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

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Good afternoon, everyone. Cheers from Cleveland, the home of the pending Super Bowl champs, the Cleveland Browns, which I'm sure my buddies at PPG would love to comment. This is Mike Sison. I cover chemicals for Wells Fargo. With that said, I want to introduce PPG Industries. They are having a very strong 2021. Their stock is up 24% year-to-date versus the S&P of 12%. They've generated an impressive 7% volume growth in Q1 with another 2% in pricing to generate 44% EPS growth year-over-year. We saw a strong recovery in both segments, Performance Coatings and Industrial Coatings. PPG expects this momentum to continue into the second quarter, looking for sales to be up low teens on a sequential basis from the first quarter. We see good upside as the stock is still at $195. Look forward to introducing Vince Morales on my left, CFO of PPG; and John Bruno, Vice President of IR, on the right side there. Thanks for joining us today, Vince and John. One quick note if anyone has a question, feel free to e-mail me at [email protected]. And I am -- Wells Fargo is allowing in-client meetings, so if you want to see this exciting new tropical business attire in person, send me an e-mail, let me know.

So with that, Vince, I thought we would start with the strategy a little bit. PPG is more diversified into several different paint verticals. 40% is architectural paints, but you have a lot of other areas in industrial, auto and such, much different than your Cleveland peer. Maybe describe your portfolio a little bit in total. And then longer term, what type of growth you think is -- the company can generate post pandemic?

Yes, Mike, and thanks, everybody, for tuning in. I do want to recognize your casual leisurewear there. And I do think it will be an interesting Browns-Steelers matchup this year. As it relates to our portfolio, I think you hit the nail on the head. We have the most broad coatings portfolio not only by vertical but also geographically. We're really the only coatings company in all verticals and all regions. That does provide us with advantages from an operational perspective. It also provides us with additional advantages as we look at acquisitions. We typically might have a fairly significant beachhead regardless of what business we're looking at or what potential acquisition target we're looking at. It's also allowed us to build back office breadth in all the main regions. So we have low-cost back-office operations in Asia, certainly in the Americas and in Europe, and it allows us to really capture synergies quicker on these acquisitions than we think most of our peers set can. From a commercial perspective, again, being in all these businesses, there's different technology requirements, but we're also able to pass technology across the fence from one business to another. We typically see leading technologies developed in either aerospace or automotive or some industrial -- big industrial type applications that we could then transfer holistically across our portfolio. And I'm sure we'll talk about some of that today.

Great. And then, yes, I thought maybe given your balance sheet is in still really good shape, you've been aggressive on the acquisition front, maybe talk a little bit about your acquisition strategy. You've made several this year. And what would you think those can do for you in terms of the bottom line?

Yes. We did include in our last earnings report, some more information on the acquisitions. But if I just look at our overall strategy, again, as I mentioned earlier, because of our breadth, we're typically involved with most M&A targets in our space. We typically certainly has to come in and look or kick the tires around all these targets. We do historically, we believe, have better synergy potential, again, because of our breadth, because it is back-office acumen we have. If you look today, we have 5 acquisitions, 6 since in the last 15 months or so, 5 in the last 6 or 7 months, 3 of them have closed, 2 of them are still open. They run the gamut in both our performance and industrial segment. Some of them were really focused on different technologies. Others are focused on additional geographic opportunities. So it just depends on each target, but we're typically able to look at these. We do have a return on capital after-tax hurdle that we try to achieve on all these. So our strategy fits in financially as well as what they do for us commercially. And I'll let John talk a little bit about some of the economics of these most recent deals.

Yes. So I think we're looking for probably above our average synergy level. So between 8% to 10% on all of these for the reasons that Vince has talked about. And we do feel that -- and those, by the way, are only our primarily cost synergies. A few of these acquisitions such as Tikkurila and Ennis-Flint also brings some cross-selling opportunities for us as well. So we're looking forward to maybe even having some additional synergies on the top line as well.

