Ladies and gentlemen, thank you for standing by, and welcome to the Axalta Coding Systems 2019 Financial Outlook Conference Call. All participants will be in listen only mode. A 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 Chris McCray for a few introductory remarks. Please go ahead, sir.
Thank you, Robin, and good morning. This is Chris McCray. 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 the potential effect Exulta'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 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 Landon has been named permanent CFO. Over the last two months, I've solicited feedback for 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 5 major goals in 2019, which are outlined on page 3 of the deck. First, we will seek to drive sales and profit growth greater than our competition while increasing our rate to solidify and 3rd, we'll focus on flawless execution and its measurement across all areas of the company. 4th, we will continue to foster a culture customer and market focus and where all decisions are based on concrete business cases.
5th, We will ensure We will be relentless and passionate in 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, in 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 and contributes to our $50,000,000 targeted range of adjusted 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 US 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. If necessary as the year develops.
Technology and working capital on the highest return projects to maximize free cash flow conversion. We will maintain the conservative balance sheet including lowering our target net leverage ratio from the from 2.5x to 3.0x range to now 2.5x. 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 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 $75,000,000 in stock at an average price of $24.15. I will now hand the call over
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 4, 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 4th 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 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 UK 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% to 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 percent sales contributions from M And A in 2018. For adjusted EBITDA, we are projecting a range of $950,000,000 to $1,000,000,000, 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 $12,000,000 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 $165,000,000. Axalta's book tax rate as adjusted is expected to fall between 20 23% for 2019, slightly higher than our 2018 range of 18% to 20%. Due to the absence of any forecast stock compensation, excess benefits, which were approximately 2 hundred basis points in 2018, as well as the marginal negative impact associated with year 2 of U.
S. Tax reform and slight impacts on mix of jurisdictional earnings. For free cash flow, we expect to generate $430,000,000 to $470,000,000 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 120,000,000 This working capital assumption is inclusive of upfront customer investments of approximately 100,000,000 Regarding capital allocation, we remain focused on M And A first. We continue to look to source and close deals similar to those we have done in the last 3 or so years, and our pipeline suggests this is achievable.
Target returns on bolt on M and 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 lowering the net debt ratio towards our equilibrium target of 2.5 times. CapEx is expected to be roughly $160,000,000 depreciation and amortization is estimated to be approximately $375,000,000, which is inclusive of $25,000,000 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 $250,000,000 of share repurchases in 2018. On slide 5, 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. Exalta 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 20172018. 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 and we are forecasting that to continue into 2019. As to date, the government has not offered direct stimulus. Global production forecast 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 and part acknowledging that global macro forecast 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. Exolve this 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, and we continue to focus efforts to grow our industrial end market. Expectations for transportation remain uncertain 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, based on what we see as reasonable demand and execution outcomes and 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 for Q and
Our first question comes from the line of David Begleiter with Deutsche Bank. Please proceed with your questions.
Robert, just on raw materials, can you give a little more color on your expectation of, I guess, of 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 $12,000,000 that number could be higher. We have most list 1 and list 2 items inflating at about 25% and some of the items on list 3 at 10%. Predominantly, it's driven by aliphatic diazocyanates. As you know, there's some there's some tightness due to a material outage in France for 1 of the key raw materials. We also see some impact in specialty solvens, specialty monomers, additives and pigments that are sourced across, 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, but it's only been a couple of months that prices have been that prices have been down. So we'll have to see how that how that trends in those categories going forward. If we look at resins, isocyanates, as I mentioned, additives and pigments, there, we do continue to see pricing pressures given what's going on from a supply perspective at this time.
And 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 Gashan Panjabi with Robert W. Baird. Please proceed with your questions.
Hey guys, good morning. Happy holidays and 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 aerodexanality and end market climate. On Slide 5.
What gives you context, Robert? 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, industrial coatings team and our the broader organization really outperformed the market. Our team's done an outstanding 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. So we are trying to take into account the fact that there could be an 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 other 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. And while the mid single digit growth may seem optimistic against certain measures, as we've mentioned before, we have a great deal of emphasis and Industrial Coatings, and our team has continued to deliver results in excess of expectations.
