A frustrating demand environment in Europe and lower-than-expected global auto OEM production put PPG Industries (PPG, Financial) in a tough spot in Q2, causing the paints and coating supplier to miss its volume growth targets. Despite a lackluster Q1 report in mid-April, PPG was hopeful about turning volumes positive in Q2. This optimism was based on improving demand across multiple regions and the start of peak buying season. However, these trends did not meet PPG's expectations, resulting in flat sales volume growth year-over-year and a significant drop in stock price today.
- The European market has shown gradual recovery each quarter, but PPG was overly confident in a near-term linear rebound. Demand remained uneven across countries and end-uses. Although year-over-year volume growth improved sequentially in Q2, it was still negative, dragging down overall volumes.
- Sluggish global auto OEM production reflects the current macroeconomic environment, with high inflation and interest rates creating challenges for automakers. PPG noted an unexpected extension of assembly plant downtime. CEO Tim Knavish suggested this is likely a temporary adjustment rather than an early recessionary sign, given some vehicles are selling below expectations.
- Not all news was negative. Volumes, though disappointing, showed notable improvement from previous quarters, including negative 3% and 1% growth in Q1 and Q4 2022, respectively. PPG has not posted positive year-over-year volume growth since before 2022, testing investors' patience.
- PPG achieved further margin enhancement in the quarter, marking its seventh consecutive quarter of year-over-year segment margin expansion. Gross margins increased by 180 basis points year-over-year to 43%, driven by record Performance Coatings margins and a healthy rise in Industrial Coatings margins.
- While PPG's bearish Q3 guidance and reduced FY24 outlook, projecting adjusted EPS of $8.15-8.30 from $8.34-8.59 and flat to low single-digit organic sales growth, were concerning, the company remains confident in activity picking up over the next two quarters. PPG anticipates sustained growth in Mexico, recovery in China, and modest improvements in Europe.
Even though PPG reiterated its FY24 outlook last quarter, its bearish Q2 outlook gave mixed signals. Concerns about a bumpy quarter ahead made PPG's FY24 guidance seem flimsy, potentially leading to a downward revision. Unfortunately, this materialized. We have doubts that the second half of the year will be as bright as PPG expects. Today's adverse reaction reflects investors' similar skepticism and is also spurring selling pressure across PPG's peer group, including Sherwin-Williams (SHW, Financial), Axalta Coating Systems (AXTA, Financial), and RPM Inc (RPM, Financial).
