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

Good morning, ladies and gentlemen, and thank you for standing by. This call is in relation to the press release entitled to PPG to review alternative for architectural coatings business in the U.S. and Canada. [Operator Instructions] I would now like to turn this conference call over to our host, Jonathan Edwards, Director of Investor Relations. Please go ahead.

Thank you, Candice, and good morning, everyone. This is Jonathan Edwards, Director of Investor Relations. We appreciate your continued interest in PPG. This call relates to the press release issued this morning regarding the strategic alternatives review of the architectural business in the U.S. and Canada. Joining me on the call from PPG are Tim Knavish, Chairman and Chief Executive Officer; and Vince Morales, Senior Vice President and Chief Financial Officer. Both the press release and discussion during this call may contain forward-looking statements reflecting the company's current view of future events and the potential effect on PPG's operating and financial performance and statements regarding the strategic review and any potential outcomes of the review. There is no assurance that the strategic reviewed process will result in the approval or completion of any specific transaction or outcome. These statements involve uncertainties and risks which may cause actual results to differ. Forward-looking statements involve uncertainties and risks, which may cause actual results to differ materially from those projected or implied by such statements. The company is under no obligation to provide subsequent updates to these forward-looking statements. And now let me introduce PPG Chairman and CEO, Tim Knavish.

Thank you, Jonathan. Good morning, everyone. This is Tim Knavish, Chairman and CEO of PPG. As announced this morning, we have initiated an evaluation of strategic alternatives for our architectural coatings business in the U.S. and Canada. We're conducting a comprehensive review, exploring all options for this business, which may include a sale of the entire business, certain parts of the business, a joint venture, a new investor or a strategic partnership. And naturally, the review may also result in us taking no portfolio action. The PPG Architectural Coatings business in the U.S. and Canada has a well-established position in a growing market, leading brands, proven innovation, well-established customer relationships and dedicated and talented employees. We've made considerable progress over the past several years in modernizing the Architectural Coatings business model to be more consistent with other contemporary, retail and distribution models. This has included instituting value-added customer-facing digital tools transitioning towards an asset-light distribution model and introducing innovative products that enhance customer productivity and sustainability. We've started a forward-looking journey to build the Architectural Coatings business model for the future in the U.S. and Canada. Our actions over the past several years have created positive momentum in the business as we have increased the number of distribution points for our well-known and respected brands. This includes our multiyear Pro painter initiative with the Home Depot and expansion of presence across our independent dealer network. We are now the majority paint supplier to Walmart with an additional incremental product assortment being added to Walmart in 2024. Also, we continue to be a leading paint supplier at Menards with strong brand placement and a broad product assortment. And finally, we continue to build a contemporary digital omnichannel for all of PPG and our digital-enabled sales for this business grew by over 110% in 2023. In addition, over the past several years, we have streamlined the overall business rightsizing our regional manufacturing footprint. We have also revamped our distribution capabilities by reconfiguring our logistics and considerably reducing our warehouse footprint while improving customer service. In conjunction with broader PPG initiatives, we have developed and deployed a digitally enabled customer-facing omnichannel. Also, we have fully utilized PPG's research and innovation capabilities as we introduced many innovative products such as Glidden Max-Flex Spray Paint and LIQUID NAILS FUZE IT MAX and the business continued to benefit from global PPG product formula improvements such as improved efficiency in TiO2, among others. And finally, we have reduced SG&A as a percentage of sales by approximately 300 basis points despite current significant growth-related investments. The current strategic assessment includes our well-known and high-performing brands such as Glidden, Olympic, Pittsburgh Paints & Stains, MANOR HALL, [ CICO ], LIQUID NAILS and Homax along with Dulux in Canada. Propane brand offerings include products such as Speed [ Height ] and Multipro. The scope also includes certain light-duty protective coatings that are primarily sold through company-owned stores and manufactured to a common factory footprint. The regional business is supported by 9 manufacturing sites, 12 distribution centers and about 750 company-owned stores. The business has approximately 6,600 employees, including dedicated research and development and technical service teams. Commercially, this business has minimal overlap with other PPG business units. And based on the current and manufacturing distribution footprint, we expect minimal operational carve-out complexities. The Canada business has a #1 position with regional offices in [ Vaughan ], Ontario and Beauceville, Quebec, which include customer service, technical service, human resources, marketing and credit teams. And additionally, we recently won additional share and a multiyear contract and now have a majority position on shelf with Rona, the #2 big-box home improvement retailer in Canada. In aggregate, of about 40% of this business is DIY facing with the remaining 60% pro painter oriented. By end use, about 50% of the business serves either commercial maintenance or commercial new build, with the remaining 50% geared toward residential repaint or new home construction. We are exploring the strategic review now, given the positive momentum in the business with the intent of ensuring its continued growth and success, while also maximizing value for PPG and its shareholders. We will assess whether the business could be better suited to grow faster with a partner or a different owner or may be better suited to operate as a core business within another company as a stand-alone entity or a joint venture. Our review will help to determine if any of these alternative structures will provide the business with more speed and accelerated growth capability. PPG's U.S. and Canada Architectural Coatings business, which accounted for approximately 10% of PPG's total 2023 sales has consumed considerable resource capacity, especially to support the recent increases in strategic commercial pathways to the market. As I said in my CEO briefing last May, we want to ensure that PPG applies our finite capacity and resources with a laser focus on overall organic growth for the entire company. Despite the business delivering flat sales volume in 2023 on a 3-year pro forma basis, PPG's overall company sales volume results would have improved cumulatively by over 200 basis points, excluding the Architectural Coatings U.S. and Canada business. Also, the company's Performance Coatings segment operating income, excluding the U.S. and Canada Architectural Coatings EBIT would have resulted in an approximately 300 basis point improvement in total segment margins in 2023. As we execute the strategic review, we will continue to fully support the business, our dedicated employees and our architectural coatings customers. That may be 100% clear. This review is only related to PPG's Architectural Coatings business and select light-duty protective coatings business in the U.S. and Canada. We remain fully committed to our Architectural Coatings businesses in all other regions around the world. This includes our Architectural Coatings businesses in Latin America, Europe, and Asia Pacific, where PPG holds strong #1 or #2 positions in a number of key countries. The timing and outcome of the strategic review is uncertain. PPG does not intend to disclose developments or provide updates on the progress or status of the review until it deems further disclosure is appropriate or required.

