Earnings Call Transcript - PPG Q2 2022

Operator, Operator

Good morning. My name is Lauren, and I will be your conference operator today. At this time, I would like to welcome everyone to the Second 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.

John Bruno, VP of Investor Relations

Thank you, Lauren, and good morning, everyone. Once again, this is John Bruno. We appreciate your continued interest in PPG and welcome you to our second quarter 2022 financial results conference call. Joining me on the call from PPG are Michael McGarry, Chairman and Chief Executive Officer; Tim Knavish, Chief Operating Officer; and Vince Morales, Senior Vice President and Chief Financial Officer. Our comments relate to the financial information released after US equity markets closed on Thursday, July 21st, 2022. We have posted detailed commentary and accompanying presentation slides on the Investors site 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 the 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 more information, please refer to PPG’s filings with the SEC. Now, let me introduce PPG Chairman and CEO, Michael McGarry.

Michael McGarry, CEO

Thank you, John, and good morning, everyone. I would like to welcome you to our second quarter 2022 earnings call. I hope you and your loved ones are remaining safe and healthy. I will provide some comments to supplement the detailed financial results we released last evening. For the second quarter, we delivered record net sales of $4.7 billion and our adjusted earnings per diluted share from continuing operations were $1.81. To quickly summarize the quarter, our sales performance was an all-time record, driven by continued realization of real-time price increases that are now fully offsetting total cost inflation. Total cost inflation includes generational high commodity cost inflation, energy, logistics, and other employee-related cost inflation. In addition to pricing, our top and bottom lines continue to benefit from recent strategic acquisitions, including our Traffic Solutions business, which delivered a record quarter. We achieved strong sales results despite softening consumer demand in Europe, longer-than-anticipated COVID-related disruptions in China, and unfavorable currency translation. While we included the European demand realities in our financial guidance we issued in April, the impact of the extended China restrictions and currency translation was negative by about $0.10 per share versus our original guidance. Our sales were aided by above-market volumes in several of our end-use markets, including our PPG-Comex business, which delivered another record quarter as concessionaires continue to add new locations. In addition, our global automotive refinish, traffic solutions, and U.S. packaging coatings businesses each set all-time quarterly sales records in the second quarter. This highlights one specific example of PPG's technologically advanced products. That is our packaging business, where we have won positions on about 75% of the new metal can packaging lines in North America over the past two years. Also, our aerospace business continues to benefit from year-over-year improvements in domestic travel in various countries, resulting in higher aftermarket demand, and we expect further aftermarket and OEM growth as the industry demand remains well below pre-pandemic levels. Although still challenging, commodity supply disruptions continue to ease in the quarter, and we expect further improvements as we progress through the second half of 2022. This includes much better raw material availability as inventories at most of our suppliers have vastly improved. We achieved adjusted earnings that were toward the upper end of our April financial guidance and would have been in line with the second quarter of 2021, if not for the negative impact of foreign currency translation. This reflects the benefit of our strong commercial discipline regarding pricing and continued focus on cost management. Our earnings performance was aided by higher selling prices of about 12% year over year, marking the 21st consecutive quarter of higher selling prices. Our selling prices are now up over 15% on a two-year stacked basis, reflecting our continued actions to offset persistent cost inflation. We anticipate by the end of 2022, we will fully offset all cumulative total inflation from 2021 and 2022. More importantly, we are converting higher prices to improve margins. During the quarter, our operating earnings improved each month. This strong progress is being reflected in the positive momentum of our operating margin recovery as we improved sequentially quarterly margins by 200 basis points and anticipate further improvement in the third quarter. Also aiding our second quarter earnings performance was continued realization of acquisition-related synergies and cost savings from previously announced programs, which together totaled about $30 million of incremental benefit. During the second quarter, we also implemented cost mitigation initiatives in Europe, reflecting the slower demand in the region and have additional contingency plans ready in the event of a broader economic slowdown. The efforts around cost management resulted in a reduction of our overall selling and general administrative costs by 100 basis points as a percent of sales compared to the prior year second quarter. Our acquisitions are also performing well, including the traffic solutions business, which achieved 15% sales growth in the second quarter. We remain excited about future growth opportunities for this business as in the next few years, we anticipate increased infrastructure spending and expect further U.S. adoption of mandatory expansion of traffic marketing for safety purposes. During the quarter, we continued to progress our launch of the expanded pro painter initiative with The Home Depot. I'll be at later than we wanted in the paint season and despite continuing raw material constraints, we