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

Good afternoon, everybody. This is Bob Koort. I head up the chemicals research effort and equities here at Goldman Sachs. And joined by my colleague, Tom Glinski, who helps me cover the coatings sector. We're super excited now to have guys from PPG, Vince Morales, who is Senior VP and CFO; as well as John Bruno, who is VP and in charge of Investor Relations. Guys, thanks for joining us today. The format will be, Tom and I will ask a bunch of questions. Vince and John, you can submit your questions or e-mail those to us if you have any, and we'll certainly prioritize our client questions.

But to kick it off Vince, you guys had a heck of a first quarter here we are now moving towards mid-May. I'm just wondering if you can give us a little update about the business tone you're seeing regionally around the world?

Sorry about that. No. I just said, Bob, thanks for having us. I wish we were there live with you as typical in New York, but this year, we'll do it virtually. With respect to the tone of business, it's really continued from what we saw in the first quarter. We're continuing to see recovery momentum in several of our markets. It's a bit choppy, as you would imagine, given the pandemic is in different phases around the world, but very similar to what we exited the first quarter with, and I'm sure we'll get into some of the details by specific end market.

Let me start off, if I could, with a topic that's been near and dear to us. And one we thought maybe the market was misreading, which was raw material inflation. Obviously, we've seen oil prices vault into the 70s. We've seen production problems, curtailments around a lot of hydrocarbons in the Gulf Coast, just creating a ton of volatility and inflation and yet you guys, at least to date, have seem to have been able to accommodate it. So I'm wondering, can you tell us a little bit about what might be different than, say, 2018, the last time we saw this kind of inflation that seemed to have a more damaging effect on the coatings industry? And maybe what PPG in the industry are doing differently or what's different this time around?

Yes. Bob, if you go back to 2018, I think one of the differences is we were experiencing a variety of product shortages due to significant curtailments in different supply chains. Those continue to occur for different reasons. We had some weather events. We had some flooding or lack of water in Europe. And so we had extended outages across a variety of different supply chains that occurred sequentially one after another. So the market was fairly tight in different sectors for a period of time. The events that took place this year really were driven by one event, which, as you pointed to, was the weather event Uri. It was short in duration, but it did cause a lot of issues, some structural issues in the supply chain. But most of those are being rectified. As we sit here today, we're still seeing spot outages. Certainly, we're still seeing some logistics issues. But by and large, most of the supply base is coming back online. More importantly, if you look at the pricing side of the equation, we came into 2017, 2018 with flat pricing in most of our end markets. What we came into 2021 with was good pricing momentum across many of our end markets, and we continue to keep that pricing momentum going forward.

I know you wouldn't certainly talk about what your competitors are doing on a price standpoint. But does it strike you that the entire industry is on their front foot here and making sure to preserve the margin progress? Does it seem like a pretty balanced ecosystem for pricing?

Well, I think, Bob, what we're seeing is what everybody else is seeing, everybody is seeing inflation. People handle that differently. But certainly, we're pushing that value. We're pushing for value in the chain, and we're pushing the pricing down the chain. Again, I think everybody is feeling the same inflationary pressures in most industries, not only paint and coatings.

Yes, for sure. Let's talk before we get into the segment detail, maybe a little bit on the M&A opportunity. And you guys have always suggested you'd like to preserve some of your capital for deals. But you haven't been shy about returning it when you've had excess capital. But I imagine despite the travel lockdowns, you've been an awfully busy guy lately. I think you've got 5 or 6 deals at various stages of completion. Talk to us a little bit about the strategy there, bolt-ons versus large deals? And then maybe specific technology, geography, end market, what's sort of been the focal point here? And why have we seen this more recent surge in in activity?

