PPG Industries (PPG): A Free Cash Flow Machine With 44 Straight Dividend Increases

PPG Industries (PPG) has rewarded its investors with higher dividend payments for 44 consecutive years. The company’s dividend appears to be one of the safest in the market with high growth potential as well.

What makes this blue chip dividend stock so special? Let’s take a closer look.

Business Overview

PPG’s roots can be traced back to 1883. Today, the company is a leading supplier of paints, coatings, and specialty materials to customers in construction (45% of sales), automotive (33%), industrial (14%), and aerospace and marine (8%) markets. Coatings provide protection, performance, and decoration for a wide range of products, improving their durability and marketability.

Approximately 60% of PPG’s 2014 sales were special-purpose coatings (aerospace, automotive OEM, general industrial, packaging, marine, etc.) with the remaining 40% related to architectural applications.

By geography, about 47% of PPG’s 2014 sales were in North America, 31% in EMEA, 16% in Asia Pacific, and 6% in Latin America. Altogether, PPG has a presence in more than 70 countries.

Business Analysis

Coatings are essential materials that make products last longer and look more appealing. For example, they make cars more resistant to corrosion and beverage cans more visually appealing.

Some categories of coatings are more valuable than others. Consumers looking to repaint part of their home are going to be more sensitive to the price of paint (they perceive it as being an undifferentiated product) than an original equipment manufacturer (OEM) that is trying to improve the fuel efficiency and durability of its vehicles.

As we mentioned earlier, the majority of PPG’s sales (60%) are special-purpose coatings, which target higher-value applications. The company has historically invested 3% of sales in R&D, which amounted to more than $500 million last year.

As a result of its investments, PPG is better able to protect its customers’ assets in some of the world’s most demanding conditions and environments and attain higher margins than most of its peers.

In automotive markets, PPG’s coatings can be applied on numerous substrates including fiberglass, composites, and metallic surfaces for resistance to corrosion, chemicals, and rain erosion. PPG’s coatings also take advantage of a “wet-on-wet” application process that lowers customers’ capital costs and requires less energy. Customers can reduce the number of steps necessary to paint a vehicle by eliminating the primer layer.

In aerospace markets, PPG’s technologies can reduce over 1,000 pounds per plane, improving aircraft fuel efficiencies. Not surprisingly, the company has demonstrated excellent pricing power over the last decade:

Source: PPG Investor Presentation

PPG’s long-standing customer relationships, economies of scale, and focus on specialty products has helped it maintain number one market share positions in aerospace, automotive OEM, and refinish / collision markets. The company is also number two in packaging, general industrial, and architectural markets.

Despite being the largest player in the $130 billion coatings market, PPG’s market share is still less than 12%. With a high degree of fragmentation, the coatings market provides PPG with plenty of opportunity for continued growth and acquisitions.

Another aspect we like about this business is that approximately half of PPG’s coatings sales are related to aftermarket and maintenance coatings, which generates a stable base of cash flow each year. Producing coatings also requires relatively little capital which, when combined with PPG’s excellent margins, results in impressive free cash flow generation:

Source: Simply Safe Dividends

Finally, we like the strategic path that PPG’s management team has taken over the last decade. Coatings only accounted for 55% of PPG’s revenue in 2005. Through a mix of acquisitions, organic growth, and divestitures of non-core businesses, high-margin coatings products increased to 935 of PPG’s total sales in 2014.

PPG’s Key Risks

Over the near-term, changes in key raw material prices (e.g. titanium dioxide) can whip around PPG’s profits. The health of key end markets such as construction and automotive will also impact demand for PPG’s coatings.

However, thinking longer-term, we believe coatings will continue to be used for many years to come. While we certainly wouldn’t be the first to find out, it’s hard to imagine a new technology displacing coatings. Perhaps the bigger risk is that competitors reduce their technology gap with PPG, which begins to pressure the industry’s margins in what used to be lucrative “special-purpose” coatings.

