying a bit more. Can you see that in your results?

Yes. Just to give the lay of the land of our business. So we've got a decent-sized aerospace business, about 30% of it is military. And we really haven't seen any effects there. We expect the military business to be at or above of 2019 levels. The remainder, the 70% remaining is split evenly between OEM and aftermarket. The OEM business remains challenged, as you would expect, we are starting to see some orders pick up in the back half of the year, but down considerably versus 2019. We've seen modest but continuous improvement in the aftermarket, especially in the last couple of weeks, especially in the U.S. We had, I think, 4 consecutive days here of over 1 million folks going through the TSA turnstiles. That's reminiscent of what we saw in China last year. We saw China domestic travel return nicely to about 90% domestically of pre-pandemic levels. So we do expect domestic travel to pick up, again, based on the vaccination rate. And we see immediate pull-through of our product. There's very little safety stock in this channel. They've obviously drawn it down due to cash considerations. So there's going to be an uptick in the aftermarket activity level, plus probably some building of safety stock this year, Jeff. So again, nothing where -- we're still not expecting to get back to 2019 levels, but certainly improvement trends underway, as evidenced by the news coming out of the JPMorgan conference yesterday.

Yes. When you think about the architectural markets in the United States, do you still see strength in the do-it-yourself market? And how do you view the contractor market or your stores business these days? Obviously, the underlying new home construction, housing turnover, all of those numbers have been very strong.

Yes. I think we look at history when we talk about DIY and these kind of surges of DIY, Jeff. If you go back to 2008, 2009, the closest proxy we have here, we saw DIY stay long above prior great recession levels for a couple of years, and we correlated that much more to unemployment and it stays higher longer based on unemployment levels than anything else. So we do expect DIY to be long -- higher than prior COVID levels for a longer period of time than I think most people expect. And again, we do have a new entrant into the painting market, which is the millennial. I think the millennials last year got their first experiences painting. They found it was a very cost-effective product -- project, not too difficult. So we think that's beneficial. They're coming into their home ownership years, childbearing years. So we think that's a positive. So we expect a little longer cycle on DIY than most. We've started to see some recovery in the professional trade market. More people are willing to put professional painters back into their homes. As you alluded to, end market demand remains very strong. Home turnover is very solid. That helps both trade and DIY. And we have a -- we do still have an offset, a negative offset with commercial. But we do expect year-over-year good improvement in the professional channel as well. So good trends here. If you go to Europe, the trends are very similar. DIY market is very strong there. We expect that to continue. Professional market is probably -- our European business is probably better than the U.S. business in terms of volume activity. In Australia, we're seeing the same trends as well. So all the mature markets around the world, we're seeing very similar trends.

I looked at some of the Lowe's and Home Depot results. And I was struck by the difference between what I perceive their level of volumes and their level of prices in that it seemed to me that big boxes, in general, were pricing paint -- either pricing paint more aggressively or that DIYers were buying more expensive paint. Do you have any comments on that?

So I think what we found, especially in the U.S., is folks are only buying 1 or 2 gallons for a 1 -- for an individual room. They do look for premium paint typically, which we welcome. There's typically a low end purchaser, but most of the folks navigate up the food chain. And especially if they're doing multiple rooms, people do see the value of a single coat paint. We all have good -- everybody in the space, so obviously, I'll promote PPG, but everybody has good products out there. And the higher you go up the price spectrum, the better the coverage is. So we're all supportive of that. Certainly, the home centers are supportive of that. And I think the consumers see the benefit.

My impression of coatings raw materials in general, is that whatever it is, whatever the rate we thought they were rising at the beginning of the year, they're rising at a faster rate. The oil price is up more. Obviously, there have been shortages in propylene, urethanes, polyethylene. Do you feel like you're ahead of the curve or behind the curve or -- of absorbing these increases in costs? And how easy is it for you to catch up once they get going?

Yes. We agree with your comments, Jeff. We obviously had, again, a weather event in mid-quarter here Q1 that had pushed up spot pricing. Fortunately, we buy very little on spot, where we're pretty much contracted for the quarter. Some of that will spill into Q2. Some of that inflationary pressure will spill into Q2, no doubt. We do see rapid healing of the supply base. And I want to be very clear here. There is sufficient supply in our supply base structurally. We're not short -- we weren't short coming into the year in virtually any product. We don't expect to be short at any big juncture throughout the year. So we'll go through some of these transitory outages. We're working -- we had good pricing momentum on the way into the year. We're certainly moving to more surgical pricing now with some of the products that are right now in a little more short supply, and then we'll continue to pivot accordingly. But we do expect this process to heal itself in short order, and we expect to offset this -- any transitory raw material inflation with pricing.

My impression is that titanium dioxide prices have moved up a little bit sequentially, but there isn't anywhere like the kind of pressure that there is in petrochemicals. Do you think that's a true statement or no?

Yes. I'd look at that from a different angle, Jeff. We didn't see titanium dioxide prices come down substantially over the last couple of years. So they've been fixed at a price, in our opinion, that does then reflect supply/demand in the last couple of years, especially in a COVID year. So given that, we wouldn't expect inflation in that cost bucket.

Many of the titanium dioxide producers are offering different terms of trade. What they seek is a more stable -- they offer a more stable price, and they want a firmer volume commitment over the coming year. When you look at your practices of buying titanium dioxide over time, have they changed very much? And do you find some of the sort of firmer priced contracts that are colored to be more attractive or less attractive than the way you had been doing business before? If you can speak on that.

