2023-09-14 03:57:25 ET
Summary
- APD has been on a roll with double-digit EPS growth for the past 8 quarters, and they didn't break the streak in Q3, achieving an impressive 16% YoY growth.
- The company's EBITDA margin has grown for 4 consecutive quarters due to higher volume and prices, along with reduced energy cost pass-through.
- The company's substantial $14 billion project pipeline and upcoming projects are poised to drive a minimum CAGR of 8.5% in EPS over the next 8 years.
- APD is a Dividend Aristocrat with a 2.23% yield and lower than 60% payout ratio, which increased dividends at a CAGR of 10% for 42 years, aiming to become a Dividend King in 8 years.
- My analysis suggests that the company's share price could reach $562 by the end of FY2023, offering an annualized return of 10.7% and outperforming historical returns of the S&P.
Investment Thesis
Air Products and Chemicals ( APD ) is a global leader in the industrial gases and chemicals industry. Founded in 1940, the company has a rich history of innovation and excellence, consistently delivering solutions that improve the environment, enhance productivity, and foster sustainable growth. With a presence in over 50 countries, Air Products serves a diverse range of industries, including energy, healthcare, electronics, and manufacturing. Their core offerings encompass industrial gases, equipment, and related services, which play a vital role in numerous industrial processes and applications.
Growth Strategy (APD Website)
Over the last decade, APD has shown its mettle, delivering a substantial total return of 294.8%. While it may not have clinched the title of the absolute best performer among its peers, this return is undeniably impressive. What's even more remarkable is the company's consistent performance, with eight consecutive quarters of double-digit EPS growth, and the trend continues with FY23 Q3, where APD reported an EPS of $2.98, reflecting an impressive 16% YoY growth.
Furthermore, APD has managed to expand its EBITDA Margins over the past four quarters, currently standing at an impressive 39.8%.
With several projects in progress, some already contributing to the company's bottom line, and an ambitious investment pipeline worth nearly $14 billion in the coming years, coupled with the potential to revolutionize the transportation and heavy industry sectors through its low-carbon hydrogen solutions, APD finds itself at the forefront of transformative efforts. These endeavors are not just about business success; they're also about shaping a better and more sustainable future, a crucial need in the face of the formidable climate change challenges many countries are grappling with.
Total Return (Seeking Alpha / YCHARTS)
To demonstrate that I walk the talk, I've been a long-term investor in APD myself. Currently, it holds a 4% share of my portfolio and ranks among my top 10 investments both from size and return perspective.
Impressive Q3 Results Underscored by Expanding Margins
APD recently released its earnings report for the Q3 FY23. In Q3, the company posted adjusted earnings of $2.98 per share, which marked a notable 16% increase of $0.40 per share compared to the previous year. This performance not only exceeded expectations for the quarter but also demonstrated positive trends in both price and volume.
Pricing strength remained robust, with prices showing a 4% increase, while volume saw a 3% improvement. It's worth highlighting that these promising profit figures were achieved in a challenging economic climate. This success was primarily driven by strong on-site performance, which included increased hydrogen demand in the Americas and the addition of over 30 new assets to the portfolio.
In Europe and the Americas, declining natural gas costs led to a reduction in energy cost pass-through to on-site customers, resulting in an 11% decline in sales. Importantly, this decline did not impact profit and actually had a positive effect on margins. While currency fluctuations had a modest overall impact, Asian currencies weakened, contributing to a slightly unfavorable currency impact against the U.S. dollar.
EBITDA improved by 12% , driven by strong pricing and equity affiliate income, including contributions from the second phase of the Jazan project, which closed in January. As a result, EBITDA Margin increased by almost 600 basis points, with lower energy cost pass-through accounting for a significant portion of the margin improvement. ROCE continued its steady progress, reaching 12%, which is 130 basis points higher than the previous year.
Q3 Results (APD IR)
APD has a strong history of achieving substantial growth in its EPS. Since 2014, the company has consistently demonstrated robust and steady growth, achieving a CAGR of 11%. Looking ahead to the end of FY23, the company is optimistic about prospects and expect to maintain a YoY growth rate ranging between 11% and 12%.
Moreover, the recent announcement regarding the acquisition of a natural gas-to-syngas facility in Uzbekistan, valued at $1 billion, and the introduction of new LNG equipment sales projects is poised to substantially enhance the future earnings.
Adjusted EPS Growth (APD IR)
Apart from the impressive EPS growth, what I find especially appealing about APD is its remarkable profitability. Although we observe fluctuations, such as a range from a 25.1% EBITDA Margin in 2014 to a peak of 42.7% achieved in 2020, and margins remaining relatively stable since 2019, it's worth noting that the company is presently bolstering its profitability through increased sales volume and pricing initiatives.
