Air Products and Chemicals: First-mover advantage not yet priced in | Private Equity Weekly

In the lab, we test industrial gas companies, air products companies, and chemical companies (NYSE:APD) is a top pick in our portfolio.For our new readers, the company has $12 With annual revenue of $1 billion, it supplies specialty gases to medical institutions, industrial manufacturers and energy companies. These gases are transported through pipelines or liquid or tank trucks in on-site production units. Additionally, for smaller customers, gas may be supplied via cylinders.

That said, our supportive Buy rating target is based on 1) an impressive project backlog driving the energy transition and hydrogen revolution, and 2) Dividend Aristocrat status coupled with a solid balance sheet. Additionally, industrial gas companies are the least sensitive to economic conditions and have higher valuations than other chemical companies.In fact, EBITDA margin About 40%. Nonetheless, in our last assessment we also highlighted two persistent negative arguments: 1) company succession plans and 2) business performance relative to peers.

profit result

Results for the first quarter of 2024 fell short of expectations. By the numbers, APD adjusts. EPS increased 7% year over year; however, this was 6% below the Wall Street consensus estimate.Specifically, the company’s sales grew 3% (vs. consensus estimate of +4%), driven by the Old Continent and its Uzbek scene When the project is launched, the pricing will be increased by 1% (consistent with consensus). Weaker sales in Asia and higher-than-expected corporate costs contributed to the unfavorable earnings variance. The company experienced a negative cost variance of approximately $40 million due to higher temporary costs and new projects. We believe some of these headwinds are one-offs. However, we have seen companies face cost pressures over the past three years to adapt to investment in energy growth. In the lab, we believe this negative output may continue into the second quarter.

Looking at APD from a high-level perspective, GAAP EPS increased to $2.73, and net margin was 20.7%. Looking at the income statement, we see adjusted EBITDA of $1.2 billion and a margin of 39.2% (Figure 1), up 510 basis points from the prior year’s figure.

And (again), consistent with our downside protection thesis, the company Increase The quarterly dividend is $1.77 per share (Figure 2). This marks 42 consecutive years of growth. Also relevant to our Buy rating is the company’s order backlog which increased to $19.6 billion from $19.4 billion last quarter.

source: APD first quarter results presentation – picture. 1

figure 2

estimated change

APD’s supporting stock story remains intact and is based on a depressed valuation. Again, we expect numerous growth profitability drivers and pricing power from its traditional natural gas business. Before offering our changes, it is necessary to report that this year’s U.S. election is approaching. This may pose a risk to the APD’s IRA credit (45V, 45Q). Nonetheless, our team believes that continued hydrogen tax credits pose limited risks under different election scenarios.

As a reminder, APD capex trajectories are at the forefront of the blue/green hydrogen revolution (Figure 3). However, our last publication reported that “New projects will grow EPS by $1.40 next yearWe also forecast earnings per share to grow 12% in 2024. APD’s first-quarter 2024 earnings highlighted a core operating profit that was 5% below expectations, suggesting future growth costs are becoming increasingly apparent ahead of its P&L gains.

image 3

APD lowered its earnings per share growth forecast due to weak first-quarter results (Figure 4). Adjusted earnings per share are expected to fall 2-3% from the previous target. Looking at the numbers, we now have a midpoint EPS of $2.68. Full-year forecasts are revised down for the first half only; this means that the second half of 2024 is in line with our previous forecast (12% annual growth).

