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Ben Reynolds
Ben Reynolds
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Dividend Aristocrats In Focus Part 3 of 54: PPG Industries

September 26, 2014 | About:

In part 3 of the 54 part Dividend Aristocrats in focus series, we will look into the operations and price drivers of PPG Industries (NYSE:PPG). PPG Industries has seen tremendous price momentum over the last 5 years, gaining over 200% versus less than 100% for the stock market overall

Source: Yahoo! Finance

PPG Industries operates primarily in the coatings industry, selling various paint and coating products throughout the world. PPG Industries (NYSE:PPG) generates close to 90% of its revenues from the coatings industry. About a decade ago, only 56% of the company’s revenue came from coatings. PPG Industries made the decision to focus on coatings; that managerial decision has given the company its explosive growth over the last decade.

The company decided to focus on coatings due to the favorable characteristics of the industry. The coatings industry is relatively slow changing. For example, It is far less likely that advances in technology will make the entire paint industry obsolete versus the smart tablet industry. The coatings industry is not capital intensive; there is very little capital involved in the production and sale of paint versus other industries, like the airline industry, for example. Low capital intensity allows coating companies to generate large free cash flows that they can pay out as dividends, repurchase shares or acquire other businesses.

PPG Industries has increased its dividend payments for 42 consecutive years. The company’s ability to grow its dividend payments year after year shows evidence of a lasting competitive advantage. Recent growth in the company’s top and bottom lines show that PPG Industries competitive advantages are growing stronger over time.

Competitive advantage

PPG Industries competitive advantage comes from its size and global scope. The company generates large cash flows and can roll up competitors through acquisitions to grow sales. The company’s focus on the growing coatings industry has allowed it to sell assets in its other more capital intensive businesses and reinvest the proceeds into the coatings industry.

An example of this strategy in action is when PPG Industries acquired the Glidden paint brand (among others) in North American from AkzoNobel (AKZO) for $1.05 billion in 2013. The transaction gives PPG Industries a nationally recognized paint coatings brand. Further, the acquisition made PPG Industries the number 2 paint company by market share in North America, second only to Sherwin-Williams (NYSE:SHW).

PPG Industries has increased its sales by about $3.3 billion per year from acquisitions over the last 4 years. The company’s long-history of acquiring and integrating coatings companies gives it the experience necessary to grow profitably using an acquisition strategy.

Source: PPG Investor Presentation

Comex acquisition & growth potential

PPG Industries’ most recent acquisition was the $2.3 billion purchase of Consorcio Comex. The deal will be financed largely by cash on hand and short-term investments. Comex is the leading architectural coatings business in Latin America. The company’s U.S. and Canada operations were recently acquired by Sherwin-Williams. Sherwin-Williams had originally planned to purchase the entire company, but the deal fell through, and PPG Industries stepped in to complete the purchase.

Comex generates about $1 billion per year in sales in Latin America. Their revenue is split between architectural coatings (65%) and industrial and specialty coatings (35%). The acquisition will make PPG Industries the leader in coatings in Mexico.

PPG Industries growth potential lies in further consolidating the coatings industry. PPG Industries is well positioned to continue acquiring smaller coatings businesses in emerging and international markets. Despite being the global industry leader in coatings, PPG Industries still has a long growth runway ahead. Nearly 50% of the $120 billion global coatings industry is controlled by smaller businesses. The Top 10 largest coatings companies make up the other 50%.

Source: PPG Investor Presentation

The company has particularly exciting growth prospects in Asia. PPG Industries is currently the second largest coatings company in Asia with an 9% market share, behind only AkzoNobel which controls an 11% market share. PPG Industries’ Asian coating revenues come primarily from industrial coatings, rather than architectural coatings. The company has managed to grow sales at over 20% a year in Asia since 2005 through organic growth and acquisitions. PPG Industries Asian expansion will likely continue through timely acquisitions. The company needs to grow its lagging architectural coatings sales in Asia. PPG Industries’ is only the 7th largest architectural coatings company by market share in Asia. I expect the company to work to bolster this portion of its operations in the future.

Fair value

PPG Industries has shown strong growth over the last several years. The company has a long history of dividend payments and currently has a dividend yield of 1.34%. PPG Industries has a high current P/E ratio of 25.6. The company’s P/E ratio reflects its status as a high quality business with strong growth potential that rewards shareholders with rising dividends and share repurchases. The overall market is trading at a P/E ratio of about 20, although its historical average is closer to 15.

PPG Industries is trading at the top of its historical P/E range, and is likely overvalued at this time. The stocks should likely trade at a P/E ratio of between 16 and 19 based on its strong growth prospects, durable competitive advantage, and shareholder focus.

Final thoughts

PPG Industries is one of the coating industry’s leaders. The company has shown a talent for acquiring other coating businesses to grow both the top and bottom lines. PPG Industries has further demonstrated its shareholder friendliness through its long history of consecutive dividend payments.

The company appears to be overvalued at this time. Because it is trading for a fairly high P/E ratio, it is likely not a good time to start a position in PPG Industries for long-term investors. I believe there are better Dividend Aristocrat investment options available for investors focused on safety, yield, and growth.

About the author:

Ben Reynolds
I run Sure Dividend, a website that finds high quality dividend stocks for long term investors using the 8 Rules of Dividend Investing.

Visit Ben Reynolds's Website

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