June 14, 2018 | Equity Research · As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and investors

June 14, 2018 | Equity Research

Chemicals

The ChemQuest Group, Inc. 8150 Corporate Park Drive, Suite 250 Cincinnati, OH, USA 45242 Phone: 513.469.7555 Fax: 513.469.7779 chemquest.com

Please see page 38 for rating definitions, important disclosures and

required analyst certifications. All estimates/forecasts are as of 06/14/18 unless otherwise stated. 06/14/18 12:23:39 ET

Wells Fargo Securities, LLC does and seeks to do business with companies covered

in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and

investors should consider this report as only a single factor in making their

investment decision.

Frank J. Mitsch

Se nior Analyst | 212 - 214 - 5022

fran k. mitsch @ we l lsfargo. com

Aziza Gazieva

Associate Analyst | 212 - 214 - 8227

aziza. gazie va@ we l lsfargo. com

Jacob Hughes

Associate Analyst | 212 - 214 - 8011

jacob. h u gh e s@ we l lsfargo. com

mailto:[email protected]



Paints, Coatings & Adhesives Equity Research

Wells Fargo Securities, LLC | 3

Table of Contents Key Points ........................................................................................................................ 5

Introduction ...................................................................................................................... 6

Paints and Coatings ........................................................................................................... 8

Market Overview .......................................................................................................... 8

Leading Producers ........................................................................................................ 9

Margins and Raw Materials ........................................................................................... 12

Architectural Coatings ................................................................................................. 16

Industrial OEM Coatings .............................................................................................. 20

Special Purpose Coatings ............................................................................................. 25

Adhesives and Sealants .................................................................................................... 28

Market Overview ........................................................................................................ 28

Industry Margin .......................................................................................................... 31

Macroeconomic Backdrop ................................................................................................. 32

Glossary ......................................................................................................................... 37

Chemicals Equity Research

4 | Wells Fargo Securities, LLC

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Key Points • We were pleased to host the ChemQuest Group for our 19th annual Paints, Coatings, & Adhesives

conference call. CEO Dan Murad provided insight into the approximately $150B coatings industry, including an overview of market conditions, trends, and forecasts. Consolidation, though still a key theme, seems to have taken a back seat to the discussion of raw materials. Nevertheless, Dan (and we) wouldn’t be surprised to see a link-up of AkzoNobel and AXTA in the not-so-distant future with Akzo “putting its cash to use”. Interestingly, during last year’s call, Dan laid out the probable scenario of (1) AkzoNobel divests its chemical business (check); (2) AkzoNobel acquires AXTA and returns to its “performance coatings roots” (TBD); and (3) spin-off architectural piece, perhaps to SHW. Looking at the layout of the current global landscape with SHW, PPG, and AkzoNobel holding the top 3 positions, with Nippon a distant 4th, he described a “significant amount of pressure on the next tier” of producers, with the top 3 driving regulations/specifications and benefitting from synergies, which will likely require the 2nd tier to “become very aggressive in M&A to keep pace”.

• Rising Raws Plague the Industry; Recovery Ahead? Raw materials continue to be a main concern for all producers, though some of the peaks witnessed appear to be abating. Specifically on TiO2, Dan expects modest price increases through 1H18 following the approximately 20% increases seen through 2017, with “a balancing of supply/demand in 3Q, possibly 4Q for TiO2.” He further expects to see the completion of the TROX-Cristal merger. The “catch-up” on margins for paints and coating producers is expected to occur in 2H18, with 2019 to be a “solid year for them.” In China, environmental regulations have affected a list of products, with the call particularly focusing on epoxies, ECH, and BPA, with further tightness to ensue. Factoring the global dynamics, CQ estimates an overall 4-6% increase in raws for 2018.

• Architectural Trending with the Millennials. Within the $11.8B U.S. Architectural Coatings segment, sales are forecast to rise 2.2% in 2018 (vol +1.0%, price +1.2%) following the 0.8% increase in 2017. Since the 2009 trough, the value of coatings has increased 36% (mainly from price) with SHW the segment leader, followed by PPG, MAS, and Benjamin Moore. Regarding trends, CQ sees a continued shift toward zero VOC formulations (regulatory driven) and a lessening dependence on TiO2 given the raw cost implications. Contractor-applied paints continue to outpace, a positive trend for SHW, while convenience paints (2-in-1 paint and primer products, faster dry, etc.) are also performing well, in our view. Mr. Murad also highlighted that the growth in single-family home construction is now outpacing that of multi-family, with home ownership at about 65% (vs. the 2016 low of 62.9%). Among the most recent “shake-ups” in the industry involve SHW’s agreement to be the only nationwide supplier of exterior/interior paints at LOW, and LOW is to be the only nationwide supplier of SHW stains (opening a door at HD on stains from PPG and RPM).

• Industrial OEM Benefitting with IP Pickup. Following 2.7% growth in 2017 OEM Coatings sales (driven by auto and durable goods), 2018 is forecast up 3.2% (vol +2.0%, price +1.2%). 2017 marked the first year in seven in which light vehicle sales declined (2017 at 17.25MM; a “momentary pause”), with 2018 trending flat to down 1%. CQ highlighted such major trends as products that create operational efficiencies (increase productivity/provide wet-on-wet applications), increase sustainability, and provide innovation (BPA replacement/infrared reflectance/noise vibration). With such trends as light-weighting, there is an increased need for functionality and fuel efficiency across multiple substrates (i.e., steel, metal alloys, plastics, composites). One of the “what’s hot” areas gaining traction now includes uniform pigment distribution of premium vivid colors. AkzoNobel, SHW, and PPG are the segment leaders.

• Special Purpose Sales Accelerating. Following a couple of years of lackluster performance, with lower oil prices hindering O&G activity, 2017 Special Purpose sales showed some recovery, up 2.3% (vol +1.3%, price +1.0%), with 2018 forecast up another 3.8% (vol +2.0%, price +1.8%). Among the puts and takes noted were O&G rebounding and auto refinish volume slightly positive (unfortunately, along with the rise in vehicle-related fatalities…stop texting while driving!), offset by continued sluggish trends in marine. Longer term, autonomous driving technology and new safety systems in cars (collision avoidance) and ride-sharing apps may pose a threat to the segment as soon as 2021. Aging U.S. infrastructure remains an area of opportunity, along with the focus on technology upgrade. PPG, AXTA, and RPM are among the segments leaders.

• Adhesives and Sealants Volume Growth. Adhesives and Sealants generated about $59B in 2017 sales, with Asia (36%; forecast 6% volume growth), Europe (32%), and North America (31%) representing 99% of the pie. Globally, paper board dominates Adhesives demand at about 35%, tied to internet shopping and fast-moving consumer goods. For Sealants, demand is largely tied to construction (32%) and transportation (30%). In North America, 2017 Adhesives volume and prices were up 1.5% and 1.0%, while volume and prices for Sealants increased 3.0% and 1.0%, respectively. While volume remains below peak levels for both categories, value continues to exceed the 2007 highs. All end markets posted growth in 2017, with CQ expecting 2018 to capture 2-3% volume growth and about 1% in price for Adhesives with Sealants. While Henkel is the dominant supplier (roughly 3x the size of No. 2 player MMM, followed by FUL), we would not be surprised to see further consolidation.