EBITDA Margin (APD IR)
Another interesting aspect of APD is the diversity in its revenue streams. As a global company with a presence across all continents, it has a wide-reaching geographical footprint. The Americas are the largest market, contributing over 42% of the total revenue and achieving an impressive EBITDA Margin of 45% in Q3.
What's particularly intriguing is the company's presence in Asia, accounting for 25% of the revenue. It's the fastest-growing region in terms of volume and is just slightly behind the Americas in terms of profitability, boasting a substantial 43.3% margin.
On the flip side, Europe, with a 24% revenue share, faced profitability challenges during the quarter, with a margin of 35.9% and only a 1% increase in volume. This was primarily due to the energy market difficulties in the continent.
Sales by Region (APD IR)
Hydrogen Opportunity, Increased Guidance and Strong Project Pipeline
Before I dive into the data, I'd like to emphasize just how immense the potential is for APD in the realm of low-carbon hydrogen. This isn't just an opportunity; it's a colossal one. Low-carbon hydrogen is gaining recognition as a pivotal component in the global fight against greenhouse gas emissions and the transition to a more sustainable energy future.
Hydrogen Opportunity (APD Website)
We're witnessing a surge in announcements about new projects aimed at producing low-emission hydrogen. However, only a mere 5% of these projects have moved forward with concrete investment decisions. Why the hesitation? Well, there are several uncertainties that are holding companies back. First, there's the uncertainty surrounding the future demand for hydrogen. Second, there's a lack of clarity regarding certification and regulation in this space. Lastly, we're facing infrastructure limitations when it comes to delivering hydrogen to end-users.
On the demand side, hydrogen usage is on the rise, but it's still predominantly concentrated in traditional applications. When we look at innovative uses in heavy industry and long-distance transport, they currently account for less than 0.1% of hydrogen demand. However, according to the Net Zero Emissions by 2050 Scenario , these novel applications are projected to make up one-third of global hydrogen demand by 2030.
Many countries are stepping up by unveiling national strategies and implementing concrete policies to support early movers in the low-emission hydrogen sector. However, there's a snag. The slow implementation of these policies, coupled with the lack of policies aimed at stimulating demand, is impeding the growth of low-emission hydrogen production and utilization.
Now, back to the numbers, as I mentioned earlier regarding management's EPS expectations for the fiscal year's end, the company is adopting a somewhat cautious tone in light of the economic challenges evident in the US, Europe, and China. Nonetheless, they have raised the lower end of their guidance from $11.30 to $11.40. The current outlook is for the company to achieve earnings in the range of $11.40 to $11.50 by year-end, reflecting a YoY growth of 11% to 12%. This underscores the company's strong foundational position and its clear trajectory in an uncertain economic environment.
Outlook (APD IR)
Looking ahead past fiscal year 2023, analysts have high expectations for APD's performance. They anticipate strong growth, driven by several projects that will become operational, making significant contributions to both global revenues and profits. The next four years are particularly crucial, as it's projected that the company will achieve an impressive CAGR of 13.6% in its EPS. This optimism is well-supported by the number of the analysts closely monitoring the company.
As the company shifts its attention to wrapping up current projects in the near term, the outlook for growth beyond 2027 appears somewhat uncertain. The lack of clarity surrounding new projects contributes to this uncertainty, and forecasts indicate that the growth rate might potentially dip below a CAGR of 4%. However, I believe that the company, especially with the increasing demand for low-carbon hydrogen solutions to fight the climate change, is well-positioned to maintain growth rates similar to those witnessed between 2023 and 2027.
EPS Estimates (Seeking Alpha)
Regarding the projects, as mentioned earlier, the completion of the second phase of the Jazan in Saudi Arabia project is already contributing to the company's bottom line in Q3, aligning with the planned timeline of 2021 - 2023. Additionally, the Juitai project in China is now completed and operational. Looking ahead, APD is investing around $5.8 billion in planned projects from 2023 to 2026, with another $7.8 billion in projects in the pipeline for 2027 and beyond.
Project Overview (APD IR)
Even though the company is pouring close to $14 billion into new projects to drive its future expansion, it's reassuring to note that it still maintains an investment-grade rating. Both S&P and Moody's have given the company A-level ratings, with S&P assigning it an A rating and Moody's rating it as A2. These ratings signify a very low probability of default.
Path to becoming Dividend King
It's worth noting that APD is presently recognized as a dividend aristocrat, having consistently raised its dividends for 42 years. Given the company's projected robust earnings growth, it's highly probable that it will maintain this successful track record for another 8 years, ultimately attaining the esteemed status of a Dividend King.
