Ppg Industries Inc Q3 FY2022 Earnings Call

Good morning. My name is Elliot; I will be your conference operator today. At this time, I would like to welcome everyone to the Third Quarter PPG Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. I would now like to turn the conference over to John Bruno, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Elliot, and good morning, everyone. Once again, this is John Bruno. We appreciate your continued interest in PPG and welcome you to our third quarter 2022 financial results conference call. Joining me on the call from PPG are Michael McGarry, Chairman and Chief Executive Officer; Tim Knavish, Chief Executive Officer, elect; and Vince Morales, Senior Vice President and Chief Financial Officer. Our comments relate to the financial information released after US equity markets closed on Wednesday, October 19, 2022. We have posted detailed commentary and accompanying presentation slides on the Investor center of our website, ppg.com. The slides are also available on the webcast site for this call and provide additional support to the brief opening comments Michael will make shortly. Following management’s perspective on the company’s results for the quarter, we will move to a Q&A session. Both the prepared commentary and discussion during this call may contain forward-looking statements, reflecting the company’s current view of future events and their potential effect on PPG’s operating and financial performance. These statements involve uncertainties and risks, which may cause actual results to differ. The company is under no obligation to provide subsequent updates to these forward-looking statements. This presentation also contains certain non-GAAP financial measures. The company has provided in the appendix of the presentation materials, which are available on our website, reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financial measures. For additional information, please refer to PPG’s filings with the SEC. Now, let me introduce PPG Chairman and CEO, Michael McGarry.

