Axalta Pulls Its Full-Year Guidance But I'm Still Optimistic

Summary

• Axalta posted an excellent performance in the first half of the year, but has pulled its full-year guidance in September.
• Pulling the guidance appears to be related to a lack of visibility and we'll likely hear more details when the Q3 results will be published.
• Axalta will remain profitable and cash flowing, and I will be looking to establish a long position in my longer term buy and hold portfolio.
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Introduction

As it has been about six months since I last discussed Axalta Coating Systems (NYSE:AXTA), I feel an update is overdue. The company’s financial performance in the first half of the year was strong, but Axalta is feeling the impact from cost inflation and has warned for lower-than-expected results due to higher raw material costs.

Data by YCharts

The first semester was strong

Before discussing the pulled guidance, it’s perhaps useful to have a look at how Axalta performed in the first semester as that will provide useful background information to interpret the impact of the pulled guidance.

Axalta obviously didn’t have any issues to beat the financial performance in Q2 and H1 2020 as the economies were reopening and that had a positive impact on the demand for its products. The revenue in second quarter almost doubled compared to last year, and in the first half of the year, the revenue increased from $1.64B to just under $2.2B. Of course, all of the operating expenses also increased but it’s clear Axalta needs the economies of scale to post a good result. In the first half of 2020, the operating income was just slightly positive at $0.6M but in H1 2021, this jumped to about $243M thanks to a very strong second quarter which was impacted by some non-recurring items.

Source: SEC filings

The total interest expenses also decreased and the bottom line shows a net income of just under $142M which represents about 61 cents per share. A decent result, but my original investment thesis in the previous article was based on my free cash flow expectations for Axalta. In that article, I mentioned I expected a full-year free cash flow result of at least $2/share.

The company reported an operating cash flow of $147M in the first half of the year, but this included an investment in the working capital position of almost $200M. As you can see in the image below, the total amount of receivables increased substantially, and this weighed on the company’s reported operating cash flow.

Source: SEC filings

On an adjusted basis, the operating cash flow was approximately $326M which is an important improvement compared to the $95M in H1 2020. Of course, it wouldn’t be fair to use the first half of 2020 as benchmark year, but it clearly shows the rapid acceleration of the cash flows.

The total capex in the first semester did increase to $60.3M, but this means the underlying free cash flow result was still approximately $266M. Much higher than the reported net income thanks to a bunch of non-cash items like FX changes and share-based compensation. But the main reason for the difference between the net income and free cash flow was the difference between the depreciation and amortization expenses ($155M) versus the capex ($60M).

The current headwinds will weigh on the result

That was a good result, and as Axalta reported an adjusted operating cash flow of in excess of $300M in H2 2020, it started to look like my expectation to see at least $2/share in adjusted free cash flow was perhaps a bit too conservative as the H1 free cash flow result was already a very respectable $1.15/share.

During the Q2 conference call, the Axalta management was already warning for the impact of inflation on its results. The cost of the raw materials was increasing fast and although Axalta hiked the prices for its own products, it warned that ‘ full coverage of the inflation will take place during 2022’.

On September 20^th, Axalta announced it anticipated its net sales in Q3 to decrease by approximately $40M while the EBIT in Q3 would be approximately $130-140M. Axalta refers to the supply chain disruptions, predominantly in the light vehicle end market, and now expects these disruptions to continue into 2022. That’s the main reason why the company pulled its full-year guidance as the visibility is just too limited.

Source: company presentation

Axalta was guiding for a full-year EBIT of $685-725M of which approximately 20% was expected to be generated in Q3 and 30% in Q4. Although pulling the entire guidance appears to be drastic, I think the lukewarm reaction of the market on the news was likely the correct reaction. It’s not like the demand for Axalta products is falling off a cliff so pulling the guidance appears to be related to a reduced visibility more than anything else.

Investment thesis

I’d like to make it clear Axalta will still be profitable this year and will still post a positive free cash flow but it’s understandable the management is pulling its full-year predictions as the impact of the escalation of the raw materials cost makes it difficult to provide any sort of guidance. We will likely see more details when Axalta publishes its Q3 results, and I hope the visibility for 2022 will improve throughout Q4 2021 so Axalta should be able to post a guidance for next year.

I currently have a small long position in Axalta in my trading portfolio (where I mainly trade in and out of stocks using written put and call options strategies), but I’m also looking into adding Axalta to my longer term buy and hold portfolio as I still like the long-term prospects of the company. The current headwinds may be temporary and could create attractive entry points to establish a larger buy and hold position.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of AXTA either through stock ownership, options, or other derivatives. 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.