01.30.18
PPG Industries (PPG: Buy, $130 PT)
Affirm Buy on Volume Acceleration; Margins Still Work in Progress
• Better organic volume growth solves one of two challenges. In broad strokes we believe two issues have weighed on PPG’s relative trading multiples in recent years: (1) a relative lack of organic sales growth; and (2) margin concerns. Based on 4Q results, we are increasingly optimistic that the former issue is finally on the mend. Volume growth of 3% marked PPG’s best result in fully 3 years and improvement here looks more sustainable than not, although we see a number of moving parts to consider going forward: (A) one less shipping day in 1Q18 vs. 1Q17; (B) the level of rebound in demand support from natural disasters; (C) net share gains evident across several coatings categories; and (D) the durability of “B” and “C” as 2018 progresses. While all of these issues bear monitoring, we do get the sense that sales will be moving in the right direction. Unfortunately, the latter challenge of margin compression persists, since raw material cost inflation remains a challenge for the industry and the pace of recovery via higher selling prices has been sluggish, particularly among PPG’s more global industrial customers. However, price continues to creep higher sequentially and we do expect more meaningful price realizations ahead in 1H18. Taking into account PPG’s ample financial flexibility and ongoing plans to deploy substantial excess capital, we affirm our Buy on the stock and consider risk-reward prospects to be marginally more appealing, consistent with Thursday’s stock move of +3.4% vs. -0.2% for the S&P500 index.
• Our top 10 takeaways: (1) PPG posted adjusted 4Q17 EPS of $1.19A, a penny ahead of consensus of $1.18 and a penny shy of our $1.20E; (2) as expected, natural disaster-related costs posed a headwind of $0.05 in 4Q; (3) sales of $3.68bn reflect markedly improved volume growth of 3%, supplemented by more than +3% from FX and modest contributions from price; (4) volume growth of +3% y-y in 4Q17 was the best since 4Q14 and represented meaningful acceleration from...
• Changes to our model: We maintain our 2018 EPS estimate of $6.50, albeit with countervailing trends. We increase our sales forecast, based on higher volumes, more favorable FX translation, and modestly higher contributions from recent bolt-on acquisitions. We also shrink our share count slightly to reflect share repurchase activity that exceeded the high end of our expectation for 4Q17. These benefits are offset by a combination of ongoing inflation of raw material costs as well as higher projected corporate expense relative to our prior model, principally as a function of higher projected incentive compensation in 2018 vs. 2017.
• We affirm our Buy and raise our target by $3 to $130. Our revised target reflects higher market multiples since our last revision and now suggests total upside potential of 11%, including a dividend yield of 1.5%. PPG now trades at a 2018 P/E multiple of 18.2x, which represents a discount of 3.3x or 15% vs. the average of three US coatings peers (SHW, AXTA and RPM). Importantly, we estimate that this discount would widen to ~25% pro forma for deployment of PPG’s excess capital vs. coatings peers. Likewise, PPG trades at 12.1x our 2018 estimate of EBITDA, or a discount of 2.3x vs. the average of US coatings peers. Our valuation of PPG is based on an average of two methodologies: DCF analysis and a relative P/E framework. Our DCF analysis suggests a warranted stock price of $131, based on a WACC of 7.8%. Using our relative P/E framework, wherein we apply a 5% premium to the S&P500 multiple, we calculate warranted value of $129 per PPG share.
(Please see full report for details)
----
Chemicals
Lithium Landscape; Supply Anxiety Escalates
• Lithium stocks hit an air pocket. In this month’s edition of Lithium Landscape, we refresh our thesis on supply-side risks to lithium as both incumbents and juniors race to market to maximize returns. Notwithstanding strong demand trends, our research highlights the likelihood of an excess supply of lithium that could cause selling prices to regress toward more normalized levels in coming years. Herein we discuss three developments in recent days that add to investors’ concerns: (1) SQM (Chile) has settled its dispute with Chilean regulator, which clears the way for relatively unfettered expansion of production capacity in the “out” years; (2) Orocobre (Argentina) has raised substantial capital and increased its phase-2 expansion plans; and (3) Galaxy’s 4Q17 results indicate a slightly sharper ascent of production capability. In response, lithium stocks around the world have come under pressure in the early days of 2018, a correction that is more warranted than not in our opinion.
• Market sentiment has begun to shift in respect of supply-side concerns. While none of the aforementioned developments come as a complete surprise, we continue to see more risk to the market balance from the start-up of three Western Australian producers (Altura, Pilbara, and Tawana) and one Canadian producer (North American Lithium) as well as organic expansions at Albemarle, than we do from the likes of these recent headlines. However, the combined effect of all of this continues to suggest to us that (A) capital is flowing freely to fuel capacity expansions; (B) global lithium operating rates are likely to come under pressure and could decline below...