Introduction This report is a more detailed follow-up to our May “quick note” on key takeaways from the ChemQuest conference call. We include further details on Architectural, OEM, and Special Purpose coatings businesses, as well as the Adhesives & Sealants industry.

We were pleased to host the ChemQuest Group for our 19th annual Paints, Coatings, & Adhesives conference call (yes, we were only 7 years old for the first call). CEO Dan Murad provided insight into the approximately $150B coatings industry (expected to exceed $155B in 2018), including an overview of market conditions, trends, and forecasts, an estimated 5% compound annual growth rate (CAGR) through 2020). Consolidation, though a key theme for the space, with 2017 reaching a high water mark seems to have taken a backseat to the discussion of raw materials (see Exhibit 8). Nevertheless, Dan (and we) wouldn’t be surprised to see a link-up of AkzoNobel and AXTA in the not-so-distant future with Akzo “putting its cash to use.” Interestingly, during last year’s call, Dan laid out the probable scenario of (1) AkzoNobel divests its chemical business (check); (2) AkzoNobel acquires AXTA and returns to its “performance coatings roots” (TBD); and (3) a spin-off architectural piece, perhaps to SHW. Looking at the layout of the current global landscape, with SHW, PPG, and AkzoNobel holding the top 3 positions, and Nippon a distant 4th, he described a “significant amount of pressure on the next tier” of producers, with the top 3 driving regulations/specifications and benefitting from synergies, which will likely require the 2nd tier to “become very aggressive in M&A to keep pace.”

Overall, U.S. coatings volume has recovered from the 2009 recession, but is still below the absolute peak in 2005. Volume growth has failed to pierce 4% yr/yr growth since 2002. Pricing has been relatively flat for the past 2 years, though 2018 is expected to be up 1.4%.

Exhibit 1. U.S. Coatings Volume and Price Trend, 1997-2018E

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

1997 2000 2003 2006 2009 2012 2015 2018E

Volume Price

Source: The ChemQuest Group estimates and Wells Fargo Securities, LLC

Looking across the three major types of coatings, 2017 sales growth was highest for OEM Coatings, at 2.7% (vol +1.8%, price <+1.0%), followed by Special Purpose, at 2.3% (vol +1.3%, price +1.0%). Among the puts and takes noted for Special Purpose were O&G rebounding (with 2018 likely to see a pickup in tanks, pipelines, rail transportation) and auto refinish volume slightly positive (unfortunately, along with the rise in vehicle-related fatalities…stop texting while driving!), offset by continued sluggish trends in marine. Longer term, autonomous driving technology and new safety systems in cars (collision avoidance) and ride-sharing apps (we prefer Lyft, Juno, Via) may pose a threat to the segment as soon as 2021. Aging U.S. infrastructure remains an area of opportunity, along with the focus on technology upgrade.

Architectual lagged behind, up only 0.8% (vol +0.5%, price +0.3%). It’s affected by such trends as (1) contractor-applied paints continue to outpace, a positive trend for SHW, while convenience paints (2-in-1 paint and primer products, faster dry, etc.); (2) formulators continue to lessen their dependence on TiO2, given the raw cost implications; and (3) the shift toward VOC formulations following regulations on thresholds are also performing well, in our view.



Mr. Murad also highlighted that the growth in new single-family home construction is now outpacing that of multi-family (up 8.9% and down 2.2%, respectively, in 2017) with home ownership at about 65% (vs. the 2016 low of 62.9%). Among the most recent “shake-ups” in the industry involve SHW’s agreement to be the only nationwide supplier of exterior/interior paints at LOW, and LOW is to be the only nationwide supplier of SHW stains (opening a door at HD on stains for PPG and RPM).

Exhibit 2. Sales Growth Across Coatings Types 2017A

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Architectural OEM Special Purpose

Volume Price

2018E

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Architectural OEM Special Purpose

Volume Price

Source for both charts: The ChemQuest Group estimates and Wells Fargo Securities, LLC



Paints and Coatings

Market Overview

Since the turn of the century (actually, millennium!), coatings have shown relatively steady growth, at about 2%. The paints and coatings industry can be categorized into three markets: Architectural (aka: decorative), OEM, and Special Purpose. Architectural Coatings have been a clear outperformer, growing at a 3.5% CAGR (2000-2017). OEM and Special Purpose coatings have grown at 1.1% and 1.2% CAGRs, respectively, for the same time period. All 3 are forecast to see a slight acceleration in growth for 2018.

Exhibit 3. U.S. Coatings Sales by Segment, 1977-2017

0

5

10

15

20

25

0

2

4

6

8

10

12

14

1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013 2016

Total

Coa

tings

Sale

s, $B

Sales

By S

egme

nt, $B

Architectural Coatings OEM CoatingsSpecial Purpose Coatings Total Coatings

Source: The ChemQuest Group and Wells Fargo Securities, LLC

Approximately 60% of the $23.4B U.S. coatings sector is made up of Architectural Coatings. Compared to 2016, 2017 U.S. new home sales increased 9.3%, while existing home sales increased 1.1%. New home sales typically contribute just 25% of demand for coatings, while existing home sales really drive Architectural Coatings growth, contributing 75%. OEM is next at about 30%, followed by Special Purpose, at about 10%. In terms of its 2018 U.S. outlook, CQ forecast Architectural volume to reach 783MM gal ($11.8B in value), exceeding the high water mark back in 2006, OEM volumes to increase to 375MM gal ($7.7B), and Special Purpose to continue to recover slightly, with volume up to 143MM gal ($4.6B).

Exhibit 4. 2017 U.S. Paints & Coatings Segments by Volume, 1.3B gal

Architectural60%

OEM29%

Special-Purpose11%

SherwinPPGBehr (Masco)Benjamin Moore

PPGBASFAxaltaSherwinAkzoNobel

PPGAxaltaRPMSherwinAkzoNobelBASF


The 2017 global breakdown differed from that of the United States, as Architectural accounted for a smaller piece of the pie in other regions. Specifically, Architectural accounted for 42% of sales on a global basis, less than the 49% it represented in the United States. OEM, at 37%, accounted for a larger portion of demand worldwide, compared to 32% domestically. Finally, Special Purpose sales accounted for 21% of global paint sales, but only 19% in the United States.



Exhibit 5. Paints & Coatings End-Market Breakdown by Value, 2017 U.S. $23B Global $140B

Architectural49%

OEM32%

Special-Purpose

19%

Architectural42%

OEM37%

Special-Purpose21%

Source for both charts: The ChemQuest Group, PPG, SHW, and Wells Fargo Securities, LLC

By region, Asia is the leading coatings consumer, accounting for 45% of global demand, followed by Europe, at 24%, and North America, at 18%.

Exhibit 6. Global Coatings Regional Breakdown, 2017

Asia45%

Europe24%

North America

18%

Latin America

7%

MEA6%


Leading Producers

Since the early 2000s, the landscape of coatings companies has changed significantly. Most recently, SHW has moved to the No. 1 position following its acquisition of Valspar, though PPG is trailing closely behind. The top three coatings firms, i.e., SHW (including VAL), PPG, and AkzoNobel, account for 66% of the top 9 coatings firms’ sales.

