Updated on January 25th, 2019 by Bob Ciura
Air Products & Chemicals (APD) may not be the most well-known Dividend Aristocrat. The company is primarily a business-to-business manufacturer and distributor of industrial gases.
However, Air Products & Chemicals is an elite dividend stock. Air Products & Chemicals is a member of the Dividend Aristocrats, a group of reliable dividend stocks with 25+ years of consecutive dividend increases.
Air Products & Chemicals’ dividend history – 37 years of consecutive dividend increases – indicates that the company is a model of consistency. With that said, we have some concerns about the company’s future dividend safety, which is a topic we explore in the following video:
With that said, the company has reinvented itself in recent years. A spinoff and a separate significant divestiture were implemented with the goal of streamlining the company’s business model and focusing on its core industrial gas operations.
Fortunately, these strategic moves will help the company gain access to new growth markets. As a result, Air Products & Chemicals should continue raising its dividend for many years.
Air Products & Chemicals is one of the largest producers and distributors of atmospheric and process gasses in the world. Its customers include other businesses in the industrial, technology, energy, and materials sectors. Headquartered in Allentown, Pennsylvania, Air Products & Chemicals was founded in 1940 and has a current market capitalization of $35 billion.
It also has a significant international presence. Roughly 40% of the company’s annual sales are generated in the U.S. and Canada, with the remainder spread across Latin America, Europe, and Asia.
Air Products & Chemicals released financial results for the fiscal 2019 first quarter on January 25th. Revenue of $2.22 billion was flat from the same quarter a year ago, and missed analyst estimates by $30 million. The core Gases America segment led the way with 9% sales growth from the same quarter last year.
Source: Earnings Presentation
Air Products & Chemicals’ adjusted earnings-per-share of $1.86 also missed estimates last quarter, by $0.01 per share. Earnings increased 4% overall, and were up 9% after excluding the impact of an asset sale.
Air Products & Chemicals focus in recent years was on divesting non-core assets, streamlining its business model, and reducing costs. The company conducted two major transactions that have helped move its streamlining initiatives forward.
First, Air Products & Chemicals completed the spinoff of its electronics materials division. The business unit now trades on the New York Stock Exchange as Versum Materials (VSM). Air Products & Chemicals shareholders received one share of Versum for every two shares of APD owned in a two-for-one stock dividend worth about $11.50/share of APD at the time of the spinoff.
The second major transaction that Air Products & Chemicals completed was the sale of its performance materials division to specialty-chemical manufacturer Evonik Industries AG for $3.8 billion in cash.
Together, the businesses that Air Products and Chemicals have sold over the past year generated about $2.0 billion in sales and nearly $530 million in earnings before interest and taxes (EBIT). Today’s Air Products & Chemicals is a smaller, leaner enterprise.
The streamlining initiatives undertaken by Air Products & Chemicals in the past several years (including those that were discussed in the last section) have led to significant profitability improvements for this industrial gas giant. The company’s EBITDA margin trend over the last several years can be seen below.
Source: Earnings Presentation
Air Products & Chemicals has seen its EBITDA margin expand by over 1,000 basis points since the second quarter of 2014 – a significant improvement by any standard.
Looking ahead, Air Products & Chemicals is likely to deliver satisfactory growth. The company has a number of growth projects either recently completed or scheduled to be completed in the coming months. Some of these investments around the world include building a second liquid hydrogen plant in California, a new air separation unit (ASU) in Minnesota, an ASU plant in India, and helium investments in Algeria.
Air Products & Chemicals was also recently awarded a sixth on-site nitrogen facility in Tianjin, China to supply a major electronic components manufacturer’s new production line. Lastly, on January 25th Air Products & Chemicals announced it will build the first hydrogen fuel cell vehicle fueling station in Saudi Arabia, along with oil giant Saudi Aramco. Together, they will establish a pilot fleet of fuel cell vehicles, including a fleet of fuel cell vehicles supplied by Toyota. The project is expected to be placed into operation in the 2019 second quarter.
Fiscal 2019 is expected to be another year of strong growth. Air Products & Chemicals expects full-year adjusted earnings-per-share of $8.05 to $8.30, a 10% increase at the midpoint of guidance. The company expects 8% growth in the current quarter. We believe that Air Products & Chemicals is likely to continue growing at a similar 8% annual rate over the next five years.
Competitive Advantages & Recession Performance
Air Products & Chemicals has a number of competitive advantages.
The first is industry expertise. The company employs a number of chemists and engineers with the technical know-how to successfully deliver projects on time and within budget. It would be difficult for a start-up company to compete with Air Products in the industrial gas distribution sector because of this.
Moreover, the industrial gas distribution business benefits from high switching costs. These costs may not necessarily be financial – instead, customers are unlikely to switch once their gas needs are being met by a particular supplier because it would be difficult to find a competitor that offers identical services in a particular geographic region. To that end, Air Products & Chemicals’ size also benefits the company.
The company’s recent divestitures and asset sales have given it an infusion of cash, bolstering its corporate finances in a way that should help it endure any upcoming economic downturns. Moreover, Air Products & Chemicals has a track record of performing resonably well during past recessions. Consider the company’s performance during the 2007-2009 financial crisis for evidence of this:
- 2007 adjusted earnings-per-share: $4.40
- 2008 adjusted earnings-per-share: $4.97 (13% increase)
- 2009 adjusted earnings-per-share: $4.06 (18% decline)
- 2010 adjusted earnings-per-share: $5.02 (24% increase)
Air Products & Chemicals experienced an 18% decline in adjusted earnings-per-share in 2009 during the financial crisis, but the company’s bottom line surged to a new high water mark by 2010. We expect a similar level of recession resiliency to be demonstrated during future periods of market turmoil.
Valuation & Expected Total Returns
As discussed previously, we believe that Air Products & Chemicals is likely to grow earnings-per-share at a reasonable 8% annual rate over full economic cycles. On the surface, earnings-per-share growth combined with the company’s 2.5% dividend yield gives Air Products & Chemicals the potential to deliver double-digit total returns.
Air Products & Chemicals is a strong dividend growth stock. Air Products & Chemicals has raised its dividend each year for the past 37 years, including a recent 5% increase on January 25th after the company reported its quarterly earnings.
However, valuation changes will also impact future returns. Air Products & Chemicals is expected to report adjusted earnings-per-share of $8.17 for fiscal 2019. The stock currently trades at a price-to-earnings ratio of 19.6.
For context, the company has traded at an average earnings multiple of 18.1 over the last 10 years. The following table illustrates Air Products & Chemicals’ historical stock valuation in the past decade:
We believe that 18 times earnings is a fair valuation estimate for Air Products & Chemicals. Mean reversion to a price-to-earnings ratio of 18 would introduce a 1.7% drag on annualized returns if it occurred over a 5-year time horizon. Total expected returns could reach almost 9% per year, which is still a suitable rate of return.
Air Products & Chemicals’ has de-risked its business model and that business transformation allows it to focus on its core business of industrial gases. It has a large slate of new projects to help stay on track for growth in the coming years. This should naturally benefit shareholders, in the form of continued dividend increases on an annual basis.
These positive factors cannot outway the significant premium that the market is placing on these shares at the present time. Valuation contraction could reduce Air Products & Chemicals’ expected returns over the next five years. That said, Air Products & Chemicals is a high-quality Dividend Aristocrat.