Akzo: Underachieving – Need The PPG Path to Higher Valuation

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Graham Copley / Nick Lipinski



September 29th, 2016

Akzo: Underachieving – Need The PPG Path to Higher Valuation

  • Akzo Nobel’s significant valuation discount relative to Coatings competitors appears justified by its less profitable and more volatile business mix – but this is the opportunity
    • In Coatings (~66% of sales) and Specialty Chemicals (~33%), Akzo’s businesses show lower and more volatile margins relative to their respective industries – Exhibits 1 and 7
    • Akzo vs PPG Performance Coatings is the most telling and relevant comparison in Exhibit 1 – PPG’s stock transformation since exiting chemicals should be a goal for Akzo
    • PPG saw greatly decreased earnings volatility by shedding commodity chemicals and steadily reducing its glass exposure, resulting in significant relative multiple expansion – the company has also focused on costs aggressively – Akzo appears to be very people heavy in coatings
  • Returns have improved but are largely raw material driven Europe (~50% sales exposure) is a structurally more fragmented market; lower margins but opportunity to consolidate
    • Akzo may not be able to make up the gap with its Coatings competitors without a strategic shift (via M&A) or an assist from the European market which remains subdued relative to pre-recession levels – the shift is what PPG needed also – that strategy has played out well
  • Given the laggard nature of Akzo’s Coatings businesses, it may be optimistic to assign PPG-like multiples to a sum-of-the-parts analysis, but the stock looks interesting on this basis and may look interesting to an activist – easy initial win by divesting chemicals, then cost focus
    • Specialty Chemicals’ five sub-businesses do not appear to have integration into Coatings – potential break-up at multiples of 8-10x could be dilutive given current valuation
    • A focused, pure-play Coatings company on a path to industry margins/returns would likely warrant a much higher multiple than the current level – Akzo needs PPG as a direct comp
  • Valuation support comes from the highest dividend in the Coatings space, 2.5% yield
    • Debt is low but pension liabilities are a constraint ($200+ million annually through 2020)

Exhibit 1

Source: Capital IQ, SSR Analysis

Overview – The PPG Example

The PPG story looks reasonably intact today, despite weaker industry dynamics in US autos and housing as the business transformation is complete and the company is well placed to pick off some reasonably large coatings businesses globally with BASF focused on automotive and Sherwin Williams distracted by the Valspar acquisition. However, the landscape might change a little for PPG and others if Akzo emerged as a more serious player. In our view there is real value to be created by turning Akzo into some hybrid of PPG and SHW – a focused coatings company with a better cost base and an M&A driven growth strategy in coatings. There is enough upside, we believe, to attract some activist attention – in the same way that Pershing thought Air Products could be more like Praxair, you could get excited about Akzo if you thought it could be more like PPG!

PPG saw a dramatic change in valuation following the decision to divest its chemical business, and this is best shown in the stock price chart in Exhibit 2. PPG always recognized the drag that the chemical business appeared to have on valuation, but was always nervous that a divestment would be dilutive to earnings and cash flows as the sale multiple would not be high and any sale would be tax inefficient. The company was persuaded by investors that its multiple would improve, but this was an intangible that could not be relied on. PPG had sought an exit strategy for years and took the tax efficient opportunity when it came.

Exhibit 2

Source: Capital IQ, SSR Analysis

PPG’s earnings have done quite well since the chlor-alkali sale – Exhibit 3 – but had done well previously and had been offset by a meaningful decline in multiple in anticipation of a chlor-alkali downturn. The company sold the business just ahead of a major downturn and while earnings growth was a contributor to stock performance, the major turnaround in multiple drove most of the upside shown in the price chart in Exhibit 2. The change in relative multiple (versus the S&P 500) is shown in Exhibit 4.

Exhibit 3

Source: Capital IQ, SSR Analysis

Exhibit 4

Source: Capital IQ, SSR Analysis

The multiple expansion comes from increased certainty and if we measure the volatility of earnings prior to the chlor-alkali sale versus the period post the sale we see a meaningful decline. The more recent period is short, but proxies for PPG’s coatings business show long-term limited earnings volatility – Exhibit 5.

PPG has gained the benefit of a changed mix and is stagnating a bit at present more because of slowing industry fundamentals and not because of a declining view of multiple/strategy.