Overall, we think the most likely risk over the next few years is a downturn in PPG’s core end markets, which it can do little to protect against.

Dividend Analysis: PPG

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. PPG’s long-term dividend and fundamental data charts can all be seen by clicking here.

Dividend Safety Score

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

With a Dividend Safety Score of 99, PPG’s dividend is one of the safest in the market.

PPG’s earnings and free cash flow payout ratios over the last 12 months are 27% and 42%, respectively. As seen below, the company’s free cash flow payout ratio has remained stable and below 40% for most of the past decade, highlighting the consistency of PPG’s business and the healthy cash flow cushion that protects the dividend..

Source: Simply Safe Dividends

Source: Simply Safe Dividends

In addition to payout ratios, analyzing a firm’s performance during the last recession can provide further clues about its business quality and the safety of its dividend. For example, a 50% payout ratio today might appear attractive, but what if the company became unprofitable during the last recession? The dividend might not be as safe as it appears.

As seen below, PPG’s sales fell by 23% in fiscal year 2009. Not surprisingly, construction, automotive, and industrial markets were especially hit hard during this time. Despite PPG’s decline in revenue, it managed to slightly improve its free cash flow in 2009 compared to 2008. As we mentioned earlier, PPG generates roughly half of its sales from aftermarket products and services, which are less discretionary in nature and provide more consistent cash flows.

Source: Simply Safe Dividends

As a result of its low capital intensity and focus on higher-margin specialty coatings markets, PPG has generated excellent returns on invested capital over the last decade for a chemical business and created value for shareholders.

Source: Simply Safe Dividends

Looking at the balance sheet, PPG appears to be in good shape. The company has an A- credit rating from S&P, and we can see why. The company could cover its entire debt with cash on hand and just 1.6 years of earnings before interest and taxes (EBIT). Its free cash flow generation last year nearly covered dividends paid by a factor of three as well. PPG’s dividend is very safe.

Source: Simply Safe Dividends

Dividend Growth Score

Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

PPG has raised its dividend for 44 straight years, including a 7.5% increase in April 2015. The company continues to have excellent long-term dividend growth potential with a Dividend Growth Score of 77.

As seen below, this dividend aristocrat has accelerated its dividend growth rate from 4.3% per year over the last 10 fiscal years to 6.5% per year over the last three years. With low payout ratios and solid prospects to continue consolidating the fragmented coatings industry, we expect at least mid-single digit dividend growth to continue and believe PPG will be crowned a dividend king by 2022.

Source: Simply Safe Dividends

Valuation

PPG trades at about 15x forward earnings and has a dividend yield of 1.5%, which is slightly lower than its five year average dividend yield of 1.65%.

While currency headwinds and sluggish global growth are weighing on near-term results, we believe PPG can compound its earnings by 6-8% per year over the long term. The coatings market should grow by around the same pace as global GDP (2-3% per year) and PPG will likely continue making acquisitions (1-2%), repurchasing shares (1-2%), and expanding margins via productivity improvements and sales mix (1-2%).

If this plays out, the stock would appear to offer total return potential of 8-10% per year, which is slightly better than the market’s 7% historical average return and reasonably attractive for a business of PPG’s quality.

Conclusion

Other than its low dividend yield, sensitivity to raw material prices, foreign currency fluctuations, and cyclical end markets such as construction, there’s really not much to dislike about PPG. The company appears to be well positioned in numerous profitable niches, has a leading portfolio of coatings technologies, regularly pushes through price increases, and generates excellent free cash flow each year. With less than 12% share of the global market, growth opportunities shouldn’t be a problem either.

While PPG’s dividend yield is relatively low (1.5%) and its dividend growth hasn’t ramped up yet because the company is reinvesting in itself and acquisitions, we think this is an interesting business for truly long-term dividend growth investors. PPG’s starting dividend yield is below the threshold we like for our Top 20 Dividend Stocks portfolio, but we will continue watching this proven compounder.

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