PPG Industries - Acquires Comex, Yet Limited Appeal After Huge Momentum

Jul. 1.14 | About: PPG Industries, (PPG)

Summary

PPG acquires Mexican-based Comex after its deal with Sherwin-Williams fell apart.

Investors are cautiously optimistic on the back of relatively sizable synergy estimates.

PPG has been on a great run, I see little appeal for the shares at current levels.

PPG Industries (NYSE:PPG) announced the acquisition of Mexican-based Comex in a deal which is complementary to its global strategy, adding to the underrepresented Mexican and Latin American markets.

While the deal looks fine, the overall valuation is too steep for me, with shares trading at a price-earnings ratio in their mid-twenties. After shares have risen some 40% over the past year, I remain on the sidelines.

The Deal Highlights

PPG Industries announced that it has reached a definitive agreement to acquire Consorcio Comex S.A., also known as Comex. The deal values the Mexican company at $2.3 billion.

Comex produces coatings and related products in Mexico. It sells coating through roughly 3,600 independently-owned stores and 700 concessionaires in Mexico, as well as Central America. Sales are made through retailers, wholesalers and direct sales.

The privately-held company owns 8 manufacturing facilities, as well as 6 distribution centers. Its roughly 3,900 workers generated sales of about a billion in 2013. The deal values Comex at roughly 2.3 times sales, while earnings have not been disclosed.

Strategic And Financial Rationale

CEO Charles Bunch calls Comex a high-quality and well-managed business with a history of excellent customer service and great recognized brands.

With the deal, PPG will add architectural coating businesses in Mexico and the rest of Central America. In this geographic area, the company currently has a negligible presence. For the year of 2013, PPG generated just 5% of its total sales in Latin America. The deal is consistent with the strategy to expand the global coating business portfolio.

The transaction is anticipated to be immediately accretive to earnings per share excluding one-time acquisition-related costs. Synergies which are anticipated to total 3% to 4% of the total acquired sales are anticipated to be achieved over a two-year period. This implies that cost savings could total $30-$40 million per annum, which will of course be accretive to earnings per share to the tune of about $0.25 per share going forward.

Originally, that is back in 2012, competitor Sherwin-Williams (NYSE:SHW) aimed to acquire Comex in a $2.34 billion deal, which fell apart in April of this year on anti-trust grounds.

Valuation

PPG ended its first quarter with $3.0 billion in cash, equivalents and short-term investments. Total debt stood at $3.4 billion, which excludes over a billion in total to be paid as settlements in asbestos claims.

The company anticipates to finance the deal through a combination of cash and debt, while it will anticipates to continue with its $2 billion share repurchase program.

On a trailing basis, PPG has posted revenues of $15.4 billion, on which it posted earnings of $2.1 billion, which were inflated thanks to a billion dollar gain from discontinued operations.

Trading around $210 per share, PPG's equity is valued at close to $29 billion. This values the company at roughly 1.8 times sales, after adding in the contribution from Comex. Shares trade at roughly 24 times earnings, assuming GAAP earnings of $1.2 billion per annum.

PPG's quarterly dividend of $0.67 per share provides investors with a 1.3% dividend yield per annum.

Business And Historical Overview

PPG is a leading business in the global coating market, competing with the likes of AkzoNobel (OTCQX:AKZOY), Sherwin-Williams, Axalta, Valspar (NYSE:VAL) and BASF (OTCQX:BASFY). The $1.05 billion acquisition of AkzoNobel's architectural coatings business in 2013 has been key in this transformation process.

The company sells about a third of its coatings to big box retailers like Home Depot (NYSE:HD), while the remainder of sales are made through company-owned stores, distributors and wholesalers. Global growth and a recovering US housing market, combined with the Akzo deal have fueled the momentum and earnings growth in recent times.

Over the past few years, the company has shifted its focus to gradually become a pure coating player, getting rid of the chemical business while shrinking the glass operations. The company made numerous deals on top of the Akzo deal over the past decade, having a great integration track record.

Final Takeaway

PPG has undergone a transformation over the past decade, acquiring many coatings businesses to become a more pure player. In the meantime, PPG has been able to boost total revenues by roughly two-thirds, with earnings growing in line. Earnings per share saw an additional boost as the company retired about a fifth of its shares outstanding over this time period, despite a string of acquisitions.

All of this, while maintaining a solid balance sheet, has pleased investors. Shares traded around $60-$80 before the recession, to fall to lows of $30 in 2009 during the financial turmoil. Ever since, shares have seen a big rally to current levels in their low $200s.

It has been roughly one and half year ago when I last checked out the prospects for PPG. Back in December of 2012, when PPG acquired the AkzoNobel's business, I concluded that the deal was great but that the valuation was too steep for me. Unfortunately, shares have risen another 50% ever since on the back of the great deal, share repurchases and solid operating performance.

Today, I come to the same conclusion, with shares trading at rich valuations in a good moment in the business cycle. While the focused premium coating player warrants a premium valuation and the underlying strategy is sound, PPG remains cyclical. These high multiples are too steep for me during the good times in the cycle.

I remain on the sidelines.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.