2023-04-15 08:15:00 ET
Summary
- Air Products and Chemicals is a leading global player in industrial gases and hydrogen energy.
- It's set to benefit from strong secular growth trends and pays a well-covered dividend with many years of growth.
- Recent share price weakness gives long-term dividend growth investors a nice opportunity to layer into the stock.
It pays to have a well-balanced portfolio that's able to withstand economic adversity, and while I like names such as Enterprise Products Partners (EPD) and Magellan Midstream Partners (MMP) for their high yields, I'd like to increase exposure to names that are more "future-proof" with exposure to new energy sources like hydrogen.
Such appears to be the case with Air Products and Chemicals (APD), which I last covered in December here . At that time, I noted the company's durable characteristics, and the valuation being above what I found attractive.
Well, lots have happened in the market since then, and APD's stock has fallen from the near $320 level in February to $286 at present. In this article, I highlight recent developments and discuss why now is an attractive opportunity on this high quality stock.
Why APD?
Air Products and Chemicals is a moat-worthy industrial gases company that's been in existence for over 80 years, and has operations worldwide. It benefits from having established operations and entrenched customer relationships in a diverse set of industries, including refining, chemicals, food, manufacturing, and metals. It also operates carbon capture projects and supplies hydrogen for global transportation.
Over the trailing 12 months, APD generated $12.9 billion in total revenue and has a respectable 5-year average revenue growth rate of 8.7% . APD also enjoys some degree of pricing power considering its scale and leverage as one of the largest producers of industrial gases. This includes trophy assets such as the $12 billion gasification joint venture it has in Saudi Arabia with Aramco (ARMCO), the world's largest oil company. APD's high profitability is reflected by its A- grade, with EBITDA margin and Return on Equity that's well in excess of the sector median, as shown below.
Meanwhile, APD continues to show aptitude for mega-scale hydrogen energy projects globally. This includes partnering with electric transmission giant AES Group (AES) to build, own, and operate America's largest green hydrogen facility in Wilbarger County, Texas. It also has projects do support downstream hydrogen infrastructure in Europe, and support from both domestic and international governments. This includes a recent $130 million win to supply NASA with liquid hydrogen and the Canadian government's 475 million to fund APD's multi-billion dollar net zero hydrogen complex in Alberta.
APD has an outsized opportunity to capture significant share in the growing hydrogen market. According to global consulting firm McKinsey, hydrogen could contribute to more than 20% reduction in global emissions by the year 2050. As shown below, the expected drop in production costs for green, blue, and grey hydrogen makes it a viable cost-effective energy alternative in the not so distant future.
Meanwhile, the market appears to be concerned around APD's less than impressive 6% adjusted EPS growth and potential for cost overruns at some of its projects. While it's hard to estimate what potential future costs may be, it appears that the weaker than expected earnings growth is due more to timing. Management expects return on common equity to improve in 2023 as it brings projects online, and adjusted for cash, APD's ROCE would have been a respectable 13.3% in the last reported quarter.
Notably, APD is generating ample amounts of cash, which amounted to a DCF per share of $14 last year. It also carries a strong A rated balance sheet with a long-term debt to capital ratio of 36%. While the 2.4% dividend yield isn't something to write home about, it does come with a safe 50% DCF payout ratio, a 5-year CAGR of 11% and 40 years of consecutive growth, making APD a dividend aristocrat. As shown below, APD scores A and B grades for dividend safety, yield, growth, and consistency.
Admittedly, APD isn't a bargain at the current price of $286 with forward PE of 25. However, long-term investors may be rewarded to the aforementioned secular growth trend of hydrogen and APD's moat-worthy positioning. Plus, analysts expect 10% to 27% annual EPS in the 2024 - 2027 timeframe, which may justify APD's current valuation. Analysts also have a consensus Buy rating with an average price target of $329 , which could mean a potential 17% total return over the next 12 months.
Investor Takeaway
Air Products & Chemicals is a leading global player in industrial gases and hydrogen energy, and is set to benefit from strong secular growth trends in its industry. It maintains a well-covered dividend and has a very long track record of growth. Recent share price weakness has made the stock attractive for long-term dividend growth investors.
For further details see:
Air Products and Chemicals: Ride The Hydrogen Wave With This Dividend Aristocrat