What truly distinguishes APD for dividend growth investors, myself included, is its exceptional track record of dividend growth. Over its history, the company has consistently increased dividends at a CAGR of 10%. It's important to note that this growth hasn't slowed down in recent years; in fact, it has slightly accelerated over the past decade, achieving a CAGR of 10.5%. With the anticipated earnings growth, I believe we can expect similar dividend growth in the range of 7.5% to 12.5% over the next decade. This makes APD an outstanding choice for dividend growth investors.
Dividend History (Seeking Alpha)
The company's dividend yield is currently at 2.23%, which isn't the highest in the market, but it looks like a promising choice when you compare it to the industry peers such as Linde ( LIN ) at 1.29%, L'Air Liquide ( OTCPK:AIQUF ) at 1.81% and Sherwin-Williams ( SHW ) at only 0.91%. Additionally, the company's payout ratio is just under 60%, indicating that it has a solid financial position to continue paying dividends and even increase them in the future.
Dividend Yield (Seeking Alpha / YCHARTS)
Valuation
Going into the valuation, the company is currently trading at Forward PE ratio of 26.22x of its FY24 earnings. This is roughly in-line with its 5-year average of 26.53x. Nevertheless, among its peers, compared to Linde trading at 27.59x and Sherwin-Williams at 27.16x the company is trading at a very slight discount.
Looking at the Forward PE ratio, the company seems fairly valued at $302 presently. Nevertheless, it's worth noting that this metric doesn't account for the company's exceptional growth potential beyond FY24.
Forward PE Ratio (Seeking Alpha / YCHARTS)
As we've covered before, the upcoming projects set for rollout between 2023 and beyond are expected to have a substantial influence on both the company's top-line revenue and its bottom-line profitability. In the analysis I'm about to present, I'll be working with the assumptions made by analysts, who anticipate that the company will experience CAGR of 8.5% in earnings from 2023 to 2030. However, it's worth noting that, in my opinion, this projection errs on the side of caution and may not fully account for the potential profitability of projects beyond 2027, as we observe a decrease in growth rates for both revenue and earnings per share, falling below their historical averages of 11%.
Furthermore, I hold the belief that low-carbon hydrogen is poised to gain significant traction in the market. This expectation aligns with the broader trend of companies emphasizing ESG principles, as the mounting evidence of climate change-related damage prompts governments to provide clearer guidance and incentives for the development of sustainable infrastructure.
Fiscal Year | 2023 | 2024 | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 |
Revenue () | $13.0 | $13.7 | $15.1 | $18.0 | $19.7 | $20.4 | $21.9 | $23.26 |
Rev. Growth | 2.5% | 7.1% | 10.4% | 19.4% | 9.3% | 3.5% | 7.2% | 6.5% |
EPS | $11.5 | $12.8 | $14.3 | $17.4 | $19.2 | $20.3 | $21.6 | $22.5 |
EPS Growth | 11.5% | 11.1% | 11.7% | 21.8% | 10.4% | 6.0% | 6.2% | 4.2% |
Forward PE | 26 | 27 | 28 | 27 | 24 | 25 | 24 | 25 |
Stock Price | 302$ | 338$ | 392$ | 460$ | 498$ | 508$ | 518$ | 562$ |
With that being said, I anticipate that the company's stock price could potentially reach $562 by the end of FY2030. If this materializes, it would translate to an annual rate of return of 10.7%, surpassing the historical average return of the S&P 500 at 10.2%. This performance would also outshine the projected returns for the index in the upcoming decade, which are expected to fall within the abysmal range of 3% to 6% annually. This is particularly noteworthy given that current valuations are higher compared to historical norms.
Conclusion
APD, as it progresses on its journey to becoming a dividend king within the next eight years, is actively shaping the world around it. The company is playing a pivotal role in initiatives aimed at decarbonizing the transportation and heavy industrial sectors while also remaining steadfast in its core business of providing industrial gases. In all its endeavors, sustainability and the imperative for industry transformation take center stage, given the unprecedented climate-related challenges that countries across the globe are currently grappling with.
The company's remarkable performance has been evident over the past eight consecutive quarters delivering double-digit growth, with the third quarter being no exception. APD has consistently exhibited strong financial results, driven by both increased volume and effective pricing. As it continues to bring multiple projects online, APD is poised to further bolster its already robust profitability. Projections suggest that it will maintain a minimum EPS CAGR of 8.5% over the next eight years.
In this era of global transformation and a shifting focus towards a sustainable future, APD stands at the forefront, set to outpace the rate of return offered by SPY and delivering an impressive annualized return of 10.7% over the coming eight years.
For further details see:
Air Products and Chemicals: Future Dividend King With Accelerating Growth