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Nathan Parsh
Nathan Parsh
Articles (143) 

Air Products & Chemicals: Holding Up Just Fine, but the Valuation Is Rich

The company is remarkably resilient and its dividend growth history is long and impressive. Does this make up for the valuation?

September 10, 2020 | About:

Air Products & Chemicals Inc. (NYSE:APD) has proven to be an excellent investment over many different periods of time.

Consider the stock's return versus that of the S&P 500 Index:

  • One-year return: 38.8% versus 14.1%.
  • Two-year return: 82% versus 18.4%.
  • Five-year return: 138% versus 73%.
  • 10-year return: 292% versus 198%.

The closest the market index has come to matching gains for that of Air Products is over the last year. Even as Covid-19 impacted results in the most recent quarter, Air Products has gained 28% year to date, while the S&P 500 has gained just over 5%.

With these price gains, however, comes an expensive valuation. Is a resilient business model and an excellent dividend growth track record enough to overcome a rich valuation? Let's dig deeper into Air Products to determine the answer to that question.

Company background and recent earnings results

Air Products is one of the largest providers of atmospheric and process gases in the world. The company's atmospheric gases include oxygen, nitrogen, argon and rare gases. Process gases include hydrogen, of which Air Products is the largest producer in the world, helium, carbon dioxide and specialty gases. The company also provides equipment for the production or processing of gases for customers in the refining, chemical, metals and food and beverage sectors. The company is divided into three regions: Industrial Gases Americas, Industrial Gases Europe/Middle East/Africa and Industrial Gases Asia. Slightly more 60% of revenues come from international markets. Air Products has a market capitalization of $69 billion.

The company released third-quarter 2020 earnings on July 23 (the company's fiscal year ends Sept. 30). Revenue declined 7.1% to $2.1 billion, though this was $8 million better than Wall Street expected. Adjusted earnings per share declined 16 cents, or 7.4%, to $2.01, but was 3 cents ahead of what analysts had anticipated. Net income was lower by 9% to $457 million. The effective tax rate of 19.3% was up from 18.6% in the prior year and reduced earnings per share results by 2 cents.

The company estimates that Covid-19 reduced revenue by 9% and lowered earnings per share results by 35 to 40 cents on account of lower demand from customers. Even with the headwinds from the pandemic, adjusted earnings before interest, taxes, depreciation and amortization dropped just 1% to $881 million. Adjusted Ebitda margins improved 260 basis points to 42.7%.

Energy pass-through revenues declined 4%, but this wasn't a major impairment on earnings per share as lower energy prices also meant lower costs. Volumes were down 3% while currency was a 2% headwind. Partially offsetting these results was a 2% improvement in pricing. This was the 12th consecutive quarter of year-over-year price increases.

The Industrial Gases Americas region suffered an 11% drop in sales to $850 million. Energy pass-through was down 6% and volumes decreased 5%. Merchant demand was down, but on-site revenues, which make up roughly two-thirds of business in this region and more than half of total revenues, was stable. Currency lowered results by 2%, but prices were higher by 2%. Operating margins were up 150 basis points to 29.2% due to lower costs related to energy pass-through. Adjusted Ebitda of $411 was flat, but adjusted Ebitda margins were up 550 basis points to 48.4%.

Industrial Gases EMEA region had a 13% decline in sales to $430 million. Lower volumes were the prime culprit as they were down 7% due to lower demand. Lower energy pass-through and currency also impacted results. Higher pricing was a small benefit for this segment as well, but operating margins were down 40 basis points to 24.5%. Adjusted Ebitda drooped 11% to $170 million, but adjusted Ebitda margins increased 110 basis points to 39.5%.

Revenues for Industrial Gases Asia region decreased 4% to $652 million. Currency reduced results by 3% and volumes were down 3%. New plants brought online were only able to partially make up for plant closures and planned maintenance. Operating margins declined 10 basis points to 34%. Adjusted Ebitda margins improved 90 basis points even as adjusted Ebitda was down 2% to $327 million.