Right. I thought we might spend a little time on Ennis-Flint. There's potentially a big infrastructure build. That was sort of a new product line extension for you guys. It adds sort of that potential exposure. This was sort of a low-growth market historically, but now maybe it could be pretty exciting for the next couple of years. Can you maybe talk about that business a little bit and how that infrastructure build could benefit this acquisition?

Yes. Just a little bit of background on Ennis-Flint. They're the global leader in traffic paint. They do have a fairly large North American presence, but not as large elsewhere in the world. As you pointed out, Mike, this hasn't been what I would call an extremely high-growth marketplace. But 2 things coming in the past here are intersecting. Number one, as we move to more driver-assist type vehicles, the road markings are becoming much more important and prominent in that equation. So we do see states trying to further drive improvement on road markings, either through more frequent application. And in some cases, in many cases, they're actually widening the road markings from a 4-inch typical road marking to a 6-inch, so a 50% increase in the road marking size. And again, with more overlay each year just to make sure they're prominent. So that's the first element. The second element really is as it relates to autonomous driving. Again, these have even higher prominence. So we do feel there is opportunities with this particular technology to grow faster than it has historically, and we spent a tremendous amount of time on EV, mobility type autonomous applications, and we feel very comfortable with this in our portfolio.

Right. Okay. And then I know the Tikkurila acquisition hasn't closed yet, but I thought what was interesting in one of your slides was the multiple purchase is in the high teens. And then post synergy, it comes down quite a bit, sort of the low teens. So is there something unique in that deal that allows you to bring that post multiple synergy to a very reasonable level?

Yes. Mike, I think it goes to what John mentioned earlier. We see a tremendous amount of synergies in this particular target. The standard synergies, which would be supply chain exists, maybe to a slightly better degree than traditional. But in addition, the Tikkurila team has started down a path of harmonization of their back-office administrative activities. They're in their infancy on that. We could really expedite that given our shared service environment. We have an extremely large footprint in the Czech Republic and that -- and they have a very disparate back-office structure. So they started the analysis work. We think in the first couple of years, we'll be able to fully take advantage of those back-office synergies to exceed our normal synergy targets on a typical transaction. And those synergies we like, we're comfortable. We've delivered those in the past, but most importantly, they don't affect the commercial side of the business, which is something we strive for is not to impact the commercial side of an acquisition.

Right. Right. So I thought we'd shift gears a little bit, talk about architectural. You guys have a much more geographic spread between your businesses than others. One of the trends that our consumer team here has talked about significantly is this trend for deurbanization, folks wanting to move to the suburbs. It seems like the pandemic has changed the housing market potentially. How do you think that impacts our paint demand here in the U.S.? And what do you think that the growth rate for the industry can be going forward?

Yes. We support the thesis you're putting forward, Mike, which is there's certainly some deurbanization going on. What that typically creates is less renters, more homeowners. Typically, a homeowner spends more money on their dwelling than a renter would. We typically see in the typical rented facility, less color, less paint cycles as opposed to additional walls in a single-family home and additional color and more -- several more conversions of color over the life cycle. So that deurbanization trend will definitely favor in our opinion, additional paint consumption, architectural paint consumption. It could come via the DIY, which we're seeing a new DIY generation come into the marketplace with the pandemic or certainly can come via professional. But we do feel this would add at least 100 basis points to the traditional growth rate of architectural.

Got it. And then since you brought up DIY, unfortunately for me, I can't really reach the ceiling, so I can't do a lot of this painting for myself, but it was a very strong channel in 2020. How do you think that's going to play out for the rest of this year? And where do you think that business should -- or that channel should grow in the U.S. longer term?

Yes, Mike, our best marker is what we've seen historically and coming out of the 2008, '09, '10 -- 2010 time frame, DIY had a very strong time period back then. And we saw DIY eventually return to normal levels, but it took multiple years. The true marker is unemployment, in our opinion, unemployment. If unemployment remains high, we typically see DIY remain high. So we think -- again, we had a significant step-up as an industry in 2020. We don't think that will dissipate very rapidly. It will eventually equalize with historical patterns, but it will take a multiyear period. So we would expect DIY to be elevated versus 2019 levels for a period of time, and we're still expecting a very strong 2020 in the DIY market.