I think we've been vocal on this, Jeff. Our strong preference is quarterly pricing based on supply demand economics for that particular quarter. This is a very seasonal product. And so again, we prefer to have pricing renegotiated on a quarterly basis.

How are your general industrial coatings doing in the current environment?

Very strong. As we saw the back half of last year, a very strong recovery. We expected that V-shape recovery. It did come through in spades. Some of these markets are exceptionally tight, things like appliances, electronics, very tight markets sold out in some cases, through the consumer. Automotive, another one. Packaging coatings, exceptionally tight. A lot of structural additions to the packaging coatings market, even pre-COVID. So these markets are performing well. Some of them still need to recover fully to the pre-COVID levels, but we expect very good strong demand in these markets this year and probably into 2022. And there has to be, at some point, even an inventory replenishment cycle that may occur later this year or not until next year. So we feel good about these markets. As you are fully aware, Jeff, these markets typically hit a lot of the technology areas that we like, which is they require functional coatings, they require coatings that are factory applied, which hits our sweet spots, decorative coatings, especially on the new appliances. So again, they're looking for differentiation with their consumers, and that plays into our technology strengths.

I would imagine that given the very good demand conditions in these markets, it might be more easy to pass on some of the raw material cost inflation. Is that correct?

Yes. I think, in addition to demand, Jeff, I think what we're seeing is, in many of these markets, our customers are facing inflation from steel, inflation from other precious metal, inflation from oil. So the inflationary backdrop exists out there, not just for coatings, but other key inputs for them. So we're not the only person walking in the door. As we were -- in 2017, we were one of the few industries walking into the door asking for inflationary increases. That's not the case today.

In general, are your businesses in Asia operating relatively strongly? Does Asia feel back to normalcy?

I definitely feel they're further along in the process. We still have some isolation issues in China, certain cities. The demand, though, coming out of the industrial sector in China is very strong. India is still in a recovery mode, but coming back rapidly. So I do feel they're probably further along, but not fully recovered. We're not seeing international travel. And again, there's still some sporadic issues in the region that have held that region back from being fully recovered, but definitely further along than any other region, Jeff.

It's funny, Vince. When I look at the overall demand for coatings, such a big part of it is the Asian market. And when I look at the behavior of the North American and the European coatings companies and the acquisitions that they make, they tend to be in Europe and in the United States. And you don't really see very often large acquisitions coming in the Asian markets. Why is that? Is there a lack of target or it turns out the prices are very high? Or it's difficult to get to the bottom of their financials? What do you make of -- sort of the lack of Asian acquisitions by Western coatings companies?

Well, I think it's all the above, Jeff. I think, number one, if you look at the pricing, there's a different multiple expectation based on the backdrop of the growth that we've seen in Asia for more than a decade now. There are smaller targets over there. Some of those targets either you have to dig through the financials. There's some very large targets over there where the multiples -- some public companies, where the multiples are well in excess of multiples of U.S. or European-based companies. So that's a differentiator. But we've tried to approach it from a different angle. So if you look at some of our recent acquisitions, whether it be Whitford, Hemmelrath, even one that's pending in Wörwag, we've been able accrue -- we've been able to buy through buying a European or a U.S. company, some Asia presence. So in all those instances, I just recited they all have Chinese exposure. So we've actually been able to get the same composition of China exposure in some of these acquisitions as we have in our portfolio. So we've been -- but we've been able to get those at a U.S. or a European multiple base, and still enjoyed the Asian growth rate. And in some cases, Jeff -- I'm sorry, if I could interrupt you. In some cases, what's been interesting for us is if you look at our capital deployment from a capital spending perspective, most of our Asian plants are running at full capacity, just given the growth we've seen over the years, and we tried not to build ahead of growth needs, but we're running at full capacity. So we've been able to pick up actually some underutilized plants in some of these acquisitions. So in addition to the acquisition synergies we've gotten from these deals that you would expect, we've had some capital avoidance because we would have had to build another factory, at least one in Asia, absent these acquisitions, and we've been able to fully utilize these acquisitions' plants over there, particularly in China. So in addition to cost synergies, maybe some sales synergies, we've got some capital avoidance from some of these acquisitions.

So you've made 3 good-sized -- or you're in the process of making 3 good-sized acquisitions. Will PPG take a break from that now, Vince? Like do you need, I don't know, 1 year or so to begin to really fully integrate these before you buy something of size? Or is it still possible to buy something of size in the current year?

Yes. Great question, Jeff. And we've talked a lot about that as we saw these things culminating. Fortunately, for us, these acquisitions have really been in different parts of the world. So Ennis-Flint's, U.S.-based, Tikkurila's solely European-based. Some of these other ones are smaller and different businesses. And we've been able to spread the integration activities out across different management teams here at PPG. We did announce and put in an integration czar a couple of weeks ago. He was going to kind of mastermind the resource allocation and the synergy capture. But the piece have been spread out enough that we do feel, and we are looking at other potential acquisitions. We will be mindful of our bandwidth as we look at those. But if something falls outside of some of these business units, we still feel we have bandwidth to undertake that. As you know, most of our management team has been very experienced in integration of acquisitions over the years. So every one of our senior leaders has done several. So again, we could do something else in a different business unit and have confidence that we'll be able to fully integrate that based on that specific leader in that business.

Okay. Well, on that note, I think we'll close. Thanks very much for joining us this morning, Vince and John. And we hope we'll see you live and in person next year.

Thank you, Jeff.

Thank you, Jeff.

Okay. Good. Take good care.