were able to fully load PPG products at all U.S. locations with our full pro product assortment by the end of the quarter. We have already had some meaningful early wins with some large pro-contractors and our near-term target list includes more than 1,000 pro-contractors that have expressed interest in buying our products at the Home Depot. We're excited about teaming up with The Home Depot, and collectively, we see opportunities for significant growth in the coming years. In the second quarter, our net debt was consistent with the first quarter and our working capital was sequentially higher, mainly due to the higher dollar value of inventories, reflecting inflationary effects and higher receivables given our selling price increases. As the supply chain disruptions continue to improve in the coming quarters, we expect our working capital to return to more normal seasonal patterns and cash flow generation to improve as we progress through the end of the year. We repurchased $135 million of our stock at attractive prices during the quarter and continue to manage our acquisition pipeline. In addition, we have progressed our key capital expenditures during the second quarter focused on productivity and growth and now expect total spending to be about $450 million for the full year. Consistent with our past practices, we will deploy cash in the most accretive manner for our shareholders, including some debt reduction. In the second quarter, we further enhanced our company's corporate governance as we received the necessary shareholder vote threshold for board declassification and elimination of supermajority voting requirements. We had worked on soliciting our shareholders for years to pass these proxy votes, and we're pleased to see our efforts pay off to further solidify our corporate governance. In addition, we continue to advance our sustainability strategy and proudly announced PPG's commitment to setting near-term company-wide emission reductions, in line with climate science through the science-based target initiative. We plan to communicate new 2030 goals that will define our decarbonization strategy over the coming months. Looking ahead, in most major regions and end-use markets, underlying demand for PPG products is expected to remain solid. We anticipate strong sequential growth in Asia due to higher industrial production compared to the second quarter that was heavily impacted by COVID restrictions. We're closely monitoring the current COVID situation in China, and at this time, we only expect minimal impact to our sales and operations from any further restrictions. In Europe, we expect economic conditions to remain soft, including normal seasonal demand trends versus the second quarter. Also, positive demand trends are generally expected to continue in North America, aided by stronger sequential automotive OEM production, further aerospace recovery, and continuation of recent trends in auto refinish sales as we work to fulfill strong back orders. In the second half, year-over-year comparisons will be aided by the sharp declines we experienced last year during the height of the supply disruption that impacted several industries, particularly in the U.S. Outside of a few commodities, we expect supply chain conditions to continue to improve, including better raw material and transportation availability as our suppliers' production capabilities are returning to a more normal condition. Also, in the second half and specific to PPG, we expect several businesses, including automotive OEMs and aerospace, to deliver strong growth due to large supply deficits and low inventories in these end-use markets. Other PPG-specific positives for the second half are continuing acquisition synergy realization and additional cost savings from previously announced restructuring actions. In the third quarter, our two-year stacked raw material inflation is expected to be about 40%, up a low single-digit percentage sequentially versus the second quarter. We'll continue to prioritize implementing further real-time selling price increases, and we expect a quicker offset versus historical lags similar to what we delivered in the second quarter. Importantly, we expect that our sequential quarterly momentum on operating margin improvement will continue in the third quarter as we work back towards our historical margins. And also, even with significant unfavorable currency impacts expected to continue resulting in about a $0.10 EPS impact in the third quarter, we are forecasting our adjusted earnings to increase on a year-over-year basis. While near-term challenges exist, I remain confident about the future earnings capabilities of PPG as the earnings catalysts that I 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. As a reminder, this includes continued recovery in the automotive refinish, OEM, and aerospace coatings businesses. Continued sequential momentum of positive price versus cost as commodity raw material costs moderate, in the event of an economic downturn, they should moderate in a more rapid manner. A lower cost structure resulted in strong operating leverage on any sales volume growth, accretive earnings, and further growth from our recent acquisitions. In closing, as we look ahead, our team of 50,000 employees remain focused on serving our customers and supporting our stakeholders. Every day, I'm inspired by our teams around the world who are making it happen, are providing products that are helping to protect and beautify the world. Thank you for your continued confidence in PPG. This concludes our prepared remarks. Now Lauren, would you please open the line for questions.

Operator, Operator

Of course. Our first question comes from David Begleiter from Deutsche Bank. David, please go ahead.

David Begleiter, Analyst

Thank you. Good morning. Michael, you discussed a path to $9 of EPS in 2023. Has that now been pushed out given the current economic backdrop and the weakening we're seeing in Europe?

Michael McGarry, CEO

Well, David, it's certainly going to make it a little bit more challenging. But all the conditions are still there, right? You have refinish that's going to have an improved outlook. Miles driven are closing in on 2019 levels. Automotive OEM is still light. I mean, we got 24.5 million builds in China. We have a supply deficit in the U.S. The fleets haven't been rebuilt, so that's still there. Aerospace is coming back at a very strong level. And I'm sure you saw the Farnborough announcements about the new planes. So you're going to have not only aftermarket doing better, but OEM doing better. You have the synergies we've talked about. We have $30 million in synergies just in the quarter alone, productivity, and manufacturing, and then price raws, even though we haven't built that in, I'm sure somebody is going to ask later on the call about that. We see certainly raw material pricing getting a little weaker in China. We know it's going to get weaker in Europe, and that's going to free up additional. And then we still have the ability to have cash deployment. So I think all options are on the table, and I think we're still pretty confident that the outlook remains good for PPG.

Operator, Operator

Thank you. Our next question comes from Ghansham Panjabi from Baird. Please go ahead.

Ghansham Panjabi, Analyst

Yes, good morning. Thank you for the time. On the weakness in Europe that you saw in 2Q and market concerns over a recession in the region, Michael, how do you think this particular business cycle could be different in a continued slowdown scenario given that some of your end markets never fully recovered to begin with? And then related to that, can you also comment on the current raw material supply situation in Europe just given concerns over not just the supply of natural gas, but also issues with logistics and the water levels and so on and so forth in the rivers? Thanks.

Michael McGarry, CEO

Sure, Ghansham. Let's start with the fact that what's going to be different this time is, look, in the U.S., we have full employment, and you have people with a lot of money in their pockets. And so even if the Fed over tightens, I'm still looking for people to maybe partially slow down, but it's not going to be anything significant. I would say that right now, there's a strong likelihood that people are going to continue to spend money in the U.S. Certainly, we see a slowdown coming in Europe. I got to be honest, I'm not as worried as other people are about gas rationing in Europe. And the reason for that is when you think about the size of the automotive business, the size of the chemical business, these are hugely important to people in Europe. And if you got into a significant gas rationing over there, you would have an economic event that would not be pleasant. So I'm anticipating the government is going to ask people to turn their thermostats up substantially during the summer. They're going to turn them down in the winter. People are going to start conserving. So I'm not worried about raw material supply from that standpoint. The other thing I would tell you is I'm already starting to see some rotation of raw materials out of China to Europe in anticipation of this. So that's going to provide additional supply, and that additional supply will help ease some of the projected challenges. So I'm, obviously, paying attention, but I'm not nearly as worried as some people are.

Vince Morales, CFO

And specific to the European demand, in the U.S., we are seeing, obviously, slowness. We were down about 10% in Q2. We're projecting to be down in Q3. And we have some markets that are improving on a go-forward basis, as Michael alluded to. Our auto OEM business, we expect to improve certainly over the next, call it, 12 months. We know aerospace is improving in that particular region as well as globally. So we have some offsets to what's already a weak environment. And so again, on a go-forward basis, we expect some puts and takes.

Operator, Operator

Thank you. Our next question comes from Christopher Parkinson from Mizuho Securities. Christopher, please go ahead.

Christopher Parkinson, Analyst

Thank you. In relation to Beg's questions, there are three factors impacting your margin outlook. These include the end market mix, with improvements in Refinish and Aerospace, although they remain at or slightly below 2019 levels. There have also been some manufacturing inefficiencies, particularly in the second half due to auto original equipment, along with price cost issues. As we consider these factors not just for the second half of this year, but also for 2023, could you provide us with the key highlights and your current thinking on these issues? Additionally, please elaborate on how your perspective may have changed compared to the past three to six months. Thank you.

Michael McGarry, CEO

Christopher, I mean, obviously, the mix is improving every single day. So that's a positive for us. As you know, Refinish and Aerospace are very good businesses for us. And you have improved pricing in automotive, which is improving that mix as well. So I think from that standpoint, that's going to be good. The second one, if you think about our manufacturing situation, we've had to adjust manufacturing schedules on very short notice or no notice in some cases because of supply disruptions and force majeures. And as supply gets better, we're able to plan better; scheduling is better. Obviously, COVID is not a challenge anymore. We don't have as many call-offs. So, from that standpoint, our manufacturing is going to improve. And as you see, our price is dropping to the bottom line. So, margins improved 200 basis points in Q2. You're going to see a significant improvement in Q3. You're going to see an improvement in Q4. So, from that standpoint, that is going to continue to be positive momentum, and we're expecting raw materials on a sequential basis only be like up low single digits in the third quarter. So, I think there's a lot of positive momentum here, and I'm feeling pretty good about that.

