EUR 850.00 For Business Accounts Only

Morningstar | Akzo Reports Weak 2Q as Expected; We Still See Improvement Coming in Second Half

Raw material and currency headwinds continued for no-moat AkzoNobel in the second quarter, as expected. We expect raw material headwinds to abate and cost savings to accelerate in the second half of 2018. Accordingly, we don’t expect to make a material change to our EUR 82 fair value estimate, leaving the stock in fairly valued territory.

Adjusted operating income of EUR 225 million was down 23% over 2017 and missed consensus by around 7%. Still, the stock was up roughly 3% at time of writing, good enough to lead the group on the day. We share the market’s modestly positive reaction, as the results were slightly ahead of our estimates. While the headline numbers were weak, we are encouraged by a sense of discipline that is emerging at the company. We believe AkzoNobel is a margin story--that is, positive stock performance will be highly dependent on closing the margin gap with peers. In that regard, we appreciate that Akzo appears to be now committed to a price over volume strategy. In the second quarter, selling prices were up 5% in decorative paints and 3% in performance coatings, with more to come, while volume was down 2% and 3%, respectively. Furthermore, Akzo indicated that it has walked away from business in the challenged marine and protective coatings market, as pricing was value-destructive.

We expect cost savings to be the primary driver of results over the next few years. Phase one of the fit-for-purpose transformation delivered EUR 25 million of cost savings in in the second quarter. We think progress will accelerate over the year and expect Akzo to achieve its EUR 110 million target by year-end.

Raw material costs increased EUR 137 million in the second quarter over 2017, for a total of EUR 237 million in the year to date. While raw material costs will likely drift upwards in second-half 2018, sharp increases have largely passed, and we expect price increases to make meaningful progress on restoring profitability by the end of the year.

In decorative paints, adjusted operating income of 123 million was up 2% over 2017 and well ahead of our expectations. This was mostly due to better-than-expected margins as price increases took effect. Lower volumes in China were somewhat surprising, as we have been calling for strong demand in the near term before a softening in economic conditions starts to weigh on growth in the medium term. It appears that China is more sensitive to price than other regions. We will be watching how this market develops over the next few quarters. In any case, we believe the improvement in margins is more important this quarter.

In performance coatings, adjusted operating income of EUR 172 million was down 15% over 2017 but in line with our estimates. Marine and protective remains the primary culprit of declining performance, as new-building of ships remains weak and fewer oil and gas projects are being undertaken. We see a very slow recovery in marine and protective coatings, owing to our modest expectations for industry capital expenditures in oil and gas, mining, and power, and limited indications of a pickup in new shipbuilding. We remain optimistic on powder coatings, as they are environmentally friendly and thus ideally positioned to capitalise on the sustainability trend. In the second quarter, powder coatings sales were up 10% in constant currencies.