Yes. The acquisition pipeline was fairly solid prior to the pandemic. It obviously took a hiatus during the first several months of the pandemic, Bob. But by last summer, we started to see some of those properties that were in the pipeline prior to the pandemic come back for resurface. And we've seen some others added since. So it's been an active pipeline. We said that for the last couple of years. We felt there would be some of the targets coming to market and they have. For us, we're fortunate. We have a full-fledged global business. We're in every vertical, in every major region. So we really have access and synergy access to almost every deal out there. So that's why I think our plate is typically a bit more full than most folks in the -- most of our competitors, just because we are already are in many of these businesses in every region. So we get more of a broad look at all of these. For us, this has been a true value creation opportunity for the last several decades. We do see synergy capabilities, we think, greater than our competitors. We probably have the same supply chain synergies as some of our competitors. But again, we have bigger businesses in most of these regions than most of our competitors. So we have a little more access over the suppliers. We do have, in every major region, a shared service center. So we're able to quickly crop off the administration side of the house and move that into our shared service center, something most of our competitors don't have access to. So we think we have better synergy opportunities than most as we look at the variety of deals that come down the pipe. I think you are on mute, Bob.

Just trying to make us all on the same page here with our technology. Can you talk about what's left to do to get Tikkurila over the finish line? And I know their year-end results continue to show that internal momentum. What's the latest on earnings trends there? And are you going to capture the peak architectural paint season, do you think?

Yes. We're still awaiting Russia antitrust approval. That's the last major approval we have to overcome. There's still some stuff with the tender we would have to meet, which is acceptance of a certain amount of shares. But again, the big government approval left is the Russian approval. They are a public company. They did put out a trading update a couple of weeks ago, things continue to progress nicely as we would expect and would have hoped. For us, I think one of the important things is we did sign a deal with them, I guess, 5 months ago. So they are certainly able to use their cash for normal business operations, but all the other free cash flow is preserved. So even though the deal is not closed yet, we're still accruing that cash. So when we do close, that will come to PPG. It's not -- we're not going to see the EPS effect, but we'll see the cash effect of the activities that they're doing this year outside of their normal business conditions. But again, good business very, very good positions in Scandinavia, in Russia, exceptionally complementary to PPG and good synergy potential as we laid out in our last earnings call.

On that same call, I was quite surprised and maybe excited to see the history of your M&A deals. You put forth some multiples. You put for synergies, you talked about return on capital in those deals. Why did you disclose all that? And do you worry from a competitive standpoint, you might have revealed a little too much of your success there to your competitors?

Well, I think for us, we're spending shareholder money. So we think it's important to be transparent. We've got several deals either in the hopper or pending closing now. So we wanted to give that transparency back to the shareholders of our past success. We did want to provide because we do expect higher synergy levels on some of these deals. We did want to provide that backdrop to give comfort. That's something we're watching. We're certainly watching the till here. And we do expect to certainly deliver on these. But we were going to give out a synergy number, I think it's 8% to 10% on a cumulative of these deals, and we wanted to let people know the historical perspective as well. And I don't think -- again, we feel we have some capabilities by region that other folks don't in our space. So I think we have a competitive advantage on a couple of these just due to the nature of our business mix and geographic mix. You are still on mute, Bob. Well, you have taken the lead now.

All right. Two for me, only 1 for you. Few years ago, you were under some pressure about the integrity of the portfolio, keeping architectural and industrial coatings together. It seems like that's given you a broader base to which you can pursue these deals and greater synergy and integration opportunity. So I'm curious, when we look around the coatings landscape, it does seem like given the concentration in some architectural regions that industrial coatings is a favored acquisition target area for companies. So can you talk about how you actually process and execute your deal targets? How you handle those negotiations? And again, what is it about the PPG acquisition integration model that you think gives you this advantage that you've been able to pull off the string and potentially future deals?

Yes. That's a great question, Bob. Again, we said back then, and we still firmly believe there's a lot of cross-pollination opportunities just organically, even excluding acquisitions. We get cross-pollination in R&D, certainly, in back office, et cetera. And again, we're able to have access to a bigger pipeline of acquisitions because we're in these we're in these end markets. We do have a much bigger access to supplier base, more weight on the supplier base. We're able to apply as opposed to being a more singular focused coatings company. Our -- the way we execute these is -- most of these are bolt-on in nature. Most of our business folks have really good relationships here, especially with folks we believe are going to become targets in the next 3 to 5 or even 10 years. We keep those communication lines open. When we see folks moving toward a sales process, we certainly are more active with that potential target. And then I think because we have good dialogue over the years, we're more comfortable and they're more comfortable with us. But be in every single region, I think we have typically at least a neutrality, if not a competitive advantage versus the folks in the region given our spread.