Vince Morales, CFO

And Christopher, this is Vince again. I want to mention that we are still down 10% in volume compared to 2019. As you noted, we are close to parity, which means we have significant incremental margins from that volume recovery. In particular, auto and aerospace sectors have experienced the largest declines compared to 2019 or pre-pandemic levels.

Operator, Operator

Thank you. Our next question comes from John McNulty from BMO Capital Markets. John, please go ahead.

John McNulty, Analyst

Yes, thanks for taking my question. So, I guess what I'd like to focus on is the price versus raws dynamic. I guess can you help us to understand what portion of the portfolio still has more pricing that it needs to catch up? It seems like you did really well in 2Q. I guess I'm curious what else you need to kind of hit on. And then equally important, it looks like you're on track for raws to be up about $2 billion or so over the last couple of years. I guess when we start to see raws coming off, I guess, how much of the pricing associated with that do you think you hold on to versus having to give back? Is there a way to think about that? Because it just seems like it's a really big number.

Vince Morales, CFO

Yes, John, this is Vince. I'll start, and then Michael can elaborate. We still have planned pricing adjustments that we will implement in the third quarter. In some sectors, we have consistent pricing that usually happens toward the end of the season. So, you'll see that reflected in our performance. We also have some pricing adjustments in our industrial and automotive sectors that will occur this quarter. Therefore, we expect higher pricing both on a percentage basis and certainly when compared to the last two years for Q3. Regarding inflation, your estimates are generally accurate concerning the inflation we've absorbed over the last 18 to 24 months. We expect to fully offset that with our pricing strategy. Additionally, as Michael mentioned in his opening remarks, we are addressing logistics costs, employee-related inflation, and packaging inflation. By the end of the year, our pricing will overcome these factors. Typically, we experience stable pricing as we navigate through different economic conditions.

Michael McGarry, CEO

So, maybe, John, to add a little bit to that. Your premise that you're trying to understand is how much of this $2 billion plus are we going to keep. The thing that we're talking to our customers about is raw material inflation is just one piece of this. And so when you add the things that Vince talked about, logistics, labor, energy, packaging costs, we need to continue to recover that. So, I fully expect, and I will be fully engaged, and Tim will be fully engaged with the businesses to ensure that we're going to be keeping a large percentage of this in our pocket. And that is a key deliverable for our business unit leaders. Everybody is well aware of it, and it's been signaled well ahead of time. So, this will not be a surprise to our customers. So, I'm feeling pretty good.

Operator, Operator

Thank you. Our next question comes from Kevin McCarthy from Vertical Research Partners. Kevin, please go ahead.

Kevin McCarthy, Analyst

Good morning. In your guidance for the third quarter on Slide 10, you're baking in volume assumptions of flat to down a low single-digit percentage. I was wondering if you could just speak to the buildup to that assumption, maybe in terms of geography, assumptions around China lockdowns, you lack thereof, European macro, but also in terms of your individual businesses and which ones you expect highest or weakest volume growth in the third quarter?

Vince Morales, CFO

Hi, Kevin. Good morning. This is Vince again. On a year-over-year basis, there are a couple of significant factors. We anticipate that Europe will decline by nearly double digits compared to last year. However, we expect some recovery in our automotive OEM business after experiencing the peak of the chip shortage last year, although it is not fully recovered yet. Additionally, we are seeing improvements in aerospace, which we have mentioned several times during the call. These are three of the larger factors influencing our outlook. Furthermore, there are various elements affecting different business segments. Sequentially, it’s crucial to note that China was down for about two months in Q2, but we expect China to be fully operational with only a very modest impact from COVID in Q3. This will be the main factor affecting our results sequentially.

Operator, Operator

Thank you. Our next question comes from Josh Spector from UBS. Josh, please go ahead.

Josh Spector, Analyst

Yes, hi. Thanks for taking my question. I was wondering, within Architectural Coatings, could you discuss some of the volume differences in DIY versus trade markets, I guess, specifically looking at North America and Europe. And I guess given some of the commentary about Europe, where you're still seeing declines on technically easier comps from last year, what does that say about your thoughts about DIY and how that holds up in a recession, this cycle potentially? Thanks.

