Every investor should take notice of PPG's warning

Myles Udland
Markets Reporter

Third quarter earnings season is going to ramp up in the weeks ahead. And some of the most closely-watched comments out of U.S. corporate will be any color on how inflation, a strong dollar, and President Donald Trump’s trade war with China are impacting the business outlook for the rest of this year.

On Monday, Pittsburgh-based coatings giant PPG (PPG) threw out the book on what it says will be a poor third quarter, citing virtually every concern investors have about the macro environment while cutting its earnings forecast for the third and fourth quarters of this year.

In a press release published after the market close, PPG provided earnings guidance for the third and fourth quarters that was well below Wall Street expectations. The market’s reaction was swift and decisive — in early trading on Tuesday, shares were down as much as 8.7%.

“In the third quarter, we continued to experience significant raw material and elevating logistics cost inflation, including the effects from higher epoxy resin and increasing oil prices,” Michael McGarry, PPG chairman and CEO said in a statement on Monday.

“These inflationary impacts increased during the quarter and, as a result, we experienced the highest level of cost inflation since the cycle began two years ago. Also, during the quarter, we saw overall demand in China soften, and we experienced weaker automotive refinish sales as several of our U.S. and European customers are carrying high inventory levels due to lower end-use market demand. 

“Finally, the impact from weakening foreign currencies, primarily in emerging regions, has resulted in a year-over-year decrease in income of about $15 million. This lower demand, coupled with the currency effects, was impactful to our year-over-year earnings and is expected to continue for the balance of the year.”

So there it is: commodities are up, Chinese demand is softening, auto inventories are on the rise, and a strong dollar is eating away at foreign sales. Sometimes companies will flag one or two or these as weighing on business, but PPG’s third quarter was hampered by all four. One expects it isn’t the only company dealing with these stresses.

Shares of PPG were sharply lower on Tuesday after the company said its third quarter earnings would miss expectations, citing a number of key macro factors for the poor performance.

In the third quarter, PPG now expects to earn $1.47-$1.51 per share on an adjusted basis, below the Street’s forecast for earnings per share of $1.59. In the second quarter, PPG reported adjusted earnings per share of $1.90.

Net sales in the third quarter are forecast to be $3.8 billion, the same as a year ago and down from $4.1 billion in the second quarter.

Fourth quarter earnings are also now forecast to be $1.03-$1.13 per share on an adjusted basis, below estimates for earnings of $1.32.

We are disappointed with the third quarter earnings results,” McGarry said.

“We continue to work proactively with our customers on higher selling prices to reflect the value of the products we sell and recover margins which have been negatively impacted by the raw material inflationary environment in all of our businesses. We will continue to aggressively manage our costs including accelerating restructuring activities wherever possible.”

And so while the U.S. economy continues to be defined by strong employment and modest inflation, a company “working proactively with its customers on higher selling prices” to recover margins does not sound like an environment where inflationary pressures are remaining at bay.

The market’s reaction to this news should also not be ignored. Last week, we noted that the trickle of S&P 500 companies reporting results over the last few weeks have seen investors punish poor quarters, with the average one-day stock reaction to results coming in at -1.2%. For companies that miss expectations, the average reaction in the second half of September was a drop of 3.5%. This trend appears to be holding.

And while PPG’s pre-announcement of a bad quarter isn’t on its own unique or out of the ordinary, as companies miss expectations all the time, the factors the PPG cites behind its current miss should grab the attention of every investor ahead of earnings season. These are all the risks that are out there, all in one place.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland