Axalta Coating Systems Ltd.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Axalta Coating Systems is a global manufacturer and supplier of performance coatings for a wide variety of industries, primarily the automotive and industrial sectors.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Axalta operates within two main segments: Performance Coatings and Mobility Coatings.

  • Performance Coatings: This segment caters to a diverse range of industrial customers, from refinish (automotive repair) to architectural applications. It comprises 62% of total net sales in 2022.
  • Mobility Coatings: This segment primarily focuses on the automotive industry, producing coatings for light vehicles, commercial vehicles, and automotive plastics. It accounts for 38% of net sales in 2022.

Revenue Distribution: Axalta’s revenue is globally diversified. While North America remains its biggest market, a significant portion of its revenue comes from Asia-Pacific and Europe. Specifically, as of Q3 2023, about 40% of total sales are from North America, while another 40% comes from EMEA (Europe, Middle East, and Africa), and the remaining 20% comes from the Asia Pacific region.

  • Geographic Breakdown: A significant portion of net sales is generated from North America, with Europe & Asia following close behind.

Industry Trends: The coatings industry is influenced by several factors, including:

  • Automotive Production: Trends in automotive production directly affect the demand for mobility coatings. Increased vehicle sales lead to a higher demand for Axalta’s products, and vice versa.
  • Industrial Activity: Industrial coatings are sensitive to the state of the economy. Strong economic growth typically leads to increased industrial activity and higher demand for Axalta’s performance coating systems.
  • Raw Material Prices: Raw material prices, particularly oil and petrochemical-based materials, can greatly affect Axalta’s profitability.
  • Sustainability: Increasing demand for sustainable coatings is reshaping the industry, creating opportunities for companies like Axalta that focus on eco-friendly products.

Competitive Landscape: Axalta operates in a competitive market that is highly fragmented. Companies vary from large global players to regional and local players. The intensity of competition varies by product line and geography. For example, within the automotive OEM coating market, there is some consolidation, while the refinish market is highly fragmented. For industrial coatings, local and regional players are abundant, where transportation distances and proximity may be preferred.

What Makes Axalta Different: While Axalta’s business is fairly commoditized, they aim to create more differentiation through their product innovation and technology, while also making sure they provide strong product quality and meet customer needs. Additionally, they also focus on supply-chain efficiencies to better service customer needs.

  • Core Strengths: focus on creating new, innovative products, and providing strong customer service.
  • Global Reach: they have a large customer base in many parts of the world, offering multiple coating lines in each region.
  • Customer Collaboration: they attempt to work closely with their customers in the development of their coatings.

Financials in-depth:

  • Revenues: Axalta’s 2022 revenue totaled $4.9 billion, a growth of 13.8%. The growth rate had decreased to 1.1% in the nine months of 2023, reflecting economic uncertainty and reduced demand, particularly in the industrial sector. However, the company has noted in their most recent earnings call that the industrial demand has rebounded and is growing positively.
  • Profitability:
    • Margins: Adjusted EBITDA margins show a decent profitability. They saw a dramatic increase in 2022 to about 18% before declining to 15.3% YTD in 2023, mainly because of an increase in costs of materials. Management has stated that cost actions are now starting to bear fruit.
    • Net Income: Net income has generally seen fluctuations over the last few years, but is growing in 2023.
    • Return on Invested Capital (ROIC): For the last five years ROIC has ranged between 10% to 19%, with recent years hovering at the higher end, indicating profitability in this metric. This is an encouraging metric as it shows the company is capable of generating returns on investments made in its own business. Management guidance indicates an improved ROIC in the future.

Recent Developments: In their most recent earnings call, management outlined a positive growth outlook, citing that their end markets have begun to grow, and the company is focused on improving operational efficiency and passing on costs to their customers. They have successfully renegotiated their contracts with a few key suppliers, and they plan to increase pricing to better reflect their value proposition. Moreover, the company is continuing to invest in their R&D pipeline in their quest for product differentiation.

  • Debt: The company is reasonably leveraged, with debt to total capitalization at about 55%. They are attempting to decrease their debt with their continued cash flow growth.
  • Cash Flow: The company produces stable free cash flow and operating cash flow, a very good sign for a company with such a complex business to sustain operations.
  • Capital Structure: Currently, the company’s capital structure is composed of about 45% debt and 55% equity.

Moat Analysis (Rating: 2/5):

  • Intangible Assets: While Axalta has a diverse portfolio of proprietary products, including brands and patents, those don’t provide a very durable advantage, especially in commodity markets, where many players may be able to find an alternative product.
  • Switching Costs: While companies have specific formulations, customers can switch between these for a variety of reasons such as price and availability. Hence switching costs are low, meaning little pricing power is afforded.
  • Network Effects: This does not apply to Axalta, as they don’t operate a network-based business.
  • Cost Advantages: While Axalta is attempting to create cost efficiencies via increased scale and production, they are not a very low-cost producer compared to many of the global players in their markets.
  • Overall Moat: Axalta’s moat is limited, mostly due to limited pricing power, and some of their advantages in customer relationships or having their supply network close to customers.

Risks to the Moat:

  • Raw material price volatility: The prices of their raw materials can fluctuate wildly with external economic factors, which could affect their margins, even if they have fixed pricing contracts.
  • Increased competition: The intensely competitive nature of the industry could squeeze their margins and make sustaining ROIC difficult.
  • Technological Disruption: Disruptive innovations, especially in coatings technology, could allow new entrants to develop competing products and bypass Axalta’s patents.
  • Economic Downturns: A contraction in the economy is likely to directly affect their end markets, especially in the industrial markets, as production and new projects tend to decline.
  • Poor acquisitions: as noted in the previous sections, any acquisition made by the company must not destroy, but rather, increase value. if acquisitions made are not done efficiently and fail to perform, this will destroy value in the company.

Business Resilience:

  • Axalta has proven to be a resilient business over the years, but is still heavily affected by changing economies.
  • A diverse end market in terms of geographic reach and segments allows for a strong base and flexibility to endure various shocks in the economy.
  • The company is trying to improve their cost structure and implement pricing action to retain stability and margins in the long term.

Understandability (Rating: 2/5):

  • Axalta operates in a technically complex area within the chemical and coatings industry, making it somewhat difficult to understand, especially for non-specialists.
  • The number of factors that influence the business, from the supply of materials, different types of customers, and different technologies, requires lots of knowledge to really appreciate the company.
  • However, understanding the basic business is simple: Axalta sells a product to customers across a large number of industries and regions.

Balance Sheet Health (Rating: 3/5):

  • Axalta’s debt-to-equity ratio of approximately 55% is somewhat high, meaning the company is reasonably leveraged.
  • Their debt maturities are spread over the next few years.
  • Free cash flow and operating cash flow are generally stable and healthy for the company.
  • They are actively trying to manage debt levels, which is commendable.

In Summary, Axalta is a well established company in the coatings industry. It possesses a narrow moat due to having a decent customer base and some advantages stemming from their supply chain. However, the competitive dynamics of the market and the volatility of the prices of the raw materials limit its advantages. However, if the management is able to execute on its plan for product differentiation and cost structure, we might see them improve their profitability and return on capital metrics. The company is also well managed with a good balance sheet. The overall rating of the company is somewhere in the middle, with a bit more room for improvement in the coming years.