Tim Knavish, COO

I'll take that one, Josh. This is Tim Knavish. Thanks for the question. The biggest driver of the volume issue in DIY is clearly Europe. We've seen a double-digit decline in DIY volumes in Europe. And, frankly, we expect that to continue. We called it at the end of the last quarter, that was accurate, and we expect that same phenomenon to continue. The trade volumes in Europe are a bit stronger. It depends on some by country. We're seeing some softness in some countries of trade and other countries like France, we continue to do very well on the trade side of the business. So that's more mixed. And when you come over to this side, to the United States, we've also seen DIY, I would call it more normalizing, where Europe was down because of a number of issues, whether it was coming out of COVID or consumer confidence because of the war. Here in the United States, it's more normalizing in a post-COVID environment, whereas in the trade side of the business here in architectural US, we still see very good backlogs. We do a survey of our professional painters every quarter. And about 80% of the professional painters that we surveyed here in the US this quarter have as much or larger backlogs than they did last quarter. So DIY normalizing here, but still good trade backlogs.

Vince Morales, CFO

This is Vince. A couple of other points here. In the US, we were still impacted early in the quarter in our US architectural business by supply challenges. April, May are still in the heart of the paint season. And in Europe, based on what we've seen to date, we're very comfortable with our share position.

Operator, Operator

Thank you. Our next question comes from Frank Mitsch from Fermium Research. Frank, please go ahead.

Frank Mitsch, Analyst

Thank you and good morning, folks. I appreciate the level of detail. Coming to the use of cash, Tikkurila is rolling off as a driver as part of the M&A increase. And I know that M&A is important to PPG. You did mention that you stepped up buybacks in a quarter at attractive prices. But I'm just curious as to what the outlook is on the M&A front that's out there.

Michael McGarry, CEO

Frank, this is Michael. The M&A front continues to be what I would call steady. You saw there were some deals done in the past 90 to 120 days. We obviously looked at those and decided that we sort value creating from a PPG shareholder perspective. And we continue to look at our portfolio. You probably noticed that we sold a couple of businesses. You saw we sold Everly and another small one. And so we're always looking at our portfolio. But we're going to do what's best. So this quarter, paying down debt and buying back a little stock made the most amount of sense. We're going to continue to look at our portfolio and decide what we're going to do. The pipeline remains what I would call steady, and we're continuing to talk to the Board about the options that are out there.

Operator, Operator

Thank you. Our next question comes from Laurent Favre from BNP Paribas. Laurent, please go ahead.

Laurent Favre, Analyst

Good morning, all. I had a question regarding this contingency plan on the European side. I mean, I hope you're right on, I guess, the lack of big curtailments of chemical production and all the mess that would be related to that. But I was wondering if you could talk about two things. One is, are you thinking about raw materials inventories and stocking up perhaps into a more turbulent time? But also in terms of areas where you may have single sourcing, I know that there was a big surprise last year in the US, I'm wondering if you plan from the US side and that now all of your European operations can run on dual sourcing, for instance, so that you can indeed import those raw materials from elsewhere? Thank you.

Michael McGarry, CEO

So Laurent, this is Michael. First of all, it's virtually impossible to be dual source on everything because we make some unique chemistries. On those that we are single source, we have a contractual relationship with our suppliers to provide that protection that we need. But we have been in a mode of being conservative on inventories right now. In Europe, though, we are going to be moving toward a mode of destocking over the next few months. We've already started to see availability raw materials get better. We anticipate that prices, we've seen some prices already soften in China. We anticipate some softening coming up in Europe. And so the plants have already put in place contingency plans. They've enacted some to lower costs. And so from that standpoint, I think we feel very comfortable. We have some additional plans in place as well.

Operator, Operator

Thank you. Our next question comes from Arun Viswanathan from RBC Capital Markets. Arun, please go ahead.

Arun Viswanathan, Analyst

Great. Thanks for taking my question. I guess, I just wanted to go back to the bridge potentially to maybe $9 or something close to that in 2023 or 2024. If you think about that, that seems to be likely that it would have to be composed of something around $250 for Q2, Q3 and $2 for Q1, Q4, I guess, is that correct? I mean, that would imply like a 20% improvement on a quarterly run rate basis. And if you think about that 20%, is that maybe one-third volume improvement and two-thirds kind of margin recovery from price cost? Or how should we think about that path to getting back to that kind of earnings power?