That's helpful. And then just second question in terms of all the looking at reasons you cited in terms of the choppy operating backdrop, how does that factor into your appetite for acquisitions? And then also just to clarify, how did you determine the 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. So we don't really see a fundamental change there. And then in terms of the leverage ratio, we had said previously that our target leverage ratio would be 2.5 to 3 times. And 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.
And given what we're seeing in some of the macro 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. And hence, that's why we've lowered the range from 2.5 to 3 times now down to 2.5 times.
Thank you.
The next question is from the line of Duffy Fischer with Barclays. Please proceed with your question.
First question is just around the working capital use, $120,000,000 seems like a big number. And I think you called out $100,000,000 in there as an investment maybe a new customers, can you kind of just break out where that those working capital dollars are going?
So Duffy, what I called out in my opening remarks is $120,000,000 of which $100,000,000 related to, upfront customer investments So these are items that we had talked about during the third quarter. Historically, these have been running around $70,000,000 to $80,000,000 at uptick quite a bit. In 2018, we expect that to fall back down in that $100,000,000 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. Okay.
And then, just on the kind of reduction in the target ratio for debt, technically, how will you operate that to get down to that 2.5? I mean, 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 is that would be a buildup of cash, Duffy. We're not expecting it at today's interest rate levels, being at 3.7to3.8percent that we would be actively paying down debt. So that's a net debt number that we're referencing.
The next question is from the line of John McNulty with BMO Capital Markets. Please proceed with your 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 in terms driving that kind of performance and accountability going forward. How should we think about that?
Basically what we're trying to indicate there is said, we will, as we have an 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. So procurement, procurement of raw materials, making good, selling good shipping goods, getting goods in our customers' hands that are 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. And then I guess one last one last area in terms of, 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 success somewhere has maybe been a little bit more struggle. Can you give us an update beyond just the auto OEM front as to 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 and logistics, and in general wage inflation, we will continue to, of course, focus on reducing costs 1st and foremost. But beyond that, we will need to get additional additional price capture in order to offset that that cost inflation as will other companies in our industry and as well as others. So I think you'll see us continue to push for price in 2019. And the amount of course that would that we have to, that we have to push for will largely depend on, how the basket of those costs inflates during the cost of the year. And 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 Fine 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 US are and 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 our models here internally as we as we think about things. Globally, for 2019, it appears 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 a percent.
I think we're potentially a little skeptical of growth rate assumption currently by the market forecasters in China, just given over the last 4 months, having seen the trend down in builds. I think we're trying to take a relatively realistic assumption there.
Fair enough. And 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. And if you can give some color on a regional basis, that would be very helpful. Thank you.
As we've seen across the, you know, across the globe, we're seeing an, you know, in each market around the world, there's been significant, significant cost inflation And 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.
The next question is from the line of Kevin McCarthy with Vertical Research Partners. Please proceed with your questions.
Good morning. It's Matt Dio 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 like 2016, 2017, or should we think about it as mid high teens? And 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 and D investment that is required, And when you also look at the technical support costs that are required, we 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. And then, so dividend payments have not been
an issue or have not been a focus for Xult in the past, but I know it's a topic of interest among some investors. I guess, how do you view the prospects of initiating a dividend?
Yes. Currently, as we think about capital deployment, that's not one of our priorities. M and A is going to continue to be a focus for us as well as share buybacks, especially at these current levels. But as far as dividends, we're not anticipating making any in the foreseeable future.
The next question is from the line of PJ Juvekar with Citibank. Please proceed with your question.
Hey, good morning guys. It's Dan Jester on for PJ. I just wanted to go back to to M And A. Can you just give us an update on the on the pipeline? You know, have buyers changed their expect to or sorry, hit sellers change their expectations at all over the past couple of quarters?
And, you know, any change in your in your focus between, you know, region or or end market.
Our focus continues to be, 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, but, build that out regionally as well as new verticals within industrial where we would like to play. So I think you'll continue to see that, that strategy remains pretty much unchanged. And then in terms of valuation, expectations, I'd say we haven't seen a material change in the last quarter. But 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. And then on the the demand side, you know, it's, you know, a lot of the commentary on the call has been about, like, vehicles in China. I'm just wondering if you broaden that lens out, throughout sort of more industrial related end markets in China, are you seeing any significant slowing there or is it predominantly, like, 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 well as the tighter credit situation and a number of other variables. So I think your question is a good one. It is not only confined to 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 per se. 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
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. We thank you for your participation.