Market outlook: PPG Industries to grow coatings and sealants

Mergers and acquisitions are a key part of PPG’s growth strategy to build out its global coatings franchise, and enhance adjacencies in adhesives and sealants

It’s been an impressive track record of growth during a span of 132 years for PPG Industries. And the story is far from over. With a solid balance sheet even after making its second largest acquisition ever, and a market focused R&D engine, the global coatings giant is set to expand its footprint further.

PPG’s Cindy Niekamp, senior vice president, automotive coatings, is congratulated at a groundbreaking ceremony at the San Juan del Rio, Mexico, facility by Jose Calzada Rovirosa, governor of the state of Queretaro Copyright: PPG

PPG is in the process of integrating its $2.3bn acquisition of Mexico’s leading architectural coatings firm Comex, completed in November 2014. While the company faces foreign exchange (FX) headwinds on Comex from the stronger US dollar as well as the impact of weaker oil prices on an oil-dependent economy, the deal positions PPG as a leader in the growing Mexico consumer market.

“The performance of Comex has been good and we are pleased with the growth. The integration work with our existing PPG business in Mexico is going well,” said Charles Bunch, chairman and CEO of PPG.

Bunch and PPG senior executives spoke with ICIS at the company’s headquarters in Pittsburgh, Pennsylvania, US.

PPG’s existing Mexico business focused on automotive OEM (coatings for new vehicles), whereas Comex is strong in consumer paints, protective coatings (industrial equipment, infrastructure) as well as auto refinish (vehicle re-painting).

“These businesses are quite complementary. New PPG products will be available through Comex channels,” said Bunch.

While the Comex deal will have organisational and supply chain synergies, PPG is focused on top-line synergies of $30m-40m in incremental growth within two years of the close, Bunch said. Comex, which also has industrial and powder coatings products and spare resins capacity, has sales of around $1bn/year.

The consumer market is clearly targeted as a future growth area for PPG. Earlier in July 2014, PPG acquired US-based Homax, which makes specialty textured wall and ceiling coatings for the DIY (do-it-yourself) home repair market.

Mergers and acquisitions (M&A) are a key part of PPG’s growth strategy to build out its global coatings franchise, and enhance adjacencies in adhesives and sealants.

In April, PPG completed its acquisition of France-based auto OEM adhesives and sealants (A&S) firm REVOCOAT – a company with annual sales of around $100m.

“This is a natural acquisition as it has similar chemistries as coatings and we already have A&S businesses in auto OEM, aerospace and industrial,” said Bunch. “We will continue to make accretive, smart acquisitions in coatings and companion products.”

“We continue to grow A&S in our auto segments. With REVOCOAT we will broaden our product exposure in the [auto OEM] paint shop, run it on a global basis and grow it faster,” said Michael McGarry, president and chief operating officer (COO) of PPG. “In A&S, we will grow where it ties into our current portfolio. It must be specialized and tied into coatings,” he added.

AEROSPACE A&S DEAL IN PROGRESS
PPG is in discussions to buy France-based aerospace A&S firm LJF (Le Joint Francais), which is a licensee of PPG’s aerospace sealant technology.

“We are going through the approval processes and feel that we can conclude this in the second half of 2015,” said Bunch.

Europe’s coatings market is far less consolidated than in the US with more independent country-oriented companies. Asia likewise has a fragmented market. “Over time, we will see more deals outside the US,” Bunch noted.

In March, PPG acquired Flood Australia, a small producer of wood stains and paint additives. It marks PPG’s entry into the wood care business in Australia where it aims to growth the brand there and in New Zealand.

PPG sees M&A opportunities in the auto refinish, packaging, protective and marine, and industrial coatings markets where it holds No. 2 global positions, noted McGarry.

“In industrial coatings, we see lots of opportunities as there are many family-owned smaller companies. We try to establish relationships with these companies around the world. If they are thinking about change, we can have a dialogue,” said Viktor Sekmakas, executive vice president at PPG.

LOOKING FOR A CULTURAL FIT

Comex employees at a store in Mexico. PPG acquired Comex in November 2014 for $2.3bn Copyright: PPG

The industrial category includes coatings for everything from computers, golf balls, aluminum extrusions, to auto underbody.

“Culturally, it must be a fit between both companies. An owner will view the business as his baby, and wants to make sure a buyer will take care of it. We can operate in all regions and for employees, offer lots of opportunities across PPG,” he added.