Thank you, Tim. We will now open the line to take questions specific to this announcement, please limit to one question per person. We'll take questions until approximately 9:30 a.m. Candice, will you please open the line for questions.

[Operator Instructions] So our first question comes from the line of John McNulty of BMO Capital Markets.

So Tim, obviously, you guys have been putting in a lot of effort into growing the business, putting a lot of investment in and admittedly, it looks like it's having a pretty negative impact on the margin. I guess, can you help us understand how much of the 2023 margin pressure that it looks like it was putting on you was just tied to the investment itself? And maybe also, can you give us an idea of what the total EBITDA was for this business as well?

John, thanks for the question. The 2023 EBIT, EBIT margin really impacted by two key factors. Number one, the growth investments that you mentioned, but also just the volume in the market, right? What's happening in the market. It's a high fixed cost business with the -- when you think about all the brick-and-mortar store costs, and the cost to serve thousands and thousands of customers. So when you get negative volume, there's really some deleveraging there. But on the growth investments that we've been making, they've been tens of millions per year, so not insignificant. So it's really the combination of those two that have led to 2023 margin profile.

Yes, John, this is Vince. In terms of the business metrics, we gave some information in the press release, if you back-calculate, you'll see the business as a low single-digit EBIT return on sales and a low to mid-single-digit EBITDA return on sales. Again, about 10% of the company sales related to this business in 2023.

Our next question comes from the line of Ghansham Panjabi of Baird.

Tim, as you sort of step back in context of what you announced for silica last month and also this morning, how should we expect the pro forma portfolio evolve going forward? I'm just asking, is it fair to assume that you're basically in front of position toward higher technology coatings verticals where the moats are deeper. Is that the takeaway here?