Thank you, John, and good morning, everyone. I would like to welcome you to our third quarter 2022 earnings call. I hope you and your loved ones are remaining safe and healthy. Before I go into my comments regarding the third quarter, I would like to congratulate Tim Knavish for being appointed President and Chief Executive Officer of PPG effective January 1, 2023, and immediately joining the company's Board of Directors. Tim has an outstanding track record, having served the company for more than 35 years and leading nearly every PPG business during his career. The Board and I have full confidence that Tim will guide PPG to future growth and additional shareholder value. With Tim's appointment, I will become Executive Chairman on January 1, 2023. Now let me turn to our financial results. Last evening, we reported third quarter 2022 financial results. For the third quarter, we delivered net sales of $4.5 billion, and our adjusted earnings per diluted share from continuing operations were $1.66. To quickly summarize the quarter, our sales performance was a record, driven by continued realization of real-time price increases that fully offset total cost inflation for the second consecutive quarter. On a two-year stack, selling prices are up about 18%. As we communicated earlier this month, these sales and earnings results were lower than our guidance for the quarter as we were impacted by further softening of demand in Europe and less of a sequential economic improvement than expected in China due to the pandemic restrictions in September. In addition, the strengthening of the US dollar lowered sales by about 6%, or $265 million worse than it was originally forecasted. Despite these lower-than-forecasted sales, we did deliver strong performances in several of our businesses, including PPG Comex, which delivered another record quarter. Also, our global automotive refinish Traffic Solutions and US Packaging Coatings businesses each set all-time quarterly sales records in the quarter. Year-to-date, our automotive refinish coatings business has delivered about 1,500 net new body shop wins as customers continued to value the product, technology, and industry-leading services and capabilities that this business delivers every day. In addition, our aerospace business delivered strong double-digit percentage sales growth, volume growth aided by recovering airline travel that is now about 85% of pre-pandemic levels. With additional industry recovery, a strong order book, and PPG's advantaged technology products, we expect this business to continue to grow into 2023 and beyond. We continue to experience improvement in commodity raw material availability. However, certain short supply raw materials impacted our automotive refinish and aerospace coatings businesses constraining their ability to meet their respective strong order books. Together, these two businesses ended the quarter with a $200 million backlog similar to the end of the second quarter. Importantly, our year-over-year segment operating margin recovery has begun. This reflects the progress we have made in implementing selling price increases. The third quarter marked the 22nd consecutive quarter of higher selling prices. We expect our margin recovery to accelerate into 2023 and anticipate by the first quarter of 2023 we will fully recover all cumulative inflation from 2021 and 2022. We continued to make good progress executing on our acquisition-related synergies and other cost savings initiatives from previously announced restructuring programs, which delivered about $25 million of incremental benefit in the third quarter. During the quarter, we continued to progress our launch of the expanded pro painter initiative with The Home Depot. Each week, our team is calling on thousands of prospective new customers and delivering new business wins. In the third quarter, we also started joint work with the HD Supply team to hunt for new paint customers, including in the commercial maintenance area. While early, this collaboration is yielding results and we expect it will be another catalyst for future growth in the US architectural coatings business. Overall, paint contractors are providing us with ongoing positive feedback on the convenience of buying well-recognized PPG pro products at The Home Depot. Collectively, we continue to see opportunities for significant growth in the coming years. While working capital remains higher than we would like, we made solid progress in the third quarter and began to lower our inventories on a sequential basis. We had been carrying higher-than-historic levels of inventory given supply chain constraints over the past year. But given the broadening elongation of supply globally, we are now able to destock, including reducing or canceling raw material orders and reducing safety stock closer to historic levels. We are prioritizing further inventory reductions in the fourth quarter, which will benefit our cash generation. We made modest repurchases of our stock during the quarter and repaid $100 million of debt. We continued to evaluate potential strategic bolt-on acquisitions. Consistent with our past practices, we will deploy cash in the most accretive manner for our shareholders, including some continued debt reduction. On the ESG front, I want to highlight yet another example of PPG leading the way. The acquisition of Tikkurila has proved to be very valuable on several fronts, including enhancing PPG's ESG program through the addition of advantaged, sustainable solutions that contribute to the circular economy. These include bio-based products and packaging made from 50% to 75% recycled plastic that is also 100% recyclable. Currently, nearly 90% of Tikkurila's products are waterborne, and 48% of the portfolio is eco-level. We are leveraging Tikkurila's sustainability approach in our architectural business beginning in Europe. Looking ahead to the fourth quarter, normal seasonal demand trends are expected, including lower sequential sales in most of our architectural businesses and also in our Traffic Solutions business, where sales historically fall about 50% due to the weather considerations. In Europe, we expect economic conditions to remain weak due to the softening consumer confidence and lower industrial activity related to the significantly higher energy costs and geopolitical issues. In China, we anticipate weaker-than-normal economic activity for the fourth quarter due to continued pandemic-related disruptions and slowing exports to Europe. PPG's largest factory in China was required to close for the first 10 days of October, and further restrictions could curtail production and commercial activity. One offset important to PPG is we expect automotive OEM builds in China to remain solid and consumer spending to improve into 2023. In general, demand in the US in the huge markets remains solid, and we expect several of our businesses to continue to deliver positive year-over-year sales volume growth. Demand for architectural DIY and residential new home coatings products in the US is beginning to slow, and industry demand is anticipated to weaken further in the fourth quarter and next year's basis leading economic indicators. PPG's exposure to the US new home market is relatively small and a low single-digit percentage of company sales and our overall exposure to the residential housing market is less than 10% of company revenue. We expect some of the industry weakness to be offset by our growth initiatives with The Home Depot and other customer gains. Raw materials are expected to remain inflationary, with a mid-single digit higher than the prior year, but fall modestly on a sequential quarterly basis. We expect supply chain conditions to continue to broadly improve, including better raw material and transportation availability as our suppliers are nearing their 2019 manufacturing and supply capability. As a reminder, we've absorbed about $1.9 billion of raw material inflation since the beginning of 2021. In the fourth quarter, we expect further increases in energy costs, especially in Europe and to some degree in the US. We will continue to prioritize implementing further real-time targeted selling price increases to mitigate these higher costs. Due to the heightened level of economic uncertainty, we have implemented an additional restructuring program focused on past payback actions targeting $70 million of annualized savings, upon full implementation. The program includes several initiatives in Europe, is mostly concentrated on matching our staffing levels with lower demand. As we enter a period of heightened economic uncertainty, we expect our business portfolio to prove more resilient in the coming quarters, with continued recovery in the automotive OEM and aerospace coatings businesses. Along with demand-stable businesses like automotive refinish and traffic solutions, we believe that more than 50% of PPG's portfolio will remain resilient even if we experience a broader global economic decline. This is noteworthy and a positive step-change from the prior recession. Also importantly, we expect that our sequential quarterly momentum on operating margin improvement will continue in the fourth quarter as we work back towards our historical margin profile. This will be supported by maintaining our selling prices to reflect the value of the products and services we provide. While economic conditions are challenging in the near term, I remain confident about the future earnings capabilities of PPG, as the earnings catalysts that I've referenced in the past remain fully intact, and we certainly see a path to return to prior peak operating margins, with opportunities to exceed them. In closing, as we look to finish the year managing intensifying challenges, I want to thank our team of 50,000 employees around the world who are making it happen by supporting our customers and the communities where we operate. Their dedication, even during the most challenging times, is inspiring and drives our purpose to protect and beautify the world. Thank you for your continued confidence in PPG. This concludes our prepared remarks.

And now, Elliott, would you please open the line for questions. Thank you. Our first question comes from Christopher Parkinson from Mizuho. Your line is open, please go ahead.

Great. Thank you so much. The macro is changing, not necessarily for the better, but per your comments it doesn't seem like the setup for this recessionary environment aligns with history, which has consequences across fixed asset leverage, end market mix when you're discussing refinish and aero, just the overall margin outlook versus past downturns. Can you just give us sort of overall update of your thoughts here and potentially anything on price-cost as well? Thank you.

