Ladies and gentlemen, thank you for standing by. Welcome to the Axalta Coating Systems 2019 financial outlook conference call. All participants will be in listen-only mode. The question-and-answer session will follow the management presentation. Today's call is being recorded and replays will be available through December 26th. Those listening after today's call should please take note that the information provided in the recording will not be updated and therefore may no longer be current. I would like to turn the call over to Christopher Mecray for a few introductory remarks. Please go ahead, sir.
Thank you, Rob, and good morning. This is Christopher Mecray of Investor Relations. Welcome to our 2019 financial outlook conference call. I'm joined today by Robert Bryant, CEO, and Sean Lannon, CFO. This morning we posted a slide presentation to accompany this call on the investor relations section of our website at axalta.com. Both the prepared remarks and discussion during this call may contain forward-looking statements reflecting the company's current view of future events and their potential effect on Axalta's operating and financial performance. These statements involve uncertainties and risks that may cause actual results to differ materially from those forward-looking statements. The company is under no obligation to provide subsequent updates to these forward-looking statements. This presentation also contains certain non-GAAP financial measures.
For additional information regarding forward-looking statements and non-GAAP financial measures, please refer to our filings with the SEC. I will now turn the call over to Robert.
Good morning, everyone, and thank you for joining us as we share our preliminary 2019 outlook for Axalta. We will update and finalize our 2019 guidance on our full-year 2018 results call. First, I'd like to say that I'm thrilled to have been named by the board as Axalta's permanent CEO and that Sean Lannon has been named permanent CFO. Over the last two months, I've solicited feedback from many of our shareholders across a variety of topics. I sincerely appreciate the insights and candor that you've shared with me. Based on your feedback, as well as my own assessment of our company's opportunities and challenges, you will see several adjustments at Axalta over the next 12 months in the areas of focus, alignment, execution, and performance management. Our team at Axalta will focus on five major goals in 2019, which are outlined on page three of the deck.
First, we will seek to drive sales and profit growth greater than our competition while increasing our rate of free cash flow conversion. Second, we will use innovation and simplicity to solidify and extend our competitive advantages and increase customer satisfaction and loyalty. Third, we'll focus on flawless execution and its measurement across all areas of the company. Fourth, we will continue to foster a culture that is accountable, collaborative, agile, customer and market-focused, and where all decisions are based on concrete business cases. Fifth, we will ensure that we have the best talent in all key positions to realize our strategy and long-term goals. We will be relentless and passionate in the pursuit of these five goals. We will discuss Axalta's longer-term strategy and goals at our 2019 Capital Markets Day to be held in the late spring.
Regarding the 2019 general business environment, based on what we're currently seeing today, macroeconomic, geopolitical, commodity, and currency factors will likely result in choppy and more volatile markets than we saw in 2018. The ongoing U.S.-China trade discussions, lower China growth, the uncertain Brexit outcome, slower European growth, and lower automotive build rates in China and Europe may impact underlying demand for coatings products. Although oil prices have recently fallen, supply shortages in certain raw materials and trade tariffs will likely diminish the margin benefit we might otherwise see from lower input costs. These factors, combined with evolving central banking policy around the world, are also expected to create more volatility in FX markets. In short, the range of potential outcomes next year is fairly broad and contributes to our $50 million targeted range of adjusted EBITDA that Sean will comment on shortly.
Potential outcomes that could push our results to the upper end of our preliminary 2019 guidance could include lower raw material inflation, better growth in China and Europe, a more favorable outcome to the U.S.-China trade discussions, more successful implementation of price increases in our Transportation Coatings segment, and a weaker U.S. dollar. As a result, Axalta will focus on the following in 2019. We will continue to implement price increases to offset raw material inflation in both of our operating segments. We will continue to drive our Axalta Way productivity initiatives and accelerate them if necessary as the year develops. We will prioritize investments in M&A, capital, R&D, technology, and working capital on the highest return projects to maximize free cash flow conversion. We will maintain a conservative balance sheet, including lowering our target net leverage ratio from 2.5x - 3.0 x range to now 2.5 x.
