PPG Industries Inc. (NYSE:PPG)
Credit Suisse 2013 Chemical and Ag Science Conference Call
September 17, 2013 8:00 AM ET
Chuck Bunch - Chief Executive Officer
Frank Sklarsky - Chief Financial Officer
Vince Morales - VP, Investor Relations
John McNulty - Crédit Suisse
John McNulty - Crédit Suisse
For our first presentation, and I think now it’s time to get on with the show. We are very happy to have one of the best performing names in the space over the past few years and that’s PPG. As you all likely know, PPG has made a number of moves over the past few years with the sales of its chlor-alkali business, the announcement of the Transitions divestiture as well as the acquisition of Akzo’s North American paint business.
Now with those moves, not only does the company have one of the biggest and best coatings platforms in the world, but it also has the financial flexibility going forward to take advantage of other opportunities to help drive shareholder value over time.
Now to tell you about these opportunities ahead for PPG, we are very happy to have the CEO, Chuck Bunch. Chuck’s been with PPG for 33 years. He has been the CEO for the past eight years, really driving the transformation that we have seen at the company over the past few years.
Also with Chuck, we are happy to have Frank Sklarsky, who is PPG’s new CFO, who recently joined the team from Tyco, and then we’ve also got Vince Morales who heads up PPG’s Investor Relations platform.
So, with that, let me turn it over to Chuck Bunch and you can hear about PPG and some of the opportunities they have.
Good morning, and thank you, John. It’s pleasure to be here. We’ve got the early shift. So, while you are still working on your coffee, we’ll try to kick it off with what we feel is a very exciting story for PPG. We have our forward-looking statements. Vince and Frank had been introduced by John. So, let’s talk about our topics for today.
Our portfolio transformation, our coatings industry overview, and why we are really excited about our focus on the coatings industry, PPG’s financial performance and cash positions, and given the time we have, we’ll try to do some Q&A at the end of the program.
PPG is now the largest paint and coatings company in the world. You can see with this collage all of the end-use markets that we are playing in including automotive, aerospace, appliances, construction, bridges, motorcycles, and a like. So we have a very diverse end -se market for our products, but we are focused as you will see increasingly on the paints and coatings products to service these -- all of these diverse industries.
If you look now at our business portfolio transformation over the last 10 years, let’s take a look back here. 2002, a little over $8 billion company, at that time 55% in coatings and then we had a mix of specialty materials, chemicals, and glass, and we were viewed at that time as a more diversified industrial company.
What’s happened, however, in the ensuing 10 years, we have grown our sales to now over $15 billion in 2002, and moved our coatings portfolio to some 74% of the total with smaller positions, particularly in our glass businesses, where we had one major divestiture in 2009.
And if you look at this from a growth rate standpoint, our coatings sales growth over this period, 175% or about 10% CAGR. Our coatings sales is now again over $11 billion, 75% of company revenues, up from 55% with again the reduction in our exposure to the glass business.
Now, let’s look at some of the additional actions that we’ve taken. We accelerated the portfolio transformation last year with several strategic initiatives. One, we made three strategic acquisitions, Spraylat here in the U.S., an industrial coatings company; Dyrup, a European architectural; and a wood stains company headquartered in Denmark.
And we also restructured our Indian joint venture with Asian Paints and took a majority role in the non-architectural, primarily the automotive and industrial businesses. So, now we have a majority share of our joint venture in the Indian market with Asian Paints.
And we also announced the separation of our commodity chemicals business and the subsequent merger with Georgia Gulf now Axiall which was completed in January 2013.
So now let’s move to 2013 where we continued again our strategic initiatives. We completed the acquisition of Akzo Nobel’s North American architectural coatings business that was announced last December. We closed on that the 1st of April. So you saw the first quarter of the operations of our combined businesses in the second -- our second quarter results in July.
We also announced and closed the acquisition of Deft Aerospace Coatings, a very strategic bolt-on for our highly successful aerospace coatings business that was done in May.
And then in July, we announced an agreement to divest our interest in our Transitions Optical joint venture to Essilor who was the minority partner in our Transitions Optical joint venture. So, again, very active period over these last several years in our strategic transformation.
If we look a little more closely at the transactions, the big transactions and some of this you have seen, but in the commodity chemicals separation, a very complex transaction, total consideration at closing was some $2.8 billion for our chlor-alkali business. We received $1.1 billion in cash and minority interest.