Our view is that this opportunity is the same for Akzo and that the company can create shareholder value by separating its core coatings business from its specialty and commodity chemicals business. In the current environment it is unlikely that anyone would buy the chemicals business and that any offer would not only undervalue the portfolio but likely create a tax headache for the company. The most obvious way forward would be to spin out the chemicals piece. Strategically this would then set “coatings” Akzo up to participate in further consolidation in the coatings space – either adding to its decorative and industrial portfolio through bolt on deals or adding auto OEM by acquiring Axalta.

Exhibit 5

Source: Capital IQ, SSR Analysis

Akzo’s Businesses Less Profitable, More Volatile – Partly a Function of Underlying Markets – Mostly Mix

Akzo is undervalued in the Coatings space with its multiples likely dragged down by its non-coatings segments, in the same way that PPG lagged the group until the chemicals sale to Axiall – Exhibit 6.

Exhibit 6

Source: Capital IQ, SSR Analysis

Coatings at Akzo is not without its problems, as highlighted in Exhibit 1 – earnings volatility is greater than for many of its peers and margins are lower – but this is partly due to business and geographic mix, with such a strong focus on Europe. In the specialty chemicals business the company appears to have the same problem – Exhibit 7 – when compared to peers its margins are lower and volatility higher. In our view this is almost entirely a function of definition. Akzo chooses to label this as a specialty business, but the commodity component is significant, creating most of the volatility.

Exhibit 7

Source: Capital IQ, SSR Analysis

Akzo’s specialty business is a conglomerate of five different units, summarized in Exhibit 8. Diversification would typically reduce volatility, suggesting that there are some areas that have commoditized and are driving the greater perceived volatility. Growth appears low for specialty business, with only polymer chemistry expected to be a 3% plus end market. We would argue that there is nothing unusual about the business – it is the label which is misleading. Polymer chemistry is likely the only true specialty segment.

Exhibit 8

Source: Company Presentations, SSR Analysis

The chemicals business, which should probably be labeled “diversified”, is certainly large enough to stand alone and might be able to implement a more appropriate and business specific strategy as an independent rather than as part of a larger and coatings dominated “conglomerate”. We cannot see any real synergies in operating the businesses together.

Exhibit 9

Source: Company Presentations, Capital IQ, SSR Analysis

Coatings Could Also Do With Some Focus

Exhibit 10 shows Akzo’s own description of its performance coatings business in terms of the segments in which it operates and its global position. The big gap is automotive with no OEM exposure and a weak share of the refinish business. On the decorative side, the company lacks any exposure to the US, having sold to PPG, and in the current economic environment is penalized by a Europe dominated portfolio – Exhibit 11.

Exhibit 10

Source: Company Presentations

Exhibit 11

Source: Company Presentations, SSR Analysis

Part of the problem with the coatings segment is cost related and in Exhibit 12 we show that revenues per employee, while in line with peers in chemicals, lags terribly in coatings. The separation of the businesses should be a first step and a cost focus in coatings should be a second step.

Exhibit 12

Source: Capital IQ, SSR Analysis

Returns Improving but Tough Path to Industry-Level Returns

The recent improvement in returns may look good on an absolute basis but have not narrowed the gap versus peers – most companies have shown gains since 2010 in a strong overall Coatings industry helped by some significant declines in raw material costs staring with TiO2 in 2012 and then any oil derived component from 2014.

Exhibit 13

Source: Capital IQ, SSR Analysis

Without a Multiple and Focus Uplift, Sum of the Parts Not Compelling

Exhibit 14 summarizes historical EBITDA multiples for Akzo comps in the Coatings and Specialty Chemicals industries. Valuing Akzo’s Coatings businesses at PPG’s average EBITDA multiple over the past five years and the Specialty business at 7.5x to account for the commodity elements of the portfolio gives the sum of the parts analysis in Exhibit 15 – Akzo could have around 10% upside on this basis. Exhibit 16 shows upside at different multiples for the Coatings business.

Exhibit 14

Source: Capital IQ, SSR Analysis

Exhibit 15

Source: Capital IQ, SSR Analysis

Exhibit 16

Source: Capital IQ, SSR Analysis

Yield Possibly Supportive, No Debt Concerns but Pension Constraints

Exhibit 17

Source: Capital IQ, SSR Analysis

Exhibit 18

Source: Capital IQ, SSR Analysis

Exhibit 19

Source: Company Reports, SSR Analysis

Normal Value vs. Coatings Peers

Akzo looks significantly cheap on normal earnings derived from the return on capital trend shown in Exhibit 12, and the discount is pronounced relative to other companies in the Coatings space – Exhibits 20 and 21.

Exhibit 20

Source: Capital IQ, SSR Analysis

Exhibit 21

Source: Capital IQ, SSR Analysis

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