Fitch affirms PPG's IDR of A- on heightened focus on its coatings businesses, excellent free cash flow generation; rating outlook stable
December 20, 2013
– Fitch Ratings has affirmed the ratings of PPG Industries, Inc. (NYSE: PPG), including the company's Issuer Default Rating (IDR), at 'A-'. The Rating Outlook is Stable. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The rating affirmation reflects a geographically well-balanced company with a heightened focus on its coatings businesses, leading market positions in all of its coatings end-markets, consistent robust earnings, and excellent free cash flow (FCF) generation. Risk factors include the cyclicality of most of PPG's end-markets, aggressive growth strategy and the company's exposure to asbestos litigation.
The Stable Outlook reflects PPG's strong liquidity position, management's consistent and disciplined capital allocation strategy, and Fitch's expectation of a moderate improvement in the most of PPG's end markets in 2014.
Management estimates that PPG is the world's largest coatings company. More importantly, PPG participates in all coatings end-markets and has leadership positions (#1 or #2) in all of these segments. Fitch believes that these leadership positions provide the company with competitive advantages such as a broad array of product offerings, access to a wider range of distribution channels, and a strong platform to execute its growth initiatives and geographic expansion.
PORTFOLIO TRANSFORMATION AND GROWTH STRATEGY
Over the past decade, PPG has revamped its business portfolio to achieve faster growth, less cyclical growth, and lower capital intensity. The acquisition of SigmaKalon in 2008, the divestiture of the commodity chemicals business in early 2013, the acquisition of the North American architectural coatings business of Akzo Nobel N.V. Amsterdam in April 2013, and the planned divestiture of its 51% interest in the Transitions Optical joint venture to Essilor International further reflect PPG's transformation into primarily a coatings company.
PPG has spent over $5 billion for acquisitions since 2006, including the $3.2 billion acquisition of SigmaKalon and the $1.05 billion purchase of the North American architectural coatings business of Akzo Nobel. Fitch expects that acquisitions will be the priority for excess cash flow. The agency expects PPG will continue to pursue acquisitions, with primary focus on coatings and adjacent businesses (i.e. sealants and adhesives), especially in emerging markets.
SOLID LIQUIDITY AND FCF GENERATION
As of Sept. 30, 2013, the company had $1.56 billion of unrestricted cash, $687 million of short-term investments and no borrowings under its $1.2 billion revolving credit facility. Additionally, the company expects to receive about $1.5 billion of after-tax cash proceeds from the Transitions Optical divestiture, which is expected to close in the first half of 2014.
PPG also generates strong FCF. For the latest-12-month (LTM) period ending Sept. 30, 2013, the company generated $1.18 billion of FCF, compared with $1.02 billion during 2012 and $691 million during 2011. Fitch expects FCF will total roughly $800 million - $900 million for all of 2013. Fitch expects FCF will represent approximately 4%-5% of sales in 2014 and 2015.
DISCIPLINED CAPITAL ALLOCATION STRATEGY
The company has been consistent in prioritizing the use of its cash and FCF, with the goal of strengthening its core businesses and providing benefits to its shareholders. At times, the company has been aggressive in repurchasing its stock, particularly during periods when the company did not find suitable acquisition opportunities. However, PPG has shown discipline in pulling back on share repurchases following a sizeable acquisition in an effort to reduce debt. Fitch believes that the company has the ability to fund moderate share repurchases without straining its liquidity position.
EXPECTED CONTINUED IMPROVEMENT IN PPG's END-MARKETS
Fitch's rating takes into account the cyclicality of many of PPG's end-markets. Fitch estimates that construction and automotive original equipment manufacturers (OEM) account for between 45%-55% of its end-markets' sales.
In the U.S., Fitch projects construction spending will grow 9.2% during 2014 following a projected 4.9% improvement during 2013. The growth will be driven primarily by continued strength in the new residential construction sector, which is forecast to increase in the high-teens. The home improvement and commercial construction sectors are forecast to grow in the mid-single digits next year while public construction spending is only expected to improve slightly.
Fitch currently expects global auto demand will rise low to mid-single digits in 2014, similar to the growth rate in 2013. Vehicle sales growth will be driven by continued strength in the U.S. and China and a gradual recovery in Europe.
The company estimates that about 32% of its sales are currently directed to Europe (27% to Western Europe and 5% to Eastern Europe). Sales in this region remain weak, although it has shown some signs of stability during the past quarter. Fitch currently expects GDP in the Eurozone will grow about 0.9% in 2014 following an estimated 0.4% contraction in 2013.
PPG's credit metrics remain appropriate for the rating level. Leverage at the end of the September 2013 quarter was 1.4x compared with 1.7x at year-end 2012. EBITDA to interest was 9.9x for the Sept. 30, 2013 LTM period compared with 11.1x during 2012.
Fitch expects the company's credit metrics will remain relatively stable despite the loss of meaningful EBITDA from the divestitures of PPG's commodity chemicals and Transitions Optical businesses. Fitch currently expects leverage will be about 1.5x at the end of 2013 and 2014. Fitch expects interest coverage will settle at 12.0x in 2013 and 2014.
PPG has been a defendant in lawsuits involving asbestos claims for over 30 years, mostly related to its 50% ownership of Pittsburgh Corning Corporation (PC), a 50-50 venture owned by PPG and Corning Incorporated. Under the terms of the current settlement arrangement, PPG would make aggregate cash payments of $825 million (payable according to a fixed payment schedule over a period ending 2023), contribute 1.4 million shares of its stock, and convey the stock it owns in PC to a trust. PPG's participating historical insurance carriers would make cash payments to the trust of approximately $1.7 billion.
If the asbestos settlement becomes effective, Fitch believes that the company has sufficient cash and CP/bank revolver availability to meet the required cash payments.
In addition, the company also has $162 million of reserves for asbestos-related claims that will not be channeled to the trust. PPG currently does not have sufficient current claim information or settlement history on which to base a better estimate of this liability. The current settlement agreement also does not cover 'premises' claims, which comprise less than 2% of the total asbestos related claims against PPG.
Future ratings and Outlooks will be influenced by broad end-market trends, as well as company specific activity, particularly FCF trends and uses, and liquidity position.
While Fitch does not currently anticipate a positive rating action in the next 12-18 months, one may be considered if the company's credit metrics improve meaningfully from current levels, including leverage consistently in the 1x - 1.5x level; interest coverage is steadily above 15x; and PPG maintains a high cash balance until its asbestos liabilities are settled.
Negative rating actions could occur if the recovery in PPG's various end markets dissipate, leading to weaker than expected financial results and credit metrics, including: pro forma revenue decline of 10%; EBITDA margins falling to between 11% - 12%; and leverage levels consistently above 2x. Additionally, Fitch may also consider a negative rating action if management undertakes a meaningful share repurchase program funded by debt, resulting in consistent debt-to-EBITDA levels above 2x.
Fitch has affirmed the following ratings for PPG with a Stable Outlook:
--Long-term IDR at 'A-';
--Senior unsecured debt at 'A-';
--Unsecured revolving credit facility at 'A-';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Robert Rulla, CPA, +1 312-606-2311
Fitch Ratings, Inc.
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Chicago, IL 60602
Robert Curran, +1 212-908-0515
William Densmore, +1 312-368-3125
Sandro Scenga, +1 212-908-0278
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