Yes, that's a good way to summarize it. I've said since I took over last year and in May when we were all together, that we're not going to try to be everything to everybody. We're going to be a very focused company, focused on where we have the highest and strongest right to win. And a lot of that is technology-based or strengthen our position in various segments and geographies. So that is exactly how you should think about it. We're going to make choices portfolio choices based on those factors. And we've made these two choices that we've now announced this year. And we'll continually assess over time, working with our Board what are the best parts of the business that belong in our portfolio. And of course, businesses need to demonstrate that and earn the right to stay in the portfolio. But I think your summary was spot on.

Our next question comes from the line of Duffy Fischer from Goldman Sachs. Please go ahead.

I just want to drill in on the 200 bps of 3-year cumulative decline. If I run that through your sales of $18 billion last year, that's roughly, say, $375 million of revenue. So relative to the size of this business, it's now $1.8 billion. Is that roughly kind of 20% of that business volumetrically went away over that 3-year period? Is that the right way to think about it?

That's cumulative over multiple years. I think as we said in the press release, we were flat in '23. But again, we were coming off of a very strong period where we had COVID benefit. And then we had, as we talked in the last couple of years, destocking in the DIY channel. So the metrics, the metrics and this is volume, not sales, but the metrics you're talking about are right, we add positive pricing over that time period.

Our next question comes from Josh Spector of UBS

It's Chris Perrella on for Josh. As we think about that to follow up, do you think you've underperformed your peers in the Architectural Coatings channel in the U.S. and North America? And then why North America and not Europe, given the weaker economic outlook there?

Yes. Thanks, Chris. This is Tim. If you look at 2023, we actually gained share in the U.S. If you look at third-party data plus our own volume numbers. I think there's a lot of macro impact. And I can't really comment on my competitors' playbooks and what they're running, but our strategies and decisions are based on the principle of maximizing shareholder and stakeholder value with the portfolio that we have, the positions that we have in each of the various segments and countries, and we make those decisions accordingly. And to your Europe question, really, it comes exactly to that. In Europe, we have a strong #1 or a strong #2 in many of the European countries and that enables better growth accretion on both top line and bottom line. And our European architectural business, despite the significant macro challenges because of the strength of our value proposition, the strength of our positioning have performed quite well. In fact, we've had record years in a number of these very challenging years, record years on both EBITDA and cash generation.

Our next question comes from Kevin McCarthy of VRP.

Yes. Tim, I think about 5 years ago, an activist made a foray into PPG. And my recollection is that the state of the architectural business was perhaps part of the conversation there. Can you comment on what is different today versus that period of time as a first question, and then secondly, with the level of profitability that you outlined here, would it be the case that a separation would most likely be accretive to your earnings?

Yes. Thanks, Kevin. So going back to, I think it was 2018 when we had an activist that put out a white paper. And the primary thesis. There were several points raised in that white paper. But the primary thesis was to split the entire company, split all of Architectural Coatings globally which is far from what we're talking about here, we remain fully committed to all of those regions that I've mentioned earlier outside of U.S., Canada, so it's a very, very different scale than what was proposed a few years ago. And even since that time, 5 years, 6 years now, the business is very, very different. We've reconfigured the footprint of the business, revamped our distribution footprint. We've introduced the digital omnichannel, the brick-and-mortar light model. We've launched a number of R&D innovations that we attained throughout PPG. We've got the PHD partnership, the Rona partnership, the MANOR partnership, Walmart expanded our dealers. So it's a very different model. We've also taken out significant SG&A since that time period. So I'd answer it in those two ways, Kevin. One is Trian had proposed that we split the company basically in half with all of deco going, and we're only looking at U.S. Canada here. And secondly, it's a very different model at pace. But I think your conclusion on if we were successful in a complete carve-out year, your conclusion on EBIT and EBIT margin is accurate.

Our next question comes from David Begleiter of Deutsche Bank.

Are there any benefits to Comex from having -- for you owning a U.S. paint business?

David, the quick answer is really no. Unlike many of our businesses like an auto or an aerospace or a packaging which are truly global businesses, common customers, common technologies around the world and, of course, just one brand PPG, Architectural Coatings, deco in particular, is really a collection of country-specific businesses. There's a little bit of R&D that's shared. But beyond that, these are largely run as independent countries. And even the R&D that's shared, frankly, a lot of the R&D that we've been getting out of this business has come from PPG Comex or come from parts of Europe. So there's really no impact here on Comex.