I just got a little ahead on the clicker here. Okay, there we go. $1.7 billion direct to PPG shareholders in the form of the exchange for Axiall stock, and we also transferred to the Axiall combined company the related pension post-retirement and other future liabilities of our chlor-alkali business structure, it was a Reverse Morris Trust, very tax efficient for PPG shareholders, voluntary exchange again for PPG shares and a reduction in PPG share account of over 11 million shares.
So a very shareholder-friendly transaction, and we feel that we positioned PPG very well going forward to focus on our coatings portfolio with even more resources, and I think the transaction was very beneficial as well to Axiall who then got size and scale in the chlor-alkali downstream markets.
If we look at our acquisition of Akzo’s North American coatings business consideration, again we picked up about $1.5 billion in sales, purchase price slightly over $1 billion including certain assumed liabilities. We received no U.S. pension post-retirement benefits or other non-commercial liabilities or relatively clean transaction for PPG.
And we have targeted synergy improvements on the earnings line of some $200 million. $60 million in lower cost achieved at closing. This was some of the allocations and fresh start accounting benefits, $30 million to $40 million in incremental synergies in the first 12 months, and again $100 million to $110 million of incremental synergies over the following 24 months.
So, we’re saying in the first three years of the transaction, $200 million in synergies which at that purchase price or the sales level, these are aggressive synergies, but as we’ve explained through the early days of the integration, we feel very confident that we’re achieving these levels. In fact, as you know, we bumped up the synergy targets at the end of the second quarter with the results from $160 million to $200 million, and I think that reflects our confidence in the success of this integration.
The expected impact of this transaction to PPG accretive in the first 12 months, excluding the non-recurring acquisition accounting charges and restructuring, and greater than a 12% EBIT return on sales by the third calendar year, so we’re quite excited about the transaction and the opportunities, and we’re on pace, we’re some five plus months now into the integration and feel very confident about the opportunity.
If we look at the Transitions Optical joint venture, this is a very successful business for PPG and has been for over 20 years. However, we felt that for our continuing focus on the coatings industry and the opportunities in front of us for this business with a partner whose true core focus was the optical industry, we made a strategic decision that we announced at the end of July to divest our majority interest in this joint venture to Essilor who is the leading optical industry player, a French company. And the agreement was to sell PPG’s majority or 51% interest in Transitions Optical and also a small sun lens business that we had in that optical and specialty materials segment.
We did sign a long-term optical product supply agreement between PPG and Essilor. Again this is for monomers and dyes, two of the kind of the core businesses for PPG from our early days of participation in the optical industry and true core businesses for PPG that reflect our heritage and expertise in chemicals and dyes and coatings.
Transaction consideration, $3.5 billion, so we’ll pick up about $1.7 billion in pretax cash for our interest, and again in another tax-efficient transaction, we now will receive after tax, $1.5 billion from the transaction. There are regulatory approvals that are required by Essilor and our assumption on the closing, it’s not definitive but our expecting closing date is the first half of 2014.
So, now if we fast forward to today’s PPG, and we look at it on a pro forma basis with these transactions, the company now would reflect on a pro forma basis a little over $14 billion in sales, a very small specialty materials segment still the remaining interest in our glass business, but the key factor here is we’ve moved from 74% of the portfolio in coatings to now 90% plus with strong organic growth and a very strong balance sheet.
So, we’ve really we think have moved the needle and almost completed fully the transformation that we set out to do some 10 plus years ago. It’s been somewhat of an evolution. But you can see we’ve picked up the pace over the last couple of years and now have almost a total focus on coatings and paints.
If we look then at the geographic shift that’s accompanied this portfolio transformation, again sales almost doubling in this 10-year period, but what we like is we’ve also globalized the businesses even more aggressively and moved to a balanced global portfolio where a little less than half of the geographic mix is here in North America or the U.S. and Canada.
We have a very strong position in Western Europe, some 26% of our sales, a nice position in Eastern Europe, and what we’ve grown significantly over the last 10 years is a strong organic growth story in Asia-Pacific in our coatings businesses. So, we feel that we have a very good mix geographically and well-positioned in the faster growing markets in emerging regions like Eastern Europe or Asia-Pacific.