Exhibit 7. Top 10 Coatings Producers, Sales in $B $ Billions 2003 2008 2014 2015 2016 2017SHW 5.4 8.0 11.1 11.3 11.9 15.0PPG 4.8 10.1 14.3 15.3 14.8 14.8AkzoNobel 6.3 14.2 12.1 11.1 10.5 10.4Nippon Paint 1.9 2.0 2.8 3.9 3.9 5.2Axalta 3.7 4.1 4.4 4.1 4.1 4.4BASF 2.4 3.3 3.8 3.5 3.5 4.3Kansai Paint - 1.9 2.9 2.9 3.0 2.8Masco - - 2.0 2.0 2.1 2.2Jotun - 1.6 2.0 2.0 1.8 1.8Valspar 2.3 3.3 4.5 4.4 4.2 - Note: Excluding RPM and Asian Paints Source: The ChemQuest Group, Inc. and Wells Fargo Securities, LLC



Consolidation continues to be a popular theme in the coatings industry, changing the landscape and market share of participants over the past decade. Among the more noteworthy transactions are SHW acquiring Comex’s North American assets, DD divesting Performance Coatings to Carlyle, AkzoNobel divesting its North American architectural paints business to PPG, VAL acquiring Ace Hardware’s paint manufacturing assets, PPG acquiring Comex’s Mexican assets, Nippon Paint acquiring Dunn-Edwards, and most recently, SHW acquiring VAL in June 2017.

Exhibit 8. Paints and Coatings Acquisitions by Acquiring Region 2005-2017

51

4 4 4

11

41

4 3 1

92

1 1 1

3

1 11

3

1

1

11

15

20 11

10

11

1212 15 8

15

11

171

1

1

1 1

1716

13

8

10

9 17

12

14

10

13

17

23

0

10

20

30

40

50

60

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Num

ber o

f Tra

nsac

tions

Asia-Pacific Central/South America MEA NAFTA Eastern Europe Western Europe

Source: The ChemQuest Group, Inc., and Company Reports

On the topic, AXTA offers such benefits from consolidation as the potential to globalize previously regional products, acceleration of new product introduction plans, and ability to access new markets at appropriate cost structures, among others. According to PPG’s estimate of an approximately $140B global industry, the top 10 producers account for nearly half of the market.

Exhibit 9. Global Coatings Industry, 2002 vs. 2017 2002, $65B 2017, $140B

AkzoNobel

PPG

ICISherwin Williams

DuPont

BASF

ValsparRPMSigma-Kalon

Nippon

Other

Sherwin Williams

PPG

AkzoNobel

Nippon Paint

RPM

AxaltaBASF

Kansai PaintAsian PaintsMasco

Other

Source for both charts: PPG, ChemQuest, and Wells Fargo Securities, LLC

By end market, PPG is the only global player that participates in all major categories. Following the 2012 sale of AkzoNobel’s North American Architectural Coatings business to PPG, AkzoNobel ranks within the top 3 global coatings positions across all markets (except for auto OEM, as it does not participate). Although SHW ended 2016 as No. 1 on the architectural front and No. 4+ in most other markets (was not meaningful in auto OEM or packaging), its VAL acquisition exposed it to general industrial and packaging. AXTA remains a market leader in auto, with growth initiatives in Asia.



Exhibit 10. Global Competitive Positions of Coatings Companies as of March 2018

Source: PPG

SHW is the No. 1 architectural paint supplier globally, with the highest brand awareness. PPG ranks No. 2, with Olympic being its most recognizable brand. But the AkzoNobel deal also added the popular Glidden brand. In 1999, Masco acquired Behr, which is sold exclusively at Home Depot. Behr produces interior products (paints, primers, and faux and decorative finishes), as well as exterior products. Berkshire Hathaway owns Benjamin Moore, which participates through a large independent retail network. Prior to being acquired, VAL was another industry leader, with its largest customer being Lowe’s.

Comparing the margins of major coatings producers, PPG historically was the leader among its competitors, sporting about an 18% margin in strictly coatings. But AXTA took first place in 2015 with a 19.1% margin. Remaining competitors SHW, AkzoNobel, and RPM all ranged between 11% and 16% in 2017.

Exhibit 11. Coatings Peers’ EBITDA Margin

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

22%

PPG Coatings Total VAL Total SHW AkzoPaints/Coatings

Total RPM Total AXTA

2013 2014 2015 2016 2017

Source: PPG and Wells Fargo Securities, LLC Note that PPG adjusted all historical data to reflect Glass operations as discontinued operations. The margin data appears to be revised downward because there are corporate costs in prior years that weren’t historically included in the “PPG Coatings” data.



The predominant 1Q18 themes for paints producers were a slower-than-expected demand environment in North America and higher raw materials costs impeding margins. On the top line, PPG reported 1Q organic sales growth of +2% (price +1.6%, vol +0.5%), which compares to AKZO (ex Specialty Chemicals) of -1% (price/mix +2%, vol -3%). SHW core sales (ex Valspar) improved 5% yr/yr, with about half coming from volume. Price increases are being pushed through to offset raws (with a lag), with AKZO noting that, “a second wave of price increases is already planned.” Volume growth has been below expectations thus far, particularly for PPG, as it focuses on more profitable business, though weather in the Midwest and Northeast has also been a factor.

Turning to margins (excluding corporate costs), PPG EBIT margins declined 180bps yr/yr and AKZO margins similarly declined 230bps yr/yr despite some SG&A savings. The predominant cause for margin contraction has been a sustained increase in the raw material basket, with companies particularly attributing the increase to epoxies, oil derivatives, and TiO2. PPG called out raws inflation of mid-single digits, while AKZO and SHW both indicated that raws inflation was about $100MM higher yr/yr.

Exhibit 12. EBIT Comparison for Coatings Competitors, 1Q12 - 1Q18

100

250

400

550

700

1Q12 3Q12 1Q13 3Q13 1Q14 3Q14 1Q15 3Q15 1Q16 3Q16 1Q17 3Q17 1Q18

PPG,

SHW

, AKZ

O EB

IT, $

MM

PPG SHW AKZO

Note: AKZO results converted to USD Source: Company reports and Wells Fargo Securities, LLC

On the outlook, SHW expects raws inflation at the high end of its previous 4-6% range, with headwinds strongest in 1Q before easing throughout the year. AKZO also commented that “higher raw material costs are projected to continue in 2018, especially during the start of the year.” All three producers implemented price increases to offset, but are still lagging raws to date.

Margins and Raw Materials

The cost structure for a U.S. coatings company has been relatively unchanged over the past few years. On average, raw materials ticked up slightly in 2017, to 45-53% of sales, approaching the peaks of earlier years with TiO2 inflation. Other major raw materials include acrylics, phenol, and other pigments. Gross margin was in the mid-30% area a decade ago, but is now in the upper 30%s/low 40%s. In 2017, EBIT margin ranged from 8% to 15%, slightly lower than in 2015 and 2016.



