Description

Thesis Summary & Price Target:

We believe AXTA’s shares are undervalued and are worth ~$47 per share (~10x ‘26E EBITDA of ~$1.245bn), which represents ~50% upside to the current price. In summary, we believe that Q4 results suggest that 2024 EBITDA is likely to beat guidance + street expectations by HSD% and that our ’24 EBITDA estimate is the right base from which AXTA should grow +MSD% annually. Despite this attractive setup, AXTA trades at a meaningful discount to coatings peers (AXTA: ~9.3x ’24 EBITDA vs. PPG: ~11.5x, RPM: ~13.5x, AKZO: ~9.8x, SHW: ~19.6x) and at a discount to its historical multiple (~10.2x over last 7-years). We believe this discount is mainly attributable to inconsistent historical profit growth and margin compression. The new management team appears to be doing the right things, as they are actively focused on maximizing profitability and returns. Please see prior write-ups on VIC that discuss AXTA’s business in greater detail.

Thesis Detail: We estimate that 2024 EBITDA will come in ~HSD% ahead of guidance and consensus as we annualize and remove certain non-recurring costs included in reported Q4 adj. EBITDA. We believe our ’24 EBITDA estimate (~$1.1bn) is also the right base from which AXTA should grow EBITDA +MSD% annually, based on modest (+LSD%) topline growth (+1% volumes and +2.5% price / mix in ’25 – ’26, driven primarily by Refinish) that grows slightly ahead of core fixed and variable costs. We also give AXTA credit for its workforce reduction program that is scheduled to deliver $10mm of savings in ’24 and ramping to ~$80mm by 2026. Consensus does not appear to be giving them any credit for this.

Q4 Adj. EBITDA Normalization: AXTA reported adj. EBITDA of ~$251mm vs. guidance / consensus of ~$250mm. However, reported adj. EBITDA included ~$10mm of ERP / consulting costs, which mgmt. has said are going to zero after Q4, and, per the 10K, another ~$13mm of inventory reserve charges related to obsolete inventory produced during COVID and the Q2 ERP disruption. While AXTA resolved the ERP operational issues by Q3, mgmt. did not fully clean up the inventory position until they closed the books on Q4 and their estimate for inventory clean-up charges embedded in the Q4 guide proved to be too low. We believe that mgmt. did not call this inventory adjustment out because they had said the ERP issues had been resolved and didn’t want to call attention back to ERP. We feel confident that the ERP and inventory position has been fully rectified and trued up given that YE ’23 inventory reserves as a % of gross inventories (net inventory + reserves) stood at 3.6%, which was the highest since the peak of COVID (Q2 ’20: 3.6%).

Adding these ~$23mm in costs / charges back implies Q4 adj. EBITDA was really ~$274mm, which would have been a significant beat vs. expectations. Given (1) that AXTA was recovering raw material hyper-inflation throughout ‘23 and (2) that Q4 typically represents ~25% of full year EBITDA on average suggests that run-rate, annualized EBITDA as of Q4 ’23 was ~$1.09bn, meanwhile mgmt. guided to 2024 EBITDA of $1.01 - $1.05bn. We believe this simple comparison suggests that mgmt. is embedding ample conservatism into its full year 2024 EBITDA guidance, especially considering the following profit upsides that will be incremental to Q4 EBITDA levels in ‘24:

Note: The $1,119mm of 2024E EBITDA in the above table does not foot exactly to the $1,135mm shown in the valuation table (first table), as the above is simply illustrative. We drive our valuation model using YoY growth rates for the different segments and cost line items that are similar to but still marginally different than what occurred in Q4.

•  AXTA announced a ~7% list price increase in Refinish in Q1, which likely translates to 3% - 4% realized price ($60 - $80mm EBITDA tailwind). This should more than offset any headwind from Mobility contractual price adjustments.

  • Our channel checks with Refinish customers, namely distributors, suggest that all Refinish OEMs raised prices by this amount in Q1 and that realization is in-line with historical ranges.

  •  Refinish is AXTA’s best business; its scale / #1 mkt position + consolidated nature of the industry gives AXTA pricing power (4% - 5% annualized pre-COVID) even in a deflationary environment like right now.