And if you look at our earnings, we’ve done this without sacrificing any of the historic high profitability or margins for PPG. If you look at our PPG coatings segment earnings for the period from 2007 to 2012 we have in excess of a 10% CAGR and we’ve grown those earnings 58% during this six-year period and this is including the severe recession that we all experienced in 2008 and 2009. So a good story in terms of the portfolio transformation and our ability to maintain our historic performance levels in profitability and earnings.
So let’s talk a little bit about this coatings industry that now PPG has become the leading company in this very attractive segment of the chemical industry. If we look at the global coatings industry, a $110 billion market with, as we’ve described before, a wide array of end use markets, the largest being the construction market, some 45% or so of total coatings sales are in the architectural or sometimes called decorative markets, then we have good industry participation in what we would call the general industrial market that could include things like consumer electronics, appliances, coil and extrusion coatings.
But also important segments in automotive both OEM and aftermarket or refinish the protective and marine segments, this is painting ships, power plants, chemical facilities, bridges and other infrastructure, and nice niche markets in packaging and aerospace, where we are really adding value typically substrate protection and decoration, these are the two primary benefits that you see in or that the coatings industry delivers to its end use market customers and we’ve got some great PPG attributes, global breath in these markets, leading technologies, a strong history for PPG of technology development and customer service, great distribution and local and regional production capabilities.
We’re active in over a 100 countries around the world. We have manufacturing facilities in more than 70. So it is truly a global business where many of our manufacturing processes are localized in the countries that are the consumers or the final consumers of these products.
The industry and we’ve described some of our strategies as we’ve globalized our business. But the industry is also consolidating with a number of the leading players playing a role here over the last 10 years in taking what was a very defused industry and not very global to one where the top 10 players are now have sales in some 60% of the total for the coatings industry.
So you can see now PPG’s position over these 10 years period the industry has doubled. We’ve more than doubled. We’re now the leading player followed by Akzo Nobel. But you can see the consolidation of those leading 10 players and I think this consolidation trend is going to continue.
You can see there’s still a large portion of the global industry in the hands of smaller, regional and local companies. So we think there’s still ample opportunity to pursue further consolidation and I would expect that as we look forward over the next five to 10 years you’re going to see these consolidation trends continuing.
PPG’s market positions not only are we the leading overall coatings company, but we have very strong end use market positions in each of what we would consider the key markets for coatings. We are now number one together with Akzo and Sherwin-Williams in the architectural space.
We have strong number two positions in industrial and protective and marine. We are the leader in automotive OEM and automotive refinish, as well as aerospace with a strong number two position in the packaging coatings business. So we are well-positioned, strong market positions in every one of these end use segments and we participate in all of these end use segments.
If you look at our end use markets, again 40% or so for architectural coatings for PPG, a little, slightly less than the overall weighting for architectural and portfolio -- end use markets but very strong positions there, as well as in special-purpose coatings.
And if you look at our mix between what we would call OEM coatings and aftermarket or maintenance coatings, about 50-50 and this would play a role as we look at cyclicality or exposure to business cycles or economic cycles around the world.
So the aftermarket and maintenance side of the business very stable, not as fast growing in the developed world but these aftermarket businesses are very fast growing in the emerging world.
And this helps cushion our business and coatings in general from what I would call sharp economic cycles that you would see in some of the commodity businesses as an example. So it helps to produce a more consistent, more stable sales and earnings picture for the coatings industry.
PPG historically despite this growth trend and our acquisition record, we have maintained our historic leadership in margins here. These are coatings peers EBITDA percentages and you can see over the last three years PPG has always been historically the leader here and we’ve maintained that position even as we’ve made acquisitions around the world and gone through integration steps. And we have countered, as you can see, some of the inflationary pressure that we talked about during 2010 or 2011 from raw materials.
So despite periods where you did see a rapid inflationary growth in our input costs, we’ve been able to manage those, pass those through effectively to our customers and maintained this very high stable set of margins for our businesses.
Let’s look at our financial performance in cash then. We have now 12 consecutive quarters with record EPS earnings and very strong EPS growth. And this continued through the first two quarters here in 2013.
We look at our PPG adjusted EPS from continuing operations. We’ve seen an average over the last two years of a 20% growth in adjusted EPS. And if you look at the most recently completed quarter, we have continued this trend and our first half 2013 performance was up 21% versus the record 2012 level. So, again, strong momentum in terms of earnings growth over the last five years.