Exhibit 13. Comparison of Average U.S. Companies’ Cost Structures, 2005-2017 2017 2016 2015 2014 2013 2012 2011 2009 2005

Sales 100% 100% 100% 100% 100% 100% 100% 100% 100%

Cost of Goods SoldRaw Materials 45-53% 43-51% 44-52% 43-51% 45-53% 45-53% 47-53% 45-49% 50-55%Labor 5% 5% 5% 5% 5% 5% 5% 5% 6%Energy 2% 2% 2% 2% 2% 2% 2% 2% 2%Overhead, Taxes, Ins., Dep., Pkg. 6% 6% 6% 6% 6% 6% 6% 6% 7%Total 58-66% 56-64% 57-65% 56-64% 58-66% 58-66% 60-66% 58-62% 65-70%

Gross Margin 34-42% 36-44% 35-43% 36-44% 34-42% 34-42% 34-40% 38-42% 30-35%

SG&A 19-34% 20-35% 19-34% 19-34% 19-34% 19-34% 19-34% 19-34% 20-30%

EBIT 8-15% 9-16% 9-16% 10-17% 8-15% 8-15% 6-15% 8-17% 5-10% Source: The ChemQuest Group estimates and Wells Fargo Securities, LLC

On raws, CQ painted a picture of shifting 2018 input costs, with resins/latex and TiO2 ticking up slightly (positive for CC, TROX, and VNTR), while containers and additives compress, pointing to raws increasing about 4-6% overall. Specifically on TiO2, Dan expects modest price increases through 1H18 following the approximately 20% increases seen through 2017, with “a balancing of supply/demand in 3Q, possibly 4Q for TiO2.” He further expects to see the completion of the TROX-Cristal merger. The “catch-up” on margins for paints and coating producers is expected to occur in 2H18, with 2019 expected to be a “solid year for them.” In China, environmental regulations have affected a list of products, with the call particularly focusing on epoxies, ECH, and BPA, with further tightness to ensue.

The following exhibit shows the expected breakdown of the various raw materials found in a typical can of paint for 2018. Whereas pigments and resins/latex contributed 26% and 44% on average for a unit of coating in 2017, CQ estimates the two will tick up to 28% and 45%, respectively.

Exhibit 14. Raw Materials Input Per Unit of Coatings (% of Cost), 2004, 2017, 2018E

Source: SHW and The ChemQuest Group, Inc

During 2012-14, pigments input was driven by mix, as solvent prices declined and new low-VOC resin systems used latex binders, driving higher pigment use. A look at the coatings cost structure over time shows that pigments trended upward during 2012-14 despite the considerable decline in TiO2 prices. However, further TiO2 price drops finally depressed cost in 2015, causing the input per unit percentage to drop from 2013-14 levels.



Exhibit 15. Raw Materials Input Per Unit of Coatings (%), 2010-2017 2017 2016 2015 2014 2013 2012 2011 2010

Resins/Latex 44 40 38 40 40 37 36 37Pigments 26 25 27 30 34 27 29 27Containers 12 14 14 11 11 16 14 16Solvents 7 8 10 9 5 10 12 10Additives 11 13 11 10 10 10 10 9 Source: The ChemQuest Group and Wells Fargo Securities, LLC

Manufacturing costs and raw material inputs vary for Architectural Coatings and Industrial Coatings. Architectural paints use more TiO2, as decorative paints require more opacity. Industrial Coatings use a larger amount of other such raws as resins, latex, solvents, and pigments. In terms of packaging, Architectural is typically sold in one-gallon paint cans and five-gallon buckets, while Industrial Coatings are mainly sold in 2,000-liter totes.

Exhibit 16. Coatings Cost Comparison

Source: PPG

Historically, price increases typically lagged raw material inputs by 3-6 months, resulting in margin squeezes in inflationary environments. The PPI and PMI for coatings dated back to February 2004 have approximately a 70% correlation. However, we have seen this relationship break down, as the correlation is closer to 30% over the past six years. In 2016, 2017, and 2018 YTD, the gap averaged 101, 90, and 85, respectively.

Raw material inflation, namely in TiO2, was a major headwind in 2011 (up 39%). However, costs began to moderate in 2012 and reversed course as prices fell 10.5% yr/yr. Price appeared to be stabilizing during 2014, but took another step down on a surplus of Chinese supply and lackluster demand.

However, paint producers have been effective at raising prices, with a significant step-up post 2010 in response to higher raws. Price increases accelerated in 2012 and have since been steady at a moderate level despite more volatile raw materials. The gap between the PPI and PMI reached a 10-year high in March 2016 and has compressed since, with the PPI 63% above that of 2004.



Exhibit 17. PPI and PMI, Paints and Coatings Manufacturing, 2004-Present

120

140

160

180

200

220

240

260

280

Feb-04 Jun-05 Oct-06 Feb-08 Jun-09 Oct-10 Feb-12 Jun-13 Oct-14 Feb-16 Jun-17

PPI a

nd P

MI

PPI- 1982=100 PMI- 1991=100

Source: Bureau of Labor Statistics and Wells Fargo Securities, LLC Note: PPI Index 1982=100, PMI Index 1991=100

Looking at a more specific example, PPG was primarily focused on organic volume in 2016, with 2017 seeing a shift, as pricing traction became the main goal.

Exhibit 18. Year-Over-Year Aggregate PPG Coatings Pricing, 2005-2017

-1%

0%

1%

2%

3%

4%

5%

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Chan

ge in

Pric

e yr/

yr

Source: PPG and Wells Fargo Securities, LLC



Architectural Coatings

Within the $11.8B U.S. Architectural Coatings segment, sales are forecast to rise 2.2% in 2018 (vol +1.0%, price +1.2%) following 0.8% in 2017, with volume to reach 783MM gallons ($11.8B in value).

Exhibit 19. U.S. Architectural Value and Volume, 2001 to Present

0

100

200

300

400

500

600

700

800

900

0

2

4

6

8

10

12

14

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18E

Gallo

ns (M

M)

Value

($B)

Volume Value


As a result of increased price and volume, the total value of coatings has increased 29% above 2006 peak levels. Over the past few years, volume was the key driver, as pricing barely moved. However, following 2017’s muted volume, 2018 forecasts are pointing to an acceleration of pricing. Since the 2009 trough, the total value of coatings has increased 36% (mainly from price), with SHW the segment leader, followed by PPG, MAS, and Benjamin Moore.

Exhibit 20. U.S. Architectural Yr/Yr Volume and Price Trends, 1997-2018E

-15%

-10%

-5%

0%

5%

10%

1997 2000 2003 2006 2009 2012 2015 2018E

Volume Price


The end-market breakdown in 2017 was similar to that of years past, with interior paints accounting for the bulk of demand at 75% of sales. The exterior paints end market is a distant second, at about 13%. The remainder includes stains, clears, lacquers, varnishes, and other categories.



Exhibit 21. Architectural Coatings End Markets, 2017

Interior Paints75%

Exterior Paints13%

Stains7%

Clears2%

Lacquers/ Varnishes

1%Other

2%


According to PPG, the top 3 global Architectural Coatings (PPG, SHW, AkzoNobel) producers take up about 40% of the global market, while the next 15 leading regionals (i.e., Asian Paints, BASF, Masco, etc.) are approximately 20% of the market.

Exhibit 22. Global Architectural Coatings Producers Top 3 Global Players

40%

Next 15 Leading

Regionals20%

Small/Niche

Regionals40%

PPGSHWAkzo

BASFAsian Paints

Benjamin MooreMasco, etc.

Source: PPG and Wells Fargo Securities, LLC

Regionally, Asia and the Americas account for roughly one-third each of sales. Over the past 7 years, Asia has been growing as a percentage of total demand, due to faster economic growth. Consequently, Europe makes up a smaller percentage of the pie today.

