PPG Industries (PPG: Buy, $124 PT) 
Fighting for Price, Restoring Margin, and Shrinking the Count
• Our meetings with management suggest that PPG is on an even keel. We visited with CFO Vince Morales and Director, Investor Relations, John Bruno over dinner last Thursday evening and during investor meetings in New York on Friday. Overall, we would describe PPG’s updates as consistent with recent commentary as it relates to the company’s consumer facing and industrial business lines as well as with regard to deployment of excess capital. As such, we exit the discussions feeling as though our constructive thesis is intact. We continue to view risk-reward prospects as asymmetrically favorable, i.e. PPG shares may not have the greatest upside among our Buy-rated names at +11%, but may offer the least downside risk, since management plans to deploy $2.8bn of capital for accretive purposes through the 15 months ended December 2018.
• Business conditions remain mixed yet steady. Our read is that the company’s industrial end markets continue to experience solid underlying demand growth, albeit with a difficult comparison ahead vs. 4Q16 when auto OEM coatings sales surged in Asia ahead of uncertainty about phase-out of auto tax incentives in China. Elsewhere in Asia…
• PPG is working to recover rising raw material costs and restore margin. TiO2 pigment costs have been a persistent source of pressure over the past 18 months, while Hurricane Harvey reinvigorated inflation among commodity petrochemical and packaging resin costs. In this context, management is working to restore the operating margin that has eroded over the past two quarters. We view this goal as achievable, albeit with a more substantial lag in…
• Akzo deal is all but dead. If PPG is posturing regarding lack of interest in re-engaging with Akzo, they are doing an excellent job of it. We detect near zero willingness to re-engage with Akzo at this juncture given the intransigence (our word) demonstrated by Akzo’s board. Stated differently…
• There are plenty of fish in the sea. The “death” of PPG-Akzo does not mean that PPG is uninterested in M&A in our view. To the contrary, we believe the company continues to evaluate numerous potential deals, although management has demonstrated discipline in passing on several higher profile coatings deals over the past year, including Albemarle’s Chemetall  business (sold to BASF for $3.2bn), Dunn Edwards (sold to Nippon Paint for an undisclosed price that we believe to be $590-750mn) and BASF’s industrial (coil) coatings business (sold to Akzo for €475mn). Still, according to PPG, half of the global coatings industry remains quite fragmented with two dozen companies that are $1bn in size or greater. Perhaps the brightest “white space” in PPG’s portfolio is…
• Share repurchases are a good plan B. PPG remains under-leveraged with net debt of less than $2.4bn or 0.9x our estimate of 2017 EBITDA. Absent M&A opportunities that are a good strategic fit with respectable returns, we expect management to direct excess capital and cash flow toward regular repurchases of stock, which makes sense to us at current valuation levels (see discussion below). Indeed, PPG has committed to deploy at least $2.8bn of capital over the 15 months ended December 2018, or nearly $200mn per month. This equates to…
• We rate PPG shares Buy with a price target of $124. Our target suggests total upside potential of 11%, including a dividend yield of 1.6%. PPG now trades at a 2018 P/E multiple of 17.8x, which represents a discount of 4.2x or 19% 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 11.7x our 2018 estimate of EBITDA, or a discount of 1.5x 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 $125. Using our relative P/E framework, wherein we apply a 5% premium to the S&P500 multiple, we calculate warranted value of $123 per PPG share.
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