PPG Industries: Sharper focus on coatings core
10:56 AM MST | December 23, 2013 | —Robert Westervelt in Pittsburgh
PPG Industries (Pittsburgh, PA) will soon pass a key milestone in its portfolio transformation as coatings revenues exceed 90% of sales.
PPG has announced three $1-billion-plus deals since 2012—two divestitures and one acquisition—that leave the company firmly focused on coatings. Revenues in its $13-billion coatings business will account for 90% of sales once the sale of its stake in Transitions, a leading producer of photochromic lenses, is complete in first-half 2014; this proportion was about 55% in 2002.
The past year has been busy for PPG. In January, it completed the exit from its commodity chemicals business, chlor-alkali and vinyls, when it merged the business with Georgia Gulf to form Axiall. PPG received more than $900 million in cash from the deal, and PPG shareholders received an additional $1.7 billion in Axiall stock when the deal closed. In July, the company announced plans to sell its majority stake in Transitions, from which it will receive $1.73 billion, or approximately $1.5 billion after-tax, when the deal closes in the next six months. The company has also completed a key coating acquisition with its $1-billion purchase of AkzoNobel’s North American architectural paint business. That deal made PPG the clear number-two producer of architectural coatings in North America, behind Sherwin-Williams (SW).
PPG posted revenues of $11.4 billion through the first nine months of 2013, up 7.6% from the year-ago quarter. Income from continuing operations increased 41%, to $822 million. Third-quarter adjusted earnings of $2.44/share, up 18% from the prior-year, marked 12 consecutive quarters of record earnings. Investors have responded favorably, sending the stock up more than 120% over the past two years compared with a 45% gain for the S&P500 and 50% gain in the Dow Jones US chemicals stock index.
Shift to coatings
PPG started operations in 1883 as a glass maker at Pittsburgh. The company made its first coatings acquisition, Patton Paint, in 1900 to diversify as flat glass and paint moved through the same distribution channels. While coatings had always been a critical part of the company, the company moved to accelerate coatings growth in the late 1990s. In 1997, coatings accounted for 42% of sales, glass 36%, and chemicals were the remaining 20%. “At that time, we took a look at portfolio and felt we had to make some decisions,” says Charles Bunch, PPG chairman and CEO. Bunch has been CEO July 2005 and had been senior v.p./strategic planning in the late 1990s. “We could not fully fund all of the opportunities that we thought were available in our businesses. Markets were also starting to rapidly globalize as companies and our customers started to move more seriously into Asia.” The company considered coatings the strongest play available. “Coatings were the most consistent performer,” Bunch says. “It had good returns and was less capital intensive. It would also be much easier to expand coatings organically in markets such as China.” The company also had strong market and technical bases to continue to rapidly build from, he adds. The company had a long history in coatings, and when it saw market shifts that would work in its favor, it decided to lead the consolidation. “Coatings were more fragmented than our other businesses,” Bunch says. “We could grow organically, and there were also opportunities for acquisition.” There were no clear global leaders in coatings at the time, Bunch adds. “We felt we could accelerate consolidation.” Larger players had strong positions in Europe and North America, but there were several smaller regional players in both regions and wide opportunities in emerging markets.
Divestitures in glass and chemicals were part of the strategy, but the company indicated that it would be patient. In fact, the two largest divestitures did not happen until the past year. PPG has sold its commodity chemicals business, a subject of divestiture speculation for more than 10 years, to Georgia Gulf and its Transitions business to Essilor. “We were going to look and wait for the best opportunities to sell,” Bunch says. “Our financial performance and balance sheet were good enough that our hand would not be forced on divestitures.” Tax considerations were a concern with commodity chemicals since the business comprised older assets with a low cost basis. The merger with Georgia Gulf allowed PPG to spin the business off to shareholders on a tax-free basis. Transitions was a profitable, high-growth business, but it decided to sell, citing changes in the optical sector, including technology shifts, that would make the business a better fit with Essilor, a leading optical materials and equipment maker. A strong valuation also made the deal attractive to PPG.
The company has expanded the coatings franchise through organic growth and more than 30 coatings deals over the past 15 years. M&A has often been challenging in chemicals, but PPG says it has now been successful by not overpaying for assets and focusing on integration. “First, we were mindful of the values we were paying,” Bunch says. “We were quite disciplined and tried to find businesses that fit well and strengthened our technology and innovation. We wanted to add strong products, technologies, and teams that complemented what we did.”
