Air Products and Chemicals (APD, Financial) is an industry leader. The company is the largest supplier of hydrogen and helium gas in the world.
The infographic below shows the size and history of Air Products and Chemicals:
Source: December 2015 Citi Presentation, slide 3
The company also supplies oxygen and nitrogen, among other atmospheric, process and specialty gases.
Dividend analysis
Air Products and Chemicals has increased its dividend payments for 38 consecutive years, making it a Dividend Aristocrat.
The image below shows the company’s dividend history since 1983
Air Products and Chemicals currently has a payout ratio of about 50%. The company’s reasonable payout ratio, long dividend streak and stable business model (which will be discussed later in this article) make it very likely Air Products and Chemicals will continue paying rising dividends.
The company currently has a dividend yield of 2.6%, which is about 0.5 percentage points higher than the Standard & Poor's 500’s current dividend yield of 2.1%.
The company’s dividend yield has fluctuated between a low of 1.3% and a high of 4.2% since 1983:
Air Products and Chemicals’ yield rarely rises above 3%. The company’s average dividend yield over the last ~30 years is 2.2%; Air Products and Chemicals is trading a bit above its historical average dividend yield at current prices.
Business overview
Air Products and Chemicals' operations are divided into four segments. The percentage of total adjusted EBITDA each segment generates is shown below:
- Industrial Gases – Americas: 42% of adjusted EBITDA.
- Industrial Gases – EMEA: 19% of adjusted EBITDA*.
- Industrial Gases – Asia: 21% of adjusted EBITDA.
- Materials Technologies: 19% of adjusted EBITDA.
*Note: EMEA stands for Europe, Middle East and Africa
The company’s operations are well diversified internationally.
The image below shows Air Products and Chemicals' EBITDA by region. As you can see, the company generates more EBITDA outside North America than inside North America:
Source: December 2015 Citi Presentation, slide 6
Air Products and Chemicals plans to spin off its Materials Technologies segment by September. The spinoff will make Air Products and Chemicals a "pure play" industrial gas supplier.
The spinoff makes sense strategically. It will allow the Industrial Gases business to allocate capital in the most efficient way it can while allowing the Materials Technologies business to pursue its own course.
Air Products and Chemicals' management has informed shareholders that the sum of dividends from the two separate companies will be the same as Air Products and Chemicals' current dividend. There is no word yet on how the dividend will be divided between the core gas business and the new materials technology spinoff.
Competitive advantage
The industrial gas industry is mature. In the United States, just three businesses cover the majority of the market:
- Air Products and Chemicals – Market cap of $27.4 billion.
- Praxair (PX, Financial) – Market cap of $28.9 billion.
- Airgas (ARG, Financial) – Market cap of $10.0 billion.
Air Liquide (AIQUY, Financial), which is based in France, is acquiring Airgas. Air Liquide has a market cap of $34.0 billion.
The gas business is highly consolidated because it has strong competitive advantages for incumbent businesses. Large projects require technical know-how and high up-front costs, which make competing difficult for a startup business.
Additionally, gas suppliers have well-established gas distribution networks. Once a customer is supplied by a gas company, it is unlikely it switches. Even if a customer wanted to switch, there are very few competitors in any one geographical region that can compete on price in the same distribution network.
As a result, the well-established gas companies (like Air Products and Chemicals) maintain their customers and grow business year after year.
Growth prospects and expected total returns
Air Products and Chemicals has grown its earnings per share at 7.2% a year over the last decade. The company had an above-average year in 2015; earnings per share increased 14%.
The company is realizing faster growth thanks to a focus on efficiency. Most mature businesses talk about raising margins. Air Products and Chemicals has actually done it.
Source: APD 4th Quarter 2015 Presentation, slide 8
The company’s margin growth is a direct result of management’s focus on cash, capital allocation, decentralization and rewarding performance.
CEO Seifi Ghasemi has done an excellent job of allocating capital and increasing efficiency since becoming CEO in June 2014.
The planned Materials Technologies spinoff will likely also be a positive for shareholders. Air Products and Chemicals' management has shown a dedication to increasing shareholder value rather than empire building.
Based on management’s positive moves and Air Products and Chemicals' competitive advantage and historical growth rate, the company can be expected to compound earnings per share at between 7% and 10% a year over the next several years.
This growth combined with the company’s current 2.6% dividend yield gives investors in Air Products and Chemicals expected total returns of 9.6% to 12.6% a year over the next several years.
Valuation
Air Products and Chemicals currently has a price-to-earnings ratio of 19.0 using adjusted earnings. Air Products and Chemicals is a bit cheaper than the S&P 500’s current price-to-earnings ratio of 21.0.
Additionally, the company’s 2.6% dividend yield compares favorably to its historical average dividend yield of 2.2%.
Valuation is more art than science. High quality businesses with growth rates in the high single digits should trade for a price-to-earnings ratio of around 20 in today’s low interest rate environment.
Air Products and Chemicals stock has declined over 7% in the last year. The company seems to be slightly undervalued at current prices, perhaps by around 10% or so. Fair value for the stock is probably between $130 and $140 a share. Air Products and Chemicals is currently trading for ~$124 a share.
Final thoughts
Air Products and Chemicals has a strong competitive advantage and operates in an industry dominated by only a few companies.
As a result, the company has a long growth runway ahead. Air Products and Chemicals' cost-cutting and growth plans have returned the company to double-digit earnings-per-share growth (for now).
Air Products and Chemicals is a hold at current prices using The 8 Rules of Dividend Investing. With steep declines in other sectors of the economy, there are simply other high-quality businesses available at bigger discounts right now.
With that said, dividend growth investors should be very happy with Air Products and Chemicals' business performance and CEO leadership. The company’s performance over the next decade looks more promising than its performance over the previous decade.