It's Tom Glinski from the team here. Just one more question on Tikkurila/M&A. And sorry to exhaust this point. But on potential cross-selling and sales synergies with TIkkurila in particular, just how are you thinking about that? I'm assuming it's not baked into your 8% to 10% of acquired sales target. But just as you look at the 2 portfolios between PPG, Tikkurila, geographic exposure, et cetera, just how are you thinking about potential sales synergies that are there?

Yes, Tom, you're correct. We have very little sales synergies typically baked into most of our acquisition economics, then we hope to certainly get as much as we can out of each one of those. We do see with Tikkurila, similar to what we saw with Comex, a really unique opportunity. They're predominantly an architectural company. We are able to bring light industrial coatings. We're able to bring a full array of protective and marine coatings to that region, again, Scandinavia, where we have very little presence and their relationships locally will also help us, hopefully, in some other businesses as well. So we do think, again, similar to our Comex acquisition, 4, 5 years or 6 years ago, this is going to give us a broader opportunity to execute on sales synergies.

Got it. And then looking now just going toward the businesses. So starting first with Performance Coatings, something that's been pretty interesting during COVID and now heading towards, hopefully, the back end of COVID is just the DIY versus contractor paint dynamic with DIY, obviously strengthening for seemingly the first time in a while. Just as we've moved more into peak paint season, have you seen any shift in consumer behavior and preferring maybe going back toward contractor paint? Or has DIY demand really hung in there?

Yes. Tom, the DIY demand has hung in there. Again, the comps are going to get obviously much more difficult as we get into Q2 and Q3, where we've seen the uplift in last year in 2020 significant uplift in DIY. The comps will get a little more difficult. But the higher activity level, we expect to remain for multiple quarters, we expect a very, very gradual descent from this level. And one of the things that we always look at is unemployment levels and high unemployment typically is a leading indicator to higher DIY. And when we go back to 2008, 2009, 2010, we saw DIY hang in there much longer than people had anticipated. And we expect something similar to that. In terms of professional painters, we are starting to see folks like professionals in their home. So some of the res repaint activity is picking up. Everybody is very familiar with the housing market. The build rate on housing is picking up. We're starting to see very early signs of commercial activity pick up, but still below prior year levels.

Got it. That's helpful. And then sticking to architectural paint. I think on the -- maybe the last earnings call or maybe 4Q, you talked a bit about rolling out this pilot program, where you might be moving a bit away from the store model, the company-owned store model in the U.S. and going more toward hub-and-spoke. Just what's the cause of that? And what have you seen for results so far from that pilot program? Is it something you're going to pursue more heavily? What could it mean from, I guess, a margin standpoint in the architectural franchise?

Yes. We characterize it, Tom, as we're really optimizing the bricks-and-mortar situation. We sell through the home center environment. We sell to what we call the dealer network. We certainly have our own company-owned stores. And we go on a micro market by micro market basis and try to optimize that bricks-and-mortar similar to what other retail chains have done over the past 5 or 10 years. And we're seeing much more acceptance of professionals who prefer to have a delivery instead of a pickup situation. There was a higher catalyst of that during certainly during the pandemic when folks were not allowed in stores. So we've seen this digital delivery acceptance. And what it really has been to allow us to do is to move to more of a hub-and-spoke approach much more efficient approach to bricks and mortar, and these are heavy labor as well. There's labor inflation coming. And if you look -- our store network has -- we have store employees. And there's a labor component. And we're really just mirroring what's been done in other retail sectors and other like professional sectors across other industries. And we think this is going to have some continued acceptance as we go on, there's not a big bang here. But this will continue to be accepted in the professional channel and allow the supply chain to get much more efficient.