As part of the focus on coatings, the company will also continue growth in “near adjacencies,” such as adhesives, sealants, and metal pretreatment used in key sectors, such as automotive, refinish, architectural, and industrial coatings. “You are going to see us continue to develop this space, which aligns well with coatings,” Bunch says. “These are companion products that fit very well,” he says. “It also gives us a wider field to play.”
Scale won’t hinder growth
PPG says it now leads the $110-billion global coatings sector after growing the business at roughly 10%/year over the past decade. PPG says that its size will not limit growth, noting that there are still significant opportunities available in the sector. “When you look globally, there is no one in the coating space that even has 15% market share,” Bunch says. “Coatings remains one of the least consolidated segments in the chemical sector,” Bunch says. “There are some segments and geographies that have become consolidated, but there are still opportunities to grow faster than industrial production or GDP.” PPG says it is the only company that participates in all end-use markets. It claims a leading position in architectural coatings, a sector in which it is roughly equal in size to AkzoNobel and SW, as well as number-one positions in automotive original equipment manufacturers (OEM) coatings, refinish, and aerospace. PPG claims number-two positions in industrial, protective and marine, and packaging coatings.
PPG says it will compete in all sectors. The entire market “is all potentially addressable to us in the long term,” Bunch says. “There are markets that are not as well developed and still very fragmented. But, over the long term, there is nothing in coatings today that we wouldn’t like to sell.”
Bunch says PPG can continue to grow the business at above-market rates. “We have been able to consistently grow the business a couple percentage points above industrial production,” Bunch says. “We think will can continue that trend and supplement that with acquisitions.” Some segments are in regions that are more consolidated, and organic growth will be a priority there, but, overall, acquisitions still have a strong opportunity. “We may not see the same strong pace of deal making at the higher end, but consolidation will continue,” he says.
AkzoNobel’s North American coatings business is a key addition to the portfolio. PPG estimates that 43% of the global coatings market is architectural finishes. The business now accounts for 40% of PPG sales. “We are not done in architectural coatings,” says Michael McGarry, PPG executive v.p. “The AkzoNobel business is nice addition and makes us a strong number two in architectural in North America. We will add more acquisitions in the space on a global basis and are looking at more growth in North America.”
Architectural coatings retains strong growth prospects and is a sector that is less consolidated than other markets in which PPG has strong positions, such as automotive OEM, refinish, and packaging. “Architectural coatings is still a fragmented market regionally and globally,” McGarry says. PPG has 900 stories in North America and looks to add more than 50 over the next few years. The company is also seeing a favorable market push as housing recovers in the United States. “We think new US home construction will be up 8–10% next year,” McGarry says. “Resale will be up, in the 4–5% range.” Light industrial coatings should grow 3–5%. “We expect a reasonable growth profile next year,” McGarry says.
The company issued a $160-million cost savings target when the AkzoNobel deal was announced and raised that number to $200 million soon after the deal was completed in April. The company has delivered half the savings in the first nine months. Sales, marketing, and finance are well along in integration, and the company is consolidating commercial operations at a new architectural headquarters in Cranberry, PA.
Industrial coatings overall remain a fragmented segment and account for 30–40% of the world’s $110-billion coatings business. “There are still many regional companies in industrial coatings,” says executive v.p. Viktor Sekmakas. The company expects roughly 60–70% of growth in industrial coatings to be organic, with the rest coming from acquisitions. Marine remains a concentrated sector dominated by PPG and AkzoNobel, but other protective coatings segments remain strong opportunities for organic and acquisition growths. Packaging offers opportunity for innovation-driven growth. PPG has a strong position outside in external can-coatings in food and beverage but is now looking inside as food and beverage companies try to remove epoxy-based linings that contain bisphenol-A out from food-contact applications. “It is a technology shift that gives us the potential to also get on the inside of cans,” Sekmakas says.
China continues to grow
The company still sees huge opportunity in China, where no coatings company has more than 10% market share. PPG’s Asia sales have grown from under $100 million in the late 1990s to approach $3 billion today. “China may have come down from low-double-digit growth rates to 7–8%, but that is still healthy growth with lots of opportunity,” Bunch says. “There is still a lot more for PPG to do there.”