PPG is the global leader in auto OEM and aerospace coatings, and on par in the architectural space with US-based Sherwin-Williams and Netherlands-based AkzoNobel, he said. PPG bought AkzoNobel’s North American architectural coatings business for $1.05bn in April 2013.

About 95% of PPG’s pro forma (including Comex) sales of around $16.3bn are in the coatings segment. Architectural coatings make up 35% of total PPG coatings sales. The global coatings market is around $130bn, half of which is architectural, noted Sekmakas.

Bunch considers PPG’s precipitated silicas business, which goes into diverse applications such as dyes, optical and OLEDs, as core to the company, likening it to specialty coatings.

However, PPG’s glass business, from which it derives its name (Pittsburgh Plate Glass Co in 1883) is “less core”. The company has sold major parts of it in recent years. “The flat glass business has recovered nicely with commercial construction and it has value. But we are willing to part with the assets if we get the right offer that creates value for shareholders,” Bunch said.

SOLID BALANCE SHEET
PPG has a solid balance sheet and cash flows to support its M&A strategy, said chief financial officer Frank Sklarsky.

“We’ve had a good balance between CAPX (capital spending) for growth, share buybacks and dividends,” said Sklarsky. PPG generated over $1bn in cash flow in 2014 after $360m in dividends and $750m in buybacks. It expects to spend $1.5bn-2.5bn in 2015-2016 on acquisitions and buybacks combined, he noted.

PPG has also slashed its weighted average cost of debt (WACD) from 5.4% in 2014 to a current 2.6%, after selling €1.2bn in euro-denominated debt in March 2015 at a blended interest rate of 1.14%, replacing previous higher cost debt, Sklarsky noted.

“Debt is significantly cheaper in Europe but you want to have significant operations and cash flow there to back it up,” he said. Sales in Western Europe are running at around 20-25% of total PPG sales.

PPG’s broad and geographically diverse portfolio allows it to “get more leverage from the technology dollars we spend” as technology can be shared across all coatings, and adhesives and sealants businesses. And its high-tech infused products represent a small fraction of overall customer costs, allowing for high margins, said Sklarsky.

FX IMPACT
PPG is facing FX headwinds from the strong US dollar throughout its business as around 60% of sales are outside the US. Exposure to the eurozone will have the greatest impact.

The company typically manufactures and sells in the same region, so does not have much “transactional” FX exposure (costs in one currency and sales in another), noted Sklarsky. However, it does have “translational” FX exposure, as sales and profits in euros, Mexican pesos, or Canadian dollars is translated into fewer US dollars.

Because production and sales are localized, “the impact to earnings is more muted – only 10% of the impact on revenues,” said Sklarsky. In PPG’s Q4 2014 conference call in mid-January, it estimated a $650m-750m hit to 2015 sales from FX, but the US dollar has gained further versus the euro since then, he added.

OIL PRICE IMPACT
The oil price decline presents both benefits and challenges to PPG. The company, as a non-integrated coatings producer, puts a great deal of effort on managing its supply chain. It is a major buyer of epoxy resins, acrylates, titanium dioxide (TiO2) and solvents such as MEK (methyl ethyl ketone) and MIBK (methyl isobutyl ketone).

Of PPG’s around $8bn/year in purchases, about $6bn consists of raw materials of which $2bn are oil derivatives, noted Sekmakas.

“We have been in discussions with suppliers and customers on direction of pricing… We don’t have indexed pricing with either, so it’s based on negotiations. There is some reluctance [on price concessions] from suppliers, until they’re convinced this is where oil prices will settle,” said Bunch.

“Customers are of course wondering: ‘When are you going to share the savings with us?’ But in the first quarter, we haven’t seen the benefits of low oil prices. Plus we are working with higher cost inventory. We won’t see much benefit in Q1 and Q2,” Bunch added.

“We are certainly working to pull savings through the supply chain but it’s premature. Customers are not shy [about asking for reductions] but they understand the time delay,” said McGarry.

PPG is seeing “some savings” from lower fuel costs to transport its products, but “not a windfall”, as trucking companies deal with labour shortages, said Bunch.

“When oil moves up or down, there are a couple of quarters of lag time [for price impact] as we are not indexed. When we see the benefits, we can share them with our customers. So there won’t be a significant margin improvement,” he said.

AUTOMOTIVE OUTLOOK

A store manager scans PPG and Glidden products. PPG acquired the Glidden brand as part of its acquisition of AkzoNobel’s North American decorative coatings business in 2013 Copyright: PPG

Automotive is a key end market for PPG. After years of solid growth in North America, the outlook remains favourable.