Exhibit 23. Architectural Coatings Demand by Region by Percentage of Sales, 2009 vs. 2017 2009 2017

Europe37%

Americas34%

Asia Pacific23%

ROW6%

Asia Pacific39%

Americas31%

Europe23%

ROW7%

Source for both charts: SHW and Wells Fargo Securities, LLC



Regardless of region, Architectural Coatings sales are largely driven by the residential market. In the U.S., the residential market currently accounts for 42% of construction spending after just 28% in 2009 as it’s been growing faster than nonresidential. However, in terms of paint consumption, residential accounts for nearly 80% of coatings volume.

Exhibit 24. U.S. Architectural Market Breakdown by Type

DIY38%

Residential Repaint (Pro)

29%

New Residential12%

Non-Residential Repaint

15%

New Non-Residential

6%

Residential

Non-Residential

Source for both charts: SHW and Wells Fargo Securities, LLC

Over the past several years (and punctuated during the recession), there has been a moderate shift back toward higher cost professional contractors (DIFM), representing about 62% of the market in 2017. The majority of DIY purchases occur through such home centers as Home Depot and Lowe’s. Paint stores are a distant second, at 16%. In contrast, contractors make a majority of their purchases at paint stores.

Exhibit 25. Contractor Share Continues to Grow, 1980-2017

59% 52% 45% 41% 45% 45% 44% 43% 42% 41% 41% 40% 38%

41% 48% 55% 59% 55% 55% 56% 57% 58% 59% 59% 60% 62%

0%

20%

40%

60%

80%

100%

1980 1988 1998 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Contractor DIY

Source: SHW and Wells Fargo Securities, LLC estimates

Looking more closely at the channels of distribution, the predominance of company-owned paint stores for the contractor market shows why the aforementioned shift has been favorable for SHW.



Exhibit 26. U.S./Canada Channel Share Do-It-Yourself Contractor

Home Centers

64%

Paint Stores16%

Dealer12%

Mass Merchants

8%

Paint Stores69%

Home Centers

17%

Dealer13%

Mass Merchants

1%

Source for both charts: PPG and Wells Fargo Securities, LLC

Globally, the Architectural Coatings customer mix is composed mostly of independent distributors, followed by such regional home centers as Lowe’s, Home Depot, and Bunnings, while mono-branded stores make up the remaining portion. Specifically for PPG in the U.S. and Canada, it estimates its Architectural Coatings sales breakdown across company stores, national retailers (DIY), and independent dealers to be 50%, 35%, and 15%, respectively.

Exhibit 27. Global Architectural Coatings Customer Mix, 2016*

Independent Distributors

45%

Regional Home

Centers30%

Mono-branded Stores25%

*this data was last provided in 2016; we believe has been some shift to company owned stores in the U.S. since then Source: PPG and Wells Fargo Securities, LLC

There has been a continuation of trends in Architectural Coatings, which we have discussed in years gone by. In 2017, the DIY/contractor mix was about 38/62; a reversal from 1980 levels. During the recession, there was a modest shift toward DIY as cost-conscious homeowners chose to forego the higher outlay associated with hiring professionals; but this has since normalized. With Baby Boomers aging and a growing attitude away from DIY (though not evident in Shickley, NE), contractor help is increasingly sought after.

Another trend that has been popular is zero-VOC formulations. Despite what the name implies, “zero-VOC” is not completely devoid of VOC, as a small amount is added when color is blended with the base coats at the retailer level. Manufacturers are moving to a zero-VOC colorant/tinting system as they try to stay ahead of industry standards.

Emphasis is also being placed on convenience. Opportunities to save time or the number of painting steps are being developed, with a prime example being “paint and primer in one.” Manufacturers are formulating paints that dry faster or reduce surface preparation to paint. Mr. Murad also highlighted that the growth in new single-family home construction is now outpacing that of multi-family (up 8.9% and down 2.2%, respectively, in 2017) with home ownership at about 65% (vs. the 2016 low of 62.9%).

All these changes help add value to products beyond what traditional painting provides, lending support to higher average selling prices, regardless of the level of raw material inflation/deflation. Among the most recent “shake-ups” in the industry involve SHW’s agreement to be the only nationwide supplier of exterior/interior paints at LOW, and LOW is to be the only nationwide supplier of SHW stains (opening a door at HD on stains for PPG and RPM).



Industrial OEM Coatings

Following 2.7% growth in 2017 OEM Coatings sales (driven by auto sales and durable goods), 2018 is forecast up 3.2% (vol +2.0%, price 1.2%). 2017 marked the first year in seven in which light vehicle sales declined (2017 at 17.25MM; a “momentary pause”), with 2018 trending flat to down 1%. PPG estimates that global auto OEM production will be up 1% in 2018.

Exhibit 28. U.S. OEM Value and Volume, 2001 to Present

0

50

100

150

200

250

300

350

400

450

0

1

2

3

4

5

6

7

8

9

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18E

Gallo

ns (M

M)

Value

($B)

Volume Value


Looking back, it’s not surprising that 2009 was the trough. However, the decline from 2008 was far more severe than for Architectural, which was affected more by the housing slowdown in 2007.

Exhibit 29. U.S. OEM Yr/Yr Price and Volume Trends, 1997-2018E

-20%

-15%

-10%

-5%

0%

5%

10%

15%

1997 2000 2003 2006 2009 2012 2015 2018E

Volume Price


CQ highlighted such major trends as products that create operational efficiencies (increase productivity/provide wet-on-wet applications), increase sustainability, and provide innovation (BPA replacement/infrared reflectance/noise vibration). With such trends as light-weighting, there is an increased need for functionality and fuel efficiency across multiple substrates (i.e., steel, metal alloys, plastics, composites). One of the “what’s hot” areas gaining traction now includes uniform pigment distribution of premium vivid colors, such as those seen in Aziza’s skiwear.

AkzoNobel, SHW, and PPG are the segment leaders. In the past few years, consolidation has been a key theme (i.e., PPG acquired IVC Coatings-2015, MetoKote-2016, Crown-2017), with the top six players currently making up nearly one-third of the market, up from 28% in 2005. However, at its 2018 Industrial Coatings Deep Dive, PPG highlighted that the industry (which it estimates to be closer to $25-30B) is still fragmented, presenting further opportunity for growth.



Exhibit 30. Competitive Landscape for Industrial Coatings, 2005 vs. 2017 2005

AkzoPPG

Competitors 3-6

Others72%

2017

Source for both charts: PPG and Wells Fargo Securities, LLC

SHW estimates that more than half of OEM Coatings sales are in Asia, followed by 23% in EMEA. Please note that according to PPG’s estimates, Asia takes up a smaller piece of the pie below, with EMEA contributing more.

Exhibit 31. OEM Coatings Demand by Region, 2017

Asia51%

EMEA23%

US/Canada21%

ROW5%

Source: SHW and Wells Fargo Securities, LLC

Much of what drives demand in Industrial Coatings end markets relies on the macroeconomic environment and is fueled by industrial production. The fastest growing region is Asia Pacific, as it continues to see bursts of economic and GDP growth.



Exhibit 32. Regional Industrial Production Trends, Indexed to 2014

Source: PPG

AXTA estimates Industrial Coatings presents about $38B of market opportunity, with its core strength in powder, developing strength in wood and coil, and further opportunities in general industrial and ACE (agriculture, construction, and earthmoving equipment). AXTA noted leveraging growth in the EV market to bolster growth in electrical insulation (a small piece of the pie now) with high-performance impregnating resins.