Right. And then last one, in terms of the U.S. architectural, a couple of years -- I think it was a year or so ago, you sort of changed your strategy for your stores and you added new leadership. Where do you stand there? And I know that business has picked up and the outlook looks pretty good, as I recall, as we head in for the rest of the year.

Yes. We're seeing improvement on the professional. We're talking about the professional store side, Mike. We're seeing demand improvement versus 2020. Obviously, 2020 was impacted by the pandemic. We're seeing primarily residential improvement, some commercial uptake versus a very lackluster year last year. We expect that to gradually continue to improve as more people get comfortable letting professionals into their home. The commercial is going to be a bit hit or miss, depending on where you are in the country. We do feel, again, longer term, there'll be an equilibrium back to normal historical patterns. As it relates to PPG, a couple of things. Again, we're trying to optimize our footprint. We do think there's enough bricks and mortars in the U.S. to serve what is a mature market. We do have overlap sometimes with our stores and our dealers and our home centers who are getting more prominent in professional. So we're trying to optimize that structure. One other thing that happened in 2020 is it really catalyzed some of the digital efforts we've been undertaking for the last couple of years. We see much more professional activity in the digital world, still very low percent relative to other industries. But we do feel that the professional painter is becoming much more acclimated to working digitally, which would then, again, provide further access for the job site delivery as opposed to needing bricks and mortar. So our asset optimization strategy, combined with our digital strategy, we think, is best fit for the future.

Right. And then shifting to Europe. It was a market that looks like it's growing better than the U.S., and you have a really good position over there. Can you maybe give us an update on what's happening in Europe and where you think that market can go?

Yes. We have a nice position in Europe. I'm going to let John talk about it. He helped integrate the acquisition we bought over there. So John, why don't you talk a little bit about our positioning by country, et cetera, the SigmaKalon acquisition?

Yes. So Mike, it's 100% right. We have #1 or strong #2 positions in really all the key countries in Western and Eastern Northern Europe. And I think we're benefiting from really a lack of -- or a missing maybe of a maintenance cycle in Europe, right? I mean if you look back 10 years ago, pre-COVID, the market is down. So they've skipped probably at least one maintenance cycle. Now with folks working from home, they've had time to renovate. And I think there's been a bit of a contagion here of people saying this is not a hard thing to do. This is pretty inexpensive. So we actually have a strong view that we expect good demand to continue in Europe in architectural for a couple of years here. So we're very excited about the position in Europe and the market there for the next few years.

Great. Shifting gears to auto OEM. It's been a market that has recovered well. You guys noted what the semiconductor impact was, so we don't need to repeat that. But just curious, as the industry transitions to EVs, I think you talked about there's opportunities for paint and paint companies like yourself and maybe just give us a thought on how you will participate in that trend.

Yes. Mike, first of all, in the industry, we are seeing continuous recovery globally. We're still not back, we think, to demand levels in terms of production. That will take certainly at least the balance of the year. Equally important is the inventory channel is extremely shallow. So there are some carmakers that have only 20 days of inventory on the lots. So we expect a very good production time period between now and the middle of next year, not only for demand, but to rebuild inventory at a minimum. And so we also have the other feature that a lot of the rental car agencies are short cars. Typically, in the U.S., for example, rental cars have represented somewhere between 10% and 15% of the auto take on an annual basis. And there -- so we have that as another growth driver as we look at the next 12, 15 months. So we feel very good about the demand prospects. We are seeing some chip shortages, as we alluded to on our earnings call and is well chronicled externally. That will elongate the demand recovery, but the demand recovery is there. As it relates to the transformation of the industry, we are starting to see a good grasp of either hybrid or electric vehicles. A truly electric vehicle, in our opinion, will have 3 to 4 times the coatings content as a traditional gas combustion vehicle. We are probably 3 or 4 years ahead of most folks. We started a mobility team here at PPG, probably 5 years ago, working with a lot of the autonomous and EV potential partners. We've identified several key gaps that we could help fill either with technology we had off-the-shelf or technologies we started to develop 3 or 4, 5 years ago. We're starting just now to commercialize those technologies. Those will benefit the next generation of cars that are coming out later this year or in subsequent years. And again, I think our head start on this project is going to help us from a capture -- a value capture perspective, especially working on some of the key items that the customers are indicating they need to make this a good proposition for the ultimate customer.