And as you shift more toward, I guess, the more e-commerce/digital-driven angle in the architectural business. Do you think there's any component of maybe customer switching costs becoming lower over time because they aren't as close with their salesperson in that store? Or do you think that's not really a dynamic that will play out and there's plenty of interaction via the digital channel?

Well, customer switching costs are low now. Most professional painters maintain an account with us and maintain an account with our competitor and vice versa. They do that, Tom, for credit reasons. They get double the credit opportunity. Most of these are small business people, and they prefer to have that variety of credit at their disposal. I think this will actually put a higher emphasis on the salesperson. So the salespeople or the people out in the field. So this will actually -- we hope, drive continued intimacy there. And again, typically, if you have the best digital tools, if it's -- you're the easiest one to do business with, which we think our end-to-end process will be, that's helpful as well to keep that customer intimacy.

And Vince, I'm curious, there's been some debate about the COVID hangover in DIY and as we reopen, maybe people paint less or have less motivation for it. But we've also heard in some channels that maybe there's a new appreciation for that. Maybe we've created some new DIY painters in the millennials and Gen Xers or where do you guys come out on that?

We're in the latter. We do see a whole new array of painters here that didn't exist in the millennials and Gen Xers, and they come in -- there's majority of home ownership -- new homebuyer, excuse me, which is where you typically would see some of this DIY paint applied, especially on a brand-new built home with very opaque walls. And they're coming into their child-bearing years, which would push you into additional colors with your children. So we're in that latter camp, Bob, where we think this has added. Hopefully, it's widened the pie or enlarged the pie for a period of time.

And if I might move to refinish, arguably one of the best businesses you have, certainly the the competitive landscape is optimal. Your pricing power has been consistent and continuous. What are you seeing in refinish from a reopening? I know on your call, you obviously had very nice results as Asia got back in here. But what are you seeing in the western markets? And what do you think the cadence will be through the balance of the year there?

Yes. Yes, this is a 2-step distribution model for us. So we go through distributors who go to the body shops. And as you pointed out, we saw a very weak Asia China market last year due to the COVID. We saw, obviously, easy comps and a return this year of that activity in Europe. In the U.S., it's a bit choppier. We do see folks in the U.S., building a little bit of inventory ahead of the season, which you would expect. I think some folks had a little bit of concern about getting product given the news out about the weather events. But we are seeing folks return to work. We're seeing almost on a weekly basis, higher levels of traffic and congestion. We've also seen really through the pandemic, a much higher level of activity of driving in the suburbs where there's probably been a bit more accidents than we would have seen. If we look historically, those collisions are typically at a lower speed as well. So instead of having as many totals, we have much more repair work. So we do expect, as we continue to see folks return to work, higher activity levels for the balance. We hope of this year in the U.S. and at some point in Europe. And Europe has come back typically when they've released the mandates to stay at home. Europe has come back much quicker because they have a much more -- their preponderance to come back to the office is much higher.

Yes. We've heard anecdotes from Asia about less enthusiasm for mass transit, and so maybe more driving, do you think that's sustainable? And do you think it will also come to the Western markets?

Yes. We see that actually, if you look at other big markets in the U.S., we see that in New York. We saw that in Asia for a period of time following the prior to pandemic that occurred over there. So we do feel that will stick for a period of time, and then it will -- again, it will dissipate over a period of time as well. But there's certainly a higher level of driving in places where there's mass transit historically.

And then we occasionally get these questions, and maybe it's even linked to sort of a similar analogy to the fuel markets where the adoption of new technology in autos is going to reduce the need for internal combustion engines, in your case, core drivers. We're going to have driver assistance. We're going to have driverless cars, autonomous, et cetera. Can you talk about how you see that sort of glide path over the next 3, 5, 10 years from the evolution of technology into the refinish space? Is there just such a big car park that it won't be observable? Do you think it is a threat to the industry? Can you give us your thoughts there?