Our next question comes from John Roberts of Mizuho.

Do you have any co-mingled manufacturing assets here in North America with your other coatings businesses.

John, it's Vince. No, as we detailed, I think, in Tim's opening remarks, this is a fairly stand-alone operating part of the company. They've dedicated manufacturing with U.S. and Canada plants that we outlined in the press release.

Our next question comes from the line of Michael Leithead of Barclays.

Great. Tim, I wanted to circle back to a couple of questions ago. I think PPG is historically how did the merits of having a strong architectural and industrial business. This move seems like a fairly large exit from a chunk of architectural that you even recently touted and invested heavily. And so can you just talk about why now in the decision-making process and would divert it all by any inbound interest into the business?

The real -- thanks, Mike. The real reason for why now is we made a strategic decision a few years ago that faces our position here in the U.S. Canada market, we were going to drive a transformational business model as opposed to a me-too business model. And we started down that journey and we've now gotten to a point where we have -- we have positive momentum with that new business model and so we felt -- that's one of the reasons we felt now was the time to bring that to market. The second reason for why now is the growth investments that it takes to continue the expansion of that business model transformation. I mentioned last May, we have to make choices on how and where we invest in which segments and geographies and there are opportunities for us to make growth investments in segments, geographies that will have a bigger impact in a more timely manner for PPG's stakeholders. So those are really the two primary reasons for why now. Momentum in the business and focus and choices that we need to make on where to make our growth investments.

Our next question comes from the line of Stephen Byrne of Bank of American Merrill Lynch.

Yes. Tim, just continuing on this pathway of why now -- you rolled out the partnership with Home Depot in 12 cities, as I understand, it seems like you've got a long way to go on this. Are those cities where you already have a pretty strong store footprint, and therefore, moving beyond those 12 cities could be more challenging if you don't have the store footprint to support that distribution model. Is there anything about the partnership that maybe fallen short of your expectations?

No, Steve. The partnership is progressing well, we're thrilled with the partnership that we have with the Home Depot on the propane initiative, combined with our Glidden DIY initiatives. You are right, we went from one city to three cities to 12 cities. And those, I would call the more intense markets. We're in all the THG stores, but we have put additional focus we call them blip cities on those 12 and it's because of those efforts that we're starting to see an acceleration of success of the model but recognizing, to your point, we're now 2 years into the business model. We're seeing -- I've said before on many calls, this is a painter by painter transform model that will take a lot of time. It's a marathon, not a sprint. And when you combine that with the continued investments that we'll make in this business model, versus the investments, the other investment opportunities that I have in the portfolio, that's really what's led to why now. We're seeing success out of those blip cities. So we're confirming that the model will work. It's now a question of how much can we invest, how fast and is that the best use of our growth investment money from a total portfolio standpoint.

Our next question comes from the line of Vincent Andrews of Morgan Stanley.

Could you talk a little bit more about the partnership opportunities or JV opportunities, what that sort of might look like? And is any of that meant to sort of help out with in sort of carving up what could otherwise be antitrust issue.

Vincent, I didn't make those comments with any basis on antitrust actually. It was more just because we want to have a wide open field of potential partners here things that could help share on the investment cost for the growth initiatives that I just mentioned, but also partners that might move more velocity through the footprint that we have, whether that's some other building products type of partner or paint partner. But it was not an antitrust comment at all. It was more, let's cast a wide net and look at all opportunities.

Our next question comes from the line of Jeff Zekauskas of JP Morgan.

Is it clear to you that the business will be sold as a whole or could it be the case that Canada is carved out or the stores business is carved out or the business you sell through other people's stores is carved out. And when you look at the returns in the stores business, are they higher or lower than the returns when you sell through other people's stores? Is there a raw material penalty that you would experience because of buying less from other people? And what would you do with the proceeds?