Exhibit 33. $37.5B Global Industrial Coatings by Market Opportunity

General Industrial $14.5B

Wood $7.5B

Powder $8.1B

Coil $4.4B

ACE $1.5B

Electrical Insulation

$1.5B

Source: Axalta and Wells Fargo Securities, LLC

SHW expects growth for general indsutrial and industrial wood to outpace the others.

Exhibit 34. Industrial Coatings Forecasted Global Activity

Source: SHW



Exhibit 35. PPG Industrial Coatings Segment Overview

Source: PPG

Interestingly, PPG noted that motorcycle coatings, with their diversity of application, represent a high growth segment in emerging markets.

Exhibit 36. Team Chem Conducts Field Research

Source: Wells Fargo Securities, LLC

Powder coatings is the largest Industrial OEM category, at about a quarter of sales, followed by transportation (auto, truck, etc.), at 14%. Industrial Coatings can serve functional (hardness, corrosion resistance) and decorative purposes in such household objects as refrigerators, HVAC, fireplaces, microwaves, and vacuum cleaners, and in such automotive parts as bumpers, axles, brake systems, and rigid and flexible exterior trim systems. They can also be used in electronic devices including mobile phones, laptops, and tablets.

Exhibit 37. Industrial OEM Coatings End Markets, 2017

Powder Coatings24%

Auto/Light Truck/SUV

14%

Container & Closure Finishes

13%Wood Furniture, Cabinet

11%

Coil Coatings11%

Non-Wood Furn & Fixture

7%

Other Industrial7%

Machinery & Equip3%

Paper, Film & Foil3%

Heavy Truck/Bus/RV

2%

Other Trans2%

Wood, Comp, Flatstock

2% Appliance/HVAC1%

Elec Insulation0%




There are four technology offerings in industrial coatings, including liquid, powder, pretreatment, and electrocoat. Liquid, which consists of traditional primers and topcoats, is by far the largest, accounting for nearly two-thirds, and continues to outpace competing technologies. Powder, for which a solid coating is applied by electrostatic spray, follows at about 25%, but PPG believes it is growing faster than the market and will likely expand its portion of the market. Pretreatment and electrocoat are about 5% each; the former includes cleaners and phosphate chemicals to condition metal before paint is applied, while the latter applies coatings by electrically charged immersion.

Exhibit 38. Industrial Coatings by Technology, 2012 vs. 2017

Source: PPG

All major coatings producers offer liquid solutions, many offer powder, a handful offer E-coat, and only PPG offers all four. Pretreatment is a primary technical solution in appliances, auto parts, general finishes, and heavy duty equipment.

Exhibit 39. 2017 Competitive Technology Profile

Source: PPG



Special Purpose Coatings

Following a couple of years of lackluster performance with lower oil prices hindering O&G activity, 2017 Special Purpose sales showed some recovery, up 2.3% (vol +1.3%, price +1.0%).

Exhibit 40. U.S. Special Purpose Value and Volume, 2001 to Present

0

50

100

150

200

250

0

1

2

3

4

5

01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18E

Gallo

ns (M

M)

Value

($B)

Volume Value


For 2018, CQ estimates another 3.8% increase (vol +2.0%, price +1.8%).

Exhibit 41. U.S. Special Purpose Yr/Yr Price and Volume Trends, 1997-2018E

-20%

-10%

0%

10%

20%

30%

1997 2000 2003 2006 2009 2012 2015 2018E

Volume Price


Special Purpose coatings serve far fewer end markets than those served by industrial OEM coatings, but typically carry higher margins. Major end markets for Special Purpose coatings include automotive refinish, industrial maintenance, and traffic-marking paints. Aerosol and marine paints are the remaining end markets, with the latter seeing particularly subdued demand in recent years with the decline in shipbuilding activity. Key producers include PPG, AXTA, and RPM.

Exhibit 42. Special Purpose Coatings Sales by Region and End Markets, 2017

Asia42%

Europe25%

North America

25%

ROW8%

Automotive Refinish

33%

Industrial Maintenance

30%

Traffic Marking Paints22%

Aersol Paint9%

Marine Paints6%

Source: The ChemQuest Group, SHW, and Wells Fargo Securities, LLC



VMT is an important metric for auto refinish, as repair/refinish activity picks up with increased driving (which means more accidents!). VMT typically slows in the early months of the year as cold weather curbs travel, partially offset by icy conditions increasing accidents. In 2018, adverse weather limited driving in January and February, with VMT falling 7% for both, month over month. In March, driving activity reaccelerated and VMT rebounded 19% over February. While new technology has enabled better safety systems, distracted driving is still a factor (for example, texting while driving; we’ve previously cited as “OMG” or “HWH” affected). In addition, more SUVs on the road allows for treating larger surface areas.

Exhibit 43. Vehicle Miles Traveled, 2008 - 2018

(5%)

0%

5%

10%

200

210

220

230

240

250

260

270

280

290

300

Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-17 Jan-18

Yr/Y

r % C

hang

e

Miles

Driv

en, 0

00s

Miles Driven, 000s Yr/Yr Change

Source: U.S. Department of Transportation and Wells Fargo Securities, LLC

AXTA provided the following outlook for refinish industry sales by region, with expectations that sales will grow at a CAGR of 3.6% from 2016 through 2020.

Exhibit 44. Refinish Industry Sales by Region, 2016 – 2020E ($B)

Source: AXTA

Among the puts and takes noted were O&G rebounding (with 2018 likely to see a pickup in tanks, pipelines, rail transportation) and auto refinish volume slightly positive (unfortunately, along with the rise in vehicle-related fatalities), offset by continued sluggish trends in marine. Longer term, autonomous driving technology and new safety systems in cars (collision avoidance) and ride-sharing apps may pose a threat to the segment as soon as 2021. Aging U.S. infrastructure remains an area of opportunity, along with the focus on technology upgrade.

Focusing in on the protective and marine market, PPG estimates the following breakdowns for the approximately $13-14B global business.



Exhibit 45. 2017 Protective and Marine Industry Segments, $B

Source: PPG

Although more than half of protective and marine coatings are generated from Asia (reflecting the relocation of marine activity to South Korea and elsewhere), SHW provided the following outlook for the subsegments below.

Exhibit 46. Protective and Marine Coatings Forecasted U.S. and Canada Activity

Source: SHW

According to Wells Fargo Securities analyst Michael Webber, dry bulk fleet growth is decelerating (slightly), with 2018E forecast at a modest 2.3% relative to 3% in 2017. Dry bulk ships typically carry large unpackaged loads of cargo and are equipped to handle as much as hundreds of thousands of metric tons – making them (effectively) big floating dump trucks. However, chemical tankers are more sophisticated and expensive equipment. The WFS Shipping team also notes that chemical contracting has been relatively consistent, with 3.6 % growth y/y, following y/y growth of 4.3% in 2017 and 5.0% in 2016 (across the broader array of Chemical tankers).