• SQM settles with CORFO. On 17 January, SQM announced its settlement agreement with CORFO, the Chilean Economic Development Agency, which establishes royalty and production quotas for lithium production in the country. The progressive royalty schedule (Figure 1) mimics the agreement that Albemarle struck with CORFO on 4 January, 2017. Encouragingly for ALB, the progressive royalty does not include…
• New agreement lays the groundwork for capacity growth. In addition to formalization of the progressive rates, the new quota significantly expanded SQM’s production window, enabling the company to pursue a more rapid pace of expansion, should they so choose. Under the prior production agreement...
• Orocobre takes up targets, hints at more expansion to come. On 16 January, Orocobre announced a new financing transaction with Toyota Tosoh, a Japanese trading company, which is paving the way for Orocobre to increase the scale of its phase-2 expansion from 17.5KTPA to 25KTPA. In exchange for AUD $282mn in cash, Toyota will receive a 15% equity stake in Orocobre as well as options on product offtake from the phase two expansion. In addition, Orocobre hinted for the first time about...
• Galaxy’s 4Q performance shows encouraging signs. On the same day as the Orocobre announcements, Galaxy Resources released its 4Q performance from the company’s Mt. Cattlin mine. Production for the quarter came in at 52,139 metric tons of lithium concentrate, which we estimate translates to…
• This new supply comes at a price; a lower price. Production growth from the likes of these aforementioned incumbents as well as a deep bench of new projects originating from Western Australia runs the risk of pushing the lithium market into oversupply. While there will undoubtedly be start-up issues and varying quality of product produced, the degree of new supply to market will likely weigh upon the global lithium contract price, which we estimate is trading at a premium of ~30% to the marginal cost of supply...
• New energy vehicle sales in China continue to grow though comps get more difficult at year end. China new energy vehicle sales ended the year at 778k, ahead of the China Association of Auto Manufacturer’s target of 700k, and represented 53% growth over 2016. However, growth lost some momentum into year end, with December new energy vehicle sales up 57%, down from the over 100% growth in October. In the US...
• Lithium carbonate prices trend flat, while lithium hydroxide inches higher. We judge that global average contract lithium carbonate (LC) prices for December trended largely flat sequentially, bringing the year end price to $16,000/mt, up 34% since 1 January, 2017. Under the hood, strength in global markets continued to offset what has been a 3.5% decline in Asian market prices since October. According to consultant Benchmark Minerals (BMI), availability of carbonate…
• Selling pressure hits the lithium sector. As depicted in Figure 5, lithium stocks have come under pressure as concerns of fresh supply have weighed on market multiples. SQM has weathered the storm better than others as the settlement with CORFO removes uncertainty around its expansion plans. Orocobre...
(Please see full report for details)
Affirm Buy on Volume Acceleration; Margins Still Work in Progress
• Better organic volume growth solves one of two challenges. In broad strokes we believe two issues have weighed on PPG’s relative trading multiples in recent years: (1) a relative lack of organic sales growth; and (2) margin concerns. Based on 4Q results, we are increasingly optimistic that the former issue is finally on the mend. Volume growth of 3% marked PPG’s best result in fully 3 years and improvement here looks more sustainable than not, although we see a number of moving parts to consider going forward: (A) one less shipping day in 1Q18 vs. 1Q17; (B) the level of rebound in demand support from natural disasters; (C) net share gains evident across several coatings categories; and (D) the durability of “B” and “C” as 2018 progresses. While all of these issues bear monitoring, we do get the sense that sales will be moving in the right direction. Unfortunately, the latter challenge of margin compression persists, since raw material cost inflation remains a challenge for the industry and the pace of recovery via higher selling prices has been sluggish, particularly among PPG’s more global industrial customers. However, price continues to creep higher sequentially and we do expect more meaningful price realizations ahead in 1H18. Taking into account PPG’s ample financial flexibility and ongoing plans to deploy substantial excess capital, we affirm our Buy on the stock and consider risk-reward prospects to be marginally more appealing, consistent with Thursday’s stock move of +3.4% vs. -0.2% for the S&P500 index.
• Our top 10 takeaways: (1) PPG posted adjusted 4Q17 EPS of $1.19A, a penny ahead of consensus of $1.18 and a penny shy of our $1.20E; (2) as expected, natural disaster-related costs posed a headwind of $0.05 in 4Q; (3) sales of $3.68bn reflect markedly improved volume growth of 3%, supplemented by more than +3% from FX and modest contributions from price; (4) volume growth of +3% y-y in 4Q17 was the best since 4Q14 and represented meaningful acceleration from...
• Changes to our model: We maintain our 2018 EPS estimate of $6.50, albeit with countervailing trends. We increase our sales forecast, based on higher volumes, more favorable FX translation, and modestly higher contributions from recent bolt-on acquisitions. We also shrink our share count slightly to reflect share repurchase activity that exceeded the high end of our expectation for 4Q17. These benefits are offset by a combination of ongoing inflation of raw material costs as well as higher projected corporate expense relative to our prior model, principally as a function of higher projected incentive compensation in 2018 vs. 2017.