There is still a lot of runway left in China, Sekmakas adds. In the late 1990s, PPG first moved aggressively into the region by aligning with large, global customers, such as automotive OEMs, as they moved to China. “This largely was in premium paints and markets.” Sekmakas says. Customers wanted assurances that quality and service levels in markets such as China would be the same as in the United States and Europe. “We played very well in the premium segment,” Sekmakas says.
With that base established, the second phase of Asian growth centered on moving into the “mid-segment” market in Asia as domestic growth started to take off. “We pursued growth through frugal innovation,” Sekmakas says. The company worked with customers to tailor solutions specific to market demand for lower-cost, no-frills solutions in consumer goods, electronics, and automotive. “We worked to develop and formulas that were appropriate for what the mid-segment was looking for,” Sekmakas says. The company has invested heavily in workforce development across the region. The efforts have left the company’s business in Asia and China in a strong position as demand in China becomes more domestically driven. “About 75–80% of what we produce in China actually stays there today,” Sekmakas says. “And, as the middle class continues to grow in the region, it will remain a very nice growth engine.”
Europe still in focus
PPG’s largest acquisition is its $3-billion purchase of SigmaKalon from Bain Capital in 2008. SigmaKalon has doubled PPG’s coatings footprint in Europe, which now accounts for about 30% of overall sales. Timing was not ideal as global recession and extended declines in Europe set in soon after the deal was complete, in 2008. “But, we have done a good job anticipating volume declines and taking cost out,” McGarry says.
Profits have continued to grow even though volumes declined for the past four years. European volumes remain more than 15% below 2008 levels, but McGarry says Europe appears to have hit bottom. “We think we will see a very mild upturn next year,” he says. Recovery in Europe could drive significant cash and earnings improvements. “The leverage to recovery in Europe is significant,” McGarry says.
The company remains interested in growing in all segments in Europe. “We are very interested in growth through acquisition in Europe,” McGarry adds. “We have a very active pipeline. Europe does not scare us from a growth perspective. We know how to manage in that tough environment. We are looking for opportunities in Europe in all segments.”
Some specialties remain
Bunch says PPG still sees growth opportunities in its “important and valuable” optical and specialty materials business. After the divestiture of Transitions, the company will have positions in optical materials and dyes, precipitated silica, and Teslin sheet. “These are nice businesses that we think we can grow on,” Bunch says.
The remaining glass businesses is “less core, but we have been patient,” Bunch says. “We try to create value and build on those businesses.” The company has sold its non-US glass business and licenses glass technology. The company continues to make investments and upgrades in areas such as furnaces, McGarry says. “The business is well maintained and capitalized with good talent. We are not going to grow, and it is noncore, however. When time is right, and if someone wants to buy, we’re happy to talk.”
US, global outlooks improving
Bunch is also very optimistic about opportunities in the United States, given shale’s impact on energy and manufacturing costs. “The impact is not just limited to what is happening in oil and gas and petrochemicals,” Bunch says. “We’re a low-cost manufacturing region. Energy costs and chemical manufacturing are such important components of our industrial base that I see this shale revolution as a boon to our economy,” he says.
“I’m more excited about the rebirth of manufacturing that I see gradually coming. That benefits all markets that PPG plays in and is going to be paying dividends for our region for years to come,” Bunch adds.
Bunch says global conditions should remain favorable. “I’m optimistic that 2014 will be a good year,” he says. “We are three years into recovery in North America, and I think we have more room to go. Automotive has rebounded well, and auto builds should be up another 4–5% in 2014. Housing is still in early stages of recovery. You can say recovery hasn’t been as strong as it should have been in the United States but will still have momentum. And there are areas important to us that are still to recover—commercial construction, for example.”
Growth in Europe should also turn positive after mid-single-digit declines over the past few years. “We are forecasting modest growth, but that is on the back of modest single-digit declines over past few years,” Bunch says. Key markets in South America, such as Brazil, have been less consistent but are well positioned with preparations for the World Cup and Olympics.
“I feel more optimistic going into 2014 largely because recovery in other markets remain intact, and we’re starting to see Europe stabilize and start to have some growth,” Bunch says.