Morningstar | PPG Margin Challenges Continue Amid Rising Oil Prices; Maintaining $103 Fair Value Estimate
PPG announced muted third-quarter results due to higher costs in what has been a challenging year for the company. Given that management provided updated guidance on Oct. 8 citing raw material inflation and tepid demand, the results were largely as expected. Higher costs stem primarily from elevated crude oil prices, leading to margin compression for both segments. This comes despite PPG being able to push about a 2% increase in selling prices over the quarter. In the longer term, we expect recent margin compression to abate. Margin recovery will be driven by the confluence of a decline in oil prices and gradual product price increases. Despite a mildly reduced 2018 outlook for PPG, our $103 per share fair value estimate and narrow moat rating are unchanged.Performance coatings net sales were flat from the prior year, at $2.29 billion, with weaker volumes and currency headwinds offsetting modest price increases. Within this segment, aerospace coatings and U.S. homebuilding performed well, while auto refinish coatings were lower as compared with a year earlier. We expect U.S. homebuilding to perform relatively well going forward, as rising U.S. construction and repair activity provides a tailwind. We expect sales to grow at around 5% per year through 2022, with margins improving slightly during this period.
Industrial coatings sales were up 3% as compared with a year earlier, with volume increases more than offsetting margin contraction. Geographically, sales were strong in the U.S., Europe, and Latin America, with lower demand coming from China. In 2018, we expect margins to decrease to 13% from 16% in 2017. In the long term, we expect margins to improve somewhat as prices increase more quickly than costs. Accordingly, we expect margins to recover to 17% by 2022. Relatively high product switching costs for PPG's customers will enable gradual price increases, allowing for this margin recovery.
PPG Industries manufactures and distributes a range of paints, coatings and specialty materials. The company's business is comprised of two reportable business segments: Performance Coatings, which primarily supplies a variety of protective and decorative coatings, sealants and finishes along with paint strippers, stains and related chemicals, as well as transparencies and transparent armor; and Industrial Coatings, which primarily supplies a variety of protective and decorative coatings and finishes along with adhesives, sealants, metal pretreatment products, optical monomers and coatings, precipitated silicas and other specialty materials.
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