2023-05-10 08:45:58 ET
Summary
- APD's Q1 earnings analysis reveals a company with robust financial performance, with an 8.7% y/y revenue growth and a 15% y/y EPS growth.
- APD's strategic balance of aggressive growth initiatives and a defensive legacy business, particularly in the hydrogen market, positions it as a resilient player in the industry.
- While APD's mega projects and aggressive growth strategy present lucrative opportunities, they also come with associated risks such as timeline delays and foreign exchange headwinds.
Air Products and Chemicals, Inc.'s ( APD ) recent Q1 earnings disclose a financial snapshot that is undeniably robust, even in the face of a post-earnings stock price dip of 5.3%. Rather than a signal for caution, we interpret this dip as an enticing investment opportunity. This report provides a comprehensive analysis of APD's Q1 earnings, revealing a company with impressive revenue growth, efficient cost management, and strong future prospects. However, as with any investment, there are associated risks, and it is crucial to understand and account for these in any investment decision. We delve into APD's mega projects, its Asian portfolio, and the impact of foreign exchange headwinds. Ultimately, we aim to present a balanced investment thesis, highlighting APD's potential while addressing its challenges.
FYQ2 Earnings Analysis
APD's Q1 earnings reveal a company in a robust financial position, notwithstanding the immediate post-earnings stock price dip of 5.3%. In our view, this dip in share price presents an intriguing opportunity for the discerning investor. Although it might signal a market that had even higher expectations, the fundamentals tell a different story. APD's Q1 revenue growth of 8.7% y/y to $3,200 million, which beat consensus estimates by 4.4%, is a clear testament to the company's solid revenue-generating capabilities.
The company's EPS growth of 15% y/y, beating consensus by 3.5%, is another strong indicator of APD's potential. An EPS growth that outpaces revenue growth suggests efficient cost management and profitability. Furthermore, the company's operating margin improvement from 19.1% to 20.1% within a year indicates improving operational efficiency, which should be viewed positively.
APD's revised FY23 EPS guidance, raising the lower end by $0.10 to $11.30-11.50 per share, is a positive signal for investors. Despite the market's negative reaction possibly due to higher expectations, an 11% y/y growth at the midpoint is a testament to the company's strong performance and future prospects.
The company's guidance for F3Q EPS at $2.85-2.95 and its reiterated FY23 capex budget of $5.0-5.5 billion further underscores the company's solid financial footing and its commitment to strategic investments, which should drive future growth. The mere 10 cents increase in guidance, albeit modest, reflects management's confidence in the company's ability to deliver on its promises.
However, the modest timeline delay for the Jutai project in China is a concern, indicating some volume uncertainty and potential sluggishness. Another possible concern is that the end of the significant price actions, with merchant pricing up ~18% y/y, hints at a near-term peak for operating income. This can lead to a temporary lull in performance, but we believe it's a short-term hurdle in an otherwise long-term growth trajectory.
Business Analysis: Playing Offense & Defense
In its recent earnings call , APD demonstrated a potent strategy that combines aggressive growth initiatives with a defensive legacy business. This dual approach, rooted in the hydrogen market and its established industrial gas business, presents a compelling narrative of a company poised for sustainable success.
The company's endeavors in the hydrogen market are nothing short of pioneering. As a first-mover , APD has boldly embraced the challenges and skepticism that come with innovation. This is evident in its groundbreaking initiatives like the NEOM Green Hydrogen Project and the Louisiana Blue Hydrogen project. With the launch of the NEOM project three years ago, APD was the first hydrogen producer to capitalize on renewable energy resources in the Middle East and recognize the potential of ammonia as a hydrogen transport medium. Similarly, by announcing the Louisiana project in 2021, APD was the first to act on carbon capture and sequestration on the US Gulf Coast.
These initiatives have not only garnered significant global government support but also motivated other companies to venture into the hydrogen market. However, APD maintains its competitive edge through its vast experience, proprietary assets, and unwavering commitment to clean energy. This commitment was further affirmed when APD became the first US chemical company to qualify green and blue hydrogen projects as an eligible expenditure category. This validation cements APD's leadership in the hydrogen market and its role in advancing the global energy transition.
On the other side of APD's strategic equation is its legacy industrial gas business. This segment provides a highly defensive and repeatable revenue stream, creating a financial bulwark against volatile market conditions. It's this stable business that allows APD the financial latitude to pursue aggressive growth initiatives in the hydrogen market.