Vince Morales, CFO

We'll try to take another stab at this, Arun. This is Vince. So look, we're down 10% in volume versus 2019. We expect the vast majority of that to return. Again, because of some of these decremental items are in very large businesses for us and businesses that are showing today, and we expect on a go-forward basis, good recovery momentum. Again, we talked about auto. We talked about aerospace. There are a couple more that are smaller. We do expect positive business mix as part of that equation as well. To your point on price, raws recovery, we've talked about a couple of times. We're still down in Q3 on a cumulative basis. We expect to be at least at parity by the end of the year on price raws, so that will pick up several points. And then I don't want to underemphasize what Michael talked about with respect to manufacturing. We typically have productivity improvements year-over-year from our manufacturing operations. If you look at the past 12 months, we've had decrements in manufacturing. So we expect to fully recover those decrements and move back to our legacy of producing productivity. So those three things, coupled with synergy capture and coupled with some cash deployment, gets us to the $9 plus of earnings power we've talked about.

Operator, Operator

Thank you. Our next question comes from Prashant Juvekar from Citi. Prashant, please go ahead.

Prashant Juvekar, Analyst

Yes. Hi, good morning. You talked about European DIY being slow. You've talked about that for a while. How did the European industrial business do throughout the quarter? Did it slow down as the quarter progressed? And then a related question to that is, are you seeing a rebound in industrial activity in China? And do you think that China activity or industrial activity can grow if the US and Europe are slowing down? Thank you.

Vince Morales, CFO

Yes, P.J., we saw declines in architectural in Europe, obviously, as Tim talked about. Automotive on a year-over-year basis and our industrial business on a year-over-year basis were also down, let's call it, mid-single-digits due to some of the same issues that caused economic slowing in the region. On a go-forward basis, auto, we expect to recover at some point. It's still going to be choppy in the back half of the year in Europe. It's going to certainly recover in the US and in China. Industrial activity, we expect at least at parity. We are seeing a very rapid recovery in China from the COVID shutdowns and expect growth on a year-over-year basis in Q3. With respect to Europe slowing, would China grow? Again, we think China is becoming more of an internally consumption market, and we still feel good about the US economy. So, there are some offsets to a European slowing that would allow China to produce good industrial activity results.

Michael McGarry, CEO

P.J., this is Michael. I think if you think about this from a China macro standpoint, the Chinese government is under significant pressure right now because of some of these COVID lockdowns. And they're injecting money, reducing the amount of bank restrictions, and they're putting pressure on the building industry as well. So, they are showing every sign to make sure that the local economies in China continue to recover. So, I feel pretty good about the fact that China is committed to having a better second half of the year than they had the first half of the year.

Operator, Operator

Thank you. Our next question comes from Michael Sison from Wells Fargo. Michael, please go ahead.

Michael Sison, Analyst

Hey guys, nice quarter. It does feel like a recession is the consensus view pending these days and your portfolio has changed. So, just curious, overall, how do you think the current portfolio would, in terms of volumes, would hold up in a recession? And given you've got $2 billion worth of inflation, is it possible that you could potentially offset that entire volume decline because you get a lot of this inflation back and maybe PPG's earnings look a little bit more resilient than maybe in the past?

Michael McGarry, CEO

I believe we have developed a more resilient company. We're also planning to retain more raw materials, meaning that if there's a decline in raw materials, it will have a quicker impact on our profit and loss than many realize. People may be overlooking this aspect. Honestly, even if there is a recession, which I don't anticipate to be significant, we have a different portfolio now. For instance, our traffic solutions business will continue to perform regardless of economic conditions, and they're currently facing a backlog. Additionally, demographic trends suggest longer lines, which will work in our favor. There's also a notable shortage of cars in the U.S., and similarly, the aviation sector is experiencing a shortage of planes. The new aircraft being introduced are much more fuel-efficient, making it impractical to keep older planes in service. If oil prices remain at around $100 for an extended period, aviation companies cannot afford to overlook these economic factors, prompting them to replace outdated aircraft. That's encouraging news. Regarding the work-from-home trend, we are seeing a shift where people are driving more in suburban areas rather than on highways, which tends to result in more low-speed collisions. Consequently, total claims have decreased by 2%, and I expect this downward trend to continue, benefiting our refinish business. Additionally, if someone experiences an accident now, they should be prepared for a waiting period of about six weeks for car repairs, assuming parts are available. Overall, I feel optimistic about our situation.

Vince Morales, CFO

And Mike, this is Vince again. I just wanted to compare the current situation to the last recession. In that time, we had a global housing and auto overhang, which we are not experiencing now. Michael mentioned aerospace, and we anticipate that it will be in recovery, along with the auto sector as it pertains to PPG's portfolio. Additionally, we have PPG-Comex, which remains a stable business for us, along with other steady businesses in different regions. Therefore, I believe Michael's initial remarks about our improved and more resilient portfolio reflect these factors.