Thanks, Christopher. First of all, I think the most encouraging thing about what we see is that we see continued price increases coming. So fourth quarter, we're still looking at high single digits, low double-digit price increases. So that's going to be significant. We have seen raw materials, they have loosened up in China. They are starting to loosen up in Europe. We are arbitraging what we see in China into Europe and we expect to arbitrage Europe elsewhere. So these are things that are a little bit different than the last ones. I'll remind everybody, by the end of the year, we'll have about $2 billion of raw material inflation, and we still have other inflation. And for the second quarter and third quarter, we covered all total inflation. That includes MRO, freight logistics, labor, you name it, we covered it, okay? So we feel very confident going into the fourth quarter that we're going to continue to recover that gap. By the end of the year, we will have recovered all raw material inflation. And before the end of the first quarter, we will recover all total inflation. So we're really in good shape from that standpoint. So I'm pleased with what I see and I think this is going to be a little bit different recession than last time because we have a strong OEM business and a strong refinish business.

Our next question comes from Ghansham Panjabi from Baird. Your line is open. Please go ahead.

Yes, thank you and congrats first off, Michael and Tim. Can you just give us a sense, Michael, on how you see architectural volumes evolving in your three major regions of the US, Europe, and Mexico as we cycle into 2023? I mean, obviously, DIY has been impacted in the US and Europe. But just given the extent of mortgage rate increases and some of the fundamental shifts in housing as well for markets such as the US, how are you planning for that evolution of volumes there?

Thank you, Ghansham. First, I want to express my gratitude to Michael and the PPG Board for their trust and confidence as we move the company forward. I also appreciate Michael personally for his leadership, mentorship, and for establishing PPG with a global portfolio that is well-positioned for growth and adept at navigating current economic challenges. I am excited about this opportunity and look forward to continuing to work with our 50,000 employees worldwide. Regarding your question about architectural volumes, PPG-Comex, our business in Mexico, is performing well. GDPs in Latin America are holding up better than in many other parts of the world. Our strong position, services, brand, and network should help us achieve solid results there. In the Asia Pacific region, architectural business is relatively small, and given the current situation in China, this is actually a positive aspect. In Europe, we are seeing continued softness in DIY markets, as we mentioned in Q1 and Q2, and we expect this trend to remain at the current depressed levels. Trade in Europe is slightly stronger, although it has declined in mid-single digits. PRO backlogs persist, primarily due to labor shortages, though we anticipate a moderation in this area. Trade business in Europe is also expected to moderate. There is variability by country, with conditions worsening closer to conflict zones. The UK is currently facing challenges, but southern regions are performing slightly better. In the US and Canadian markets, DIY activity is showing some softness, but it is not as pronounced as in Europe, with a decline in low single digits. However, the PRO business remains strong, with backlogs consistent at around 12 weeks, similar to the previous quarter. Our omni-channel business for PRO has also seen an increase this quarter, indicating better performance in the US and Canada regions.

Our next question comes from Josh Spector from UBS. Your line is open.

Hey, guys. Thanks for taking my question. Just curious if you can comment on the pricing progression in the two segments. I mean, clearly, you have momentum in Performance with that increase on a two-year stack. But Industrial maybe a little bit less obvious, 20%, two-year stack or slightly above that isn't much of an improvement Q-on-Q. So I'm wondering if you can comment on why pricing there would it be moving up higher, especially if you just talking about margins accelerating. And does energy prices, and that being a new inflationary factor, perhaps a higher inflationary factor, impact the ability to get pricing in either segment? Thanks.

Josh, this is Michael. First, I want to point out that part of the slowdown in price increases in the Performance Coatings segment is due to a decline in architectural sales, which creates a mix issue. Additionally, we've implemented pricing changes earlier in the Performance Coatings segment, while the Industrial side tends to lag a bit behind. So, in addition to the mix issue, there's also a timing aspect. The Industrial side was previously above the company average, and we expect that trend to continue into the fourth quarter. Most importantly, in our automotive segment, several customers have provided us with retroactive pricing, which also supports that margin. We still anticipate significant price improvements in the fourth quarter, and we're prepared to discuss the first quarter later, where we expect to see substantial positive pricing as well.

Josh, this is Vince. I think the key things to remember for us are that the margin recovery we promised in Industrial is underway. We're seeing that margin recovery continue into Q4 and expand into Q1. Regarding energy in Europe, we have implemented select energy surcharges, as most companies have, to adapt to the situation. We're not a major energy consumer in Europe; we're downstream and doing our best to respond to the challenging energy environment there.

Our next question comes from John McNulty from BMO Capital Markets. Your line is open.