“We are still in the upward part of the cycle in the auto industry in North America. We see a really good recovery in 2015 and the next few years, and should hit a multi-year record of over 17m light vehicles,” said Bunch. “There is lots of activity in the SUV market.”

And global automakers based in Japan, South Korea and Germany are building more manufacturing plants in North America – particularly in the US and Mexico – making them more likely to use PPG coatings. In Japan, PPG has no participation in the auto OEM market and in South Korea only a small share.

“With the new auto plants, we are going to benefit from more production in North America. Japan OEMs, after the Fukushima [nuclear] setbacks, have made a nice recovery in globalizing their supply chain. And Mexico will be more of a manufacturing player,” said Bunch.

Globally, auto markets are also improving, with expected unit growth of 3-4% in Europe and 5-6% in China in 2015, said McGarry.

“We are seeing very nice growth in our auto OEM business and are positive for 2015. For China we are projecting 7-9% growth in auto OEM, while the US will grow at 2-3% and Europe 0-2%, depending on the country,” said Sekmakas.

PPG can see outsized future gains for auto refinish in China as the installed vehicle base increases faster, noted Sklarsky.

For auto OEMs, PPG has been developing “compact processes” that can deliver multiple layers of coatings at the same time, using fewer curing ovens. “That makes for a smaller footprint, less capital, and less energy consumed,” said McGarry.

For the US housing market, Bunch sees moderate growth. The residential side has been positive, especially for refurbishing which represents around 75% of the architectural coatings market, even as housing starts remain flat at around 1m units. And the commercial construction market appears to be gaining strength.

LOCAL MANUFACTURING
Coatings, while being a materials-intensive business with a global supply base, tends to be localized when it comes to producing and selling.

In March 2015, PPG completed a $40m coatings resins plant in Sumare, Sao Paulo, Brazil for auto OEM and industrial coatings.

It is also building a $60m plant in Lipetsk, Russia, to produce auto OEM, packaging, and protective and marine coatings. Given difficult market conditions, it is a “slow build” set for start-up in late 2016.

“We are better off manufacturing locally, as mixing, blending, finishing product and adding services are an asset-light part of the supply chain,” said Bunch. “The cost of transporting water-based products around the world doesn’t justify manufacturing in one location and exporting to another.”

BULLISH ON CHINA, ASIA
PPG continues to build out its presence in Asia, which represents 19% of coatings sales. The company has 24 production facilities in Asia in nine countries. Its largest coatings plant is in Tianjin China, where it serves auto and industrial customers, noted Sekmakas.

“We continue to be very bullish on China. About 80% of what we manufacture in China stays there,” said Sekmakas, who had earlier been president of PPG Asia Pacific.

As consumers get wealthier, they will need more autos and drive more miles, increasing demand for auto OEM and refinish. There will also be more air travel and a greater need for aerospace coatings.

“In packaging coatings, China still has low can consumption per capita. As they switch from glass to cans, this is a growth business. They will also need coatings for computers and mobile phones,” said Sekmakas. “Growth is not as robust as it had been years ago, but it is still high growth. We have not seen declines.”

In China, PPG has a key partnership with Henan Billions, which is ramping up production of chloride-based TiO2 based on technology licensed from PPG after starting up in October 2014. Capacity at the new plant is 100,000 tonnes/year and PPG is already using some of the material.

“We’ve seen the continued development of China’s TiO2 industry, which had primarily been sulfate-based,” said Bunch. “Years ago there had been lots of imports of TiO2 into China but the growth of local producers curtailed imports. Now we are starting to see China TiO2 in other regional markets – not so much the US, but in developing markets.”

With Henan Billions, PPG is working on “improving the consistency of quality” of the TiO2 produced and expects full ramp-up in Q2, McGarry said.

It is using the product in formulations in China, Brazil, Australia and Europe. PPG is also using TiO2 from other China suppliers, as sulfate-based TiO2 has also improved in quality, he added.

TIO2 OUTLOOK
Bunch sees the TiO2 market “in balance” and expects stable pricing in 2015, despite recent efforts of producers to increase prices in Europe.

“TiO2 is a well-supplied market. There is more capacity coming on in China and Mexico, and more effort to use less TiO2 with new TiO2 extenders in the market,” said McGarry. “TiO2 has no upward [price] momentum.”

Over the last three years since the TiO2 price spike, PPG has taken out “well north of 10%” of TiO2 levels throughout its architectural paints formulations, and still aims to take out another 1-2%, McGarry said.