Air Products has several projects in development that should allow for future growth. The company announced in July that it will partner with two other companies on a hydrogen-based ammonia production facility that will be powered by renewable energy. Air Products is investing approximately $3.7 billion in the project and will be the exclusive off-taker of the green ammonia. The project should be online in 2025.

The company announced in May that it will invest $2 billion in a coal-to-methanol production facility in Indonesia. Air Products will build, own and operate the air separation, gasification, clean up, utilities and methanol production assets that will production of almost 2 million tons per year of methanol from 6 million tons per year of coal. This project should be online in 2024.

Air Products' $12 billion gasification project in Jazan, Saudi Arabia remains on track to close in October.

In total, the company expects $18 billion in investments through fiscal 2022 with about 90% of this investment budget already committed.

Air Products raised $5 billion from debt offerings in April. The company plans to use this to retire $1 billion of debt maturing between now and 2021. Cash from this debt offering will also be used to find the Jazan project.

The company ended the quarter with $4.6 billion in current assets, with $2.4 billion of cash and cash equivalents, against current liabilities of $1.8 billion, which includes less than $90 million of debt due with the next year, on its balance sheet. Long-term debt is just $3.2 billion.

Air Products' business held up surprisingly well given the circumstances that it faced. Revenues were down, but ahead of estimates. Currency will always play a part in the company's results, but pricing remains strong despite weaker demand. Air Products also has a strong balance sheet and multiple pathways forward for future growth.

Analysts, according to Yahoo finance, expect the company will earn $8.38 this year, which would be a 2.1% increase from the previous year. Air Products initially guided toward earnings per share of $9.35 to $9.60 at the beginning of the year before the impact of Covid-19. Earnings per share has compounded at an annual rate of 5% since fiscal 2010.

Dividend and valuation analysis

Looking at Air Products' ability to withstand the business environment in the most recent quarter, it is no surprise that the company has also been able to raise its dividend for 38 consecutive years.

Using information from Dividend Investing Resource Center, we see that the company has raised its dividend by an average of:

  • 10.5% per year over the past three years.
  • 8.7% per year over the past five years.
  • 9.9% per year over the past 10 years.

Air Products has had solid dividend growth rates over the various periods of times listed above, but the company went above all of them when it increased its dividend by 15.6% for the May 10 payment.

Shares yield 1.8% currently, which is lower than the average yield of 2.6% that the stock has traded with over the last decade.

The annualized dividend of $5.36 would consume 64% of expected earnings per share, above the 10-year average payout ratio of 49%. The payout ratio is higher than normal, but not yet to the point where I am concerned about the viability of future dividend payments. The company has a long history of growing its dividend through difficult times. For example, Air Products grew its dividend a total of 21% from 2007 to 2009.

While I appreciate the resilient business and dividend growth history, it is Air Products' valuation that I struggle with. With shares trading hands at around $300 and expected earnings per share of $8.38, the stock has a forward price-earnings ratio of 35.8.

Analysts do expect results to be better next fiscal year, with consensus estimates calling for earnings of $9.80 per share. Still, this results in a valuation of more than 30 times fiscal 2021 earnings. The 10-year average price-earnings ratio is 19.1.

I have a price-earnings target range of 19 to 21 for shares of Air Products. I feel this takes into account the cyclical nature of the business, but also incorporates the company's future projects and dividend growth history. Therefore, Air Products' stock would need to decline more than 41% to $176 before I would consider adding the stock to my portfolio.

Final thoughts

I am truly impressed by Air Products' performance in the most recent quarter. Pricing remains a positive for the company even as volumes and currency impacted results. Air Products also has solid prospects for growth as the company isn't shy about making investments in projects. As a dividend growth investor, I find the streak of increases and growth rates attractive. However, the valuation is stretched considerably higher than my target valuation range. As such, I remain on the sidelines when it comes to Air Products.

Disclosure: The author has no positions in any stocks mentioned.

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About the author:

Nathan Parsh
I am originally from Detroit, Michigan, before moving to Maryland to begin a career as an educator. This is my 14th year teaching. My wife and I have two young children who keep us on our toes.

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