AXTA – Not Cheap But 18 Months of Momentum

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Graham Copley / Nick Lipinski

203.901.1629/203.989.0412

gcopley@/nlipinski@ssrllc.com

August 30th, 2016

AXTA – Not Cheap But 18 Months of Momentum

  • Smaller in size than its global Coatings peers, AXTA has multiple opportunities to expand in its focused end-markets and outperform peers as a multi-year raw material tailwind ends
  • Valuation metrics are mixed
    • AXTA is as highly valued as SHW on forward EPS, but several multiple points below peers on forward EBITDA – Return on Capital is lower than for peers and should improve
    • FCF yield is strong and the company needs to de-lever (likely benefiting equity values) before this cash can be returned to shareholders via potential dividends
    • Longer-term, we noted in our comprehensive Coatings report that AXTA could be an intriguing takeout candidate when the cost opportunities and market growth play out
  • Improvements in car technology should offset texting related rise in auto accident rates, but consolidation of multi-shop operators (MSOs) in the North American auto body space is driving growth in AXTA’s core auto refinish business
    • AXTA holds #1 positions with the “Big Four” that have been on a consolidating spree
  • AXTA has made niche, high-margin Industrial applications a focus
    • Investments here come at a time when global industrial production is subdued, valuations are reasonable and should generate leverage to an upswing
    • SHW and PPG, have bought what may be near the peak in architectural coatings
  • Commanding share in the heavy duty truck market gives AXTA more insulation to a slowdown in light vehicle production from current peaks
    • Smaller market than light vehicle, but margins higher and near-term growth superior
  • Operational upside should increase returns – some legacy DuPont cost overhangs remain
    • Cost opportunities should bring return metrics more in line with industry averages
  • The major risk to the story is a broad recession in developed markets (Europe and North America account for 70% of sales) but the refinish business (42% of total sales) has defensive characteristics

Exhibit 1

Source: Capital IQ, SSR Analysis

Auto Refinish – Defensive with Consolidation Upside

AXTA is the leader in the global refinish coatings market, which has strong defensive characteristics. In North America in particular, more than 90% of spending resulting from collisions is handled by insurance.

Exhibit 2

Source: Company Reports, SSR Analysis

While refinish market customers (auto body shops) tend to be highly fragmented (over 80,000 locations globally) the trend in North America is very clearly toward consolidation. The major four multi-shop operators (“Big 4”) have steadily expanded their share through acquisitions, and the trend is expected to continue – Exhibit 3. AXTA has clearly prioritized the Big 4, roughly tripling its market share with these major consolidators over the past three years – Exhibit 4.

Exhibit 3

Source: Company Reports, SSR Analysis

Exhibit 4

Source: Company Reports, SSR Analysis

Industrial Investments – Coming At the Lows

Aside from continued focus on the core refinish business, the industrial coatings market (currently 17% of AXTA sales) has been a designated area of investment. Exhibit 5 summarizes AXTA’s market positions.

Exhibit 5

Source: Company Reports, SSR Analysis

AXTA’s focus on the industrial sector should generate significant leverage to an upswing in global manufacturing activity, which has been tepid of late. Compare this to SHW and PPG having bought into architectural coatings in North America at a time when raw material costs have been flat for the better part of three years – Exhibit 6 – and are widely expected to inflect higher from here.

Exhibit 6

Source: Bloomberg, SSR Analysis

Auto OEM – Leading Position in Heavy Trucks Positions Better Than Light Vehicle Near-Term

AXTA’s position with OEMs is stronger in the heavy duty market (greater than 30% share globally) than in light vehicle (19% global share). Its position in the North American heavy duty market is notably commanding – Exhibit 7. Overall this mix should be beneficial near-term, given concerns of flattening light vehicle production/sales in North America, while the heavy duty market has been more resilient. There is also predictably more value in larger vehicles – Exhibit 8.

Exhibit 7

Source: Company Reports, SSR Analysis

Exhibit 8

Source: Company Reports, SSR Analysis

Cost Opportunities – Should Bring Returns on Capital in Line with Industry Average

Management believes several years of cost opportunities remain, which will help AXTA’s lagging return metrics. Returns on tangible capital are far lower than its European and North American peers – Exhibit 9 – and there appears to be room to expand sales per employee – Exhibit 10.

Exhibit 9

Source: Capital IQ, SSR Analysis

Exhibit 10

Source: Capital IQ, SSR Analysis

Valuation

AXTA appears cheap versus peers on EV/forward EBITDA – Exhibit 11 – but more expensive on forward EPS – Exhibit 12. The company is generating ample cash – Exhibit 13 – but currently pays no dividend as debt remains elevated relative to peers and company intentions. AXTA is targeting 2.5-3 times debt to EBITDA, and is approaching that range following several years of steady deleveraging.

Exhibit 11

Source: Capital IQ, SSR Analysis

Exhibit 12

Source: Capital IQ, SSR Analysis

Exhibit 13

Source: Capital IQ, SSR Analysis

Exhibit 14

Source: Capital IQ, SSR Analysis

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