Performance Coatings Rallies to Drive 4Q Beat
• Operating earnings came in ahead of estimates. AXTA posted 4Q17 EPS of $0.37A ex items vs. our $0.32E and consensus of $0.31. Adjusted EBITDA increased 8.3% y-y to $245mn, better than our $235mn, and the Street at $237mn. While cognizant of the raw material risks, we had entered the quarter cautiously optimistic regarding the Performance Coatings segment following a more positive tone from management on the 2018 outlook call (click here) regarding the improvements to the auto refinish business. Thus we are encouraged by the better underlying margin and top line performance for that segment on the quarter. While overall EBITDA margins declined 100ps y-y to 20.9% (vs. our 20.5% and consensus of 20.4%) this is a marked improvement from the negative 350bps of y-y degradation in 3Q17. Relative to our EBITDA forecast, Performance Coatings beat our estimates while and Transportation Coatings continues to lag. Total sales of $1.17bn came in ahead of our $1.15bn reflecting 13.3% growth as organic sales of 1.3% were aided by an 8.6% contribution by the Valspar Wood Coatings and a larger than expected FX tailwind. Net debt declined by $168mn q-q to $3.14bn or 3.4x our 2018 EBITDA estimate. Axalta did not repurchase shares in 4Q17 as the company failed to reengage the market following a breakdown of public deal discussions at the end of November.
• EBITDA guidance reiterated. On 14 December, Axalta issued its initial 2018 EBITDA guidance range of $940-980mn. In this morning’s release the company is reiterating this range, though the company is making various alterations to other guided line items. Despite the unchanged EBITDA guidance, FCF is now expected to be between $420-$460mn, a net reduction from the $430-$470mn prior. Interest expense guidance has been increased by $15mn, now expected at ~$165mn. However this is largely recovered through a new lower tax rate which now anticipated in the range of 19-21% a net reduction vs. the prior guidance of 21-23%.
• Performance Coatings beats as price initiatives take hold. EBITDA for Performance Coatings of $165mn beat our estimate of $149mn as a combination of a stronger top line and margin profile resulted in a $0.05 tailwind in EPS terms vs. our estimate. EBITDA margins of 22.6% were nearly flat y-y, much better than our 20.9% estimate as price initiatives are beginning to show significant traction, up 2.5% y-y. As mentioned, Axalta struck an optimistic tone on its outlook call regarding the improved performance of the refinish business, and while it appears volumes were still negative in this business on the Q, trends appear to be improving from prior quarters.
• Transportation Coatings is a different story. In EPS terms, the transportation segment was a $0.02 headwind, as total EBITDA of $80mn was weaker than the $86mn we had penciled in. We have been cautious on Transportation margins given the elevated raw material costs and the competitive pricing pressures in OEM auto. These factors continued to be issues on the quarter, with price down 2.2% y-y leading to a margin decline of 240bps from 4Q16 levels. Sales of $433mn were up 2.8%, driving a modest beat vs the 1.0% growth that we anticipated. Sales to LV auto OEM customers were down 3.8% with North America again weak on the quarter, perhaps signaling relative underperformance vs. PPG’s low single digit volume growth. Commercial Vehicle sales continues to improve, up 17.4%, which is encouraging but perhaps not too surprising given Class 8 build rates in North America did rally by ~40% y-y.
• We rate AXTA shares Hold with a price target of $31. Our target suggests shares are fairly valued on a total return basis (AXTA shares do not currently pay a dividend). As a reminder, our valuation of AXTA 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 $32. Using our relative P/E framework wherein we apply a 30% premium to the S&P500 multiple, we calculate warranted value of $30 per AXTA share.
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