Exhibit 47. Number of Chemical Tankers (10-54,999 dwt), 1996-Present

0

50

100

150

200

250

300

350

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18YTD

Numb

er of

Che

mica

l Tan

kers

Contr

actin

g

Source: Clarksons Research Services Limited 2017 and Wells Fargo Securities, LLC Some of the Material on SIN is provided by third parties and CRSL cannot be held responsible for third party Material. It is further understood and agreed that the complex nature of the shipping business may result in inherent limitations, inaccuracies and shortfalls in the Material and other information collected, processed and provided by CRSL. For example: (i) Material may be based on estimates or subjective judgements (such as ship prices where no sales information for comparable ships is available); (ii) The information in the databases of other maritime data collection agencies may vary from the information in the CRSL database; (iii) Whilst CRSL has taken reasonable care in the compilation of its statistical and graphical information, which is believed to be accurate and correct, the compilation of data is inherently subject to limited audit and validation procedures and may therefore contain errors.



Adhesives and Sealants

Market Overview

In 2017, the global Adhesives and Sealants Industry generated about $59B in sales and 31B lbs in volume, up 5% yr/yr. North American sales and volume have trended upward since the 2009 recession, with CQ estimating that 2018 will see another 3.5% increased for Adhesives and 4% increased for Sealants.

Exhibit 48. North American Adhesives and Sealants Industry, 1997-2018E Adhesives

0

2

4

6

8

10

12

0

2

4

6

8

10

12

14

16

18

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18E

Volum

e, B

lbs

Value

$B

Volume Value

Sealants

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

0.0

0.5

1.0

1.5

2.0

2.5

97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16 17 18E

Volum

e, B

lbs

Value

$B

Volume Value

Source for both charts: The ChemQuest Group and Wells Fargo Securities, LLC

Regionally, Asia, Europe, and North America each represent roughly a third for adhesives and sealants.



Exhibit 49. Global Adhesives and Sealants Sales by Region, 2017

Asia36%

EMEA32%

North America

31%

South America

1%


Globally, paper board dominates Adhesives demand, at about 35% tied to internet shopping and fast-moving consumer goods. For Sealants, demand is largely tied to construction (32%) and transportation (30%).

In North America, 2017 Adhesives volume and prices were up 1.5% and 1.0%, while volume and prices for Sealants increased 3.0% and 1.0%. While volume remains below peak levels for both categories, value continues to exceed the 2007 highs. All end markets posted growth in 2017, with CQ expecting 2018 to capture 2-3% volume growth and about 1% in price for Adhesives with Sealants.

The top adhesives producers are shown below with a comparison between the 2005 and 2017 landscapes. Over the past decade, Henkel has retained its leading position and nearly doubled its revenue. Contrary to the coatings market, where top players have similar market shares, the leader here far outpaces its nearest competitor. While Henkel is the dominant supplier (roughly 3x the size of No. 2 player MMM, followed by FUL), we would not be surprised to see consolidation.

Exhibit 50. Top Adhesives Producers by Sales, 2005 vs. 2017 2005 2017

0.7

1.5

1.5

1.6

2.4

5.9

0 2 4 6 8 10 12

Rohm andHaas

H.B. Fuller

Bostik

National Starch

3M

Henkel

Sales ($B)

0.8

1.0

1.1

1.5

2.0

2.0

2.3

2.3

3.7

10.2

0 2 4 6 8 10 12

DWDP

Lord

Mapei

RPM

Sika

ITW

Arkema

H.B. Fuller

3M

Henkel

Sales ($B) Source for both charts: The ChemQuest Group and Wells Fargo Securities, LLC

Building/construction accounts for the largest end market, at about 25% globally and in North America. Whereas packaging is the second-largest globally at 22%, transportation ranks next in North America at 24%.



Exhibit 51. Adhesives and Sealants Market Sectors, 2017

North America Global

Building/Construction

26%

Transportation24%

Converting/Pkg18%

Assembly17%

DIY8%

Woodworking & Joinery

7%

Building/Construction

24%

Converting/Pkg22%

Assembly20%

Transportation15%

Woodworking & Joinery

9%

DIY8%

Other2%


In construction, improved building standards are among the demand drivers. Adhesives in general have been gaining at the expense of metal fasteners, due in part to the light-weighting trend. Also, Adhesives offer such desired traits as flexibility, ease of repair, and strength.

The increasing presence of adhesives and sealants in the transportation industry is driven in part by fuel efficiency. Manufacturers continue to replace metals with plastics, composites, and lighter metals. These products cannot be put together with traditional mechanical fastening, and instead require adhesives to assemble various layers. At the same time, these adhesives must provide heat shielding and have enough strength to replace mechanical fasteners, etc. End-market trends during 2017 were positive across the board, with all areas trending positively.

Exhibit 52. Adhesives End-Market Performance, 2017

Source: The ChemQuest Group



Industry Margin

Raw materials are the largest component of costs, representing 54-64% of cost of goods sold, compared to 45-53% in the coatings industry. Adhesives typically use higher molecular weight products, which generally include dependence on crude oil input. Similar to coatings producers, Adhesives producers have been facing raw material price increases and have been working to offset with their own increases. In addition, producers have rationalized and shed less strategic customers, which midsize players have picked up.

Exhibit 53. Average U.S. Adhesive Company’s Cost Structure, 2005-2017 2017 2016 2015 2014 2013 2012 2011 2009 2005

Sales 100% 100% 100% 100% 100% 100% 100% 100% 100%

Cost of Goods SoldRaw Materials 54-64% 51-61% 53-63% 53-63% 53-63% 53-63% 53-63% 52-60% 53-59%Packaging 0% 0% 0% 0% 0% 0% 1% 2% 2%Labor 3% 3% 3% 3% 3% 3% 3% 2-3% 5-7%Energy 1% 1% 1% 1% 1% 1% 1% 1% 2%Overhead, Taxes, Ins., Dep., Pkg. 6% 6% 6% 6% 6% 6% 5% 5-7% 5%Total 64-74% 61-71% 63-73% 63-73% 63-73% 63-73% 63-73% 62-72% 67-75%

Gross Margin 26-36% 29-39% 27-37% 27-37% 27-37% 27-37% 27-37% 28-38% 25-33%

SG&A 15-21% 16-22% 15-21% 15-21% 15-21% 15-21% 15-21% 15-21% 19-25%

EBIT 5-21% 6-22% 6-22% 6-22% 6-22% 6-22% 6-22% 7-23% 6-14% Source: The ChemQuest Group and Wells Fargo Securities, LLC

Adhesives pricing increased steadily until 2014, though it remained relatively flat through 2016 and has since seen a gradual recovery, reflecting consumer spending. In 2009, despite the recession, continued pricing momentum, coupled with lower resin costs, helped margin expansion. Resin PPI has typically tracked the adhesives material cost index, especially the declines since 2014, though 2018E is calling for a more accelerated increase.

Exhibit 54. Adhesives PPI, Resin PPI, and Cost Index (Indexed to 2009)

90

100

110

120

130

140

150

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E

Adhesives PPI Adhesives Material Cost Index Resins PPI

Source: The ChemQuest Group



Macroeconomic Backdrop The global macroeconomic environment has been muted in recent years, with 2017 marking the 11th year in a row that GDP has remained at less than 3% (not a heart), at 2.3%. With 1Q18’s initial GDP reading of +2.2%, 2018 is forecast up 3.9% (U.S. +2.8% vs. 2017 +2.3%; EU +2.3%, similar to 2017; China +6.3% vs. 2017, +6.9%).