We will accelerate our penetration of underserved markets and customers in Refinish. We will continue to build out our Industrial business in existing and new verticals. Finally, we will support the growth of our Transportation customers, but will strive to be fairly compensated for the high capital intensity, world-class technology, and high service levels this business requires. In closing, we believe in the long-term value creation opportunity for Axalta, especially at current trading levels. As such, since the beginning of November, we have repurchased $75 million in stock at an average price of $24.15. I will now hand the call over to Sean, who will review our preliminary 2019 guidance metrics and key drivers.
Thank you, Robert, and thanks to those on the call. I look forward to working with many of you and getting to know you better as Axalta's new CFO. Turning to slide four, we have detailed some key financial metrics for Axalta's preliminary 2019 outlook compared against our current guidance for 2018, last updated on October 25th. Regarding fourth quarter performance, our results through November have been largely on plan with our latest guidance. While demand indications in our end markets have been broadly stable, we acknowledge that China automotive markets continue to weaken, and there has been some softening in U.S. housing-related markets which impact our wood coatings business. In Europe, Brexit uncertainty may be dampening the impact on U.K.-related markets.
In aggregate, however, we have not seen a major shift to date in the quarter outside of these already widely reported elements, and we believe we are on track to meet our guidance as updated in October for the remainder of the year. For 2019, we expect net sales to grow 2%-3% before FX headwinds of approximately 1%. This includes ongoing price realization, primarily coming from Performance Coatings and ongoing growth in both Refinish and Industrial end markets. We take a more cautious base assumption from Transportation Coatings, given still unresolved questions around China demand, as well as ongoing factors which could impact the outcomes of our intended raw material inflation pricing offsets. We also have no material contribution expected in 2019 from completed acquisitions versus the approximate 3% sales contributions from M&A in 2018.
For adjusted EBITDA, we are projecting a range of $950 million-$1 billion, which implies modest margin expansion at the midpoint of our guidance from just over 20% this year to about 20.4% in 2019. This is driven principally by ongoing price and mix contribution, modest volume growth, and the benefit of incremental Axalta Way savings. This is offset by projected further variable input pricing pressure, currently anticipated to inflate around low single digits on a percentage basis at the variable cost of goods sold level, including approximately $12 million related to trade tariffs. We are also expecting further headwinds related to the drop through impact of the FX headwinds noted for net sales, as well as operating expenses in 2019 supporting discrete projects, including the pre-announced Belgium site closure as we begin the transition-related steps and the associated timing of when certain Belgium employees will exit Axalta.
In the aggregate, FX and these operating expenses will approximate a 3% headwind for adjusted EBITDA in 2019. Interest expense for 2019 should approximate $165 million. Axalta's book tax rate, as adjusted, is expected to fall between 20%-23% for 2019, slightly higher than our 2018 range of 18%-20% due to the absence of any forecasted stock compensation excess benefits, which were approximately 200 basis points in 2018, as well as the marginal negative impacts associated with year two of U.S. tax reform and slight impacts on mix of jurisdictional earnings. For free cash flow, we expect to generate $430 million-$470 million in 2019, which implies 46% of adjusted EBITDA at the midpoints. This result is driven by expected adjusted EBITDA growth and an assumed use of working capital of approximately $120 million.
This working capital assumption is inclusive of upfront customer investments of approximately $100 million. Regarding capital allocation, we remain focused on M&A first. We continue to look to source and close deals similar to those we have done in the last three or so years, and our pipeline suggests this is achievable. Target returns on bolt-on M&A remain in the mid-teens and above. Opportunistic share buybacks will remain an alternative use of capital that we expect to create value, while remaining excess cash flow can contribute to lowering the net debt ratio towards our equilibrium target of 2.5 times. CapEx is expected to be roughly $160 million. Depreciation and amortization is estimated to be approximately $375 million, which is inclusive of $25 million in accelerated depreciation associated with our Belgium site closure. Diluted share count does not currently anticipate any additional share repurchases in 2019.