Yes. First of all, Bob, we think autonomous is still a ways off, especially when you talk about having -- getting an acceptable product, getting it through regulation and then getting that bought into the market with a $200 million, $250 million car park. So it's going to take a long time for that to have an impact. I would say 10 years is probably optimistic. If you look at the driver assist, most cars today have driver assist. So we've seen or we felt the impact of that driver assist process already. I'm sure they're still getting better and better product out there. But by and large, a lot of the driver assist has been baked into the current environment. This is a situation where we're going to see some recovery in refinish. This year, certainly next year in the material -- I'm talking mature markets now, we do expect, again, a higher level of driving. One of the -- as you deurbanize, you get more cars on the road. So we've seen an urbanization process. We've seen driver assist, that's impacted the last 10 years. Now we're seeing deurbanization. And again, that will drive from 1 car family to 2 car family, et cetera. So we think there's there's certainly a push on volume down, but we think there's some offset to curtail that for quite some time.

I have a question on Ennis-Flint asset that you bought earlier this year. I think this is something that you've mentioned in the past where there's actually an opportunity potentially from autonomous vehicles and assisted driving, et cetera, because of wider lane markings. Could you just talk through the cadence with which that growth or that excess growth relative to what the market has seen historically with which it could be realized? And I guess, what are you seeing so far from a pickup in seasonal activity in that business as we've entered into the spring?

Yes, Tom, a couple of things within Ennis-Flint. So we'll be closing that transaction right at the turn of the year. It's a world leader in traffic marking. We do see in the U.S., some -- many states trying to improve the traffic markings, really around driver assist. It does provide opportunities to prevent accidents. And what they're doing is, first of all, more frequent painting, which is significant. The second thing they're doing is they're extending or expanding the traffic painting lines. Traditionally, it was a 4-inch line. Now many states are adopting a 6-inch line. So it's a 50% increase in the size of the line. And so we do feel those are 2 potential opportunities for growth. And then this plays into the infrastructure opportunity that many people are talking about now. As we look at that infrastructure window, won't be in 2021. But as infrastructure money is approved and/or rolled out this will play into that as well. So 3 opportunities for growth more near-term. And then it will play, if and when autonomous comes, it will play into that as well as certainly one of the key identification markers for autonomous vehicles are those road markings.

And Vince, you mentioned the infrastructure, your Protective & Marine has been a challenged market for a few years now. Is there potential we're lighting a fuse here and are going to start to see a lot more momentum in that business? And can you talk about what the profit opportunity as that volume comes back might be?

Yes. We're definitely feeling the effects of the pandemic, effects of energy impacts in our Protective & Marine business. It's a very technology-savvy business. So we certainly welcome any return of volume that we can get. Typically, though, Bob, just to be fully transparent, we're typically 12 months removed from shoveling around until we're putting paint on. So I don't think that's going to be -- if something is approved this summer, it's not going to be a -- certainly not going to be a 2021 event. Likely back-half of 2022 before we start to see noticeable activity in that business, but certainly welcomed on many fronts.

Moving over to the industrial side of the business. So a question on auto OEM. A lot of different moving parts here in the near-term with production rates slowing down a bit. But consumer demand still remaining very strong. But I think one thing that has gotten a decent amount of focus over the last year or so has been the electric vehicle opportunity for PPG. So it would be great to just hear your thoughts and comments on what you think we could see from, I guess, a detachment from normal auto OEM production rates? Is that something that could happen in the near-term for your OEM volumes? Or is that going to be a more longer-term growth story for the company?

Yes. Tom, I would put this as a midterm growth opportunity for us. We've been working on what we call mobility opportunities for really 5 years. We understand some of the technology gaps that the EV -- move to EV has created, and we've really tried to put patented technology around some of this, commercialize some of it. It's really on the next-generation of product that's coming out. Right now, what you're seeing we're classifying as electric vehicles are more hybrids. We're really focused on these, what I would call a true electric vehicle. And it's really, for us, an opportunity, as you said, a detach from just a straight on auto builds. We're looking at 2x to 3x the content -- 2x to 4x the content, depending on the vehicle as a traditional gas combustion engine. And that will allow us as electric vehicles become a bigger portion of the global auto market that will allow us to grow, we think, well above market. Most important thing, though, we think we have a 2 to 3-year head start here versus most of our competition because we really began working on this 4 or 5 years ago and really putting some stakes in the ground 2 to 3 years. And getting product to be tested into the market well before, I think most of our competition was working on this.