• Mobility’s raw material indexed contracts are unlikely to be needle moving (~$15mm estimated headwind).

  • ~40% of Mobility (10% of consolidated) sales have raw material indexation, typically on ~6-month lag.

  • Mgmt. plainly stated that it is confident in achieving positive full year price / mix in Mobility despite raw material indexed contracts, as they look to raise prices on contracts outside of indexation contracts.

•  AXTA is likely to realize incremental raw material deflation relative to Q4 ($15 - $20mm EBITDA tailwind).

  • We estimate based on historical AXTA variable cost + inflation / deflation disclosures that Q4 variable costs were likely ~45% of sales (~$585mm) w/ raw materials likely 65% - 70% of that (~$400mm).

    • An incremental 1% - 2% deflation vs. raws flowing through Q4 implies $4 - $8mm of additional quarterly EBITDA, which would imply $15 - $20mm of incremental annualized EBITDA.

  • Raw mat costs flowing through AXTA’s Q4 ’23 P&L likely reflected raws purchased at 3 – 6 months earlier.

    • Q1 ’24 spot prices for several key raw materials for industrial coatings are 1% - 2% below Q2 - Q3 ’23 spot prices, which is what flowed through AXTA’s Q4 P&L. See table below for details.

      • While the data is imperfect (several spot indices only provided monthly on a lag), it does not appear that these key raw materials have moved higher with the recent oil price move.

• AXTA’s late Feb. ’24 headcount reduction will drive an incremental ~$10mm of EBITDA savings in ’24. We view this as both a profit driver and evidence that the new mgmt. team is focused on profits / returns over topline.

  • There will be ~$80mm of non-recurring severance costs associated with this (some to all of this will flow through flow through P&L and in adj. EBITDA, so we will need to appropriately adjust for this as well).

    • Mgmt. said that the cuts are 100% back-office and expect ~$75mm of run-rate opex saving by ’26.

  • We were initially skeptical of this cost saving opportunity within AXTA given the historical restructurings, but we now believe this to be a real opportunity.

    • Under prior mgmt. teams AXTA did 20 acquisitions and most have still not been integrated. This has meant that AXTA has achieved virtually no cost productivity in the last 4 – 5 years and that its operational systems are prone to error.

      • The new ERP system in NA (and the disruption it caused during implementation where the old systems were further exposed) is great evidence of the need and opportunity to improve operations.

  • Mgmt. also believes that it can optimize the portfolio by divesting / rationalizing product lines that are lower margin, more competitive, and take up capacity that could be allocated to Refinish.

    • This should help drive ROIC higher.

    • AXTA has an opportunity to gain share within Refinish Economy and Mainstream segments (10% and 20% AXTA share, respectively), as it has focused most on the Premium segment (40% AXTA share) in the last few years. Reallocating capacity + investment dollars should support gains in these categories, where AXTA has a right to win.

• Fixed cost inflation will be a $50 - $70mm headwind.

  • This assumes ~3.5% inflation on a fixed cost base of ~$440mm. Mgmt. told us that its headcount reduction program combined with investments in the new ERP system and more efficient capital equipment, is expected to drive future savings in this line (i.e. lower fixed cost inflation through already implemented and future productivity enhancements).

• High-level topline algorithm suggests +LSD% to +MSD% topline driven primarily by Refinish pricing. This level of topline growth should translate to +MSD% to +HSD% annualized EBITDA growth due to operating leverage and price growth in-line to slightly ahead of fixed cost inflation.

  • Consensus has a similar topline + EBITDA growth outlook for PPG, yet AXTA trades at a discount to PPG.

    • AXTA isnt without its issues, but PPG has had plenty of restructurings and missteps, as well, such as the massive share loss and total loss of profits within its Architectural coatings business. 

  • We believe 10x EBITDA (12.5x – 13.0x implied core EBIT ex. acquired intangible amortization) is a reasonable multiple for AXTA based on where peers trade, AXTA’s own historical multiple (~10.2x over last 7 years), and for a company positioned to grow EBITDA +5% annually given the a-cyclical nature of its core Refinish biz.

Catalyst

Q1 and Q2 earnings and guidance