We are maintaining our Neutral recommendation on PPG Industries Inc. (PPG). The company expects to see higher demand in 2011 compared with 2010, but intends to remain focused on continued cost management entered in 2011 with about $2 billion in cash and short-term investments, which is a historically high level for the company and includes proceeds from a $1 billion debt offering in November 2010.
Despite the recession, the company’s cash generation has been consistent and at or near record levels for the past three years. A stronger operating focus has resulted in lower operating working capital over that time period. The strengthening economic recovery, broad geographic footprint, reductions in cost structure and substantial financial flexibility inspire optimism about PPG’s prospects for 2011.
PPG Industries has a leading position in several paints and coatings end markets. We like PPG’s Optical business and the portfolio’s improved mix, higher growth and diminished cyclicality following the separation of auto glass.
The company’s strong portfolio has acted as a key positive catalyst for the company. With the acquisition of SigmaKalon Group of the Netherlands, PPG has further globalized and diversified its business mix. The company’s Optical product sales are approaching the peak level following the launch of the Generation 6 Transition Lense product. PPG’s Glass segment is also likely to outperform with higher fiber glass demand.
In 2011, we expect the economic recovery to strengthen and broaden in most end-markets and regions. We anticipate that the North American recovery will continue with higher industrial activity and construction markets will no longer act as a headwind.
The recovery rate in Europe in 2011 is expected to once again lag that of Asia, Latin America and North America, as export growth moderates and further impacts are realized from the 2010 austerity measures.
We believe that PPG’s significant presence in the U.S. construction, European architectural and global auto, appliance and industrial coating markets expose it to substantial headwinds. The company expects construction markets in the US to remain sluggish in the near future.
We are concerned about the late-cycle exposure in non-residential construction, aerospace coatings, marine coatings and PPG’s overexposure in Europe. This puts PPG’s earnings estimates and share price at risk.
PPG’s operating results are significantly affected by the cost of raw materials and energy. Changes in natural gas prices have a significant impact on the operating performance of its Commodity Chemicals and Glass segments. It also imports raw materials, particularly for use at its manufacturing facilities in the emerging regions of the world.
In most cases, those imports are priced in the currency of the supplier, risking margins if the foreign currency strengthens against the local currency of its manufacturing facilities.
Furthermore, PPG’s return on capital and profitability lags its peers due to excessive investment in the paint business and little focus on the chlor alkali and glass business.
PPG faces stiff competition from the DuPont Performance Coatings segment of EI DuPont de Nemours & Co. (DD) and BASF Coatings AG.
PPG Industries has a Zacks #2 Rank (Buy) in the short term and we hold a long-term Neutral recommendation on the stock.
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