Consistency can be a great thing for investors when it defines a business's growth and execution. But it's rarely good when it merely means that revenue and net income have stayed consistently flat over several years. Unfortunately for shareholders of PPG Industries (NYSE: PPG), the latter has been the reality lately.
The coatings specialist grew full-year revenue and income from continuing operations just 3.6% and 4.5%, respectively, from 2015 to 2017. While it reported a 9% jump on the top line in the first quarter of 2018, fully 6 percentage points of that increase was derived from currency fluctuations. Sure, PPG Industries stock has beaten the returns of the S&P 500 over the long term, but aside from a respectable 2017, it has severely underperformed the index in the last five years.
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Mediocrity could continue. While management plans to spend $2.4 billion on share repurchases and acquisitions in 2018, growth is no sure thing. Here's why.
By the numbers
PPG Industries designs, manufactures, and markets coatings that provide unique characteristics for specific applications. For example, one product allows ships to resist the buildup of marine critters on their hulls (biofouling), while another helps companies make contact lenses that last longer. PPG reports performance in two business segments: performance coatings and industrial coatings.
In the first three months of 2018, both segments grew sales compared to the prior-year period. As noted above, however, in local currency terms (a metric that excludes any benefit from currency conversions) total revenue grew just 3%. Worse, the continued rise of raw materials costs led to a decrease in segment income.
PPG Industries managed to report growth in income before taxes due to a few one-time charges that occurred in the first quarter of 2017. When coupled with $600 million in share repurchases during the opening frame of 2018, the company grew EPS 8.5% from the prior-year period.
While progress is the goal, growth achieved through accounting is not as robust nor valuable as growth achieved through operating improvements. Even the accounting improvements may not hold up.
Management told investors that an internal investigation had uncovered violations of its accounting policies that could decrease first-quarter 2018 income before taxes by $7.8 million -- or more if additional errors are found. That would offset much of the $22 million year-over-year improvement in income before taxes, but investors will have to await the filing of the company's quarterly report to assess the fallout.
It will take some time before the dust settles from the internal investigation into faulty accounting. Aside from time, the best way to move beyond the scandal will be with good old-fashioned operational growth.
Pursuit of growth
Investors should consider taking management's pledge to spend $2.4 billion on both share repurchases and acquisitions with a grain of salt. After all, PPG Industries failed multiple times to acquire large rival Akzo Nobel for $28 billion in 2017. And with $600 million spent on share repurchases in the first three months of this year, the company is on pace to spend the entire amount gobbling up shares. It's not exactly a sign of confidence that PPG will find new deals and get them done.
Share repurchases and cost-cutting efforts can only go so far. To offset rising raw materials pricing, PPG Industries will need to increase the prices of its products. The good news is that stronger end markets allow for that possibility globally. In fact, the company announced price hikes for automotive OEM coatings earlier this year.
The bad news is higher selling prices may not be enough. As shareholders saw in the first quarter of 2018, higher selling prices helped to grow the top line but failed to trickle down the income statement. The higher revenue totals were simply chewed up by higher cost of goods for both performance coatings and industrial coatings. With the majority of cost-cutting measures already in place, there's little profit left to squeeze out of operations barring head count reductions (which the company has recently started doing).
This stock could struggle
PPG Industries is in a difficult spot. It's spending more on raw materials to manufacture its products, which will force it to increase selling prices and pass those costs onto customers. That practice has yet to yield both top- and bottom-line growth, however. So without organic growth or the immediate injection of growth from an acquisition, there's not much that can be done to improve profits beyond further cost-cutting, which has its limitations. While share repurchases could continue to boost share prices, it's not a productive use of capital. Put it all together, and this stock's growth is no sure thing.
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