Good morning. Thanks for taking my question and congratulations again to Michael and Tim both. So, when we think about the raw material basket, it sounds like a lot of things have improved, but there are still some challenges. I guess can you help us to understand what portion of the raw material basket is still currently challenged? And then, as the supply chains continue to improve, and it looks like they have a lot, I guess, how should we be thinking about what that might mean for raw material relief as we look to 2023? Thanks.

Yes, John, this is Vince. Let me start real quickly and then I think Tim is going to chime in here. If you look, again, we have cumulative, about 40% inflation levels. We do see inflation year-over-year in Q4, but it's down sequentially. And that's, I think is the key is we're starting to see the fever break. It's different, as Michael mentioned, by region and we're seeing arbitrage opportunities. And I think Tim has some specifics.

Yes. And so from the availability situation, John, it's much better. We're now to isolated examples. You've got the singular example here in the US with a fire at a particular resin supplier that has caused a transient disruption. We put some alternatives in place to deal with that. And if you look at like cut across the aerospace transparencies, you've got some things not related to coatings, but components, machine parts, acrylic parts that go into the manufacture and assembly of a windshield. But now we're down to handfuls of items, some minor additives as opposed to what we had a quarter, or certainly two quarters ago.

Yeah. And just one other comment here is if you think about the inflation that we've absorbed in the past almost two years now, a part of it started as a supply chain issue, but we then were saddled with inflation that included COVID absenteeism, freight issues, port issues. A lot of those other issues have fallen by the wayside. So we do feel, given those other issues have been resolved, the supply/demand economics will start to play a bigger factor.

Our next question comes from Stephen Byrne from Bank of America Merrill Lynch. Your line is open.

Yeah. So I was curious to hear your view on the ability for you to expand geographically in your various businesses. Which of them do you think you have the most potential to expand? For example, Tikkurila, did that give you a footprint in a region where you think you can meaningfully expand either refinish or traffic markings? What's the outlook for you in that region?

Well, Stephen, this is Michael. Let me provide some examples that illustrate the benefits of our acquisition strategy. For instance, our traffic solutions business was mainly based in the US, with a small presence in Mexico. By leveraging our PPG-Comex team, which is very strong in Mexico, we were able to take the formulations from the US, adapt them to the local market, and begin selling them. Since acquiring this business five quarters ago, our traffic solutions division has been growing by over 20 percent each quarter. Similarly, with Tikkurila, they had established customer relationships in Scandinavia. While we were already selling there, those relationships were advantageous. We were able to introduce our industrial products and expand our refinish offerings in that region, which we showcased during the Investor Day visit to birch in Scandinavia. Additionally, when we acquired [indiscernible] in China, we transferred those formulations and successfully grew our automotive parts and accessories business, marking a significant win for us. We've developed a new waterborne technology for automotive parts that is outpacing market growth. Overall, these examples demonstrate how our acquisitions allow us to expand globally, resulting in strong positive outcomes for our business. Thank you for your question.

Our next question comes from Kevin McCarthy from VRP. Your line is open.

Yes, good morning. I'd like to ask how much destocking do you anticipate internally and externally. For example, do you expect to run your assets at a rate that's below underlying consumption in the next several quarters perhaps outside of auto OEM and aerospace where those markets have been more dislocated or depressed?

Well, we're certainly, Kevin, going to do that for some of our businesses where the raw materials we built up. So that's going to happen. But you did highlight a number that are going to be well north of that. So automotive, refinish, traffic solutions, things like that are all going to be well above company average. But the thing you have to remember is, we're also going to take advantage of the arbitrage in raw materials. So if it makes sense for us, we're moving TiO2 right now from China. We're moving it into Europe. So we're going to take advantage of things like that. And net-net, I would tell you that we're probably going to be pretty close. We took down inventories $100 million in Q3. We're probably going to take down another couple of hundred million dollars in Q4. And I think we're in pretty good shape.

Yes. Let me just add on to what Michael said here. I think if you think about the coatings industry more broadly, we're a batch process. So we typically can start and stop as we please. We're not a continuous process. Where we are this cycle versus prior cycles is, we don't have a lot of inventory. Our end customers, with a few exceptions, do not have a lot of inventory in the chain. We're seeing that in, for example, automotive refinish, as Michael alluded to. We're certainly seeing that in aerospace. So there's not, Kevin, a big destock coming in many of our industries. Automotive, another one where we're inventory light all the way through the chain. So we're going to run at or slightly below what we see as our end customers' consumption to draw down our inventories. But with a couple of small exceptions, we're including in some of our big box DIY customers, there's not a lot of inventory in channels. But we do have a huge focus on drawing down our raw material inventories in the fourth quarter.

Our next question comes from Laurent Favre from Exane BNP Paribas. Your line is open, please go ahead.

