APD (APD, Financial) delivered its seventh consecutive quarter of double-digit earnings-per-share (“EPS”) growth under the leadership of CEO Seifi Ghasemi, despite continued foreign exchange (“FX”) and other headwinds. In the first quarter of 2016 (APD’s fiscal 2Q), the company grew EPS by 17%, exceeding consensus estimates by a modest amount. Results were driven by a significant improvement in margins which increased 500 basis points (“bps”) during the quarter to 23.4%. Now halfway through its fiscal year, the company also increased annual EPS guidance modestly to $7.40 to $7.55 or 12% to 14% growth for Fiscal Year 2016.
While the margin improvement was impressive, the company’s volume trends reflected the current economic environment and muted global growth. Sales were $2.3 billion, down 6%, due to decreased energy pass-through (-3%) and FX headwinds (-3%). Underlying growth was flat, on flat volume and pricing. In North America and Europe, APD continued to grow price 1% to 2%, a level it has achieved since Seifi joined. APD can control pricing more than volume, so we view this as a positive sign that the company should be able to sustain modest price growth if and when global growth and volume returns.
Versum, APD’s Materials Technologies business, reported modestly increased profits. It produced a 6% decline in organic revenue due to lower equipment sales in electronics (which are often lumpy) and weak macro trends. Despite lower sales, margins increased 290 bps to 26.2% and EBIT was up 4%. This weak revenue growth and strong margin performance were consistent with recent trends.
APD’s consolidated operating income was up 20% as operating margins increased 500 bps to 23.4%. Of this increase, 460 bps reflected organic improvements while 40 bps was from lower energy pass-through to customers, (which inflates margins with no profit impact). Margins increased across all regions and businesses. Excluding Versum, industrial gas margins were ~22.7%, still ~200 bps behind Praxair’s industrial gas margins. The company intends to close this gap through a further $225 million of operating efficiencies in 2017 to 2019. Seifi stated that he is pleased with the company’s progress on capturing operating efficiencies.
The company lowered full-year capex guidance from $1.3 to $1.2 billion, due to the lower cost of specific projects in the budget. The company brought on-stream a large-scale hydrogen facility in Edmonton, Alberta, which is connected to a regional pipeline and further expands APD’s hydrogen presence in this region. APD spent $400 million on this facility which should produce ~$0.10 to 0.15 cents of earnings per share based on the Company’s guidance for returns on capital expenditures. Growth capex will continue to be an important driver of earnings growth. As the company takes a more disciplined approach to capex, which is expected to be at lower levels than under previous management, we expect returns on capital to increase, generating more capital for share repurchases and dividends.
On May 6th, APD announced that it had signed a definitive agreement to sell the Performance Materials Division (PMD) of its Materials Technologies segment to Evonik Industries AG, a world leader in specialty chemicals and materials, for $3.8 billion. APD had previously announced that it would spin off PMD with its Electronics Material Division (“EMD”) later this year. We view the sale favorably because by selling the business, APD generates cash proceeds that can be used for investment in the business or shareholder return, while eliminating market risk from the financing required for a spinoff transaction. The company will incur substantial taxes on the sale, but, in light of the high purchase price, reflecting its value to a strategic buyer, the net proceeds are likely to generate more value than could be achieved in a spinoff. APD intends to proceed with the spinoff or sale of the EMD later this year, subject to market conditions.
From Bill Ackman (Trades, Portfolio)'s first quarter shareholder letter.
