2023-04-28 14:37:39 ET
Summary
- APD's products are necessary for many industries to operate.
- The company is taking on several ambitious mega-projects in the near future.
- We believe this stock is a compelling prospect for dividend and long-term investors.
Overview
Air Products and Chemicals (APD), the $63 billion market-cap industrial gas giant, belongs to the league of companies which few laypeople have heard of but whose business is one upon which modern life relies. The company produces, stores, and delivers various industrial gasses at large scale to enterprise-level customers who use those gases in the manufacturing of myriad products.
One would expect that such a company would be a stable, mature enterprise, unlikely to be displaced by upstart rivals, and one would be correct in assuming so. Contracts in this business can last as long as twenty-five years, many times with physical pipelines being connected from producer facilities into customer facilities, rendering the ability to switch suppliers incredibly difficult. The business is also not materially subject to any sort of seasonality, given the consistent demand.
Over the last ten years, the market has rewarded APD shareholders as well, with the stock delivering a total return of over 350% while the broader S&P 500 ( SPY ) turned in just over 200%.
All of this is likely to sound like music to a long-term, dividend-seeking investor's ears. Such a steady state business with pre-negotiated contracts and high switching costs certainly seem right up this style of investor's alley. In our opinion, however, APD does not fit this bill, and in this article we'll explore why. Let's dive in.
Performance
APD has posted strong growth over the last three years, with total revenues growing from $8.8 billion to $12.6 billion.
This growth, however, is a recent development and likely the result of older contracts rolling off and new agreements being put in place. Over a longer horizon, the relative stability of the business becomes clear. The company recently reported its first quarter results (the quarter ending Decemeber 31st), and they were good--year over year revenue for the quarter grew 6% to $3.1 billion, and gross profit expanded by 17% to $900 million.
Analyst expectations for top line growth at the company are similarly rosy. While future year revenue expectations have not exactly exploded, analyst estimates have ground upward steadily over the past three years, only stalling out a bit over the past twelve months or so.
The company has also maintained relatively stable margins, though there are signs of pressure. Over the past twenty years, APD has averaged a net income margin of a respectable 13.7%, while CapEx as a percentage of revenue over the same period has averaged 15.3%.
Recently, however, the company has boosted its CapEx spend significantly. As a percentage of revenues, CapEx was 17.7% in 2022, 20% in 2021, and 21% in 2020. These trends, impacted in part by inflation, are not likely to abate. This, of course, eats into the company's free cash flow.
Inflation has also eaten into the company's gross margin. In 2022 APD reported gross margins of 26%--the company's lowest reported gross margin in more than ten years, though margins ticked back up to 28% in the most recent quarter.
With revenues on the upswing, then, and margins being compressed, what should investors think in terms of valuation?
Valuation
Consistent with the stability that seems to pervade the company as a whole, APD is not excessively over or under-valued on either a forward price-to-earnings or forward EV/EBITDA basis.
APD currently trades at a forward P/E multiple of 24.5x against its five year historical average of 24.9x. On a forward EV/EBITDA basis the stock trades hands at 14.4x against a five year average of 13.7x.
The Dividend & Cash Flow
As of this writing, APD's indicated dividend yield is 2.43%, which in the company's FY 2022 cost it $2.9 billion.
APD Indicated Dividend Yield (Koyfin)
The dividend also appears quite safe. The company generated $10.14 EPS for FY 2022 on a diluted basis, and paid dividends of $6.36 per share for the same period.
Of course, viewing dividend coverage through earnings-per-share metrics can be a bit narrow and lull investors into a sense of complacency. One metric for APD that we think is a bit concerning is the company's ballooning price to free cash flow.
This metric has blown up over the past year. While the five-year average is an eye-popping 82x (pulled upwards, of course, by the recent surge), the stock now trades at 232x free cash flow.
The Future
APD has a slate of mega-projects on its calendar, and these ambitious projects form a big part of the company's allure. In the most recent conference call, management announced that the company would embark on a $4 billion investment in Wilbarger County, Texas to build a green hydrogen plant.
With an estimated completion date of 2027, this is only the latest in a string of ambitious projects undertaken by management, including a 30-year contract to offtake green ammonia from the planned Saudi Arabian super-city of Neom (this project is estimated to require a cash outlay from APD of roughly $800 million).
The Bottom Line
APD is a stellar, stable business that has executed well in the past and is looking to make highly ambitious steps towards the future. With a reasonable valuation and products with near-universal needs, we think the company is well positioned for the future.
Risks to this thesis are any disruption to the company's mega-projects. Should Saudi Arabia not follow through with its commitment, or if the company is unable to complete its Texas project, it would likely cause the stock to suffer materially.
Today, however, we believe the stock is interesting for dividend seeking, long-term time horizon investors.
For further details see:
Air Products and Chemicals Is A Great Deal Right Now