Yes. Good morning, all. Congrats again to Michael and team. My question is, again, on this inventory point and destocking. On the volume guidance for Q4, I was wondering if you had made a specific assumption on destocking itself on the customer side.

Yes, Laurent, thanks for the question. This is Tim. To Vince's point, really, the only segment where we're seeing destocking on the customer side is architectural DIY big box. And we are seeing that in Europe predominantly, but also here in the United States. And so, we do expect that to continue really for the remainder of the year until they reach their targeted levels. But beyond that, many of our customer channels are still fairly light or very light in some cases on inventory. So that's the only destocking we expect to see.

Yes, this is Vince again. When looking at Europe, we started noticing the trends really in the first and early second quarter of this year. In a couple of months, we will be comparing against those declines, so we will have a different base for comparison in 2023 for Europe.

Our next question comes from Michael Sison from Wells Fargo. Your line is open.

Good morning. Congratulations, Tim, and it has been great collaborating with you, Michael. I assume you’ll be moving to Cleveland after retirement. My first question for you, Mike, is regarding your outlook for the fourth quarter. The forecast of $1.05 to $1.20 appears relatively low on a quarterly basis. I'm curious about what you think needs to occur to see improvement heading into the first half of 2023. And for Tim, could you share your thoughts on PPG's earnings potential? There was a $9 target mentioned previously, and I wasn’t sure if you still consider that to be valid. Thank you.

Okay, this is Michael. I'll address the first question, and then I'll hand it over to Tim for the second. When we initially provided our pre-announcement guidance, our team in China was optimistic that after President Xi's election for a third term, COVID policies would be eased and would shift towards a more normalized approach. However, following the recent speech, that's clearly not happening, so we've made adjustments accordingly. Our Tianjin plant, which is our largest coatings facility globally, was inactive for the last ten days of September and the first ten days of October, operating at reduced rates. We're closely monitoring consumer confidence in China. On a positive note, the broader automotive sector in China had a strong third quarter and is projected to perform well in the fourth quarter, historically the best time for automotive sales in the country. I am particularly encouraged that automotive manufacturers in China are exporting electric vehicles, which is beneficial for us. BYD, for instance, is not only exporting to Europe but also exploring opportunities in Southeast Asia, which gives us confidence. While our guidance might seem a bit conservative, there are numerous uncertainties ahead. We are unsure about the extent of destocking by DIY retailers in the fourth quarter, and typically, they start purchasing in December to prepare for the new season, which we have not factored into our projections. Thus, we are adopting a cautious stance based on current observations. I believe our guidance is reasonable, and we will keep you updated throughout the quarter. Now, I'll let Tim discuss the $9 earnings potential.

Right. The $9, the answer is it's a question of when, not if. The fundamentals for $9 are absolutely there. If you look at the pluses and minuses on the ledger for that, you've got aero recovery, you've got auto recovery, you've got more refinish recovery. That great business is still down 10% versus pre-COVID. We've got the inflection of the price-cost curve. You know about our restructuring and footprint work we've done. China's still closed, acquisition, synergies, technology, et cetera, et cetera. So that side of the ledger is a lot stronger than the other. The other side of the ledger is really only about macroeconomic-driven volume. And we only need some of that to come back to get to that $9. So it's absolutely in our future. And thanks for the question.

We now turn to Noah Poponak from Goldman Sachs. Your line is open.

Hey, guys. This is Duffy. Can you hear me okay?

Yes, Duffy. Good morning.

Good morning. I want to start by thanking Michael and Tim. I have two questions about price costs. First, to achieve your goal of offsetting all raw material inflation for the first half, what kind of sequential price increase do you anticipate between Q3 and either Q1 or Q2 next year? Secondly, regarding the $1.9 billion you mentioned, what do you realistically expect to achieve over the next three years? There seems to be some genuine inflation that we might not recover, and with the Alnext plant coming back online, we should see some relief there. However, it would be helpful to have a better analysis of the supply and demand changes for each aspect. Is it half? Is it three-quarters? What is a realistic target we can set for recovering on the raw material front over the next few years?

Duffy, this is Vince. I'll address the first part of your question, and then Michael will cover the second part. As we mentioned earlier, to fully recover from our total inflation, we have planned some modest targeted pricing actions for Q4 and will also implement certain actions in Q1. So, to clarify, this does not depend on extremely high prices moving forward.