Tim Knavish, COO

Yes. And Mike, it's Tim. Just to pile on here, even one more business from a recession or a potential recession resiliency standpoint, the military part of our aerospace business, given what's happening geopolitically, tremendous backlog there too.

Operator, Operator

Thank you. Our next question comes from Jeff Zekauskas from JPMorgan. Jeff, please go ahead.

Jeff Zekauskas, Analyst

Thank you very much. Your volume expectation in Performance Coatings for the third quarter is projected to be flat or decline by a low single-digit percentage. Isn't that too low? I understand that European Deco is weak, but isn't the aerospace sector performing better along with auto refinish? Last year, there were significant shortages in raw materials in the North American architectural market. Shouldn't we expect volumes to increase in the third quarter? Additionally, for Vince, inventories and receivables are rising at around a 10% rate, while payables are increasing at roughly half that rate. Is this trend expected to continue, and what accounts for the difference?

Vince Morales, CFO

Yes, Jeff, I'll address the second question first. Regarding inventory, we entered the quarter and the year focused on maintaining excess inventory wherever possible to ensure we can supply our customers. We are definitely considering this as we approach the latter half of the year. We will gradually reduce inventory as supply conditions have improved and continue to improve. Receivables have increased primarily due to higher pricing and a larger portfolio. I believe receivables are up by about $600 million to $700 million compared to last year. We expect to collect these amounts, and we are not experiencing any significant issues with collections. Therefore, the high receivable balance will convert to cash in the third and fourth quarters. As for payables, we are punctual with our suppliers, so there is nothing concerning in that area. Concerning the Performance Coatings volumes, there are various factors at play. Aerospace is up, as you mentioned, while the DIY segment is down in Europe, the US, and other mature markets like Australia. We are facing some difficulties in our protective business going into Q3, which stems from challenges in Q2 in China. With the reporting segment, there are always various factors influencing outcomes. This is our best estimate currently, and we hope we are being conservative in our projections.

Operator, Operator

Thank you. Our next question comes from Duffy Fischer from Goldman Sachs. Duffy, please go ahead.

Duffy Fischer, Analyst

Yes, good morning. Question just around raw materials. If you could talk about the different buckets, solvents, resins, pigments and maybe packaging. What's your view what's happening with price and availability going into the back half of the year? And then maybe kind of what do you think the two-year outlook is for some of these raw materials that have been quite tight?

Michael McGarry, CEO

Let's begin with the challenges we are facing. Emulsions continue to be problematic for us, and we have encountered a few force majeure incidents, including one recently in Next. We are not completely out of those challenges yet. Additionally, we have observed a weakening of TiO2 and other materials from China, which is now being shipped into Europe. The market for epoxies in Asia is also showing signs of weakness. Several of our solvents are starting to stabilize, with much improved availability, although pricing is also leveling off. The same trend applies to packaging, which is also stabilizing. Overall, we categorize our raw materials into about 12 categories. Last quarter, 11 out of those were experiencing price increases, but this quarter, we see four or five that are stabilizing, indicating moderated prices, with one category showing improvement. Looking ahead to the fourth quarter, we anticipate further improvements in several categories. This suggests we may be nearing the end of raw material inflation, which bodes well for us. We expect low single-digit changes in the third quarter, with sequential improvement in the fourth quarter.

Tim Knavish, COO

Hey, Duffy, it's Tim. Just to add to what Michael said. While supply is significantly better than it was at the beginning of Q2 and certainly better than last year, we still have spot supply issues, I would call it, in refinish, in auto, in architectural. So we're not quite back to what you would call completely normal supply, pre-COVID kind of supply situations, although sequentially much better, and we expect that to sequentially continue to improve.

Vince Morales, CFO

And Duffy, you asked about this. It's Vince. Just about two years. That's beyond our forecasting horizon. We typically have visibility into three to six-month windows, so we can't make predictions for two years. If there is structural commodity supply being built in China, we plan to fully exploit that. But that's the best we can provide regarding a two-year outlook.

Operator, Operator

Thank you. Our next question comes from Vincent Andrews from Morgan Stanley. Vincent, please go ahead.

Vincent Andrews, Analyst

Yes. Thank you. Just wondering if you can talk a little bit about the cost work you're doing in Europe and whether that's sort of structural or just sort of temporal. And along those same lines, given sort of the normalization in DIY, has there been an opportunity to reduce maybe promotional spending? I mean, maybe that was already being reduced during the hot demand period, or ad spending. Or is anything changing on how you're allocating investment spending into that business?

