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PPG Industries Cut to Neutral

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We are downgrading our recommendation on PPG Industries Inc. (PPG - Free Report) to Neutral factoring in the challenges the company is expected to face in the second half of 2012.

The Pennsylvania-based company racked up record earnings in second-quarter 2012 despite lower sales. It logged adjusted earnings of $2.36 a share, matching the Zacks Consensus Estimate.

Revenues, however, fell 0.8% year over year to $3,955 million, and also missed the Zacks Consensus Estimate of $4,153 million. Unfavorable currency exchange translation weighed on the top line in the quarter. Strong internal growth in domestic market was somewhat offset by weakness in Europe.

PPG Industries, which competes with the DuPont Performance Coatings segment of EI DuPont de Nemours & Co. , has a diversified business, both in terms of products offered and geographical presence. It has a leading position in several paints and coatings end markets. The company looks to grow its businesses strategically along with controlling costs.

Moreover, PPG Industries has a strong cash position, and continues to utilize cash on earnings growth initiatives. The company has been returning cash to its shareholders in the form of uninterrupted dividend payouts. It has also initiated restructuring measures, especially in its European operation, which is expected to fetch cost savings in the back half of 2012.

PPG Industries, in July 2012, announced a definitive agreement, under which, it will split its commodity chemicals unit and merge it with Georgia Gulf. The transaction, which is valued roughly $2.1 billion, is expected to consummate in late 2012 or early 2013. The move is expected to deliver enhanced value to PPG shareholders.

However, raw material costs have been a matter of concern. Although raw material costs have shown a moderating trend, the price of the company’s primary raw material TiO2 has been escalating. The company expects raw material inflation to continue to weigh on its results in the second half of 2012.

PPG Industries is expected to continue to face macroeconomic challenges going ahead. The company expects continued softness in the European market and foresees inconsistent growth in North America and Asia.

We also feel that PPG Industries’ significant presence in the U.S. construction, European architectural and global auto, appliance and industrial coating markets exposes it to substantial headwinds.

Our recommendation on the stock is in tandem with a short-term Zacks #3 Rank (Hold).

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