AIQUF - Air Liquide: Lower Gas Price Equals Higher Margin

2023-05-30 05:20:25 ET

Summary

• Five reasons why we believe nat gas prices will likely decrease.
• Lower nat gas will enhance Air Liquide's profitability. This was already evident in Q1 on the cash flow evolution.
• 2023 guidance confirmed and so is our valuation.

Before providing our deep dive into Air Liquide ( OTCPK:AIQUF , OTCPK:AIQUY ), we focused on natural gas price development. Since the year's start, nat gas price has lost about 70% and is now trading at around €25 (almost a tenth of the value recorded in August 2022). After losing 8.5% in the previous session, today the TTF price in Amsterdam is dropping by an additional 4%. This is the longest streak of weekly declines since 2007, with demand struggling to return as the economy shows little sign of a meaningful recovery amid a lackluster post-COVID-19 reopening in China. The sharp decline comes for several reasons. On the one hand, the industrial sector is ramping up production in a controlled manner amid persistent inflation and a gray economic environment.

On the other hand, the economic slowdown raised concerns that 1) some gas demand could now be permanently lost or replaced after last year's record prices significantly hit producers (such as EU chemical companies). We should also add that 2) gas storages are full , 3) there was better weather conditions in winter, and 4) there is an abundance of LNG, which raised the question of how much prices can fall before producers start limiting extraction. The slump isn't just hitting short-dated contracts, traders are seeing how sluggish demand could affect prices ahead of winter. Europe will struggle to absorb the September-October gas supply if injections stay fast enough to push inventories above 100 bcm. Our 5) concern is related to Germany, the largest European economy, which closed Q1 with a contracting GDP , this has not happened since the beginning of the pandemic.

Here at the Lab, we believe that the EU is on track to fill gas storage facilities before next winter to get through the 2023/24 heating season without shortages and without running the risk of government-imposed rationing. The risks of an energy shock continue to diminish as Russia supplies limited quantities of gas. It would take several adverse shocks, such as the closure of all Russian pipelines, very cold weather, and reduced savings implemented before shortages could become a serious risk for winter 2023/24. Therefore, we likely expect a prolonged gas price reduction in our base-case scenario.

Air Liquide Upside

Since our last update released on FY 2022 comment, Air Liquide's stock price performance is up by 9.43% (including its dividend per share payment). Our buy rating was supported by many MICRO reasons, in detail, we emphasized : the company's order backlog, 2) a strong pricing power , 3) the EU Hydrogen Opportunity with a positive environment towards green incentives supported by worldwide regulatory frameworks, 4) a higher pick up in EVs growth and above all, 5) an interesting valuation compared to its closest peers ( Linde and Air Product & Chemicals ).

Our call today focuses on Air Liquide's pricing power and cost basis evolution. Among the three specialty gas companies, Air Liquide is the most exposed to the EU region (31%), where gas prices recorded the highest level. Indeed, the company was heavily penalized in 2022. A similar situation was also recorded by APD, and in the snap below (Fig 1) is evident the negative relationship between higher gas cost and lower profitability (Fig 2).

Fig 1

Fig 2

This upside starts to be already evident in the Q1 number. In detail, the company's top-line sales grew by 6.2% on a comparable basis , after a positive performance already achieved in Q4 (+4.5%). In particular, our focus is on the Gas & Services division which represents 96% of Air Liquide's turnover. This division was up by 6.7%. In line with our target and AL's strategic plan called " ADVANCE ", the company continued to achieve best-in-class operational performance. In number, they generated €91 million in efficiency despite an inflationary environment, and also the company was able to increase prices at a double-digit rate at the Industrial Merchant (Fig 3) while preserving sales volumes. Looking at the operating cash flow, they recorded a plus of 14.3% in Q1. Unfortunately, we do not have visibility on margin, but Europe recorded a plus 21% uptake in price (Fig 4). In our assumption, we are currently estimating a plus 70 basis point of core operating margin excluding energy whilst consensus is currently expecting none.

Fig 3

Fig 4

Conclusion and Valuation

Here at the Lab, we are confident that Air Liquide is a top beneficiary of the EU energy transition and is one of the few companies that can provide energy transition solutions. Unfortunately, there was no disclosure of the company's margin. However, the company "is confident in its ability to further increase its operating margin and to deliver recurring net profit growth, at constant exchange rates ". Therefore, management confirmed the 2023 guidance with a positive outlook on the strategic plan. We see Air Liquide European exposure has an internal engine growth and going to the valuation, we are now more confident in the company's future. The company is trading at 11.7x on 2024 EBITDA estimates, while Linde and APD are trading at 15.5x and 14.4x respectively. Here at the Lab, our implied multiple is set at 13.6x (in line with the company's historical average pre-COVID-19 level) and we derived a valuation of €190 per share . Our risks include COGS volatility with failure to raise margins, negative FX development, lower ROI on new projects, execution risk given the order backlog, a slowdown in economic activities, and softer decarbonization impetus.

For further details see: