EUR 850.00 For Business Accounts Only

Morningstar | Channel Shift From Lowe's to Home Depot to Weigh on PPG's Second-Half Results; Maintaining $103 FVE. See Updated Analyst Note from 20 Jul 2018

After more than a year of operating margin pressure, PPG's second-quarter results showed a slowdown in the decline. Input prices remain a meaningful headwind, with oil-based components up meaningfully versus the year prior, along with higher transportation costs and rising tinplate prices. However, the company successfully pushed prices up by roughly 2% in local-currency terms, with further prices increases announced in the coming quarters. In addition, PPG was also able to boost volumes by more than 3% despite higher prices.

Management also called out a 2.25% hit to performance coatings sales beginning next quarter as the company transitions sales out of Lowe's, following an exclusivity deal signed between Sherwin-Williams and Lowe's. This will also reduce the number of items Sherwin can sell to Home Depot. As a result, we expect PPG to benefit from higher sales to Home Depot over the medium term. Although this shift between retailers will ding short-term sales growth, our long-term forecasts are unchanged, as we expect PPG will make up lost Lowe's sales with additional volumes to Home Depot. Having updated our model to reflect these changes, we maintain our $103 per share fair value estimate and narrow moat rating for PPG.

Industrial coatings performance remains weak, as there is a delay in raising prices to customers in order to offset higher input costs. Operating margins declined to 13.7%, down 3.8% from the prior year, as a more oil-dependent product mix magnified the rising input costs. Given that most of PPG's customers in this segment are larger and have more bargaining power, we expect margin recovery to take longer as compared with performance coatings.

In performance coatings, margins fell just 0.5% to 17.1%, a smaller decline than that seen in the first quarter. Given a fragmented customer base and stronger demand growth in the architectural end use, PPG has found it easier to recoup input price increases on this side of the business. We expect sales and operating income to take a hit throughout the second half of 2018, but believe that falling oil prices in 2019 and beyond should enable coatings companies to recapture the losses they've experienced since 2016.