Right. And then just as a quick follow-up, just in case folks haven't spent a lot of time here. Why is there more coatings? Is it more in the inside, the battery box and so can you maybe explain where the opportunity is?

Yes. And John, why don't you describe that, plus there's -- we have some slides, you can talk to?

Yes, absolutely. So we do have a slide deck on our website to articulate, shows the 7 different products, 5 of them are commerciable today, 2 of them were still working on developing. But Mike, if you take a step back, the batteries that are out there, the EVs are out there today, a lot of them are hybrids, which present a lot of complexity and high cost because you're running a traditional engine and having a battery. At the same time, that battery in that hybrid environment does not have as much power. So thus, it doesn't have as much driving range. So people aren't as interested in maybe buying those. So basically, they're looking for improvement in driving range, which involves a more powerful battery. So with a more powerful battery, Mike, there are certain elements of coatings products that help the battery. One is the positioning of the battery in the battery case. It now needs to sit in there snugly and we have gap fillers and we have coatings that helped -- and sealants that help seal the battery with the battery case. If that's loose, that causes an issue, safety issues and also performance issues. The other issue now is that as these become more powerful batteries, they are more at risk of fires. So we have a fire protection coating, which typically wasn't as required. But now with a more powerful battery, this fire-protection coating is either being required or in high demand to be part of the solution to either prevent or allow occupants to escape within 5 minutes if there is a fire. So the development of the battery tool, a higher-powered battery is now creating an opportunity for some of the products we have on the coating side.

Great. We have about 9 minutes left. So there are a couple of questions that hit my inbox. I'll just touch them really quick. Vince, I guess, what's continued to be on investors' minds, I'll summarize, is raw materials. The basket of raw materials are going up high single digits. What does the pressure look like in 2Q alone was the question? Just curiosity of how big the pressure is in 2Q. And then again, explain maybe a little bit how confident you are in terms of pricing and closing the gap and maybe the differences from the prior cycle where it was a little bit more challenging.

Yes, Michael. We're seeing the highest inflation, we think for the year in Q2. We came into the quarter with some supply shortages and some critical raw materials for the coatings industry. We are experiencing, as you alluded to, high single-digit inflation. We have seen some availability come back online. So we're starting to see some of this dissipate. So we do expect a little bit of a haircut as we put in our guidance around some supply issues. But again, our expectation, which has come to fruition is that supply is coming back online in a timely manner and will be available for us either later this quarter or certainly in the Q3. We do have -- we had a lot of pricing momentum coming into the year from a selling price perspective. We've been able to piggyback on that as a result of the Texas freezes and try to really fully recover our raw material inflation in the back half of the year. It happened very quickly at the end of Q1 where we saw these effects. So we're a bit behind in Q2, as you would expect. But we've been -- our teams have been out really since mid-March, securing additional pricing, be it for late Q2 or early Q3, but our expectation is in the back half of the year, we'll have this fully offset price versus raws.

Got it. And then another follow-up on just industrial demand, Industrial Coatings business. You did see a double-digit recovery -- or expecting a double-digit recovery in 2Q. Where do you think we are in terms of industrial demand? And how long of a recovery will it take to get back to pre-pandemic levels, which could be a big opportunity going forward?

Yes, if you look at us versus 2019 and our kind of general industrial buckets, it's a wide array of buckets, first of all. So some are up and some are down. But generically, we're down about -- we're down by low to mid-single digits versus 2019. Equally important, there's no inventory in the chain, whether it be appliance or other type of general industrial products. So we have good demand coming back. A lot of this demand also support infrastructure. And then on top of that, we have to really rebuild inventories in many of these channels. So we're very bullish on the general industrial market on the next 6- to 12-month basis in terms of the demand profile.

Right. And then another question. In terms of auto refinish, I think some folks, they were surprised that you had growth in Q1. Can you maybe talk about what's driving that? I think you have a little bit more on the national exposure. And what will you think about that market going forward?

