Air Products and Chemicals (APD, Financial) is the world’s largest supplier of hydrogen and helium gas. The company also supplies oxygen and nitrogen, among other atmospheric, process, and specialty gasses. The company has increased its dividend payments for 37 consecutive years, making it a dividend aristocrat, and the subject of part 37 of the Dividend Aristocrats In Focus series. The company’s business is analyzed below to paint a clearer picture of Air Products and Chemicals’ operations.
Business Overview
Air Products and Chemicals operations are divided into four segments: merchant gases, tonnage gases, electronics and performance materials, and equipment and energy. The company generates about 40% of its revenue in North America, 25% in Europe, 25% in Asia, and 10% in Latin America. Each of Air Product and Chemical’s segments is analyzed below.
The merchant gases segment is Air Products and Chemicals' largest. It was responsible for 40% of full year 2013 revenues for the company. The merchant gases segment supplies oxygen, nitrogen, argon, and other gases to industrial and medical customers. The merchant gas segment supplies gas to customers either by tanker tube trailer, or through smaller tanks filled at the customer’s location.
The tonnage gases segment provides large volume quantities of industrial gases such as hydrogen, carbon monoxide, and oxygen. The segment either constructs a gas plant on site or delivers gas through a pipeline from a nearby facility. The tonnage gases segment works primarily with the oil and gas industry. It is the company’s second largest segment and was responsible for 33% of revenues in fiscal 2013.
The electronics and performance materials divisions provides various gases to customers in the computer, semiconductor, and technology fields. The electronics and performance materials segment was responsible for 22% of revenue in 2013 for Air Products and Chemicals.
The equipment and energy segment is Air Product and Chemicals’ smallest. It generated just 5% of revenue for the company in 2013. The segment designs and manufactures gas processing equipment for air separation, hydrocarbon recovery, and natural gas liquefaction.
Competitive Advantage
The gas business is highly consolidated. Just three business cover the bulk of the market in the US; Air Products and Chemicals, Praxair (PX, Financial), and Airgas (ARG, Financial). Air Products and Chemicals is the second largest by market cap of the three primary gas providers. Praxair has a market cap of $36.8 billion, Air Products and Chemicals has a market cap of $28.7 billion, and Airgas has a market cap of $8.5 billion. Internationally, Air Liquide and Linde also compete with Praxair and Air Products and Chemicals. Both domestically and internationally, the gas market is dominated by only a few players.
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 start-up business.
Additionally, gas suppliers have well-established gas distribution networks. Once a customer is supplied by a gas company, it is unlikely they switch. 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. Air Products and Chemicals durable competitive advantage is shown by its more than three decades of dividend increases.
Growth Prospects
Air Products and Chemicals is expecting 9-13% EPS growth for its full fiscal 2015. The company is restructuring itself to better take advantage of its competitive advantages. The company is focusing on building strong distribution networks in geographic locations that the company already has a competitive advantage in and offer enticing returns. The company is further attempting to drive profitability by reducing corporate overhead and expenses.
Over the last decade, Air Products and Chemicals has only managed to grow revenue per share by about 2% per year. The company’s new cost-cutting and restructuring initiatives will likely make growth over the next decade higher than the previous decade.
Dividend Analysis
Air Products and Chemicals has a current dividend yield of 2.3%. The company has a payout ratio of close to 60% which is fairly high. Going forward, Air Products and Chemicals dividend will likely grow in line with overall company growth. This is good news next year, with EPS expected to grow 9% to 13%. Air Products and Chemicals will likely not be able to sustain double-digit growth, as a significant portion of gains come from cost-cutting which cannot be replicated every year. I expect Air Products and Chemicals to deliver long-term dividend growth in the mid single-digit range after one to two years of double-digit growth.
Valuation
Air Products and Chemicals currently trades at a P/E ratio of about 23, well above the S&P 500’s P/E ratio of 19.7. The company has historically traded at about the same P/E ratio as the market over the last decade. As a result, I believe Air Products and Chemicals to be somewhat overvalued at this time. I believe the company’s fair P/E ratio is in line with the S&P 500’s based on historical data over the last 10 years.
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. Growth over the last decade has not been strong as the company has been out competed by its rivals. Air Products and Chemicals' new cost-cutting and growth plans should return the company to faster growth going forward. The company is not a top stock using the 8 Rules of Dividend Investing due to its high payout ratio, sluggish historical growth rate, and fairly high price standard deviation of about 28%.