Got it. And then on the more traditional OEM side, with this chip shortage that's been going on over the last quarter and appears to be set to go on for almost the remainder of 2021. It'd be interesting to hear just what your different customers and obviously, no names need to be included. But just what they're saying on the order book and the cadence for recovery and production rates throughout the remainder of the year and into 2022? Does this just extend the growth path for OEM, which some might have thought would be a shorter cycle growth story here in '21 or '22?

Yes, Tom, I think you nailed it perfectly. For us, the -- what's most important is we have a very important end mark to us with what I would consider exceptionally strong underlying demand. We have underlying demand from the consumer, which they're trying to fulfill real time. Once that's done, we have underlying demand in terms of an inventory rebuild. The dealer lots are very, very low inventory. So we'll see that get rebuilt after the consumer is satisfied. And then the third leg of the stool here is there's tremendously sparse cars on rental car lots. And that is typically 10% to 15% of the industry. And so once these other things get rebuilt, you still have this need to rebuild the rental agency car fleets. So this will definitely extend the growth patterns for this business. If customer order patterns are choppy. We expected that coming into the year. But this will definitely extend us from a shorter cycle to a much longer cycle, given the 3 levers -- at a minimum, the 3 levers for growth.

Got it. And then last one for me here on industrial is just on the packaging side. I think one thing you've talked about in the past is the secular shift over to aluminum as a more sustainable solution. So just where are we in that kind of growth path? And has it been more inconsistent at all from an adoption standpoint because of COVID? I know single-use plastics were out of favor for a while but have now kind of had a resurgence. So just how are you thinking about the longer-term growth path there?

Yes. We're seeing many, many can manufacturings, either under construction or get ready to start-up in the balance of the year. So we're definitely firm believers, and we're seeing the numbers that can manufacturing can production is going to be up this year, next year in terms of our -- the industry's BPA or BPA-free products, the food side fairly well converted. The beverage side is still under conversion, and we expect that to continue. But the pace has definitely been more modest than we had anticipated 2 or 3 years ago, due in part to COVID. But this is definitely a growth sector, growth industry, the coatings sector is supplying into. And we're seeing it here. We're seeing it in Europe and in Asia.

And Vince, I'm just curious, you got an industrial category as well, which is a catch-all for a number of other end markets you sell into. Can you give us some sense, are we seeing the same kind of momentum there that you're seeing across your broader portfolio?

Yes. For us, Bob, our industrial portfolio is typically the proxy, and we started to see that really perk up in, let's call, it late second quarter going into third quarter of last year and it continued to do well. Again, it serves a lot of different verticals. So not all of them are have strong momentum. But we are seeing good volume around the world. We're seeing light inventory all the way through to the consumer around the world, things like appliance, heavy-duty equipment is perking up. So we're seeing, again, what I'd call, a robust industrial recovery afoot. We came into actually 2019, very light on an industrial activity, everybody was calling it a mini industrial recession, and we're seeing that reverse as we speak.

And client asking, and I was trying to be deferential and ask it at the end. TiO2, it sounds like there was an attempt to create a new world order in TiO2 pricing. And so maybe it never went down as much as it should have, but perhaps that means it won't go up as much as it should. Could you just give us your insights on what you're seeing and if it's a different environment than the good old boom-and-bust days in TIo2 pricing?

Yes. I'd say that we -- as you characterized it, Bob, we didn't see TiO2 prices come down even though there was significant excess supply in the past 12, 18 months. We don't expect them to move up radically for the same reason. There is still excess supply today. We're sitting right now in the heart of mass production for architectural paint. April, May, June are typically months where we're building tons of inventory and selling hand to mouth to consumers and the professionals. And there's still excess TiO2 supply out there. So again, we don't expect any radical moves here. I think you are on mute, Bob, one more time.

3 times, 3:1. We've run out of time unfortunately, guys. Really appreciate the help and look forward to catching up down the line. Thanks so much.

Thanks, you guys. Take care.

Take care.