PPG Industries (PPG) has rewarded its shareholders with higher dividend payments for 46 consecutive years, making it a member of the dividend aristocrats list here.
The company’s dividend growth has accelerated in recent years, and management boosted PPG’s payout by 13% earlier this year.
PPG is arguably one of the highest quality dividend aristocrats for long-term investors, and its industry is one of my favorites.
While investors seeking greater current income should consider reviewing some of the best high dividend stocks here instead, let’s take a closer look at this impressive business to see if it could be a reasonable long-term investment choice for dividend growth investors today.
Business Overview
PPG Industries’ roots can be traced back to 1883. Today, the company is a leading supplier of paints, coatings, and specialty materials to customers in construction (43% of sales), industrial (28%), protective and marine (12%), auto OEM (8%), refinish (6%), packaging (2%) and aerospace (1%) markets.
Coatings provide protection, performance, and decoration for a wide range of products, improving their durability and marketability.
Approximately 60% of PPG’s sales are special-purpose coatings (aerospace, automotive OEM, general industrial, packaging, marine, etc.) with the remaining 40% related to architectural applications.
By geography, about 45% of PPG’s 2016 sales were in North America, 29% in EMEA, 16% in Asia Pacific, and 10% in Latin America. Altogether, PPG Industries has a presence in more than 70 countries.
Business Segments
Performance Coatings segment (58% of 2016 revenues): comprises of the refinish, aerospace, protective and marine, architectural (Americas and Asia Pacific) and architectural (EMEA) coatings businesses.
Industrial Coatings (39% of sales): comprises of the automotive OEM, industrial coatings, packaging coatings, coatings services and specialty coatings and materials businesses.
Glass (3% of sales): comprises of the North American fiber glass business. During 2016, PPG Industries divested its flat glass, European fiber glass business and its ownership interest in two Asian fiber glass joint ventures.
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.
However, 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 previously mentioned, the majority of PPG’s (60%) are special-purpose coatings, which target higher-value applications. The company is able to pursue these more complex and higher-margin opportunities because it has historically invested 3% of sales in R&D, which amounted to $466 million last year.
As a result of its investments, PPG’s coatings are 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, for example, PPG Industries’ coatings can be applied on numerous substrates including fiberglass, composites, and metallic surfaces for resistance to corrosion, chemicals, and rain erosion.
PPG Industries’ 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 2,200 pounds per plane, improving aircraft fuel efficiencies.
PPG Industries’ 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 second largest player in the $150 billion paint and coatings market, PPG Industries’ market share is only around 10%.
With a high degree of fragmentation, the coatings market provides PPG with plenty of opportunity for continued growth and acquisitions. The company’s large cash reserve also provides it with increased financial flexibility to fund acquisitions of all sizes.
For example, it has acquired numerous companies such as Futian Xinshi, DEUTEK, PPG Univer and MetoKote Corporation to strengthen its coatings portfolio.
Another aspect to 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 flows 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, the strategic path that PPG’s management team has taken over the last decade has created a more valuable enterprise.
Coatings only accounted for 55% of PPG Industries’ revenue in 2005. Through a mix of acquisitions, organic growth, and divestitures of non-core businesses, high-margin coatings products increased to 97% of PPG’s total sales in 2016.
PPG also announced a business restructuring plan in April 2015 to achieve cost synergies relating to its acquisitions. As a result, the company has successfully made significant structural improvements to its acquired businesses over the recent years.
In December 2016, the company approved another business restructuring program to further reduce its global cost structure and expects to achieve $40 million to $50 million in savings this year. In addition, the company divested its flat glass, European fiber glass and Asia fiber glass joint venture businesses to focus more on its core coatings business.
All of these efforts should help PPG maintain excellent profitability and continue generating high and growing amounts of free cash flow over the coming years to pay fast-growing dividends.
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 any given quarter.
Being a global company headquartered in the U.S., currency appreciation has also been a headwind on sales in the past but given the weakening of the U.S. dollar, this effect has now started to moderate.
However, none of these risks seem likely to impact PPG’s long-term earnings power.
Thinking longer-term, coatings will almost certainly continue to be used for many years to come. It’s hard to imagine a new technology displacing coatings, so perhaps the bigger risk is that competitors reduce their technology gap with PPG, which begins to pressure the industry’s margins.
There’s also the chance that management pursues a significant acquisition to boost growth, which could come with financial and operational risks.
Overall, 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.
PPG’s Dividend Safety
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
With a Dividend Safety Score of 83, PPG’s dividend appears to be one of the safest in the market. Its solid ranking starts with management’s conservative payout policy.
PPG’s earnings and free cash flow payout ratios over the last 12 months are 42% and 31%, 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.
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 throughout a full economic cycle.
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 Industries’ decline in revenue, it managed to slightly improve its free cash flow in 2009 compared to 2008. As previously mentioned, PPG generates roughly half of its sales from aftermarket products and services, which are less discretionary in nature and provide more consistent cash flows.
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, indicating that it has an economic moat.
Looking at the balance sheet, PPG appears to be in good shape and even has an A- credit rating from S&P. Its net debt / EBIT ratio is under 2.0, indicating that its debt is reasonably covered by cash on hand and annual earnings, and PPG’s consistent free cash flow generation adds further support.
PPG’s Dividend Growth
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 46 straight years, including a 13% increase in July 2017. It’s no surprise that the company continues to have excellent long-term dividend growth potential as indicated by its solid Dividend Growth Score of 67.
As seen below, this dividend aristocrat has accelerated its dividend growth rate from 5% per year over the last 10 fiscal years to 8.8% per year over the last three years.
With healthy payout ratios and solid prospects to continue consolidating the fragmented coatings industry, PPG can likely generate at least mid to upper single-digit dividend growth over the coming years. PPG will almost certainly be crowned a dividend king by 2022, too.
Valuation
PPG trades at a forward P/E ratio of 17.1, which is slightly lower than S&P 500’s multiple of 17.6 despite the company’s high quality business model and superior dividend growth potential.
PPG also offers a dividend yield of 1.7%, which is higher than its five-year average dividend yield of 1.4%.
While sluggish growth in several major end markets is weighing on near-term results, PPG can likely compound its earnings by 6% to 8% per year over the long-term.
The coatings market should grow by around the same pace as global GDP (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% to 10% per year (1.7% dividend yield plus 6% to 8% annual earnings growth), which is reasonably attractive for a business of PPG’s quality.
The stock appears to be reasonably priced today, but investors should remain aware that PPG’s stock is sensitive to the economy.
Conclusion
Other than its relatively low dividend yield and 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 around 10% share of the global market, growth opportunities shouldn’t be a problem either.
With the stock trailing the S&P 500 by close to 15% over the past year and trading at a seemingly reasonable valuation today, long-term dividend growth investors should consider giving PPG a closer look.
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