PPG Industries, Inc. (NYSE:PPG) Q3 2023 Earnings Call Transcript

PPG Industries, Inc. (NYSE:PPG) Q3 2023 Earnings Call Transcript October 19, 2023

Operator: Good morning. My name is Emily, and I will be your conference operator for today. At this time, I’d like to welcome everyone to the Third Quarter PPG Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the conference over to John Bruno, Vice President of Investor Relations. Please go ahead, sir.

John Bruno: Thank you, Emily, and good morning, everyone. We appreciate your continued interest in PPG and welcome you for our third quarter 2023 financial results conference call. Joining me on the call from PPG are Tim Knavish, Chairman and Chief Executive Officer, and Vince Morales, Senior Vice President and Chief Financial Officer. Our comments relate to the financial information released after U.S. equity markets closed on Wednesday, October 18, 2023. We have posted detailed commentary and accompanying presentation slides on the Investor Center of our website, ppg.com. The slides are also available on the webcast site for this call and provide additional support to the opening comments Tim will make shortly. Following management’s perspective on the company’s results for the quarter, we will move to a Q&A session.

Both the prepared commentary and discussion during this call may contain forward-looking statements, reflecting the company’s current view of future events and their potential effect on PPG’s operating and financial performance. These statements involve uncertainties and risks which may cause actual results to differ. The company is under no obligation to provide subsequent updates to these forward-looking statements. The presentation also contains certain non-GAAP financial measures The company has provided in the appendix of the presentation materials, which are available on our website, reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information, please refer to PPG’s filings with the SEC.

Now, let me introduce PPG Chairman and CEO, Tim Knavish.

Tim Knavish: Thank you, John, and good morning, everyone. Welcome to our third quarter 2023 earnings call. I’d like to start by providing a few highlights on our third quarter record financial performance, and then I’ll move to our outlook. In the third quarter, the PPG team continued to deliver strong financial results, including sales of $4.6 billion and adjusted earnings per diluted share of $2.07, both records for our third quarter. Our year-to-date cash generation is over $1.5 billion, which is also a record on a year-to-date basis. Our adjusted EPS of $2.07 was 25% higher year-over-year. We benefited from several non-recurring favorable discrete income tax items, which added $0.10 versus our beginning of quarter guidance.

Excluding this favorable tax benefit this year, our EPS was still about 20% higher than the third quarter of 2022. We’re on pace to finish 2023 with all-time record adjusted earnings per share. As we communicated at the beginning of the year, we had a high degree of conviction that our global business portfolio mix would prove resilient this year and as we had anticipated a challenging economic environment. That has clearly played out through the first nine months of the year. Our results were supported by good growth trends and strong execution in several of our leading and technology advantaged businesses, which resulted in record third quarter sales in the aerospace, automotive OEM, automotive refinish and PPG Comex Coatings businesses. Our third quarter sales volumes were impacted by soft global industrial production, which worsened in many countries during the quarter and also by cautious consumer buying patterns in Europe, China and other parts of the world.

The selling price increases we implemented earlier this year, primarily in the Performance Coatings segment drove a solid 3% increase for the quarter. We expect selling prices to remain positive in the fourth quarter of 2023, albeit a little lower sequentially as we continue to see prior price increases reach their anniversaries. Throughout 2023, a key priority for our team has been restoring our margin profile. The third quarter marked the fourth consecutive quarter of year-over-year operating segment margin improvement with aggregate segment margins up 260 basis points. This led to both of our operating segments delivering at least 25% earnings growth in the third quarter with the Industrial Coatings segment also delivering higher sequential margins.

Another key focus remains strong cash generation. Throughout the first three quarters of the year, the $1.5 billion operating cash generation that we delivered is up more than $1.1 billion over a year — on a year-over-year basis. In addition to our strong earnings performance, we significantly reduced working capital in total by about $300 million, mainly driven by lower inventories, contributing to the robust operating cash flow generation. We use part of this cash to reduce our higher variable cost debt during the quarter and despite significant increases in market interest rates, our net interest expense declined year-over-year. As we look to continue our momentum into the fourth quarter, we are laser-focused on achieving top line sales and earnings growth in 2024 and beyond.

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I’d like to highlight a few items that we expect will support growth in 2024. First, as I communicated at our CEO investor briefing in May, we are working on a number of commercial growth opportunities and several of these initiatives have been launched and are now gaining momentum. For example, we are pleased with the progress being made supporting our customers’ rapid growth of electric vehicles in China with PPG technology advantage products and services. We are well positioned with the leading electric vehicle producers and continue to gain share as the production rate increases each quarter, including strong EV export activity out of China. In the past few years, we’ve invested to enhance our manufacturing and technology capabilities around powder coatings products with prudent capacity additions.

