AXTA - Rumors Stir Axalta Coating Systems

Summary

• Axalta Coating Systems Ltd deserves a moderately bullish rating. Rumors stir that other companies want to buy it.
• Strong liquidity, good cash flow, and higher Q3 revenue reported in October moved the shares up this month by about 11%.
• There are headwinds keeping the Axalta Coating Systems share price down that will persist, but a strong Q4 can potentially drive up the share price.

Axalta Coating Systems Ltd. ( AXTA ) deserves a moderately bullish rating. Rumors stir that The Sherwin-Williams Company ( SHW ), PPG Industries ( PPG ), or another industry leader is ready to acquire the company. We talk about this persistent speculation since our recommendation five years ago.

Rumor, strong liquidity, good cash flow, and higher Q3 revenue reported in October, moved the shares up this month by about 11%. There are several strong headwinds depressing the share price that will blow into next year, in our opinion. But management and analysts forecast a healthy Q4, and the company has a record of beating estimates for eight of the last nine quarters.

The Company and Industry

On the bright side, there is a recurring demand for food and paint. There are endless applications for Axalta's paints and high-performance coatings.

Transportation Coatings Improve Performance and Reduce Costs

Axalta sells products in North America, Europe, the Middle East, Africa, the Asia Pacific, and Latin America. Distribution is through independent body shops, multi-shop operators, original equipment manufacturers (OEM), and dealership body shops. About 75% of Axalta Coating Systems' ~$4.4B in FY '21 sales are in North America and Europe. 15% are in Asia-Pacific and 9% in Latin America.

Frost & Sullivan named Axalta 2021 Global Commercial Vehicle Coatings Company of the Year. It was the Supplier of the Year in the paint category at General Motors Co ( GM ).

Its liquid and powder performance coatings are used in various industrial applications for cladding protection, the energy industry for tanks and pipelines, HVAC, and appliances. Axalta has coatings for building materials, cabinets, wood and luxury vinyl flooring, and the furniture market. It sells products under over two-dozen brand names since 1866.

The global paint and performance coatings industry is estimated at $160B in annual sales. It is forecast to grow to $235B in the next seven years. We believe the growth outlook for the next few years is probably going to slow to less than 3% because of extrinsic megatrends ; e.g., higher costs due to the host of environmental concerns; a +35% global 2020-21 increase in oil, solvents, and other raw materials; rising labor costs; chemical supply chain issues; the war in Ukraine; China's tight lockdowns, etc.

Expect higher prices for coatings that might slow demand. Seeking Alpha reports new vehicle sales in the U. S. are up 13 Y/Y, while used vehicle sales, a huge market for Axalta, is -11% Y/Y.

Investors are Poorer

Paint and coating stocks are stumbling, tumbling, and diving. They tumbled 26.5% over the last 12 months and are down ~27.5% for 2022. Axalta's shares fell almost 16% over the last five years. Investors are not paid a dividend. The Beta for AXTA stock is 1.30. It is more turbulent than the overall market's volatility . Axalta investors can commiserate with shareholders in three other paint and coatings companies.

PPG's share price is a little less than even for five years, -29.4% for the past year, and -33.8% this year. Sherwin-Williams stock rollicked over the past five years (+66%) but -29% over the last year and -35% year-to-date. In 2019, we forecast a healthy potential for Akzo Nobel ( AKZOY ) under $30 per share, and the stock subsequently topped $43 but now is down to $21.12.

We expect an average price target for Axalta Coating Systems stock for the rest of this fiscal year to hover in the low to mid-$20s for three reasons: threats of a recession and the high price of used vehicles can stifle Axalta sales; an acquisition the company made might prove too expensive; and the rumored failure of another buyout has been a drag.

By February 1, 2023, the next earnings report date, shares can potentially increase to $32 if there is a better-than-expected year-end report. The company usually beats analysts' estimates. We do not expect a major improvement in the economy, an end to the war in Ukraine, or China's GDP to top 3% real growth . Consumer demand there is stagnating with high unemployment and rising prices.

Valuation

On October 25, '22, Axalta reported net sales for nine months rose to $3.64B from $3.279B Y/Y. Management expects Q4 free cash flow between $175M and $225M. That is the good news.

The cost of goods popped higher to $2.6B from $2.18B. Net income from operations fell for nine months to $313M from $3.67M in the nine months of 2021. Income from operations in Q3 '22 was $123.5M compared to Q3 '21 of $124.7M in Q3 2021. Diluted EPS was $0.28 versus $0.30 in Q3 2021.

Total asset growth is -3.7%. Shareholders' equity went from $1.493B in 2021 to $1.27B over the last nine months. Long-term debt barely moved. It is down from about $3.75M in '21 to $3.66M in 2022.

Despite the industry and company's challenges, Axalta purchased U-POL Holdings Ltd. U-POL supplies paint, protective coatings and accessories, primarily for automotive refinishing. It operates in over 100 countries. Axalta spent nearly $620M, of which, they paid ~$350M for Goodwill. The estimated FY '21 adjusted profit was less than $40M on sales of about $145M.

We are not sure what Axalta management can contribute in the short term to increasing U-POL sales and profits. Cost cuts lead to lower morale, and threats to revenue and customer service. The CEO barely discussed the impact of the deal in the Q3 '22 earnings call .

Hedge funds, however, reduced their holdings through most of 2021 and the first half of 2022. 48 funds owned Axalta shares in Q2 '21. Only 36 owned the shares one year later.

The third headwind has to do with the recurring M&A rumor . According to Barron's, Warren Buffett's company "sold its entire Axalta stake" in 2021 after rumors circulated that a merger with his company's Benjamin Moore failed. Buy on the rumor, sell on the news.

Hope Springs Eternal

Seeking Alpha authors have been bullish on Axalta Coating Systems for most of the last four years. SA's Quant Rating is a solid Hold leaning to the Sell side. Wall Street's opinion is divided. Half rate Axalta Coating Systems a Buy or Strong Buy and others a Hold with one recommending to Sell. SA Factor Grades has mostly slipped compared to three months and six months ago.

Conclusion

Good revenue in the third quarter and great expectations for the fourth quarter are not sparking a significant rise in Axalta's share price. It has been falling throughout most of the year. Operating income faces a continuing uphill battle in the face of raw material, labor, and logistics inflation. Megatrends are hitting the coatings industry hard. Share prices of industry leaders are all down. The sentiment is, at best, cloudy.

It is our opinion that Axalta's biggest potential asset is the rumors others want to buy the $5.2B company. We think the potential for retail value investors to realize a worthwhile return in the short term is risky; there is no dividend to cushion holding it. But Axalta is number one or two in its coatings sectors, and with a modest 2.5% short interest, there is not much to lose cautiously buying the stock.

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