Figure 4

Before going into valuation, we still believe there are four additional reasons to buy APD stock:

1. There are valuation differences with Linde. Based on our internal estimates, Air Products trades at 12.0x 2024 EBITDA, while Linde trades at 15.7x;
2. We believe that project backlog poses less risk. According to management’s admission, we know that the blue ammonia and green ammonia projects will not come online until 1.5 years. However, there are unreasonable discounts for new energy projects. We estimate that these large projects are not properly evaluated as specialty chemicals players. The pipeline assumes Air Products is the market leader in new energy. We believe earnings per share CAGR will reach at least double digits;
3. We believe the company’s underlying business is solid compared with the adverse market outlook. In fact, it has the ability to generate 6-8% EPS annually. Therefore, we believe that APD can achieve a return on investment higher than WACC even in a market downturn;
4. Related to new capital expenditures, the company sees Europe as a key end market. The Old World is rapidly moving towards the adoption of green hydrogen. The APD NEOM program has a clear mandate to market clean fuels in the EU. From the details, EU revision By 2030, the proportion of renewable energy use will increase from the revised 32% in 2018 to 42.5%. Looking at APD capital expenditures, the company will become the only large commercial-scale industrial producer of green hydrogen during the 2030s. This first-mover advantage cannot be ignored. According to our estimates, NEOM industrial output will account for less than 10% of EU demand.The EU green hydrogen market is developing and we have clear support from the EU Latest bid price From Total Energy.

Valuation: Too much discount

At Labs, we think APD is a buy for the long term. Still, it’s now more apparent that this is a second-half stock opportunity, and the company may suffer short-term volatility. This further drives our investment timeline. Our team is looking for better core performance and companies can consider co-investment opportunities to de-risk their major large-cap investments. This could mean selling a minority stake in the current project backlog, providing a positive catalyst to fully assess ongoing capex charges. Before proceeding with a valuation, there are three key factors to consider:

1. APD’s share price has fallen sharply and currently trades at 17 times 2025 earnings. That makes the company the cheapest among the large industrial gases businesses. The price-to-earnings ratios of Air Liquide and Linde are 22.7 times and 24.7 times respectively. We view this bargain valuation as an invitation to contrarian long-term thinking, fully supported by the resilience of APD’s existing business;

2. Second, using a projected 2030 EBITDA baseline of $1.8 billion generated by energy transition investments and assuming the underlying business doesn’t grow (which it doesn’t) means that the EBITDA multiple is valued in the single digits. Currently, Linde is trading at 15.7x 2025 EV/EBITDA;
3. Air Products and Linde’s forward price-to-earnings ratios had moved in tandem a year ago. There is now a 10x spread, which we believe is unreasonable, and we expect this spread to end over the next few quarters as many investors question APD’s EPS growth guidance for the year. .

Our previous valuation of APD was for 2024 earnings per share growth of 12%. Today, we decided to lower our EPS estimates to reflect slightly higher corporate costs and lower margins in Asia Pacific. Pushing our valuation to Q1 2025, we arrive at NTM EPS of $13.2 (including better estimates for H2 2024). We still imply upside to current 2024 APD guidance (Figure 4).

Taking into account the launch of large projects, we decided to reduce the APD multiple to 24 times the ten-year average. Therefore, our target price is raised from US$330 per share to €316.8 per share. APD yields nearly 3% and is supported by an industry-leading backlog. Air Liquide and Linde have high price-to-earnings ratios; both companies are expected to post high-single-digit EPS growth this year (similar to APD). This valuation difference is unjustified.

risk

Downside risks include 1) capital expenditure project execution and cost inflation-related risks, 2) inability to increase prices, 3) unplanned plant outages, 4) raw material price fluctuations, gray hydrogen, blue hydrogen and green hydrogen adoption, and 4) Potential earnings disappointments often result in large moves in the stock price, as happened with the fourth-quarter 2023 and first-quarter 2024 results. In addition, we include lower profit margins on helium sales in Asia.

in conclusion

Lower earnings per share are something to consider, and investors must regain confidence. However, higher year-over-year DPS must be achieved while investing in growth and maintaining a balance sheet A rating be noticed. H2 earnings normalization and APD’s long-term investment in blue/green hydrogen programs are encouraging. Even if we lower our target price, we still believe in APD’s growth trajectory. Granted, growth comes at a cost, but we’re still supportive. Therefore, we decided to confirm our strong BUY recommendation.