PPG Industries, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

PPG Industries is a global manufacturer and distributor of a broad range of paints, coatings, and specialty materials, serving various industries.

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:

PPG Industries, established in 1883, operates primarily in two major business segments: Performance Coatings and Industrial Coatings. The Performance Coatings segment supplies a vast array of paints, coatings, and related materials to customers in the automotive refinish, architectural, and protective & marine markets. Meanwhile, the Industrial Coatings segment sells coatings used in manufacturing processes, such as for appliances, automotive OEM parts, and packaging materials.

Recent Developments:

PPG announced that it entered into a definitive agreement to sell its 50% products business in Brazil (Tikkurila) to Sherwin Williams. The transaction is expected to close in the first quarter of 2024.

Moat Analysis: 2 / 5

PPG’s moat is categorized as “Narrow” because it has some elements of a moat but there are strong forces diminishing it.

  • Brand Recognition (Intangible Asset): PPG has a recognizable brand in its industry, which may be an advantage. However, brand alone isn’t sufficient. A moat rating requires that the brand translate into pricing power, which may or may not be present for PPG across all of its product lines.

    • In Performance Coatings, products like coatings for cars require a level of customer trust given safety and regulatory standards which could provide some form of brand advantage and high switching costs (discussed below).
    • In Industrial Coatings however, it’s not clear if the brand has any significant value as it is an input to other manufacturers that don’t care about the brand itself.
  • Switching Costs: PPG coatings products, when used to protect valuable assets or machines, can have high switching costs, because quality is of primary importance to customers. Automotive refinish coatings represent the best case for switching costs as the customer must have the paint perfectly compatible with their cars. But, this will not apply across all businesses as most of them don’t have a high level of switching costs, but rely on the brand and price.
  • Cost Efficiency (Potential Cost Advantage): PPG may generate cost advantages via improved supply chains and operational excellence. But, this is not a unique capability as they don’t own some valuable resource that creates a barrier to entry against other companies doing the same. The majority of the industries that PPG operates in can be seen as commodity industries where cost matters the most.

In summary, though PPG operates in some areas where there are strong moats present, it doesn’t qualify for “Wide” moat, as the overall performance of the company can be affected by a weaker division, while a narrow moat seems appropriate as there is something preventing strong competition, but not to a high degree.

Risks to the Moat and Business Resilience:

  1. Raw Material Volatility: PPG’s operations are susceptible to changes in raw material prices, which might impair profitability if the firm can not pass through these changes to their customers. Moreover, any supply chain disruptions could also create shortages in inputs and create operational problems.
  2. Competition: PPG faces strong competition across multiple industries, and those competitors are always trying to develop better and more efficient products. This could reduce the demand for their current products, or put pressure on the pricing power they have.
  3. Global Economic Fluctuations: Economic cycles (recession) affect various industries, especially construction and automotive. A slowdown in these industries could cause a considerable drop in demand for PPG’s products and affect the returns.
  4. Accounting and Regulatory Changes: Constant changes to accounting regulations, tax laws, and environmental regulations and other operational regulations can impact their margins and ability to serve their customer base. This may require additional capital expenditure or negatively affect the revenues.
  5. Integration Risks of Acquisitions and Divestments: PPG engages in frequent acquisitions and divestitures. There is always a risk of miscalculation in prices and issues during integration of acquired companies, as well as not being able to realize the full benefits from such activities, which may negatively impact the profitability of the business.

Business Description:

  • Revenue Distribution: PPG operates through two main segments:
    • Performance Coatings: Revenue generated from the sale of paints, coatings, and related products across various industries like automotive, architectural and specialty, generating around 60% of its total revenue.
    • Industrial Coatings: Revenue generated from the sale of products used in the manufacturing of automobiles, packaging materials, construction, and consumer electronics generating around 40% of total revenue.
    • Revenues are diversified globally, with operations in the Americas (North and South America), Europe, Asia Pacific, and Middle East and Africa.
  • Industry Trends: The coatings market is influenced by global economic activity, industrialization, and environmental regulations. The industry is gradually moving towards more environmentally friendly products (such as water-based and low-VOC coatings).
  • Margins: PPG’s profitability is determined by sales volume and price, and a company’s ability to control costs is key for improving margins. Input prices are extremely important in this industry as they are one of the key drivers for profitability.
    • Raw materials prices are highly volatile and can fluctuate depending on geopolitical situations.
    • Operating efficiency is an important way to keep costs low and improve operating margins.
  • Competitive Landscape: PPG competes with other large paint and coating companies, such as Sherwin Williams, Akzo Nobel, and other smaller regional players. While scale is important to have a competitive advantage and better price negotiations with suppliers, product differentiation is also important for obtaining price power.
  • What Makes PPG Different?: A strength of PPG is their ability to manufacture large quantities of goods and provide a large variety of products, combined with having a worldwide presence across various industries. This makes the company a large supplier to many customers, thus ensuring stability of earnings. They are also able to gain some cost efficiencies by scale and improving their supply chains.

Financial Analysis:

  • Revenue: PPG’s revenue growth has been inconsistent, mainly due to acquisitions and divestitures, as well as the nature of the company being exposed to economic conditions. Revenue has slightly decreased YoY (year over year) in recent years.
  • Profitability: Although margins in some divisions are stable, the overall net income margins of PPG have been below 10% in the past few years. * Recent problems with raw material costs and supply chain disruptions have negatively impacted profitability.

  • Free Cash Flow: In recent years, PPG has had varying free cash flow numbers but are usually positive. The free cash flow and the investment of new capital will be a good parameter for assessing the value of this company.

  • Capital Structure: PPG has a significant amount of debt, but maintains manageable levels for such a large business. The cash reserves are somewhat limited, so it might be dependent on new credit markets for further funding if needed.
    • Debt-to-capital ratios have ranged from 40-50%, which is higher but not a cause for worry, as long as the company keeps consistent revenues.
  • Recent Concerns: A potential cause for concern is the negative or low profitability growth, despite good revenue results in most recent results. This could be a sign of management inefficiency, as they are not able to fully convert their revenue into profits. Also, there have been a number of charges recognized for acquisitions in the recent past that are affecting the financial results. The company has also failed to increase the return on invested capital in recent times, which could reduce long-term value creation.

Management View: Management has emphasized its commitment to portfolio value creation via operational efficiencies and strategic acquisitions. The company aims to grow by focusing on improving the operations, and cost structure of their business units and has highlighted its ability to achieve this in past periods.

Understandability: 3 / 5

The business model is understandable, in that PPG produces and sells coatings for various industries, and some of these coatings provide brand advantages. However, the financial statements have some intricacies due to constant changes in accounting standards, and goodwill and intangibles resulting from frequent acquisitions. These make understanding the numbers slightly difficult, especially regarding the valuation of the company. Also, there are nuances in understanding the different business segments and the specific industries it operates in. Overall, it is an intermediate level of complexity for most investors.

Balance Sheet Health: 4 / 5

While PPG has a substantial amount of debt, it is still within manageable limits. PPG’s history of having positive free cash flow can ensure future debt repayment. Cash reserves are a little concerning, as the company doesn’t seem to keep high enough cash for an unforeseen event. The company shows good liquidity ratios, and their credit rating is investment grade, which indicates financial stability. Overall, it looks like a reasonably safe and healthy company.