However, it does largely benefit from approximately $250 million of share repurchases in 2018. On slide five, we have a few bullets on key drivers for our end markets in 2019. For Refinish, we see a fundamentally stable global market, as expected, given the highly dispersed nature of the market and the basic underpinning of miles driven. For next year, we expect modest market growth and continued incremental share gains consistent with our established pattern. Axalta continues to diversify geographically as well as deepen our product offerings, both of which contribute to this market outgrowth. In our Industrial end market, we continue to drive organic growth through active innovation investment. New product introductions and active selling investment have translated to high single-digit organic growth for Industrial during 2017 and 2018. We expect mid-single-digit organic growth to continue into 2019, and maintain a robust investment profile coupled with market-specific strategies.
Within the Transportation segment, the light vehicle end market remains fairly stable in terms of aggregate global demand. China continues to exhibit further weaker fundamentals. We are forecasting that to continue into 2019, as to date, the government has not offered direct stimulus. Global production forecasts currently indicate flat to 1% growth next year, including modest growth in the Americas and EMEA, offset by some pullback in Asia-Pac , driven by China. For Axalta, we're expecting flat to modest growth, in part acknowledging that global macro forecasts remain in active adjustment mode given fundamentals we see today. Finally, in commercial vehicle, truck markets are expected to remain healthy in most areas, including North America, which is our largest exposure. Axalta's focus remains on broadening our presence in underserved markets for truck and growing in other non-truck submarkets, including bus and train, among others.
For 2019, we forecast modest net sales growth, in part given our ongoing focus on accomplishing pricing offsets to structural inflation. For our consolidated results, we see an overall market environment that supports a stable result with slightly mixed trends across our businesses. The Refinish market remains the core underpinning. We continue to focus efforts to grow our Industrial end market. Expectations for Transportation remain uncertain, with the global demand picture complicated by some regionally specific demand ripples. Given this, we've opted to begin the year with a forecast that relies more on ongoing price realization rather than volume growth.
Overall, however, we see ongoing top-line and profit growth in 2019 based on what we see as reasonable demand and execution outcomes. We look forward to providing updates on this outlook as we move through 2019. We thank you for your attention and would like to open the line up for Q&A. Operator?
Thank you. At this time, we'll be conducting a question-and-answer session. If you'd like to ask a question, please press star one from your telephone keypad, and a confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants that are using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of David Begleiter with Deutsche Bank. Please proceed with your questions.
Thank you. Good morning. Robert, just on raw materials, can you give a little more color on your expectation of, I guess, an increase next year, and exactly what products are in supply shortage, and where you might get some tailwinds, i.e., from either low oil-based raws or TiO2? Thank you.
David, we expect currently the impact from tariffs on our raw materials to be about $12 million. That number could be higher. We have most list one and list two items inflating at about 25%, and some of the items on list three at 10%. Predominantly, it's driven by aliphatic diisocyanates. As you know, there's some tightness due to a material outage in France for one of the key raw materials. We also see some impact in specialty solvents, specialty monomers, additives, and pigments that are sourced across geographies. Overall, as we look at the basket of raw materials, if oil prices continue to stay down, we could see some relief in solvents and in monomers beginning in Q1. It's only been a couple of months that prices have been down. We'll have to see how that trends in those categories going forward.
If we look at resins, isocyanates, as I mentioned, additives, pigments, there we do continue to see pricing pressures given what's going on from a supply perspective at this time.
Robert, just on auto OEM pricing, do you expect to get any pricing in 2019 on auto OEM?
As you saw in our press release issued several weeks ago, we have initiated several price increases with certain customers around the globe, and those price increases are currently in progress. We'll have probably more to update on that as we go forward in future earnings calls.
Thank you.
Our next question is from the line of Ghansham Panjabi with Robert W. Baird. Please proceed with your questions.
Hey, guys. Good morning. Happy holidays.
Morning, Ghansham.
Congrats on shedding the interim title. Morning. I guess first question on Industrial. It looks like it's still expected to grow in 2019 based on the [inaudible] and end market climate on slide five. What gives you confidence, I should say, in context of the current market anxiety about global growth specific to that segment?
What we've seen throughout the year, our Industrial Coatings team and the broader organization really outperformed the market. Our team's done an outstanding job there, growing in the high single digits organically. You do see a little bit of conservatism in our projection in 2019 as we talk about mid-single-digit organic growth. We are trying to take into account the fact that there could be, based upon what we're seeing now, we'll have to wait and see as we get into Q1 from an Industrial production as well as some of the other markets that are driven by other factors within Industrial. We could see some pressure there in 2019, so we've tried to reflect that conservatism.