Yes. We're still down, let's call it, low double digits in terms of miles driven. We did see our customers really deplete -- our customers are small business people. We really saw them really run down their inventories last year. First, due to the pandemic and cash flow concerns and they never rebuild them. We did see some demand pickup, and we saw an immediate feed-through hand-to-mouth to the body shops. And our customers had to partially rebuild their inventories. They're still low relative to historical terms. We are seeing much more driving in the suburbs that driving typically is occurring at lower speeds. So even though the accident rate down -- is down, the total rate is also down. So we do see some of the activity kind of coming back toward a pre-pandemic level, and we're seeing miles tick up almost every day and in many states in the U.S. And we're also seeing good activity return in other parts of the world. We're still below -- frankly, we're still below 2019 levels, but we do expect this to be one of the other growth levers when you get to the second half of the year into 2022.

And Mike, just to add one point on to Vince's comments. We are the leading auto refinish supplier in China. And that enabled growth in 1Q because obviously, they had a small amount of output in 1Q of last year, but it really highlights our positioning in China. And as we move to more waterborne products in China, the opportunity the company has in refinish there.

Right. And then I wanted to shift gears real quick. We've got about 4 minutes left. Sustainability, I saw, Vince, you have 2025 goals, which somewhat refreshing given that a lot of them are a long time from now. So if you just had any comments on PPG's sustainability initiatives, I know one of the markers was to replace 40% of sales with more sustainable solutions, I guess, a lot of waste disposal, energy reduction. Just maybe a quick summary on what PPG is doing there.

Yes. I'll take the technology side of it, Mike. I'll let John handle some of the other -- the S&G. But from -- we have 2 avenues here. One, it's the technology that goes into our coatings products, making those as sustainable as possible. That's a key avenue for us. We're working on that, and we're working on very diligently. The second avenue along those same lines, though, is we spend a lot of time at our customers' facilities, and we could really enhance their sustainability through things that we develop, such as low-temperature cure coatings, that requires them to have less heat in their facilities and many things like that. So we know it can affect our product composition, but we really can affect the application of the coatings, which is a much broader opportunity when you look at it from a holistic perspective. And John, maybe you can talk some of this.

Correct. Mike, I think we're in a great position because we're going to be playing offense than sort of defense with ESG. We are -- coatings companies are not significant emitters of greenhouse gases. We have some, and we'll continue to reduce those. But what we'll continue to do is produce sustainable products for our customers. And we'll have that downstream benefit where the large OEMs will use less energy, they'll use less water, and that will be our narrative, the value we bring to our customers. So we're excited because I think we can play offense with ESG as a company.

Right. Okay. Great. And actually, just one last quick one that came in. Aerospace was your highest margin business and maybe takeoffs and landings are coming back. I'm willing to fly as much as I can if I'm allowed. So would love to go international, if I could. But just a quick update there and -- because that one should have a nice margin lift when that comes back.

Yes, a big business for us, aerospace. It's obviously feeling full breadth of the pandemic as we sit here today. We do see some recovery in many parts of the world on domestic travel. That's a key element for us is how many times a plane takes off and lands as you pointed out, Mike, that drives that MRO market aftermarket. We are starting to see some pickup in the OEM market in the back half of the year. Military has been very steady and strong, and we expect that to continue. So as we look at the demand improvements, Q2, Q3, there's probably won't be a big element there, but this will provide us kind of that next level of improvement when we get to Q4 or even into 2022. So an earnings lever for us for next year, for sure.

Well, great. Well, thanks, guys. I appreciate it. I want to keep everybody on time. And congrats, your stock is outpacing your -- my peer here, unlike your Steelers relative to my Browns. So it's kind of unusual time. And hopefully, you can keep orange and brown stock. I know that's a very popular color these days and...

Just in Cleveland, Mike. Just in Cleveland.

Well, thank you, guys, again. I appreciate it. And I look forward to seeing you guys in person soon and everybody else as well.

Thanks.

Thank you, Mike. Stay safe. See you soon. Bye-bye.