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Investors in paintings and coatings company PPG Industries (NYSE: PPG)
have enjoyed a nearly 45% rise over the last year, but the stock has
remained in a tight $150-$160 range over the last few months. Is this a
sign that it’s time to take profits on the stock? Before you rush to
hit the sell trigger, you should consider the upside potential in this
stock. PPG can move higher in 2013, and here is why.
End market conditions
PPG’s prospects for 2013 will largely be governed by its performance
within the industrial and architectural/construction end markets.
With regard to the industrial sector, it’s been a mixed earnings
season so far. As a general rule, companies exposed to sub-sectors such
as aerospace and automotive have done really well, while the rest of the
industrial sector has faltered. For example, aluminum manufacturer Alcoa(NYSE: AA)started this trend
in this earnings season by affirming its forecast for 9%-10% growth in
its aerospace market, and also upgrading its expectations for the North
American automotive market.
However, while Alcoa is seeing strength within some of its key end
markets, companies exposed to general industrial trends like supply
companies Fastenal (NASDAQ: FAST), and MSC Industrial(NYSE: MSM), are seeing weaker conditions.
Both companies cited the softening Institute for Supply Management
(ISM) survey data as being indicative of a difficult industrial
environment. Fastenal reported disappointing industrial fastener sales
(an indication of cyclical weakness), and announced plans to hire new
staff in an effort to generate revenue growth. Similarly, MSC Industrial
declared that it wouldn’t be pushing through its usual midyear price
increase due to softening demand from its customers.
The architectural markets have also seen some mixed
performances. A look at the data from the Architectural Billings Index
from the American Institute of Architects (AIA) reveals the difference
in performance between the residential and commercial markets in 2013.
Source: American Institute of Architects.
The idea is that a recovering residential market will lead to an
improvement in commercial/industrial conditions, but it hasn’t happened
so far in 2013.
How is PPG faring?
A brief look at its segmental income demonstrates that PPG is generating income growth from a variety of sources.
Source: PPG accounts.
In its recent earnings release, PPG disclosed that its performance
coatings saw its automotive and aerospace refinish businesses deliver
”mid-to-high single digit sales increases”. PPG received a major
contribution to sales and income growth, from its acquisition of
Akzo-Nobel’s US household paints division. However, its
North American architectural coatings sales (excluding acquisitions)
actually declined 5%. The decline was partly due to a major customer
changing its product mix, but PPG also referenced some cautious
purchasing patterns amongst independent dealers.
Indeed, its rival Sherwin-Williams(NYSE: SHW)
referenced similar market dynamics in its conference call on July 18.
Sherwin-Williams spoke of the loss of business from a key retailer (in
this case Wal-Mart), and outlined that its non-residential sales were
lagging residential. In addition, its consumer group sales declined 1%
even after a positive 3.2% contribution from an acquisition.
Industrial coatings sales benefitted from a 12% rise in volumes from
its automotive sales, and PPG was keen to highlight that this is partly a
result of excellent long-term positioning within the leading car
companies. It claims to be the number one player in automotive coatings
in North America and China.
Perhaps the most surprising aspect of PPG's results were that its
Europe, Middle East and Africa (EMEA) – architectural coatings income
increased by $5 million to $69 million, despite sales declining 5%. This
increase is a testimony to how well its management is implementing cost
savings programs.
Where next for PPG?
The company has a number of good catalysts for growth. Input costs
are moderating, the automotive and aerospace sectors are growing
strongly, and investors can look forward to some improvement in the
commercial/industrial construction market. PPG is a well-run company
that has coped admirably with the slowdown in Europe. In addition, it
plans for to generate around $200 million in synergies thanks to the
Akzo-Nobel acquisition.
With regard to valuation, the stock trades on a discount to its peers:
In conclusion, I think the company is set for good growth going
forward, and its valuation makes the stock attractive for the long term
investor.
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