If we look at the regional volume trends, what I would like to point out is this financial performance that we’ve just shared has been done despite some headwinds especially on the global economic picture. Our coatings volumes have improved consistently in emerging regions versus the pre-recession level.
So if you look at that -- if you look at the chart on the left, you can see in blue the emerging regions. This is Asia. Eastern Europe, we’ve had other than the recession year in 2009 solid growth in volumes through that period. However, as you can see from the green and the red bars, this is the U.S. and Canada in green and Europe in red, we have been fighting volume declines in these regions as we’ve gone through this great recessionary period.
What you see from these graphs is in the U.S. markets, things have begun to turn. So you see now from a steep decline in 2009, steady improvement in the U.S. and Canada in volumes. We’re still not back to where we were, however, in 2008. And in Europe, steep decline but that has not yet begun to reverse.
We’ve talked earlier this morning already marks talking about early signs that this is bottoming out. And we may be seeing a return to modest growth in Europe. But it’s certainly not been seen through 2012 over the first half of 2013.
But despite that, if we just turn your attention to the right side of the slide, you can see our full year segment earnings by region have continued with a positive trend. So the U.S. and Canada as we restructured and focused our businesses despite the fact that we haven’t come back fully from the 2009 recession, we have been able to set new regional records in terms of segment earnings for our coatings business. And you can see over the last three years, nice recovery and strong momentum despite volume weakness.
Same thing and I think even more impressive story for us is what’s happening in Europe. So you’ve seen the volume trends quite weak but despite that because of our focused efforts, because of some of the restructuring that you’ve seen us do, we have continued to set regional earnings record in Europe. And we’ve done so in 2012 and the first half of 2013 despite a lack of economic recovery in that region.
On the emerging region side, again good growth, good volume growth and good earnings growth as we continue to be profitable in what is some times a challenging region not for our businesses but for some industries. You can go to Asia, find growth. You can always find growth and profitability. We’ve been able to do that in our businesses in Asia and in China.
And I think this is a recap of what you’ve seen from us in the first half of this year, again continued growth in the U.S. and Canada, in Europe and in the emerging regions despite some of this continuing volume weakness and some of that has been, I think one of the key pillars of this recovery has been the restructuring program that we approved in 2012.
We’ve really been going after our structural cost, realizing that this is a very challenging time. So we’ve continued to push cost reduction and a focus on operational excellence. And it has delivered earnings for PPG in what is one of the most challenging times especially in Europe that I have seen in my career.
The Asian growth story, I think, is one of our most positive here. If you look on the left side sales, we’re up over 22% or CAGR over these last eight years. Almost all of this is organic.
So great story there and again a segment income quite profitable. It’s at a margin level that’s comparable to our global coatings businesses. And you can see in Asia on the right hand side that we have similar strong positions, number one or number two in almost all of our businesses in Asia in the same way that we have these positions globally or in the North America or Europe.
So if you look at a couple of these automotive OEM and Refinish, we are number one in China, number one in Asia -- in the same way that we are here in this market or in Europe. So we’re well positioned for what we think is going to be a continued good story in Asia. We’re confident that the markets despite lot of the challenges and some of the concerns over the last couple of years, our China business in particular has continued to do well.
There are few challenges out there in some of the markets like India but overall we’re still confident. Businesses are performing well. We’ve had some -- I would say some cyclical headwinds in one of our industries, marine as well as the consumer electronics businesses. But in all, we think the growth story is still intact in these markets and the automotive business in China continues to boom.
If you look at our U.S. and Canadian performance, we’ve come out of the recession strongly both as an economy and as PPG. And we’ve had good regional sales growth and earnings and margin growth in this business and led here in the first half of this year by the growth that we’ve seen from the acquisitions, both the Akzo market’s actual business as well as Spraylat and Deft.
So again good volume growth here in the U.S. and Canada. We’re not all the way back as you know. And we’ve aggressively going after acquisitions which are driving both sales and earnings growth for us in this region.
We have increased significantly with the Akzo acquisition, our architectural coatings business profile. So you can see now we have participation in architectural coatings here in North America in all of the major channels. We’ve strengthened our position in company-owned stores.
We are now the number two player with the thousand stores. We are participating in all the major home centers. We have a very good footprint with independent distributors. So we count some 15,000 customer touch points and a whole array of brands available to supply and create value for our customers in this market.