• We affirm our Buy and raise our target by $3 to $130. Our revised target reflects higher market multiples since our last revision and now suggests total upside potential of 11%, including a dividend yield of 1.5%. PPG now trades at a 2018 P/E multiple of 18.2x, which represents a discount of 3.3x or 15% vs. the average of three US coatings peers (SHW, AXTA and RPM). Importantly, we estimate that this discount would widen to ~25% pro forma for deployment of PPG’s excess capital vs. coatings peers. Likewise, PPG trades at 12.1x our 2018 estimate of EBITDA, or a discount of 2.3x vs. the average of US coatings peers. Our valuation of PPG is based on an average of two methodologies: DCF analysis and a relative P/E framework. Our DCF analysis suggests a warranted stock price of $131, based on a WACC of 7.8%. Using our relative P/E framework, wherein we apply a 5% premium to the S&P500 multiple, we calculate warranted value of $129 per PPG share.
(Please see full report for details)
----
Chemicals
Lithium Landscape; Supply Anxiety Escalates
• Lithium stocks hit an air pocket. In this month’s edition of Lithium Landscape, we refresh our thesis on supply-side risks to lithium as both incumbents and juniors race to market to maximize returns. Notwithstanding strong demand trends, our research highlights the likelihood of an excess supply of lithium that could cause selling prices to regress toward more normalized levels in coming years. Herein we discuss three developments in recent days that add to investors’ concerns: (1) SQM (Chile) has settled its dispute with Chilean regulator, which clears the way for relatively unfettered expansion of production capacity in the “out” years; (2) Orocobre (Argentina) has raised substantial capital and increased its phase-2 expansion plans; and (3) Galaxy’s 4Q17 results indicate a slightly sharper ascent of production capability. In response, lithium stocks around the world have come under pressure in the early days of 2018, a correction that is more warranted than not in our opinion.
• Market sentiment has begun to shift in respect of supply-side concerns. While none of the aforementioned developments come as a complete surprise, we continue to see more risk to the market balance from the start-up of three Western Australian producers (Altura, Pilbara, and Tawana) and one Canadian producer (North American Lithium) as well as organic expansions at Albemarle, than we do from the likes of these recent headlines. However, the combined effect of all of this continues to suggest to us that (A) capital is flowing freely to fuel capacity expansions; (B) global lithium operating rates are likely to come under pressure and could decline below...
• SQM settles with CORFO. On 17 January, SQM announced its settlement agreement with CORFO, the Chilean Economic Development Agency, which establishes royalty and production quotas for lithium production in the country. The progressive royalty schedule (Figure 1) mimics the agreement that Albemarle struck with CORFO on 4 January, 2017. Encouragingly for ALB, the progressive royalty does not include…
• New agreement lays the groundwork for capacity growth. In addition to formalization of the progressive rates, the new quota significantly expanded SQM’s production window, enabling the company to pursue a more rapid pace of expansion, should they so choose. Under the prior production agreement...
• Orocobre takes up targets, hints at more expansion to come. On 16 January, Orocobre announced a new financing transaction with Toyota Tosoh, a Japanese trading company, which is paving the way for Orocobre to increase the scale of its phase-2 expansion from 17.5KTPA to 25KTPA. In exchange for AUD $282mn in cash, Toyota will receive a 15% equity stake in Orocobre as well as options on product offtake from the phase two expansion. In addition, Orocobre hinted for the first time about...
• Galaxy’s 4Q performance shows encouraging signs. On the same day as the Orocobre announcements, Galaxy Resources released its 4Q performance from the company’s Mt. Cattlin mine. Production for the quarter came in at 52,139 metric tons of lithium concentrate, which we estimate translates to…
• This new supply comes at a price; a lower price. Production growth from the likes of these aforementioned incumbents as well as a deep bench of new projects originating from Western Australia runs the risk of pushing the lithium market into oversupply. While there will undoubtedly be start-up issues and varying quality of product produced, the degree of new supply to market will likely weigh upon the global lithium contract price, which we estimate is trading at a premium of ~30% to the marginal cost of supply...
• New energy vehicle sales in China continue to grow though comps get more difficult at year end. China new energy vehicle sales ended the year at 778k, ahead of the China Association of Auto Manufacturer’s target of 700k, and represented 53% growth over 2016. However, growth lost some momentum into year end, with December new energy vehicle sales up 57%, down from the over 100% growth in October. In the US...
• Lithium carbonate prices trend flat, while lithium hydroxide inches higher. We judge that global average contract lithium carbonate (LC) prices for December trended largely flat sequentially, bringing the year end price to $16,000/mt, up 34% since 1 January, 2017. Under the hood, strength in global markets continued to offset what has been a 3.5% decline in Asian market prices since October. According to consultant Benchmark Minerals (BMI), availability of carbonate…
• Selling pressure hits the lithium sector. As depicted in Figure 5, lithium stocks have come under pressure as concerns of fresh supply have weighed on market multiples. SQM has weathered the storm better than others as the settlement with CORFO removes uncertainty around its expansion plans. Orocobre...
(Please see full report for details)