While the mid-single-digit growth may seem optimistic against certain measures, as we've mentioned before, we have a great deal of emphasis in Industrial Coatings, and our team has continued to deliver results in excess of expectations.
Okay, that's helpful. J ust second question in terms of all the litany of reasons you cited in terms of the choppy operating backdrop, how does that factor into your appetite for acquisitions? Also, just to clarify, how did you determine that 2.5 times is the right leverage ratio for the company versus what you had previously? Thanks so much.
From an acquisition perspective, it won't fundamentally change how we think about things. We continue to pursue bolt-on and tuck-in acquisitions consistent with our strategy. We don't really see a fundamental change there. In terms of the leverage ratio, we had said previously that our target leverage ratio would be 2.5x-3 x, that any change in that would depend on potentially if there was an evolution in the interest rate environment as well as the macro environment. Given what we're seeing in some of the macro elements that I'm sure you all are seeing as well for next year, we just think it's helpful to be a little bit more conservative from an overall leverage perspective, hence, that's why we've lowered the range from 2.5-3 times now down to 2.5 x.
Thank you.
The next question is from the line of Duffy Fischer with Barclays. Please proceed with your question.
Good morning, fellas. First question is just around the working capital use. $120 million seems like a big number, and I think you called out $100 million in there as an investment, maybe in new customers. Can you kind of just break out where those working capital dollars are going?
Duffy, what I called out in my opening remarks was $120 million, of which $100 million related to upfront customer investments. These are items that we had talked about during the third quarter . Historically, these have been running around $70 million-$80 million. That uptick quite a bit in 2018. We expect that to fall back down in that $100 million range. When we think about the other areas of working capital, we are expecting some improvement across AR inventory and accounts payable with some small offsets as it relates to accrued liabilities as we start to pay some of the pre-announced severance in 2019.
Oh, okay. Just on the kind of reduction in the target ratio for debt, technically, how will you operate that to get down to that 2.5x? What will you pay down? Is that kind of a net debt number where you'll just build cash, or is that a true reduction of debt at the end of the day?
That would be a buildup of cash, Duffy. We're not expecting it at today's interest rate levels being at 3.7%-3.8%, that we would be actively paying down debt. That's a net debt number that we're referencing.
Okay, great. Thank you, guys.
The next question is from the line of John McNulty with BMO Capital Markets. Please proceed with your question.
Yeah, thanks for taking my question. Robert, you had spoken, I guess, early on in your presentation about kind of a greater focus on accountability, that type of thing. I guess any changes in terms of now that you're the CEO, any changes in terms of how to think about management compensation at the division head level and that type of thing in terms of driving that kind of performance and accountability going forward? How should we think about that?
Basically, what we're trying to indicate there is that we will, as we have in Axalta, but I think we'll be stepping it up to an even higher level, really focusing on the day-to-day execution in the business. Procurement of raw materials, making goods, selling goods, shipping goods, getting goods in our customers' hands that are of the quality expectations, and then also making sure that we're providing the service levels, especially technical service that we need to be, and really focusing on just the basics of operating the business. That was really the spirit of that comment.
Okay, fair point. I guess one last area. In terms of the pricing that you've been trying to push through all year, I guess there have been certain areas where you've had some successes and some where it's maybe been a little bit more struggle. Can you give us an update beyond just the auto OEM front as to how we should be thinking about that as we're going forward?
Given the inflation that we've seen, not only in raw materials, but also in packaging, in logistics, and in general wage inflation, we will continue to, of course, focus on reducing costs first and foremost. Beyond that, we will need to get additional price capture in order to offset that cost inflation, as will other companies in our industry and as well as others. I think you'll see us continue to push for price in 2019. The amount, of course, that we have to push for will largely depend on how the basket of those costs inflates during the cost of the year. That'll be across both segments, Performance as well as Transportation.
Great. Thanks very much for the color.
Our next question is from the line of Christopher Parkinson with Credit Suisse. Please proceed with your question.
