Published by Nick McCullum on October 17th, 2017
PPG Industries (PPG) is the largest paint company in the world.
It is also one of the most reliable dividend stocks. PPG has paid dividends every quarter since 1899. Moreover, the company has increased its dividend each year for the last 45 years, which qualifies it to be a member of the exclusive Dividend Aristocrats list.
PPG’s remarkable dividend consistency helps it to appeal to the more conservative members of the dividend growth investing community. This article will analyze PPG’s investment prospects in detail and determine whether the company merits a buy recommendation at current prices.
Business Overview
PPG Industries was originally founded in 1883 as a manufacturer and distributor of glass. The ‘PPG’ in PPG Industries stands for Pittsburgh Plate Glass, which is a reference to the company’s original operations. A timeline of PPG’s illustrious corporate history can be seen below.
Source: PPG Industries 2016 Investor Presentation, slide 23
Over time, PPG has made remarkable strides in becoming an industry leader in the paints and coatings industry. With a market capitalization of $29 billion and annual revenues of nearly $15 billion, PPG’s only competitor of similar size is fellow Dividend Aristocrat Sherwin-Williams (SHW) as well as Dutch paint company Akzo Nobel. PPGs’ industry-leading market share can be seen in the following chart.
Source: Sherwin-Williams October 2017 Investor Presentation
PPG Industries has grown to such an impressive size thanks to its worldwide operating presence and focus on technology and innovation. The company has approximately 3,500 technical employees located in more than 70 countries at 100 unique locations. The company’s research and development focus is a key differentiator between PPG and other paint & coatings companies.
Source: PPG Industries 2016 Investor Presentation, slide 25
PPG has grown to be a market leader today. The next section of this analysis discusses the levers that PPG can pull to initiate growth moving forward.
Growth Prospects
By and large, a company’s ability to increase revenues and profits is a function of their capital allocation. PPG’s capital allocation in fiscal 2016 and over the past decade can be seen below.
Source: PPG Industries Presentation at the 2017 UBS Chemicals Conference, slide 9
The image shows that PPG has historically spent about 37% of its cash flow on acquisitions, but this proportion was significantly smaller last year with the remainder being devoted to share repurchases.
With this in mind, it is likely that mergers and acquisitions will be a focus for PPG moving forward as the company moves back towards its core competency of portfolio optimization.
The evidence supports this thesis. Earlier this year (on June 1st), PPG announced the sales of its last remaining glass business – the North American fiberglass unit – for $545 million. The company also states that it has ‘completed several additional bolt-on acquisitions’.
Source: PPG Industries Presentation at the 2017 UBS Chemicals Conference, slide 4
More importantly, PPG made three bids for AkzoNobel (AKZO.AS), the third-largest operator in the paints and coatings industry. This merger, if completed, would have created an industry giant and it’s questionable whether it would have received regulatory approval given the implication on overall industry competitiveness.
It turns out that competition concerns were unnecessary, as Akzo’s board of directors rejected each bid from PPG despite pressure from multiple large investors (in particular, activist shareholder firm Elliott Management led by Paul Singer was willing to oust Akzo’s Chairman to get the merger approved). The largest offer was for nearly $30 billion, but PPG eventually decided to focus on ‘other opportunities’ in its M&A pipeline.
PPG is likely to continue focusing on its coatings unit. As mentioned, PPG recently sold its last glass business and over time has been concentrated on its paint businesses with laser-like focus. This has resulted in an increased proportion of the company’s sales being generated by the coatings unit, a trend which is visualized below.
Source: PPG Industries 2016 Investor Presentation, slide 11
PPG’s track record suggests that the stock’s underlying business is likely to continue growing at a satisfactory rate for the foreseeable future. The company’s adjusted earnings-per-share over the trailing 15-year period can be seen below.
Source: Value Line
PPG Industries managed to compound its adjusted earnings-per-share at 7.2% per year between 2001 and 2016.
Note that PPG’s adjusted earnings-per-share in 2016 were significantly depressed by real but one-time expenses related to its pension plan. If we consider the company’s growth between 2001 and 2015, it was a robust 11.2% per year.
We believe that PPG is likely to grow more slowly than this ~11% rate moving forward. Investors can reasonably expect 6%-8% adjusted earnings-per-share growth from PPG Industries through full economic cycles.
PPG’s performance is likely to suffer during periods of economic recession, an observation that is discussed in the next section of this analysis.
Competitive Advantage & Recession Performance
PPG operates in the paints & coatings industry, which is economically attractive for a number of reasons:
- Products have high margins
- It requires little capital investment
- It generates significant cash flow
Given these facts, it begins to make more sense that there are two paint companies (Sherwin-Williams and PPG Industries) in the Dividend Aristocrats list.
With that said, the paint and coatings industry is not very recession-resistant because it depends on a health housing market. This impact can be seen in PPG’s performance during the 2007-2009 financial crisis:
- 2007 adjusted earnings-per-share: $2.52
- 2008 adjusted earnings-per-share: $1.63
- 2009 adjusted earnings-per-share: $1.02
- 2010 adjusted earnings-per-share: $2.32
- 2011 adjusted earnings-per-share: $3.44
PPG’s adjusted earnings-per-share fell by more than 50% during the last major recession, and took two years to recover. While the long-term prospects of this Dividend Aristocrat remain bright, investors that own PPG should be willing to double-down and purchase more shares of this stock if a recession hits and its stock price fall precipitously.
Valuation & Expected Total Returns
PPG’s earnings are expected to rebound considerably after 2016’s weak number, which was caused by a significant one-time pension charge. More specifically, PPG is expected to report adjusted earnings-per-share of $6.35 in fiscal 2017, which combined with the company’s current stock price of ~$113 gives a price-to-earnings ratio of 17.8.
The following diagram compares PPG’s current price-to-earnings ratio to its long-term historical average.
Source: Value Line
PPG’s current price-to-earnings ratio is 17.8 and its 10-year average price-to-earnings ratio is 19.7. While the company’s quantitative valuation appears low right now, it is because the economy is booming (which boosts its earnings).
Buying PPG right now is similar to buying oil stocks when oil prices are at ~$130 – of course the company is going to look cheap because the business (and the economy) is firing on all cylinders.
Right now it probably not the best time to buy PPG because the stock will probably drop like a rock during the next recession. We recommend waiting, as better buying opportunities should present themselves eventually.
Final Thoughts
PPG Industries has many of the characteristics of a very high-quality business:
- More than 40 years of consecutive dividend increases
- Significant international presence
- A focus on enhancing shareholder value through M&A
However, the company’s weakness during recessions means that even though its valuation looks appealing on paper, better buying opportunities are likely to occur in the future. We’ll pass on PPG Industries for now, although the stock remains a strong hold for investors that are holding it with lower costs bases.