In essence, APD's approach intertwines pioneering growth initiatives in the hydrogen market with the stability provided by its legacy industrial gas business. This strategic balance positions APD as a resilient player capable of weathering different parts of the economic cycle. We believe that the market should appreciate these defensive attributes alongside APD's aggressive growth strategy.
Risks
APD's aggressive growth strategy, particularly its ambitious mega projects, does come with a set of inherent risks that potential investors should be aware of. Given the size and complexity of these ventures, the risk associated with the timing and productivity of APD's mega project backlog is potentially higher than traditional industrial gas backlogs. This is evidenced by the recent delay in the Debang project from FY2H23 to FY1H24 and an increase in the World Energy project investment from $2.0B to $2.5B. Such developments remind us that these large-scale, innovative projects can often face unforeseen hurdles, leading to delays or cost overruns.
Moreover, APD's projects in Asia carry their own set of risks. Following the cancellation of projects in Indonesia, further delays-even if minor and unrelated-can affect investor sentiment. The Jiutai project is reminiscent of many of the initial warnings at Lu'An , which underscores the potential pitfalls in APD's Asian portfolio. The region's complex regulatory environment and logistical challenges can potentially impact APD's project timelines and overall profitability.
Finally, the company is not immune to the effects of foreign exchange headwinds. Currency fluctuations have had a notable impact on sales, with a consolidated 4% Y/Y headwind. This impact is even more pronounced in Asia and Europe, where FX was a 7% and 6% Y/Y headwind, respectively. These significant currency translation headwinds pose a persistent challenge to APD's international business.
While APD's pioneering approach and commitment to growth are commendable, the associated risks are real. The company's ambitious mega projects, its Asian portfolio, and foreign exchange headwinds all pose considerable challenges. Potential investors need to consider these risks alongside the company's growth prospects when making their investment decisions.
Financial & Valuation
Note: All historical data in this section comes from the company's 10-K filings, and all consensus numbers come from FactSet.
Over the last three fiscal years, APD's EBIT margin has indeed shrunk from 24.2% to 19.0%. Although this contraction is concerning, it's worth noting the market consensus forecast, which forecasts an EBIT margin expansion to 20.8% this fiscal year, and further to 21.9% in the following fiscal year. If achieved, this will represent a significant turnaround in profitability.
With APD spending only 0.5% of its revenue on share-based compensation (SBC) over the past three years, the 0.6% increase in diluted outstanding common shares over the same period seems minimal. We believe this conservative approach to SBC is a strong indicator of shareholder-friendly capital management, which is a positive sign for potential investors.
APD's stock trading 0.6% above its 200-day moving average and 28% above its 52-week low indicates a positive market sentiment, notwithstanding it being 15% below its 52-week high. With low short interest at 0.8%, the risk of a short squeeze or a bear raid are negligible, adding a degree of stability to the stock.
The stock's current dividend yield is 2.4%, 80 bps above the S&P 500. This higher yield, coupled with strong returns over the past year, adds another feather to APD's cap. The company's return on invested capital at 10.7% is a clear indicator of efficient use of capital, strengthening our positive opinion of the company's potential.
Despite these positives, APD's PEG ratio is currently 1.9 compared to the S&P 500's PEG ratio of 1.5, which indicates a premium of 22.2%. This higher valuation might be a concern for some investors. However, considering the company's robust financial performance and solid future prospects, we believe that this premium is justified.
Overall, our analysis suggests that APD is a solid investment proposition, despite some concerns about its valuation and past EBIT margin contraction. Its strong financial performance, efficient capital management, and favorable market sentiment make it a stock worth considering.
Conclusion
APD presents a compelling investment proposition, despite certain inherent risks associated with its aggressive growth strategy. Its robust financial performance, underscored by impressive revenue and EPS growth, is testament to its strong fundamentals. The company's strategic balance of pioneering growth initiatives in the hydrogen market and a stable legacy business offers both excitement of innovation and the comfort of stability. However, potential investors should be aware of the associated risks, particularly those related to the company's mega projects and foreign exchange headwinds. Despite these, we believe that APD's strengths outweigh its challenges. Its solid financial footing, aggressive yet calculated growth strategy, and resilience in the face of market uncertainties make it a worthy contender for any discerning investor's portfolio.
For further details see:
Air Products And Chemicals' Q1 Earnings Uncovers Investment Opportunities