Okay, Jeff. I'm going to take a couple of those and I'll let Vince take a couple of them. We're open to a bunch of different scenarios. You mentioned Canada, you mentioned buying the stores. We're open to all of different possibilities of any kind of resolutions here, whether it's a wholesale or any of the ones you mentioned. Right? You could also think about different brands and specialty products that we have embedded in the business. So lots of optionality. On the raw materials, we don't expect any impact. If you look at what we've done -- first of all, we're a huge coatings supplier in North America with or without this business. If you look at adding the volume of PPG Comex, adding the volumes of [indiscernible] adding the volumes of other acquisitions that we've made over the last few years. Our footprint in North America will continue to keep us as a major player here and a major consumer of raw materials in the coatings space. And we've got great partnerships and flexibilities in this area

Yes, Jeff, in terms of channel profitability, I think it really gets to what Tim alluded to earlier on the call, is in a normal volume environment, each channel has -- each channel holds their own, these channels, some of them had a bigger fixed cost load. So volumes fall, it affects the profitability on a short-term basis. But in the normal volume environment, these channels [ are all their own ] similar to the overall profitability. In terms of proceeds, we're not going to be -- we're not going to speculate. Again, this -- the strategic review can go in a bunch of different directions. We'll just say what we said on our earnings call, which is we're not going to let cash grow on our balance sheet this year. So in terms of proceeds, affects the outcome of this, it will fit into that algorithm.

Our next question comes from the line of Frank Mitsch of Fermium Research.

Just curious, what would you consider normal EBIT margins pre-pandemic for this business? How has this business been performing? Because obviously, the most recent margins are pretty disappointing. And then I was just curious like hey, listen, I appreciate the transparency. Why did you guys decide to make this a public announcement.

Frank, I'll start. The normal margins is all volume dependent and growth investment dependent. And these last couple of years, we've been double whammy by those two impacts. It's a very volume-sensitive business. So if you go back pre-COVID, when we had better volume and lower profile growth spending, the margins were much better. And as for why we went public on it. Again, as I said on the prior question, we wanted to cast as wide in that as possible for possible partners and possible scenarios to look at.

Yes. And in fact, we are starting a process -- external process that have got to become public without this press release. So we wanted to make sure we had the same messaging to everybody.

Our next question comes from the line of Arun Vishwanathan of RBC Capital Markets.

Congrats on the announcement. I guess I just wanted to ask two questions. So first off, I think you mentioned that there's maybe a 300 basis point improvement on margins that would have been there had this business not been in the portfolio over the last couple of years or so. Does that also take into account, say, the dissynergies on the procurement side or anything else that may be a drag? So really, it's maybe something more on the [indiscernible] basis point range if you exclude those and then similarly, on the capital side, could you address maybe how much investment that has been -- that you would kind of save over the next little while if this exit is successful?

Yes, Arun, just this is Vince. Let me make sure the numbers are clear here. So the 300 basis point improvement was specific to the Performance Coatings operating income or segment income. Again, our view, again, we'll see which way this strategic review goes. But our view in a carve-out will work through and minimize any raw material dis-synergies. As Tim said, we have a full-scale business in North America, coatings scale business in North America, still be our largest region. We will work through as we've done in the past as we've carved out other businesses. We sold our glass business, our chemical business in the past and if there are any stranded costs, we'll rectify that in fairly short order. So I would say at this point with that 300 basis point number on the Performance Coatings margins. In terms of capital, this business is 1% to 1.5% of sales of the business's sales for cap spending.

Our next question comes from the line of Mike Harrison, Seaport Research Partners. Please go ahead.

I was just wondering if you could break down the portion of sales that are associated with your big box retailers with your company-owned stores. And I assume there's still a portion that goes through independent dealers just broad [indiscernible]. It doesn't need to be specific.

Mike, I think we covered this in the prepared remarks, but just to make sure it's clear. About 60% of the business is pro-painter facing. Again, with our omnichannel, some of that gets distorted by channel. About 40% of it, I would call DIY.

The vast majority of that DIY you should think through our big box partners and not very much through the stores and dealer network. Our stores and dealer network are much, much more pro.

Okay. So thank you, Candice again for organizing the call. We're past the 9:30 time slot. We appreciate your interest and confidence in PPG, and this officially concludes our conference call.

Ladies and gentlemen, thank you for joining today's call. Have a great rest of your day. You may now disconnect your lines.