The green hydrogen rush is unfolding exponentially, and many financial market participants have taken note. However, stocks with green hydrogen exposure need to be critically analyzed, as a good company doesn't always equate to a good investment opportunity.
Why is this? Well, the stock market is forward-looking, meaning you ideally need to invest in financial assets before institutional investors take note. Otherwise, you'll be what's called a bag holder. A bag holder is someone that invests in a stock after the market has already priced in its prospects; thus, bag holders often allocate capital into overvalued stocks and don't capture any margin of safety. Moreover, they could be left holding the bag if the company ends up failing to meet growth expectations.
One such fully-priced company in the green hydrogen industry is Air Products & Chemicals (APD, Financial). Air Products & Chemicals is tapping into green hydrogen at a rate of knots. However, let's run through a few fundamental talking points to find out whether new investors have already missed the bus.
Operational review
Air Products & Chemicals generates approximately 79.32% of its revenue from industrial gasses and 20.68% from materials technologies sales. The company's industrial gasses segment sells everything from atmospheric gasses to process and specialty gasses, equipment and services worldwide. Moreover, the enterprise has an agreement with Baker Hughes Company (BKR, Financial) to produce hydrogen compression systems, providing a key synergy in the lucrative green hydrogen industry.
Air Products & Chemicals' materials segment was born in 2001 after garnering extensive experience in the electromechanical sector. The segment supplies an array of subversive pumps and motors. Lately, Air Products & Chemicals jumped onto the renewable energy trend by rolling out inverters for solar-powered pumps.
Source: CSI Market
The table below shows Air Products & Chemicals' current projects and committed projects. Apart from producing $3.19 billion in revenue during its third quarter, Air Products & Chemicals has a backlog of $15.2 billion, meaning there's plenty more business to be done.
Source: Air Products & Chemicals
From a financial statement vantage point, Air Products & Chemicals is producing solid residual growth for its shareholders. For example, the company's earnings per shares are compounding steadily, meaning it is creating value for its investors.
Source: Air Products & Chemicals
Lastly, by observing GuruFocus' financial strength ranking for the stock, it's clear that Air Products & Chemicals exhibits a robust set of financial metrics. What stands out is the company's resilient interest coverage ratio. Additionally, Air Products & Chemicals isn't overlevered with debt, meaning it passes through much of its Ebit margin to its shareholders.
Green hydrogen industry
Next, let's take a look at the market opportunity for green hydrogen. There is a green hydrogen craze as net zero is becoming a key talking point at most corporate C-Suite tables. According to Statista, the green hydrogen market could skyrocket by 51.6% per annum (compounded) until 2031. Much of the hype is likely due to factors such as the adaptation of hydrogen as a major energy source in Europe, fuel cell vehicles and space exploration. However, although green hydrogen is clean, it's still considered expensive. Thus, as a financial market participant, I would consider avoiding just jumping onto the bandwagon.
Source: GrandView Research
At face value, Air Products & Chemicals could benefit from the green hydrogen rush as it is investing aggressively to tap into green hydrogen's prospects. For example, the company recently agreed to spend $500 million on a New York-based green hydrogen plant that could produce 35 metric tonnes of green hydrogen per day; commercial operations are likely set to start by 2026 or 2027, with much optimism surrounding this greenfield project.
Having said that, investors need to understand that with a booming industry comes serious competition. Thus, Air Products & Chemicals may need to spend aggressively to compete in a hotly contested market and forgo short-term profits in its other segments.
Valuation and dividends
Despite Air Products & Chemicals' operational tailwinds, its valuation metrics provide cause for concern. Air Products & Chemicals' fundamental valuation multiples indicate that the market has possibly overhyped the stock. Its price-book and price-sales ratios both exceed their valuation thresholds. In addition, the price-earnings ratio is trading at a 1.19 times premium compared to the rest of the sector.
Morgan Stanley (MS, Financial) recently listed Air Products & Chemicals as a top dividend stock to buy. The investment bank's call is quite astonishing as Air Products & Chemicals' 2.75% dividend yield isn't impressive at all. Moreover, the stock's dividend coverage ratio lags, and it's estimated that the company's operating cash flow growth is bound to stagnate. Therefore, it's valid to classify this stock's dividend as potentially unsafe and low yielding.
Although Air Products & Chemicals is fundamentally overvalued, there's a counter to my argument. Air Products & Chemicals' price action relates to what's called "the momentum anomaly." Momentum anomaly theory suggests stocks that beat the broader stock market in the previous 12 months are likely to beat the broader stock market in the following 12 months.
According to GuruFocus' momentum data and the stock's movement relative to the S&P 500, Air Products & Chemicals has outperformed the market and can be classified as a momentum anomaly stock.
Final word
It is easy to get caught up in the green hydrogen hype. However, the signs are that Air Products & Chemicals has to streamline its income statement to garner value as a financial asset. The company's backlog and project uptake is consistent; nonetheless, key operating metrics aren't all aligned toward the upside.
An area of concern is Air Products & Chemicals' elevated price multiples. It's likely that green hydrogen prospects have already been fully priced by the market. Thus, investors should be careful of jumping onto the Air Products & Chemicals bandwagon too soon.
