Published October 20th, 2016 by Bob Ciura
Air Products & Chemicals (APD) is an industrial gases firm. It has been in operation for 75 years. It now has annual sales nearing $10 billion and has 17,000 employees in 50 countries around the world. The company is the largest supplier of Hydrogen & Helium gas in the world.
Air Products is a Dividend Aristocrat. It has raised its dividend for 34 years in a row. Being a Dividend Aristocrat is not arbitrary. Only stocks with 25+ consecutive years of dividend increases in the S&P 500 are eligible. Dividend Aristocrats are high quality stocks…
Not surprisingly, the Dividend Aristocrats Index has significantly outperformed the market over the last decade.
Source: S&P Fact Sheet
You can see the full list of all 50 Dividend Aristocrats here (along with metrics that matter for each).
Air Products stock offers a nice combination of a slightly above-average dividend yield as well as annual dividend growth rates that exceed inflation. The company currently has a dividend yield of 2.6%.
The most recent dividend increase was 6%. Over the past five years, Air Products has averaged 8.2% compound annual dividend growth. In the past decade, the stock has delivered a 177% total return to shareholders.
Air Products is a diversified industrial firm.
Source: 2015 Annual Report, page 2
It provides atmospheric and process gases, along with the equipment used to handle these gases, to customers in a wide range of industries. Air Products’ major customers are spread across the industrial, materials, and energy sectors. It also supplies the food and beverage and electronics industries. The company has a global reach, with operations in 50 countries.
Air Products has a diversified business model. It operates several large segments, which are Merchant Gases, Tonnage Gases, Electronics and Performance Materials, and Equipment and Energy. No individual business segment comprises more than 37% of its annual revenue. In addition, the company is diversified geographically. Approximately 42% of Air Products’ revenue comes from the U.S. and Canada, and 58% is derived from outside the U.S. and Canada.
A strategic priority for Air Products is to grow further in under-developed nations. The emerging markets in Asia and Latin America have rapidly-growing economies that should experience faster GDP growth than mature markets like the U.S.
Air Products is repositioning its portfolio to meet these goals. For example, the company is making progress toward the sale of its Performance Material division and a spin-off of the Electronics Material division. With these moves, it will focus on its Industrial Gases business, which it believes will bring it further margin improvement opportunities.
Air Products enjoys high margins, as a result of its global scale. Company sales declined 5% last fiscal year, but this was mostly due to the strong U.S. dollar. Since Air Products has such a significant international operation, it is highly exposed to currency risk. The strengthening U.S. dollar has made exports less competitive, and revenue generated overseas is worth less when it is converted back into U.S. dollars. Air Products still managed 14% growth in earnings-per-share last year.
Its strong record of earnings-per-share growth is mostly due to margin expansion.
Source: Credit Suisse 2016 Basic Materials Conference Presentation, Page 2
Air Products’ earnings before interest, taxes, depreciation, and amortization (EBITDA) margin last quarter was 34.2%; in the same quarter last fiscal year, its EBITDA margin was 30.7%. Air Products management is very effective at allocating capital.
Management has a stated minimum 10% internal rate of return before accepting any new projects. This laser-like focus on creating shareholder value and not wasting shareholders’ money is why the company generated an 11.3% return on capital employed last fiscal year, which was a 150-basis point year over year expansion.
The company is seeing strong results in fiscal 2017 as well. Last fiscal quarter, earnings-per-share adjusted for one-time items increased 16% year-over-year. For the full fiscal year, management expects 13% growth at the midpoint of its earnings-per-share guidance.
The company has managed to compound its earnings-per-share at 7.9% a year over the last decade. A good portion of this growth came from steadily rising profit margins. In 2006, the company’s net profit margin was 9.0%. The company is expected to generate a net profit margin of 17.1% percent in fiscal 2016. The company’s margins nearly doubled in one decade. This is clear evidence of a widening competitive advantage.
Competitive Advantages & Recession Performance
The U.S. industrial gas industry is mature. Air Products, Praxair (PX), and Airgas, which was acquired by France-based Air Liquide (AIQUY) cover the majority of the market.
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 maintain their customers and grow business year after year. These qualities helped Air Products remain profitable even during the depths of the Great Recession.
- 2006 earnings-per-share of $3.18
- 2007 earnings-per-share of $4.64
- 2008 earnings-per-share of $4.15
- 2009 earnings-per-share of $2.96
- 2010 earnings-per-share of $4.74
Earnings-per-share did fall significantly in 2009, but the company remained profitable throughout the recession. Earnings-per-share quickly recovered to new all time highs the next year, in 2010.
Valuation & Expected Total Return
Because it is a high-quality company with a profitable business model and a runway for future earnings growth, Air Products’ stock deserves a premium valuation multiple. The stock currently trades for 22 times earnings, which is nearly on-par with the S&P 500. As a result, there could be an argument made that Air Products stock is either a bit to cheap or trading around fair value given the elevated overall market level.
The company’s average price-to-earnings ratio was above 20 in both 2014 and 2015. Prior to that, the company’s price-to-earnings ratio hovered around 14 to 16 from 2009 through 2013. Air Products is another example of a business that is trading at elevated levels (likely) due to ultra low interest rates. It’s trading at reasonable prices given today’s bloated valuation levels, but is likely overvalued on a historical basis.
Air Products’ future returns will be comprised of earnings growth, which is likely to be in the high single digit, 7%-9% range. This target is in line with historical growth over the last decade.
In addition, shareholders will earn a return from the dividend. Air Products stock pays $3.44 per share in current annual dividends. The annual dividend amounts to a 2.6% current dividend yield. As a result, Air Products shareholders can reasonably expect 9.6%-11.6% annual returns going forward.
Air Products has a long track record of raising its dividend. It should be able to continue its streak for many years going forward. Air Products is experiencing significant margin expansion.
It will return significant amounts of earnings in the form of rising dividends. Air Products stock is a solid long-term hold for dividend growth investors looking for exposure to the industrial gas industry, or the basic materials segment.
The company currently ranks in the top one third of the Sure Dividend database using The 8 Rules of Dividend Investing thanks to its reasonable payout ratio, solid-but-not-spectacular yield, decent valuation, stability, and fairly strong growth. The company’s stock doesn’t ‘stand out’ in any one metric, but it does score reasonably well on all metrics.