It’s not the best known of the stock picks held by Warren Buffett’s Berkshire Hathaway, but Axalta Coating Systems (NYSE:AXTA) deserves to be looked at closely by investors. The company trades at a favorable valuation at a time when its sales momentum looks likely to change significantly. It’s a combination that makes the stock a buy.
Axalta Coating Systems operates in two segments, with performance coatings (automotive refinish and industrial coatings) being the largest and highest margin. Performance coatings generated $449 million in adjusted earnings before interest and taxation (EBIT) on $2.9 billion worth of sales with a 15.4% margin in 2019.
This is compared to just $137 million in EBIT from transportation coatings (automotive original equipment manufacturer coatings and commercial vehicle coatings) on $1.56 billion worth of sales on an 8.8% margin.
You can see the revenue split by segment in the chart below. It’s clear that the automotive refinish market is Axalta’s key earnings generator. That’s seen as a good thing because the refinish market — a market driven by the number of vehicle collisions — tends to be relatively stable.
What’s going on?
With the COVID-19 pandemic leading to a dramatic slump in traffic and industrial activity, it’s no surprise that sales in Axalta’s performance coatings segment declined 36% in the second quarter. Meanwhile, automotive production shutdowns led to a whopping 57% decrease in transportation coatings sales in the second quarter.
However, the good news is that its end markets appear to be recovering. For example, the management of fellow paint and coatings company Sherwin-Williams recently spoke of “emerging momentum” in its automotive refinish markets. That bodes well for Axalta’s performance coatings segment.
Meanwhile, PPG CEO Michael McGarry referred to “strengthening demand for our automotive original equipment manufacturer and general industrial coatings.” That’s good news for both of Axalta’s segments, and it will be no surprise if Axalta gives a brighter outlook when it reports third-quarter earnings, scheduled for Oct. 22.
The commentary and guidance from PPG and Sherwin-Williams is backed up by industry data, which implies a recovery is in place. The chart below shows U.S. light vehicle sales and total vehicle miles traveled. Both have snapped back nicely from the lows in the spring, although they haven’t regained pre-pandemic levels.
Given the devastation wrought on Axalta’s business in 2020, it’s not a good idea to base a valuation assessment on 2020 earnings. For example, Wall Street analysts have Axalta’s sales declining 20% for the full-year with EPS of $0.85, putting the stock at nearly 30 times 2020 earnings.
However, sales are expected to grow by 15% in 2021, with EPS forecast to recover to $1.55 and free cash flow (FCF) of around $385 million. These figures put the company on a 2021 price-to-earnings (P/E) multiple of 16.5, and a price-to-FCF multiple of 15.6.
Not only are these multiples attractive on an absolute basis, they also look good when compared to PPG’s estimated 2021 P/E multiple of 21 and Sherwin-Williams’ estimated 2021 P/E multiple of 27.
Axalta is also a company with a pretty good record of converting earnings into FCF. Moreover, if things keep turning around, analysts may well have to upgrade earnings expectations for Axalta in the near future. Time will tell.
Investors appear to be fearful of stocks with exposure to the automotive market, but it might be time to follow Buffett’s famous dictum and get greedy with them.
Bearish investors worried that the economy will be weak in 2021 will want to avoid the stock — not least because a sluggish economy often means poor car sales/production and weakness in light vehicle miles driven.
However, for those who think the economy will grow well in 2021, Axalta’s stock is attractive.