Axalta: A High-Quality Player In The Global Coatings Industry

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About: Axalta Coating Systems Ltd. (AXTA), Includes: AKZOY, NPCPF, PPG
by: JP Research
Summary

High-quality manufacturer and distributor trading at a significant discount to peers.

Consolidating industry provides M&A optionality to which the market is assigning little credit.

Axalta offers investors the opportunity to invest alongside Berkshire Hathaway.

We think the risk-reward makes sense at these valuations.

We think Axalta (AXTA) shares are worth a look at current prices - the stock trades at the cheapest valuation (~10x forward EV/EBITDA) in its peer group (average ~7x forward EBITDA multiple). Consolidation in the industry is another major trigger that could see a significant rerating - Axalta is currently trading far below Nippon's (OTCPK:NPCPF) $37/share offer (~15x implied EV/EBITDA). With Axalta having been approached by both Nippon Paint and Akzo Nobel (OTCQX:AKZOY) in 2017 alone, there is clearly strong interest in among the bigger players. Its valuations notwithstanding, Axalta also has strong fundamentals - it holds dominant positions in its end markets. Plus, with Berkshire (NYSE:BRK.A) (NYSE:BRK.B) owning ~10%, the stock offers the opportunity to invest alongside Warren Buffett.

Axalta - a high-quality player in the global coatings industry

Axalta Coating Systems is a leading global manufacturer and distributor of high-performance coatings systems (paint) with applications in the light and commercial vehicles and provides refinish coatings to electric motors, buildings, and pipelines.

The company operates in two business segments - performance coatings (65% of sales as of 2018) and transportation coatings (35% of sales) and globally ranks #1 and #2 in the respective segments.

(Source: Investor Presentation)

In refinishing coatings, where Axalta is a clear leader (25% market share and ahead of PPG), the company has a customer base of ~80,000 body shops and over 4,000 distributors. Key customers include Auto Nation, Lithia, Service King, etc. while its major industrial coatings customers include Tesla Motors, Weber, Baosteel, etc.

(Source: Investor Presentation)

The coatings are mainly designed to prevent corrosion and increase productivity and durability of the industrial products. Naturally, R&D is key here - Axalta, which has 50 manufacturing facilities and operations in 130 countries, holds over 1,000 patents. R&D is the primary use of cash flow after debt repayments, along with M&A.

(Source: Investor Presentation)

Axalta announced another round of cost savings last year, which could save $200mn over the next three to four years. The savings will likely be reinvested into the business via capex/R&D or deployed into accretive acquisitions. Although the company is firmly set on M&A, there has been steady capital returns via buybacks - Axalta has repurchased $374mn of common shares to date. It has also completed 21 M&A transactions amounting to $819mn from 2016-Q1 2019.

(Source: Investor Presentation)

Inorganic growth - a key trigger

With continued weakness in the global auto OEM market, the coatings industry has moved into a consolidation phase. Axalta, which is the smallest of the publicly traded companies, has become the ideal target for many global coatings companies. In the recent past, Axalta has been approached by Nippon Paint, Japan’s biggest paint company and Akzo Nobel, the Dutch paints major. Though talks failed with both the companies mainly on valuation issues, the keen interest shown by these large companies emphasizes Axalta’s strategic position.

Axalta would fit well with the major players - an acquisition by Akzo Nobel and Nippon Paint would allow either party to expand its footprint into the U.S. market and boost earnings from the automotive segment.

If either party comes back to the table, Axalta shareholders could be set for a nice premium - Nippon, for instance, recently acquired DuluxGroup for $2.6bn - a ~28% premium to the closing price. Other strategics that may be interested include PPG, RPM International, BASF, and Kansai Paint.

As the global economic growth is expected to weaken further, eventually depressing volume growth of the paints companies, Axalta’s merger talks with global paint companies could revive sooner rather than later.

Management is optimistic on M&A

In its Q1 2019 commentary, management seemed fairly optimistic on its M&A prospects. Per Robert Bryant, Axalta CEO:

“M&A is an integral part of our strategy in terms of building out our coverage globally, building out different verticals within each one of our end markets and we remain committed to M&A, but not M&A at any price. Moreover, so we will continue to be return-disciplined as we go forward and look at M&A transactions.”

The slew of recent transactions support his assertion - Axalta alone completed seven acquisitions in 2018. The acquisitions (see table below) covered the refinish, light vehicle, and industrial end-markets.

(Source: Investor Presentation)

Strategic investment by Warren Buffett

In 2015, Warren Buffett’s Berkshire Hathaway invested in Axalta and raised its stake further in 2018 at an estimated $30 per share. Berkshire Hathaway is now the largest investor in the company with a stake of 9.8%. Though the market has at some point been rife with speculation that Berkshire could ultimately acquire the company, this has not played out thus far. Nonetheless, Warren Buffett continuing to increase his stake in Axalta is a clear mark of confidence in both the stock's fundamentals and the compelling valuations.

Trading at attractive valuations

Axalta is one of the cheapest plays in the coatings sector today. It currently trades at ~10x forward EV/EBITDA compared to a peer average of ~13x. PPG (NYSE:PPG), for instance, which also has substantial exposure to the auto OEM and automotive refinish markets, trades at 12.5x fwd EV/EBITDA.

Notably, Axalta is trading far below prior offers. Previously, Nippon offered to pay $37/share (15x implied EV/EBITDA). In other similar recent bids, PPG offered ~15x fwd EBITDA for Akzo Nobel’s coatings businesses while Sherwin-Williams was willing to pay ~17x EBITDA for Valspar. There is no reason to believe that the probable suitors of Axalta might not match or offer a better price than Nippon.

(Source: Trian Presentation)

Relative to its trading comparables and precedent transactions, Axalta’s current valuation is the most attractive of the lot. Global paints majors could find Axalta to be an interesting bet due to its leadership position and cheaper valuations. We think a revival in merger discussions is likely and would be a key catalyst to re-rating the stock.

Conclusion

Axalta is a leading global coatings company with a market leading presence in its end-markets. The company has been gaining market share, especially in North America and Europe. As the global coating industry is facing headwinds such as rising raw material prices and declining auto volumes, the industry might see consolidation in the years to come.

Axalta, with its stock trading at a discounted multiple despite strong fundamentals, could see increased interest from major suitors like Nippon, Akzo Nobel, and Sherwin-Williams (NYSE:SHW). While industry headwinds are pronounced, we believe that the risk-reward is in favor of Axalta at current valuations.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.