So Duffy, I want to emphasize that we have addressed all inflation concerns in the second quarter, including total inflation, not just raw materials. We've also managed to tackle it in the third quarter and plan to do the same in the fourth quarter. Currently, we're beginning to reduce the gap we had previously established, and we expect to be fully caught up by Q1. This is based on the price increases we anticipate, though it doesn’t account for any new developments that may arise in the next 30 to 60 days that we might consider adding. As for challenges, we clearly won't see relief in labor costs. However, we are starting to see some easing in transportation expenses. We believe warehousing costs will also decrease somewhat, albeit not substantially. In terms of raw materials, we've already observed reductions beginning with TiO2 and epoxy, and we expect to see similar trends with some basic isocyanates. By Q1, we are confident that we will experience lower emulsion costs. While it’s uncertain if we will return to 2019 pricing levels for some materials, I’m confident our team has effectively managed pricing. Our customers are aware of the current dynamics, and I believe we will continue to narrow this gap, fully closing it by the end of Q1. This gives us confidence that margins will continue to expand throughout 2023.

Our next question comes from Frank Mitsch from Fermium Research. Your line is open.

Thank you. First, we are experiencing a leadership change at the quarterback position in Pittsburgh, and now this. Michael, it has been a pleasure working with you. Best wishes for your future, and congratulations to Tim. I would like to delve deeper into the volume trends. In the third quarter, volumes were down 3%. Could you provide more details by month to see if there was any decline as we moved out of the quarter? As we look ahead to the fourth quarter, you mentioned that you expect volumes to decline in the mid-single digits. In your prepared remarks, you stated that Asia is projected to decrease by 10%. Could you share your expectations for Europe, the US, Canada, and Asia?

Frank, this is Michael. Thank you for your kind words. It's been great working with you, and I will continue to follow the Jets no matter where I play golf in the future. Now, let's discuss the third quarter. September in China was weaker than expected, particularly with the unexpected request to reduce rates by over 50 percent at our Tianjin plant. We also anticipated declines in the architectural channel in Europe, which became more aggressive in September. We started to see similar patterns in the US, especially in areas like appliances and products similar to a Peloton, which remain weak. We're monitoring this closely. As for the fourth quarter, we do not anticipate major surprises. I am cautiously optimistic that the OEM segment in Europe has hit the bottom, and we will be looking for it to stabilize. We are concerned about interest rates in the US and their potential impact on the automotive sector. This year, we're likely to see automotive builds around 81 million cars, with projections for next year at about 85 million. While some sectors are weakening, there are areas showing strength. If China begins to ease its Zero-COVID policy, we expect a significant increase in flights, as people are eager to travel but have been restricted by government regulations. Overall, I feel confident about this situation.

Our next question comes from Arun Viswanathan from RBC Capital Markets. Your line is open.

Great, Thanks for taking my question. Apologies for that. And Michael, congratulations on your next endeavors there. Good working with you. I'm just curious on the volume side. So when we think about it, there looks like there's been some real structural damage in Europe. Volumes may not necessarily recover to where they were pre-pandemic levels. I don't know if you'd agree with that, but maybe you can just comment on that. And then secondarily, if we do see some continued weakness in Europe, is there a risk that volumes also could deteriorate in North America? And if that's the case, then are we kind of thinking about Q4 earnings run rate as likely a good starting point for Q1 and most of next year. Thanks.

Yes, Arun, this is Tim. I appreciate your question. I'll start, and then I can pass it over to Vince. Regarding Europe, we are confident in our guidance from an architectural perspective, as well as industrial and automotive sectors. We believe that we have reached a low point in terms of volume for the European market. As for the US, we have not seen the same situation. The volumes in the US are performing well, with the exception of consumer-related areas in the industrial and architectural DIY segments. So far, we have not observed any negative impact from Europe affecting the US market.

Yes. Arun, this is Vince. Regarding your question about structural demand, I believe it's too soon to provide a definitive answer. As we approach 2023, we will start to see easier comparisons beginning in March. We do recognize that there is a healthy consumer base that usually spends money, although we have noticed some effects from higher energy prices. The duration of this energy price situation will influence some of the answers to your question, which we currently cannot provide. Additionally, if activity or production moves from Europe to other parts of the world due to these energy prices, we are already positioned to respond. Whether it shifts to China or Mexico, we will be able to supply those customers.

Our next question comes from John Roberts from Credit Suisse. Your line is open.

Thanks and best wishes, Michael, and congrats, Tim. The theme in auto OEM is that in Europe and the US, we're already at recession levels so that we don't decline further. Now that Europe is actually probably in a recession, do you still think that European auto OEM is going to be flat to up next year?

John, this is Michael. I believe that European auto demand will remain stable for the next two to three quarters. I don't anticipate any catalysts for change. Typically, Europe does not drop below 8 to 9 million cars in Western Europe, which is where we currently stand. Furthermore, a significant portion of vehicle purchases is driven by corporate and fleet buying, and those trends have been consistent due to established company habits. Therefore, we are confident we are maintaining this level. In the US, we have faced constraints, with only 32 days of inventory available. Many popular colors are quite difficult to find, yet consumers are still making purchases. The truck market is particularly strong; availability is limited, indicating a solid market. This is a positive sign because there is consistent demand among trades that require trucks. We are also observing continued momentum in the electric vehicle sector, especially in China. I did not mention this earlier, but China aimed for 25% of all cars to be electric by 2025 and reached that goal last quarter. The fact that they are beginning to export EVs is promising. Notably, BYD, the largest EV manufacturer in China, is our biggest customer, positioning us well in the market.

