Dividend Aristocrats In Focus: Linde plc - Sure Dividend

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Dividend Aristocrats In Focus: Linde plc


Updated on April 22nd, 2021 by Bob Ciura

The Dividend Aristocrats represent a group of 65 stocks in the S&P 500 Index, each with at least 25 consecutive years of dividend increases.

The Dividend Aristocrats are among the highest-quality dividend growth stocks in the entire stock market. For this reason, we individually review every Dividend Aristocrat each year.

You can download your full list of all 65 Dividend Aristocrats (along with important financial metrics like price-to-earnings ratios and dividend yields) by clicking on the link below:

 

The next installment of the 2021 series takes a closer look at Linde plc (LIN), which qualifies on the list as a result of its acquisition of Praxair, a former Dividend Aristocrat.

The Praxair acquisition should be a meaningful growth catalyst for many years to come. As a result, we view Linde favorably as a dividend growth stock, albeit one with an elevated valuation.

Business Overview

Linde plc – which was created through the merger of Linde AG and Praxair – is the world’s largest industrial gas corporation. Linde AG is headquartered in the U.K. following the merger. The company produces, sells, and distributes atmospheric, process, and specialty gases, along with high-performance surface coatings.

Linde products and services can be found in nearly every industry, in more than 100 countries around the world. The combined company now generates over $27 billion of annual revenue. Line is a large-cap stock with a market capitalization of $148 billion.

The company operates in five segments: Americas, EMEA, APAC, Engineering, and Global Other. Linde gases are used in a variety of industries, including energy, steel production, chemical processing, environmental protection, food processing, electronics, and more. The company also has a healthcare business consisting of medical gases and services.

Linde’s exposure to any particular geographical area has been improved thanks to the merger, as it now has a strong, global customer base throughout a variety of industries. Indeed, Linde now serves customers in more than 100 countries around the world. In addition, it has scale and size unlike any competitor, putting it in an enviable position.

The company struggled in 2020 as the coronavirus pandemic sent the U.S. economy into recession. Still, the company remained highly profitable with strong ROIC.

Source: Investor Presentation

In 2020, revenue fell 3% to $27.2 billion. Still, the company grew its adjusted earnings-per-share by 12% for the full year as operating profit margins expanded by 260 basis points in 2020.

The revenue decline for 2020 reflected the company’s reliance on a healthy economy. That said, Linde’s revenue performance improved as the year progressed, and the company returned to growth in the fourth quarter.

Fourth-quarter revenues totaled $7.3 billion, which was up 3% from the prior year’s quarter. This was an improvement versus the previous quarters, during which Linde reported revenue declines.

Linde was also able to grow its profit margins meaningfully, which allowed for stronger earnings growth during the quarter. Earningspershare for the fourth quarter totaled $2.30, which up 22% versus the previous year’s quarter.

Growth Prospects

The Praxair merger has been the primary driver of growth for Linde in recent years, with 2020 results continuing to show the margin expansion benefits of the acquisition. Even though sales fell in the fourth quarter, Linde produced double-digit adjusted EPS growth. Cost savings are resulting in much higher operating margins, growing earnings at a much faster rate than revenue.

The company’s increased cash flow can be seen in the image below:

Source: Investor Presentation

This slide gives us an overview of the types of savings the company expects to accrue over time, and the methods via which those synergies will be achieved. These synergies continue to accrue, meaning margins could continue to improve in 2021 and beyond.

Share repurchases will also be a major catalyst for Linde’s future earnings growth. Linde completed net share repurchases of $2.4 billion in 2020. This is impressive, as many companies curtailed share buybacks to preserve cash. Linde also approved a $5 billion repurchase for 2021.

In addition, the dividend was recently raised once again, by 10% for 2021. Linde is very serious about its capital returns as the business generates more cash than it can profitably invest, leading to these strong buyback and dividend numbers.

We expect Linde to grow its earnings-per-share by 6% per year over the next five years. We see revenue growth as modest, in addition to a small tailwind from margin growth and a lower share count, respectively.

Competitive Advantages & Recession Performance

Linde enjoys multiple competitive advantages. As the leader in industrial gases, the company enjoys economic scale and greater operational efficiency than its smaller competitors.

In addition, Linde’s financial resources allow the company to invest heavily in research and development. Linde spendt about $152 million on R&D in 2020 to build and maintain its competitive advantages.

Another competitive advantage is Linde’s strong financial position. The company has a healthy balance sheet, with high credit ratings of ‘A2’ from Moody’s and ‘A’ from Standard & Poor’s. Given that total liabilities have fallen since the merger was completed, we expect these credit ratings to be stable. Maintaining investment-grade credit ratings helps the company access capital markets at an attractive cost, which means Linde can spend its cash on things like the dividend and buyback.

On the other hand, Linde is not a recession-resistant business. As a global industrial manufacturer, its business model is sensitive to fluctuations in the global economy. An economic downturn typically sees lower demand from industrial customers.

Linde’s earnings-per-share during the Great Recession are as follows:

• 2008 earnings-per-share of $4.19
• 2009 earnings-per-share of $4.01 (4.3% decline)
• 2010 earnings-per-share of $3.84 (4.2% decline)
• 2011 earnings-per-share of $5.45 (42% increase)

The company did see a modest decline in earnings-per-share during the recession, but fortunately saw its earnings improve alongside the broader global economic recovery. By 2011, Linde’s earnings had surpassed 2008 levels. We expect Linde’s revenue and margins to suffer during the next recession, but note that its current growth outlook is robust.

Valuation & Expected Returns

Linde is expected to generate earnings-per-share of $9.20 for 2021. Based on this, shares currently trade for a price-to-earnings ratio of 31.7. This is a high valuation for the stock, even though the company is highly profitable and growing earnings at a satisfactory rate. In addition, we see Linde as receiving a premium valuation due to its unmatched competitive position in the industry it serves.

Our fair value estimate for the stock is a price-to-earnings ratio of 21. This is a reasonable fair value target for a strong company with durable competitive advantages.

As a result, Linde appears to be significantly overvalued. If shares were to experience a falling valuation to reach our fair value estimate, it would reduce annual returns by 7.9% per year. This represents a strong headwind for investors buying at the current price level.

Future returns will be boosted by earnings growth and dividends. In addition to Linde’s expected earnings growth of 6% per year over the next five years, the stock has a current annualized dividend yield of 1.5%.

Linde can certainly be classified as a dividend growth stock. The most recently quarterly dividend payout was increased 10% from the previous dividend.

The combination of valuation changes, earnings growth, and dividends results in total expected returns of -0.4% per year over the next five years. Earnings-per-share growth and the dividend yield will be virtually entirely offset by the valuation headwind, and we therefore see the stock as unattractive.

Linde is a very profitable company with a positive earnings and dividend growth outlooks, but the impact of overvaluation is enough to warrant a sell recommendation at the current price.

Final Thoughts

Linde stock has performed well since the merger with Praxair. Expectations are high for the potential of the combined company, but at this time we feel Linde’s stock is significantly overvalued.

Linde will be an industry leader with clear and durable competitive advantages. The company should grow revenue and earnings at a steady rate going forward, assuming the global economy stays out of recession.

However, while Linde is a strong business, the stock is too richly valued to buy today. While Linde should continue to raise its dividend each year, investors should wait for a significant decline in the share price before buying Linde stock.

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