Hi, this is Harris Fein on for Chris. Thank you for taking my question. Could you just quickly break down your regional assumptions for light vehicle builds and specifically what your expectation is for U.S. SAAR? In Europe, how concerned are you about lower consumer confidence and some of the current WLTP headwinds, and maybe do you see those leaking into 2019 at all? Thank you.
For a preliminary guidance call, we won't get into specific assumptions within an end market around each one of those individual markets. At this point, the IHS forecasts, of course, were just updated within the last couple of days. We've fed those through our models here internally as we think about things. Globally, for 2019, it appears the market will be growing at about a little bit north of 1%, maybe 1.4%. China's projected to grow at about 2.2%, and Europe a little bit over 1%. I think we're potentially a little skeptical of the growth rate assumption currently by the market forecasters in China, just given over the last four months, having seen the trend down in builds. I think we're trying to take a relatively realistic assumption there.
Fair enough. Can you also just quickly comment on the pricing discipline that you're seeing in Industrial? We've seen some anecdotal evidence that it's getting better, but how are you seeing that evolve from your perspective? If you can give some color on a regional basis, that would be very helpful. Thank you.
As we've seen across the globe, we're seeing in each market around the world, there's been significant cost inflation. We have seen Axalta as well as the market in general, continue to increase prices to offset that cost inflation. We wouldn't expect that to change.
Thank you.
The next question is from the line of Kevin McCarthy with Vertical Research Partners . Please proceed with your question.
Morning, it's Matt DeYoe on for Kevin. Robert, just to start off, congratulations on the appointment to CEO. Starting on Transportation Coatings, over time, what do you think the right margin is for this business on the EBITDA basis? Is it the low 20% range we saw in 2016, 2017, or should we think about it as mid-high teens? Especially, I guess, in the context of your ongoing price increase initiatives.
I think the best way to characterize that is that the appropriate margin in our Transportation business is higher than we are today. When you look at the relative level of asset intensity, in other words, the amount of steel we have to put in the ground in order to service that business. When you look at the level of R&D investment that is required, and when you also look at the technical support costs that are required, w e need to be at a level that much higher than we're currently at today in order for the return on that investment to make sense.
Okay. Dividend payments have not been a focus for Axalta in the past, but I know it's a topic of interest amongst some investors. I guess, how do you view the prospects of initiating a dividend?
Yeah. Currently, as we think about capital deployment, that's not one of our priorities. M&A is going to continue to be a focus for us as well as share buybacks, especially at these current levels. As far as dividends, we're not anticipating making any in the foreseeable future.
All right. Thank you.
The next question is from the line of P.J. Juvekar with Citi. Please proceed with your question.
Hey, good morning, guys. It's Dan Jester on for P.J. I just wanted to go back to M&A. Can you just give us an update on the pipeline? Have sellers changed their expectations at all over the past couple of quarters? Any change in your focus between region or end market?
Our focus continues to be the same. As we talked about before, we're looking to continue to fortify our Refinish franchise to build out our Industrial business in the existing verticals we're in. Build that out regionally, as well as new verticals within Industrial, where we would like to play. I think you'll continue to see that strategy remains pretty much unchanged. I n terms of valuation expectations, I'd say we haven't seen a material change in the last quarter. What we would expect going forward is given the increase in interest rates as well as the macroeconomic outlook for 2019, we would expect expectations to start to come down.
Okay. On the demand side, a lot of the commentary on the call has been about light vehicles in China. I'm just wondering if you broaden that lens out throughout more industrial-related end markets in China, are you seeing any significant slowing there, or is it predominantly light vehicles where you're seeing the weakness? Thank you.
In China, it's not only in light vehicle. We are seeing some softening across broader industrial markets in China, reflective of the slowdown in the economy as well as the tighter credit situation and a number of other variables. I think your question's a good one. It is not only confined to light vehicle, but also to other industrial markets.
Thank you. At this time, we've reached the end of our question- and answer session for today. I'll turn the floor back to Robert Bryant for closing remarks.
Thank you, Rob. As we wrap up today's call, I'd like to reiterate the excitement the Axalta leadership team and I have about our company's future. We will drive even more energy around focus, alignment, execution, and performance measurement moving forward. We wish all of you a great holiday season and a prosperous new year. Thanks again for joining us this morning.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. We thank you for your participation.