You can see now our network of PPG company-owned stores here in the U.S. We are the number one player now through this acquisition in Canada with a very strong share. So we feel very confident that we have strengthened our businesses, grown them at a time when the market dynamics are continuing to be positive. And we think we’re going to be on a multi-year run of strength in the U.S. and North American construction market businesses.
Just a few words on our cash and short-term investments with some of the actions that we’ve taken plus PPG has continued to have a strong cash flow record again -- in par because we have consistent earnings growth and the coatings industry in our businesses are what we would describe as capital like we’re -- our capital expenditures are between 2.5% to 3% of sales. So very low capital requirements for these coatings businesses. That helps to have a strong consistent cash flow.
We finished the second quarter at just under $2 billion in cash. If you look at how we deploy that over the last 10 years. It’s fairly evenly split between acquisitions, capital spending, dividends and share repurchases and we continue to look at all of these levers as we go forward.
And I would say that the opportunities and the focus for us is going to be on continued M&A activity as well as share buybacks to deploy the considerable cash resources because this is the current position. And this is before we realize the proceeds from the transaction with Transitions which we again expect to get about a $1.5 billion in the first half of next year.
So in summary, what I would like to close with is coatings is an excellent consolidating industry. We’re the global leader in almost all of the coatings end-use markets. We have a broad well-established global coatings business. We have been creating value for our PPG shareholders through an accelerated portfolio transformation and continued our excellent record of financial performance.
We have -- we think a lot of momentum currently in our businesses and in their operations but we have some future catalyst for continued performance. One is going to be cash deployment. So if you look at our current cash position, we’re going to be adding to that in the second half of the year plus the Transitions transaction.
We have amplified our power in the balance sheet to provide future earnings growth and we are levered to even a modest European recovery. So if we’re posting record earnings in Europe despite what has been a very difficult period, if we start to see even the beginning signs of volume recovery or some recovery in the European economy, I think we’re very well positioned.
So with that, I don’t know John, if we have time for questions or where we are with our schedule.
John McNulty - Crédit Suisse
Chuck, maybe I can kick it off. So it looks like back at the envelope you should have over the next 12 months somewhere between $4 billion and $5 billion of cash to put to work. And I know you’ve talked about M&A and share repurchase. Can you help us to understand kind of what you’re seeing in the M&A pipeline right now, the types of assets or the size of the assets that might be there and how that may eat into some of that cash or may not?
If you look at the activities over the last, let say 12 to 24 months, the majority of acquisitions that we may have been in, what I would call the $50 million to $400 million range, we did make one at over a billion dollars for Akzo. And if you look at that, as we showed you the pie chart for the global coatings industry, I would say still we’re going to see most of those opportunities develop in that $50 million to $500 million-dollar category.
There is not as many of the largest companies that would be considered for sale. So I would say that we’re going to have to get more aggressive in terms of realizing acquisitions in that space. But there are a number of companies that were out there that we think would be suitable. Merger or acquisition targets for PPG more in Europe, Latin America and Asia.
The North American market is more consolidated fewer opportunities but we think that there's still plenty of opportunities here. But we’re going to have to move more aggressively with -- especially with the cash resources that we have now.
John McNulty - Crédit Suisse
Just -- just on the cash again, I didn’t quite understand the slide on the Transitions. Are you netting $1.5 billion after tax cash, that’s the total cash?
John McNulty - Crédit Suisse
Or is it something…
So we -- we sold our interest for about $1.7 billion. Again this was joint venture. We had 51% but net after tax $1.5 billion. So if you look at -- we finished the end of the second quarter a little less than $2 billion. In the second half of the year, traditionally PPG is the cash generator. Now we are -- we have resumed share buyback activities here in the third quarter but we’re going to get a $1.5 billion after tax when that transaction closes.
So that’s going to add to the cash resources. So if you’re just -- if it happened today, we’re sitting on $2 billion in cash. We’ve got a $1.5 billion coming. So we’re going to have, let say, in that scenario $3.5 billion in cash. We probably need a little more than $300 million to run the company. So we have an opportunity to deploy this cash again as an earnings catalyst either in M&A or share buybacks.
John McNulty - Crédit Suisse
I think with that I’ll have to wrap it up. Thanks very much Chuck.
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