Stock Analysis

Is PPG Industries (NYSE:PPG) A Risky Investment?

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NYSE:PPG
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The external fund manager backed by Berkshire Hathaway's Charlie Munger, Li Lu, makes no bones about it when he says 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. We can see that PPG Industries, Inc. (NYSE:PPG) does use debt in its business. But the more important question is: how much risk is that debt creating?

When Is Debt A Problem?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Part and parcel of capitalism is the process of 'creative destruction' where failed businesses are mercilessly liquidated by their bankers. However, a more usual (but still expensive) situation is where a company must dilute shareholders at a cheap share price simply to get debt under control. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we examine debt levels, we first consider both cash and debt levels, together.

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How Much Debt Does PPG Industries Carry?

The chart below, which you can click on for greater detail, shows that PPG Industries had US$7.08b in debt in June 2022; about the same as the year before. On the flip side, it has US$1.00b in cash leading to net debt of about US$6.08b.

debt-equity-history-analysis
NYSE:PPG Debt to Equity History September 30th 2022

How Strong Is PPG Industries' Balance Sheet?

We can see from the most recent balance sheet that PPG Industries had liabilities of US$5.17b falling due within a year, and liabilities of US$10.1b due beyond that. On the other hand, it had cash of US$1.00b and US$3.82b worth of receivables due within a year. So it has liabilities totalling US$10.5b more than its cash and near-term receivables, combined.

While this might seem like a lot, it is not so bad since PPG Industries has a huge market capitalization of US$26.2b, and so it could probably strengthen its balance sheet by raising capital if it needed to. But we definitely want to keep our eyes open to indications that its debt is bringing too much risk.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

PPG Industries's net debt is 2.8 times its EBITDA, which is a significant but still reasonable amount of leverage. But its EBIT was about 16.6 times its interest expense, implying the company isn't really paying a high cost to maintain that level of debt. Even were the low cost to prove unsustainable, that is a good sign. Shareholders should be aware that PPG Industries's EBIT was down 27% last year. If that decline continues then paying off debt will be harder than selling foie gras at a vegan convention. There's no doubt that we learn most about debt from the balance sheet. But it is future earnings, more than anything, that will determine PPG Industries's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. During the last three years, PPG Industries produced sturdy free cash flow equating to 76% of its EBIT, about what we'd expect. This cold hard cash means it can reduce its debt when it wants to.

Our View

PPG Industries's EBIT growth rate was a real negative on this analysis, although the other factors we considered were considerably better. In particular, we are dazzled with its interest cover. When we consider all the factors mentioned above, we do feel a bit cautious about PPG Industries's use of debt. While debt does have its upside in higher potential returns, we think shareholders should definitely consider how debt levels might make the stock more risky. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. We've identified 3 warning signs with PPG Industries (at least 1 which doesn't sit too well with us) , and understanding them should be part of your investment process.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

What are the risks and opportunities for PPG Industries?

PPG Industries, Inc. manufactures and distributes paints, coatings, and specialty materials worldwide.

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Rewards

  • Trading at 18.6% below our estimate of its fair value

  • Earnings are forecast to grow 18.37% per year

Risks

  • Debt is not well covered by operating cash flow

  • Profit margins (6%) are lower than last year (8.7%)

  • Large one-off items impacting financial results

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About NYSE:PPG

PPG Industries

PPG Industries, Inc. manufactures and distributes paints, coatings, and specialty materials worldwide.

The Snowflake is a visual investment summary with the score of each axis being calculated by 6 checks in 5 areas.

Analysis AreaScore (0-6)
Valuation1
Future Growth3
Past Performance0
Financial Health2
Dividends4

Read more about these checks in the individual report sections or in our analysis model.

Average dividend payer with moderate growth potential.