Yes, I think holistically, when we look at the global auto market next year, our forecast six months ago was that we would see an increase of 5% to 10% year-over-year. Our current forecast is now an increase of 5% to 8%. While there may be a slight reduction at the higher end, we remain optimistic about global auto growth next year.

We now turn to Mike Harrison from Seaport Research Partners. Your line is open. Please go ahead.

Hi, good morning. And let me add my congratulations, Michael and Tim. Wanted to ask maybe for a little bit more color on the actions that you guys are taking to reduce cost by another $70 million. You mentioned that a lot of those are going to be taken in Europe. But can you talk about some of the different buckets in terms of whether it's supply chain procurement, manufacturing optimization, headcount reduction. Maybe talk about the timing? And also, should we assume that it's split pretty ratably between the two segments? Thank you.

Hey, Mike, this is Tim. I'll start by thanking you for the question. The majority of the new cost-cutting program involves reductions in personnel. We expect to decrease our global headcount by about 2%, with most of these reductions happening relatively quickly. For any discussions regarding facilities, we will coordinate with the appropriate works councils. However, it's important to note that the bulk of this new program consists of swift staffing reductions.

And Mike, this is Michael. It is ratably the same between the performance side and the industrial side. And I'll let John talk a little bit about the $70 million.

Yeah, yeah, Mike. So we are targeting $70 million and that will start benefiting the company as early as the fourth quarter, along with other open progress we've had from prior years. At this time, we expect next year the savings will be a total of about $70 million.

Our next question comes from David Begleiter from Deutsche Bank. Your line is open.

Hi, good morning. This is Anthony Merandetti on for David Begleiter. Can you discuss the benefit in US architectural coatings from The Home Depot relationship? And maybe quantify the additional wins that were mentioned in the prepared commentary?

Sure, Anthony. This is Tim. Thanks for the question. The Home Depot Pro program is progressing well. We've got thousands of new customers from the program. And we've actually, as you heard in the prepared comments, we've activated the next phase, which is engaging with HD Supply. The beauty of HD Supply, they're largely MRO focused, hospitality, healthcare, government, multifamily, maintenance, repair, and delivered on site and previously did not do a lot of paint. So this is a lot of upside opportunity for us. And to put some scale on some of the comments earlier, we're focused heavily on lead indicators and we're averaging over 6,000 new customer engagements every week, and that is enabled by the linkage of our CRM systems between The Home Depot and PPG. So these are new customer opportunities for us that are already buying paint from somewhere else and buying other products from The Home Depot. We've got about a 40% win rate. That compares to historical levels of about a 20% win rate. So we're very satisfied with that lead indicator. And then on the HD Supply, we're very early days here, but we've also started to engage in the first month 12,000 new customers just through that next stage of the program. So big picture, this is a $10 billion US addressable market for the pro painter. It's a marathon, not a sprint as you convert each one of these contractors. But we're pleased with the results so far, and we're expecting double-digit growth in this category for us for many quarters to come.

Our next question comes from Aleksey Yefremov from Key Corp. Your line is open.

Thanks and congratulations, Michael and Tim. In the US, Canada DIY market, you mentioned that it's down low single digit. How does this compare to prior downturns? How bad do you think this could get? And also in the short term, if you can comment if this is down low single digit, was getting worse in September, October or was stable?

This is Michael, Aleksey. I would tell you, the architectural business in September was a little bit lighter on the destocking in the big boxes. So that is not demand related. They just decided they would move into a little bit lower inventory position. As Tim has said on multiple occasions, our business with The Home Depot continues to grow. We're really pleased with that. We'll have some further announcements about some other wins in the big box segment when it's appropriate to put it out there. But we're going to have a substantial nice little win in the big box segment starting in the first quarter, and so we'll be starting to ship that in Q1. And what I would tell you is that, this slight downturn is lighter than historical. It's still too early to call, obviously, interest rates. When I think about interest rates of 6% and 7%, it's still low compared to my first house that I got at 11%. So, of course, my kids don't understand that. But I would tell you that, we still have a positive outlook on the housing market. We know that there is a labor shortage and more of this is being driven by the fact that both our pro painters don't have enough labor. There's not enough labor in the new home construction market. So net-net, I would still tell you that we're optimistic.

