When the usually staid industrial gas sector gained the spotlight recently, thanks to hedge fund manager Bill Ackman's announcement of a large stake in a major player, two questions came to mind. Did the industry really deserve the extra attention it was getting, and more importantly, were there any good stock buys hidden in industrial gas? I decided to check it out. Here's some of what I found:
Industrial gas companies typically produce atmospheric gases and then distribute them for industrial use. Using air as a raw material, they produce gases like oxygen and nitrogen through separation processes. Other gases like carbon dioxide, hydrogen and helium are also offered. Large volume customers usually get supplied by on-site manufacturing plants. Customers with less gas needs can get merchant deliveries by tanker trucks to storage containers or in smaller cylinders under medium to high pressure.
The industrial gas sector is fairly low growth, mainly because it is highly reliant on economically sensitive customers such as chemical companies and the metallurgical industry. The good news is that, other than in deep economic downturns, the sector is a fairly strong income generator. Since they offer a necessary product, without a lot of competition, on a fairly stringent long-term contract basis, they are usually able to maintain good profit margins of between 10% and 17%.
Though capital intensive, with typically 70% to 90% of operating cash reinvested back into plant and equipment, industrial gas companies have put their free cash to good use. Most have been able to build up their businesses incrementally through a combination of acquisition, share buybacks and prudent leverage.
All in all, the industry looks like a very solid investment consideration with surprisingly stable profitability and slow but steady growth. While one probably can't go too far wrong buying into the sector at reasonable prices, the stocks look really appealing if able to be bought "on sale." Are there any sales in the sector currently?
Some of the Industry's Major Players
Whether due to a generally strong stock market or recent activist attention, there don't appear to be any bargains in industrial gas stocks at the moment.
Praxair Inc. (PX), the largest industrial gas company in North and South America with sales around $11 billion in 2012, reported net income of $445 million, up 4% from the prior year in its last quarter. Sales rose 7% to $3.1 billion, helped by strong volumes in Asia and South America with acquisitions contributing about 3% of growth. Revenues in North America, its largest region with 51% of total sales, came in at around $1.6 billion, up 11% from the prior year. Acquisitions and increased pricing contributed most of that gain with volumes flat.
Praxair's share price currently seem a bit rich. Using a cash earnings times a capitalization multiplier valuation, fair business value looks around $112 a share at a 16 times multiple, slightly higher than its mid-2000s historical multiple average of 15 times. The calculation is based on revenues of around $12.1 billion, cash earnings of $2.08 billion, and a cash profit margin of around 17.2%.
Air Products & Chemicals (APD), with fiscal 2012 sales of around $10 billion, received a lot of attention lately when Bill Ackman (Trades, Portfolio) revealed a 9.8% stake in the company. In its most recent period, Air Products reported adjusted net income of $288 million, down 5% from last year’s comparable quarter. Revenues of $2.5 billion increased 9% versus the prior year. Underlying sales were down 2% due to a business divestiture but acquisitions contributed 6% and higher energy cost pass-throughs boosted sales 5%. Its largest business segment, merchant gas with 41% of total sales, had revenue of $1.03 billion, an increase of 18% versus the prior year on stronger volumes and a major acquisition. On-site gas segment sales of $846 million increased 10% versus the prior year on higher energy pass-throughs.
Air Products shares look fairly priced with a reasonable business value around $108 a share. Figuring revenues around $10.3 billion, average cash earnings of $1.4 billion at a roughly 13.6% margin, and a slightly higher than historical 16 times multiple, there might be some upside if the recent activist attention can help improve results.
Airgas Inc. (ARG) is a smaller player in the industry with around $5 billion in annual sales. The company had tepid results in its latest quarter. Earnings per diluted share were $1.14, up 1% over prior-year adjusted figures and sales of $1.28 billion increased a slight 2%. Organic sales in the quarter were flat and acquisitions contributed most of the sales growth. The company held sluggish business conditions and the negative impact from a recent Environmental Protection Agency ruling on refrigerant production allowances as major reasons for the moderate showing.
Offsetting the negatives was some benefit from the company’s near completion of a SAP enterprise information system multi-year rollout. Airgas is expecting some significant economic benefits from its implementation. They believe the system will yield at least $75 million in annual run-rate operating income additions by the end of 2013.
Airgas shares currently look optimistically priced. This could be due to recent increased interest in the sector, expected industry consolidation, or anticipated bottom line improvements. But fair value calculates to around $98 a share at a slightly elevated 14 times multiple with estimated sales of $5.2 billion and average cash earnings of $520 million at a 10.0% profit margin.
The industrial gas industry looks like an attractive, relatively stable, sector. The companies are generally well run and nicely profitable. Industrial gas stocks, though not on sale currently, look like they might want to be a serious investment consideration whenever offered at a noticeable discount to fair value.