This year, we’re realizing the benefit of these investments as our powder coating related sales have increased about 15% compared to last year. We’re winning new business every quarter and supporting our customers’ sustainability and productivity objectives, and we expect powder to outgrow the market for a number of years to come. Another commercial growth initiatives supporting our growth in 2024 and beyond involves expanding the breadth of products being sold through the PPG Comex distribution network. Our world-class network of over 5,100 concessionaire locations in Mexico has consistently outgrown the regional architectural market and provides customers with their preferred paint brand and products in Mexico. We are very excited about the opportunity to now leverage this distribution network to support customer needs for protective, refinish, traffic and light industrial products.

So these focus areas are part of a larger basket of commercial initiatives that will support our previously communicated organic sales growth targets. I will provide periodic updates on these initiatives in subsequent quarters. On legacy of PPG and another catalyst for earnings growth going forward is strong cash generation and value-creating capital deployment. I plan to continue to abide by our hallmark of prudent balance sheet management and financial flexibility, supported by strong free cash flow of our business portfolio. Year-to-date, we have delivered record cash flow from operations and we have utilized this to deliver on our prior commitment to repay some variable rate debt, driving down our interest expense. In the fourth quarter, we will likely incorporate some additional debt repayment, but will also likely complete some share repurchases, reflecting our strong cash position and seasonality of our cash flows.

In addition to the sales and earnings growth initiatives, one other strategic initiative that we’ve been actioning relates to some selective pruning of our business portfolio. As a reminder, we’ve recently divested a number of smaller assets, including most of our coatings businesses in Africa, a non-core business that we acquired with the Ennis-Flint acquisition and have exited certain product categories in some businesses. In addition, this week, we announced the divestiture of certain international operations in our Traffic Solutions business. These actions allow us to channel our growth bandwidth in areas that are meaningful and where we have winning advantages, including technology, brands and customer relationships. We will continue to actively assess each of our businesses and product lines to ensure they’re consistent with our growth objectives and that they meet our financial objectives, and they earn the right to remain in the portfolio.

Now I’ll comment on our fourth quarter outlook. We expect several of the businesses in our Performance Coatings segment to deliver organic growth, including continued solid growth in our PPG Comex and aerospace businesses. We do expect slowing in U.S. architectural coatings demand stemming from multi-decade highs in interest rates and lowering housing turnover. While we expect our automotive OEM business to grow in the fourth quarter in most regions, other portions of our Industrial Coatings segment will be challenged due to sluggish overall global industrial production. While there are many variables in uncertain timing, we have prudently included an estimated financial impact of the UAW strikes of a few cents of EPS in our fourth quarter financial guidance.

As we have communicated in the past, our regional sales to the OEMs impacted by the strike are low-single digit percentage of our total company sales. Also, we sell to other OEM customers in the region not impacted by the strikes and given the historically low dealer inventory levels, we expect any lost volume will be made up in subsequent quarters. Certain other sales volume headwinds are beginning to abate, as we expect China is at or approaching trough levels. Also, we do not expect destocking to be a significant issue in our packaging coating end-use market in 2024. With regard to commodity raw materials, supply has normalized to pre-pandemic levels and we expect to continue to realize benefits from moderating input costs. We will maintain emphasis on diligently managing our costs and expect to make more progress on our previously announced restructuring initiatives.

In addition, we are beginning to deliver manufacturing productivity gains, which are supported by a more stable supply chain and customer order pattern. Despite the challenging environment, we’ve raised full year earnings guidance and expect fourth quarter aggregate segment margins will be higher on a year-over-year basis for the fifth consecutive quarter. Lastly, I’d like to thank our team members around the world who live our purpose every day to protect and beautify the world. Thanks to their hard work and dedication, we’re able to support our customers and help them solve their biggest challenges. I remain confident in our team’s ability to make it happen. Thank you for your continued confidence in PPG. This concludes our prepared remarks and now would you please open the line for questions.

Operator: Thank you. [Operator Instructions] Your first question today comes from the line of John McNulty with BMO. John, please go ahead. Your line is now open.

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Q&A Session

John McNulty: Yeah. Good morning. Thanks for taking my call and congrats on a solid set of results. Wanted to ask on the raw material environment, we’ve seen a decent jump up in oil recently. I guess, can you speak to how we should be thinking about raws moving from 3Q to 4Q and if you expect those to be down and how much on a sequential basis, do you expect them to be down? And then, I guess, how should we be thinking about that as it rolls through into 2024?

Tim Knavish: Hey, John. Thanks for the question. So let me talk about oil first. Obviously, oil is going to produce some impact on solvents for us. But really, our raw material basket is much more dependent upon supply demand, where several steps removed from oil with the exception of solvents, so that’s a much bigger impact for us. And then, the total impact for Q4, we saw high-single digit deflation in Q3. We expect high-single digits in Q4, and we expect further deflation as we move into 2024 on a broader basis.

Vince Morales: Hey, John. This is Vince. Let me just add a little bit to what Tim was saying. So the supply demand environment, as we pointed out, I think, in our prepared remarks and the press release, we have seen sufficient — more than sufficient supply, that’s typically a bigger driver of our input costs than just the feedstocks. And right now and heading into a seasonally lower fourth quarter, we expect that to continue. So I would expect the increase in rise in oil to have no impact other than solvents on our fourth quarter and as we head into next year, we will start negotiating with our suppliers in Q4 — late Q4, and the tone from our suppliers has been more volume driven as opposed to price driven.

Operator: Your next question comes from the line of Duffy Fischer with Goldman Sachs. Duffy, please go ahead. Your line is now open.

Duffy Fischer: Yeah. Good morning, guys. Just a question around the delta between Industrial and Performance. So Industrial margins were up 300 bps year-over-year and Performance was up a little under 2.5%. But Industrial trailed on volumes by 4% and trailed on dollar pricing by 3%. So it doesn’t look like there were any leverage from price and volume on the margin spread, so what’s underlying that gap and why was Industrial able to do better than Performance even though it didn’t on price or volume?

Vince Morales: Yeah, Duffy. This is Vince. Let me just start, I’ll let Tim add some color, obviously. But if you look at Q3 alone, the improvement year-over-year in Industrial is larger but the Performance segment improved quicker. So we got pricing, we typically have pricing and performance quicker. So we had price injected into our businesses quicker in Performance. We lagged that with Industrial, and we were still getting price in Industrial and certainly in 2022 in the back half. So on a year-over-year delta, you’re correct, the Industrial segment looks better, but Performance just recovered earlier. Tim, do you want to add?

Tim Knavish: Yeah. I think it’s spot on, and I think both segments will see continued year-over-year margin improvement, depending upon with the addition of manufacturing productivity improvements that I mentioned in my opening comments. And of course, as we get into seasonality, more volume will help that step change in margins as well.

Operator: Your next question comes from the line of Ghansham Panjabi with Baird. Ghansham, please go ahead. Your line is now open.

Ghansham Panjabi: Thank you, operator. Good morning, everybody. As we kind of think about 2023, two of your higher margin verticals, including aerospace and Comex had delivered on outsized growth and obviously, margin conversion as well. How should we think about the sustainability of these growth verticals into 2024 and just more broadly, what is your base case for volumes for each of the two operating segments next year?

Tim Knavish: Yeah, Ghansham. Thanks for the question. Aerospace, you should expect that to continue not only for ’24, but multiple years going forward. We have just such a unique technology advantaged position in that industry across commercial new build, commercial aftermarket, general aviation, military and all of those are strong and projected to be strong for the foreseeable future. We’ve got a tremendous backlog. Everything we make, we can sell. So that you should feel very good about we do for coming quarters and years. Likewise, with PPG Comex, I think this was the 13th quarter in a row of record performance. There’s nothing to say, we won’t have 14th, 15th and beyond. In my opening comments, I mentioned and back in May at the CEO briefing, I mentioned that while we will continue to gain share in the conventional architectural business.

We’re now focused on kind of our next chapter of accelerated growth in PPG Comex and that’s using our world-class distribution network to sell refinish coatings, traffic, industrial protective and those are all up and running. So you should feel really good about those two businesses continuing record-breaking performance, and we certainly do. On an overall volume basis, I’m confident that we’re going to swing to overall positive volume in 2024 based on a number of green shoots that we’re seeing throughout our portfolio.

Vince Morales: Yeah. And Ghansham, if I could add just to those green shoots. We are seeing Europe, in our opinion is troughing especially for our business mix. We were essentially flat in Q3 in European volume across our portfolio. We do expect growth to resume in China, albeit at a lower level. Those are two pieces of our — two big pieces of our portfolio geographically. And as Tim mentioned, Mexico, we expect to have outsized growth relative to other regions. And then the other business, as Tim mentioned, I would agree with, but I would also add that we do — we are picking up share in our refinish business based on some of the technologies that we talked about in May.

Operator: Your next question comes from the line of Christopher Parkinson with Mizuho. Christopher, please go ahead. Your line is now open.

Christopher Parkinson: Thank you so much. Good morning. Tim, you’ve spoken a lot about kind of refocusing on R&D and just further positioning PPG to outgrow some of its respect to end markets, new products, new technologies has been literally just mentioned one. Once we’re through this macro mayhem or however, you want to characterize it, what’s your level and degree of confidence that you will, in fact, be able to outgrow certain end markets and where are you ultimately the most enthusiastic? Thank you.

Tim Knavish: Yeah. Hey, Chris. Thanks for the question. I like how you described the macro. The way I’m thinking about the broader kind of sequential what you should expect to see from us, most of ’23, you heard me say many times, laser focused on margin recovery. We’ve made progress there. I think the next phase, I would call mostly focused on recovery growth in some of our stronger portfolio segments. But while all of that is happening, we have been shifting those focus in investment areas that you alluded to in, I would say innovation areas, not just classic R&D because some of that innovation is inside the can and some of that innovation is outside the can. And we’re starting to see progress in a number of those areas, which is some of the green shoots and confidence that I have on go forward.