I would like to mention one more point regarding the US housing market, particularly focusing on new housing. We need to be realistic in our planning, considering the current situation in that sector. We observe a temporary slowdown in new housing for a few quarters. However, from PPG's perspective, this segment only makes up about 1% to 2% of our overall sales. Additionally, we have a much stronger position in commercial maintenance and repair. We are taking the new housing trends into account in our forecasts. Moreover, as Michael pointed out, the long-term fundamentals of housing remain robust. There is a significant housing shortage in the US and several other countries. While we may see a temporary dip in the short term, the fundamentals in the mid to long term are still strong.

Our next question comes from P.J. Juvekar from Citigroup. Your line is open.

This is Patrick Cunningham on for P.J. How is Tikkurila holding up relative to your expectations, especially given the energy crunch in Europe and the consumer slowdown?

Yes, Patrick, this is Tim again. We are very pleased with Tikkurila as a result of our first year of ownership. It has provided us with technology, ESG benefits, and an excellent wood care offering that we can expand throughout the rest of PPG, starting in Europe. It's also given us market access and a strong leading position in several countries. Additionally, we have a great management team, which has exceeded our expectations regarding their strength and depth. We are genuinely thrilled with Tikkurila and the path forward. Of course, from a DIY perspective, they are experiencing some of the challenges I mentioned earlier regarding the Pan-European situation. However, considering what we acquired with Tikkurila and what we can integrate into it, along with their position in other sectors like light industrial, finishes, and protective coatings, we are very excited about how this acquisition is performing.

And Patrick, I would add one thing that the skill set that we brought to Tikkurila that they were starting to learn how to do, but we've accelerated is pricing. And this is an area where they have a market-leading position in Finland, a market-leading position in Sweden, and a market-leading position in the Baltics. That pricing muscle hadn't been exercised previously, and we're showing them how to exercise it. So it's a win-win from that standpoint.

And Patrick, this is Vince. I don't want to stray from your question, but the other acquisition we made was NS Plant. Michael mentioned it earlier. We've experienced double-digit sales growth in that business. The outlook remains positive for that business heading into 2023, particularly with ongoing infrastructure activities in the US. So, once again, NS Plant presents a very promising situation as well.

Our next question comes from Laurence Alexander from Jefferies. Your line is open.

Hey, good morning. This is Kevin Estok on for Laurence. Thank you for taking my question. I was just wondering if you could discuss how you guys think about incremental margins between the different regions you operate in, in particular, if there was a difference between EU and US incremental margins, let's say, every additional dollar that spent by customers?

Yes, we're still looking at a 30% to 40% range for incremental margins. As activity in Europe increases, we expect that number to be a bit higher due to lower utilization rates. However, I would estimate incremental margins to remain in the 30% to 40% range. Additionally, as we've mentioned several times during this call, there will be some advantages from pricing adjustments as things normalize, which will be above those incremental margins.

Our next question comes from Steven Haynes from Morgan Stanley. Your line is open.

Hi. Thanks for squeezing me in. As working capital frees up a little bit as inventories come down, can you just provide a bit of an update on your M&A pipeline and how you're thinking about doing deals versus share buyback going forward? Thank you.

Steven, this is Michael. Listen, our inventory on the pipeline of deals is still solid, but the most important thing is we're going to remain disciplined on how it affects total shareholder returns. So we're going to decide whether it's better to pay down debt versus do acquisitions versus buying back stock, whatever is the most accretive to our shareholders. So we're actively engaged in this space. There are still a number of deals we had. I always tell people that when earnings are falling, it's always harder to get deals done because people want to be paid on what their old earnings look like and not what the current earnings are looking like. So that always does make it a little bit more of a challenge, talk about normalized earnings versus where they currently are. But we're going to remain disciplined in this area. And I don't think you should expect anything different than what you've seen from PPG in the past.

Our last question today comes from Adrien Tamagno from Berenberg. Your line is open. Please go ahead.

Hello. Good morning gentlemen. And congratulations to Tim and Michael. A question for Tim, I mean given your extensive experience in all of the areas of PPG, where do you see the greatest potential for self-help and margin recovery in the current environment?

Thank you, Adrien, for the question. And let me just first say I am very excited about the opportunity we have at PPG. And I can assure you that we will continue to execute on our margin recovery and we will continue to execute on the optimization of shareholder return, first and foremost. Beyond that, second, as Michael indicated, the change becomes effective on January 1, and at the appropriate time after that, I look forward to engaging all of our key stakeholders, including this group, to communicate further about my priorities, my vision for the next phase of evolution for PPG. So thrilled with the opportunity, encouraged on our path to margin recovery, encouraged on the opportunity to deliver shareholder return and look forward to 2023 for both organic growth and continued opportunities on the inorganic side.

There are no further questions at this time. Mr. John Bruno, I turn the call back over to you.

Thank you, Elliot. I want to thank everyone for your interest and your attention today. This concludes our third quarter earnings call. Have a good day.

This concludes today's conference call. You may now disconnect.