Michael McGarry, CEO

Well, certainly, on the ad spending, as you see the decline, you're also getting near the end of the paint season by the time the quarter is going to be over. So that is on a decline. That's typical, though. So that's not really that much of a difference. We do bucket our cost reductions in Europe into two things. One is structural and one is short term. The structural ones, you see that flowing through. We have plants that we have targeted to be closed. We have headcount that we're taking out. We have productivity initiatives through dispense cells and other high-volume packaging equipment that is driving productivity in the plant. All those things are underway. And then, of course, we are on a temporary basis. You are reducing headcount as you're seeing that lower demand in the Architectural segment. So I'm feeling comfortable that we're going to continue to grow margins. If you look at our history in Europe, we have consistently grown our earnings in Europe year-over-year regularly. So I don't think this should be any different this year.

Tim Knavish, COO

Hi, Vince, Tim here. We also have continuation of the Tikkurila synergies, which, of course, are structural. We've captured a lot of those. But footprint-wise and back-office wise, we continue to make progress there. And just to put some perspective, margin improvement progression has continued in our AC Europe business despite the volume challenges, and we expect that to continue as well.

Operator, Operator

Thank you. Our next question comes from Mike Leithead from Barclays. Mike, please go ahead.

Mike Leithead, Analyst

Great. Thanks. Good morning, guys. Just on auto OE. I was hoping you could give some context about your volume levels today versus maybe, say, pre-pandemic. I'm just trying to figure out, if we get back to, say, a 2019 type build rate, what sort of upside does that offer? And maybe just remind us what type of incremental margin levels we should think about broadly for your Industrial Coatings business today after all the restructuring and whatnot.

Vince Morales, CFO

Well, Mike, if I remember right, last year, there was about 78 million cars built. We're on a path to have a little bit over 80 million cars built. At the peak, it was 95 million cars, and there is a substantial backlog of vehicles that need to be built. And plus, I think what you're going to be seeing, you're already starting to see some of these electric vehicles being made in China that are being exported to Europe. So you're going to start to see a better mix in our automotive business because of mobility. And right now, our margins in automotive are improving on a sequential basis. So what I would do is I'd look back at the historical margins in our industrial segment. And you know automotive is the biggest business in that. So they're going to be somewhat close to that margin, and that's the way I would do the math. Yes. Mike, I’d like to expand on what we refer to as the latent demand in the auto sector. We mentioned this last quarter, but US dealer inventory is currently just under 30 days, whereas typically it would be over 60 or even 70 days. This indicates that inventories need to be replenished. There's been a significant fleet rebuild process occurring in the US, which includes company-owned vehicles as well as other fleet cars. This has a considerable impact. Additionally, there will eventually be a rebuild of the European fleet, which includes a substantial number of employees having company cars in Europe. This adds to the demand. Presently, many vehicles are on back order. Therefore, we feel confident about the next 12 to 15 months, anticipating a robust recovery back towards the high 80s or low 90s level. Overall, the industry is still down nearly 20% compared to pre-pandemic levels.

Operator, Operator

Thank you. Our next question comes from Mike Harrison from Seaport Research Partners. Mike, please go ahead.

Mike Harrison, Analyst

Hi, good morning. I was wondering if we could go back to some of the raw material availability issues and specifically dig in on what's going on in the Refinish business. It sounds like some of the raw material and logistics bottlenecks that you've been seeing are going to continue into Q3. So maybe just a little more detail on what you're seeing there? What needs to happen to get some resolution to those supply issues? And I guess, is your expectation that, that improvement is going to happen sometime this year? Or is that an early 2023 thing? What's the timing looking like? Thank you.

Tim Knavish, COO

Hey Mike, it's Tim. Despite having a record quarter in Refinish, which we anticipate will continue, we are facing ongoing shortages of certain raw materials that have contributed to some backlogs. In addition to our customers' existing backlog of work, we also have our own backlog to manage as we try to replenish the channel due to these issues. This situation won't resolve quickly, but it is gradually improving. I expect we will continue to make progress on this for the remainder of the year. Additionally, with the high activity levels in body shops, particularly in the US, there is some pent-up potential for us as we work through inventory replenishment over the year.

Operator, Operator

Thank you. That is the end of the Q&A session. So I'll now hand you back over to John Bruno for closing remarks.

John Bruno, VP of Investor Relations

Thank you, Lauren, and everyone, for listening, for your interest in PPG. I look forward to talking and seeing many of you in the coming weeks. This concludes our second quarter earnings call. Have a good day.

Operator, Operator

This concludes today's call. Thank you for joining. You may now disconnect your lines.