AKZOF - Akzo Nobel: A Cheap Paint Producer

2023-06-20 11:30:00 ET

Summary

• Akzo Nobel is one of the world's largest paint producers.
• The company is digesting a large acquisition, but the debt ratio is decreasing fast.
• Rapidly reducing the gross debt will result in lower interest expenses going forward.
• The stock is trading at around 10x EBITDA versus peers PPG and Sherwin-Williams with 13 and 18 multiples.

Introduction

There's only a handful of paint producers in the world with a global footprint and sufficient economies of scale to unlock the benefits. Akzo Nobel ( AKZOF ) ( AKZOY ) is one of those leaders and the Dutch company has been a very consistent performer in the past few years.

Akzo Nobel's primary listing is on Euronext Amsterdam where the company is trading with AKZA as its ticker symbol . As it clearly is the most liquid listing with an average daily volume of roughly 400,000 shares I'd strongly recommend to use the Amsterdam listing to trade in Akzo's shares. There also are options available. There are currently 170.5M shares outstanding, resulting in a market cap of around 12.1B EUR.

Q1 was okay, but keep the impact of seasonality in mind

Before discussing the Q1 results, keep in mind Akzo Nobel has to deal with the impact of seasonality. Its first and fourth quarters are traditionally the worst quarters while Q2 and Q3 (the summer quarters) are better for this producer of paint and coatings. This means we for sure cannot extrapolate the Q1 result to figure out if the company is still on track for a strong year.

The total revenue in the first quarter increased by approximately 5% to 2.66B EUR but the gross profit remained virtually unchanged which further confirms the impact of margin pressure. And as the SG&A expenses increased, the operating income actually decreased by in excess of 20% .

It also shouldn't come as a surprise to see a higher net financing expense, and this resulted in a pre-tax profit of 151M EUR and a net income of 106M EUR of which 94M EUR was attributable to the shareholders of Akzo Nobel. This represents 0.55 EUR per share, and that's a 40% decrease compared to the first quarter of last year.

That definitely isn't great news, let's be clear about that. But let's also not forget the adjusted operating income was about 36M EUR higher than the 182M EUR reported operating income. And the adjusted operating income of 218M EUR is only slightly lower than the 230M EUR in adjusted operating income generated in Q1 of last year.

I am usually not too keen on using 'adjusted' numbers (other than for instance adjusting operating cash flows for changes in the working capital position) but in Akzo Nobel's case, the adjustment is the result of a restructuring process, and in this case, I am willing to accept these are non-recurring items and an adjusted operating profit is a more realistic and fair way to compare quarters and Akzo's absolute performance.

That being said, the company's operating cash flow wasn't that great either (it looks like the restructuring items were mainly cash items) and the reported operating cash flow was a negative 50M EUR.

That's again nothing to be too worried about as there traditionally is a build-up of the working capital elements in the first quarter of the year, and the higher working capital generally gets released during the busier quarters. The operating cash flow before changes in the working capital position was approximately 211M EUR.

The total capex was only 62M EUR so on a pre-working capital basis, the underlying free cash flow was 149M EUR or 87 cents per share.

As you may have noticed, the interest expenses have sharply increased in the first quarter compared to a year ago, and this is directly related to the acquisition of Kansai Paint Africa. Fortunately, Akzo's CFO has taken action and the company recently issued a 500M EUR 10-year bond with a 4% coupon. This should reduce the uncertainty regarding the interest expenses and provide better visibility going forward. Akzo has reaffirmed its commitment to reduce the debt ratio to less than 3.4 times EBITDA by the end of this year and reiterated its vision to keep the debt ratio below 2 on a normalized basis.

This also means we shouldn't expect to see Akzo pursuing larger M&A deals but we may continue to see smaller bolt-on acquisitions like the purchase of the Chinese Decorative Paints business from Sherwin-Williams ( SHW ). While Akzo didn't disclose the total purchase price , the company only has one manufacturing plant and generates a revenue of 100M EUR per year so I can't imagine the purchase price was very steep.

Investment thesis

Akzo Nobel is managing its balance sheet quite well and I'm glad to see the efforts to reduce the net debt remain a priority for the company. I expect Akzo to reach the targeted leverage ratio by the end of 2025 as I expect the EBITDA to normalize above 1.5B EUR.

For this year, Akzo Nobel is targeting an adjusted EBITDA of 1.2-1.5B EUR, of which 269M EUR has been generated in the first quarter. This means the total EBITDA over the next three quarters will likely exceed 1B EUR. On an EV/EBITDA basis, Akzo is currently trading at just around 10 (decreasing to just over 9 in 2024 on the back of a slightly higher EBITDA and lower net debt), which makes it substantially cheaper than for instance a Sherwin-Williams (trading at an EV/EBITDA multiple in the high-teens range) and PPG Industries (in the mid-teens range).

I currently have no position in Akzo Nobel as I was hoping for the stock to get a bit cheaper. I may change my strategy and write some out-of-the-money put options as suggested in my previous article . The P58 I mentioned expired out of the money last Friday so I might be looking to write a P65 for September but I may wait for a weaker day on the markets before pulling the trigger.

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