Major End Markets

Construction

Within the United States, construction continues to recover from trough levels and has surpassed peak 2006 conditions, marking growth of Architectural Coatings. Total construction spending has been on the rebound since 2011, including yr/yr growth of 7% in 2013, 11% in 2014, another 11% in 2015, 7% in 2016, and another 4% in 2017, reaching approximately $1.23T. This string of increases follows five years of declines that drove activity down 33% from the 2006 peak of about $1.17T.

Exhibit 55. U.S. Construction Spending, 1993-2017

0

200

400

600

800

1,000

1,200

1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Cons

tructi

on S

pend

ing, $

B

Public Private


The recovery in construction continues to be driven by private spending, up 6.2% (in 2017), while public spending decreased 2.5%. Since the biggest annual decline in total construction in 2009, private spending has increased 61% in aggregate, which compares to an 11% decline in public spending.

Exhibit 56. Yr/Yr Change in Construction Spending, 1994-2017

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016

Private Total Public


Residential construction spending continues to recover, 42% in 2017, after falling to a low of 28% of construction spending in 2009.



Exhibit 57. U.S. Construction Spending, 2006-2017 (Green Residential; Orange Nonresidential)


Wells Fargo economists forecast 2018 housing starts to reach 1.31MM units, up 9% from 1.20MM units in 2017, and increasing to 1.39MM units in 2019. However, these numbers are far from the 2.27MM unit peak number in 2006. The SAAR of housing starts for April rang in at 1.29MM, up 10.5% yr/yr, but down 3.7% sequentially.

Exhibit 58. Housing Starts and Completions, 1995 - Present

0

500

1,000

1,500

2,000

2,500

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017

Hous

ing S

tarts

& Co

mplet

ions (

000)

Starts Completions

Source: U.S. Census Bureau and Wells Fargo Securities, LLC

Compared to housing starts, existing home sales are a more relevant indicator and driver of coatings demand; 75-80% of coatings are tied to existing home sales and remodeling, with the balance being new homes. In 1Q18, existing home sales were down 2% yr/yr, compared to new home sales, up 6%. Comparing 2017 to 2016, existing home sales and new home sales increased 2% and 10%, respectively.

Exhibit 59. Existing Home Sales and New Home Sales, 2001 - Present

0.0

0.3

0.6

0.9

1.2

1.5

3

4

5

6

7

8

2001 2003 2005 2007 2009 2011 2013 2015 2017

New

Home

Sale

s (SA

AR),

MMs

Exist

ing H

ome S

ales (

SAAR

), MM

s

Existing Home Sales New Home Sales




Remodeling activity continues to advance and is predicted to increase by about 7.2% by the end of 2018 and continue into 1Q19E (based on annualized rates), according to the Harvard Joint Center for Housing Studies. Following a share shift to the DIY market during 2006-09, professional contractor share is once again on the upswing, more so benefitting SHW than PPG.

Exhibit 60. Homeowner Improvements, 2014-2019E

Source: Harvard Joint Center on Housing Studies and SHW

Transportation

Infrastructure spending and auto-related trends are important drivers for both the OEM and Special Purpose Coatings segments. For the latter, automotive refinish accounts for about one-third of sales. Auto and light-truck sales have recovered nicely from a trough of about 9.5MM units in early 2009, having reached a seasonally adjusted rate of about 16.8MM units as of May 2018.

Exhibit 61. Light-Vehicle Sales versus Auto Production, 2007-Present

0

50

100

150

200

250

300

350

400

0

5

10

15

20

2007 2009 2011 2013 2015 2017

Dome

stic A

uto P

rodu

ction

, 000

, SAA

R

New,

Ligh

t Veh

icle

Sales

, MM,

SAA

R

Light Vehicle Sales Auto Production

August '09 Cash-for-Clunkers

Source: Bureau of Economic Analysis and Wells Fargo Securities, LLC



Industrial

IP in the United States continues to improve following the nadir reached in 2009. In 1Q18, IP increased 4% yr/yr, while capacity utilization ticked up 200 bps, to 77.2%. Recovery in this area would bode well for Industrial OEM coatings, which benefits from strength in U.S. manufacturing.

Exhibit 62. Industrial Production and Capacity Utilization, 2001 - Present

65

70

75

80

85

85

90

95

100

105

110

2001 2003 2005 2007 2009 2011 2013 2015 2017

Capa

city U

tiliza

tion

Prod

uctio

n Ind

ex

Industrial Production Capacity Utilization




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Glossary

ag – agriculture

BPA-NI – bisphenol-A – non intent

CAGR – compound annual growth rate

CAI – Color, Additives, & Inks

CO2 – carbon dioxide

CQ – ChemQuest

DIY – do-it-yourself

dst – dry short ton

dwt – deadweight metric ton

E-coat – electrocoat

FCF – free cash flow

FX – foreign exchange

gal – gallons

HWH – hey wassup hello

IP – Industrial Production

IVC – IVC Industrial Coatings

JV – joint venture

KT – thousand tonnes

LATAM – Latin America

MT – metric tons

NA – North America

NWE - Northwest Europe

O&G – oil and gas

OEM - original equipment manufacturer

P&A – Pigments & Additives

PC – Performance Coatings

PMI – purchasing managers index

PPI – producer price index

ROI – return on investment

SAAR - seasonally adjusted annual rate

SSBR - solution styrene-butadiene rubber

TiO2 – titanium dioxide

vmt – vehicle miles traveled

VOC – volatile organic compounds

vol – volume

YTD – year-to-date



Required Disclosures

Additional Information Available Upon Request

I certify that: 1) All views expressed in this research report accurately reflect my personal views about any and all of the subject securities or issuers discussed; and 2) No part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by me in this research report.

Wells Fargo Securities, LLC does not compensate its research analysts based on specific investment banking transactions. Wells Fargo Securities, LLC’s research analysts receive compensation that is based upon and impacted by the overall profitability and revenue of the firm, which includes, but is not limited to investment banking revenue. STOCK RATING 1=Outperform: The stock appears attractively valued, and we believe the stock's total return will exceed that of the market over the next 12 months. BUY 2=Market Perform: The stock appears appropriately valued, and we believe the stock's total return will be in line with the market over the next 12 months. HOLD 3=Underperform: The stock appears overvalued, and we believe the stock's total return will be below the market over the next 12 months. SELL

SECTOR RATING O=Overweight: Industry expected to outperform the relevant broad market benchmark over the next 12 months. M=Market Weight: Industry expected to perform in-line with the relevant broad market benchmark over the next 12 months. U=Underweight: Industry expected to underperform the relevant broad market benchmark over the next 12 months.

VOLATILITY RATING V=A stock is defined as volatile if the stock price has fluctuated by +/-20% or greater in at least 8 of the past 24 months or if the analyst expects significant volatility. All IPO stocks are automatically rated volatile within the first 24 months of trading.

As of: June 14, 2018

47% of companies covered by Wells Fargo Securities, LLC Equity Research are rated Outperform.

Wells Fargo Securities, LLC has provided investment banking services for 43% of its Equity Research Outperform-rated companies.

51% of companies covered by Wells Fargo Securities, LLC Equity Research are rated Market Perform.

Wells Fargo Securities, LLC has provided investment banking services for 30% of its Equity Research Market Perform-rated companies.

2% of companies covered by Wells Fargo Securities, LLC Equity Research are rated Underperform.

Wells Fargo Securities, LLC has provided investment banking services for 19% of its Equity Research Underperform-rated companies.

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June 14, 2018 | Equity Research · As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and investors