2023-04-19 10:48:04 ET
Summary
- In this article, we discuss one of the oldest and most fascinating chemical companies on the market.
- LIN, which is a dividend aristocrat, brings a great mix of growth and value to the table, which should provide strong dividend growth and capital gains on a long-term basis.
- The company has strong pricing power and benefits from secular growth in hydrogen. Unfortunately, its valuation isn't very attractive. I believe waiting for a correction could be prudent.
Introduction
Dividend aristocrats are companies that have hiked their dividends for at least 25 consecutive years. This gives them one of the most prestigious stamps of approval on the market. However, a lot of these companies are very mature, which means that growth tends to be somewhat limited. Linde Plc. (LIN) is different. This company has hiked its dividend for 30 consecutive years without compromising on growth.
Founded in 1879, the company is still a fast-growing dividend stock with exposure to a wide number of supply chains. Its wide-moat business model includes benefiting from secular trends like hydrogen.
In this article, I will share my thoughts on this company, as I believe in buying the next correction.
So, let's get to it!
Old, Yet Fast-Growing
Linde is the world's largest industrial gas company. With a market cap of $180 billion, it's more than twice as big as its largest competitor Air Products and Chemicals (APD).
The current company is the result of a 2018 merger between Linde AG (founded in 1879) and Praxair, an American industrial gases company that was founded in 1907 as Linde Air Products Company in Germany.
LIN is incorporated in Ireland. Its headquarters is located in Guildford, United Kingdom. The company reports its earnings in USD.
When it comes to its products, the company specializes in the production and processing of industrial gases, including atmospheric gases like oxygen, nitrogen, argon, and rare gases, and process gases like carbon dioxide, helium, hydrogen, electronic gases, specialty gases, and acetylene.
Linde also designs and constructs gas production equipment and provides various gas production and processing services, including olefin plants, natural gas plants, air separation plants, hydrogen and synthesis gas plants, and other plant types.
In the hydrogen industry, the company produces grey hydrogen from natural gas or methane via steam methane reformation. Linde also produces blue and green hydrogen, which are considered clean energy. Blue hydrogen involves capturing carbon emissions from the plant and either utilizing or sequestering them. Green hydrogen is produced through electrolysis using renewable energy or steam methane reforming of biomethane. Additionally, Linde recovers by-product hydrogen from the chemical and petrochemical industries, producing low-carbon intensity, high-purity hydrogen.
The company currently works with fertilizer giant OCI. It will invest $1.8 billion as the long-term supplier of nitrogen and blue hydrogen into OCI's ammonia facility. This is a win-win as Linde provides the supplies to produce fertilizers and decarbonize the process, while OCI focuses on the production of ammonia, something Linde doesn't want to engage in.
Furthermore, when it comes to chemical companies, it's important to view these companies as players in a wide variety of supply chains. Chemicals are the cornerstone of multiple industries, including healthcare, food & beverages, mining, and electronics.
This is why the company tracks and reports growth trends in every one of these end markets. In 4Q22, the company was bullish on almost all of its end markets.
Based on this context, the company does not just have a wide-moat business, but it also has pricing power.
For example, in 4Q22, the company saw a 1% decline in sales volumes. However, price/mix was up 8%, which more than offset these issues. Sales were only down 5%, as currency headwinds and divestitures offset these benefits. After all, the company reports its numbers in USD, yet only generates 32% of its sales in the United States. Hence, a stronger dollar tends to be a drag on sales.
Thanks to strong global chemical growth, pricing power, and secular growth in areas like hydrogen, the company is a fast-growing chemical giant. Over the past ten years, the company has grown its revenue by 11.5% per year, which is truly impressive. Compounding annual EBITDA growth was 12.2% during this period.
Furthermore, while the chemical business is highly capital-intensive, the company spent just 10% of its revenue on capital expenditures in the past four quarters. The long-term median is close to 14%. While CapEx rose to $3.1 billion over the past four quarters, higher operating cash flow paved the road for a free cash flow surge to $5.7 billion.
Please note that the steep surges below were caused by the 2018 merger with Praxair.
Even better is that this trend is expected to continue. These are the free cash flow estimates for the next few years:
- 2023: $5,800 million
- 2024: $6,200 million (+6.9%)
- 2025: $6,600 million (+6.5%)
With that said, here's what this means for shareholders.
The Linde Dividend
Linde is a dividend aristocrat, meaning it has hiked its dividend for at least 25 consecutive years.
In February of this year, the company increased its dividend for the 30th consecutive year.
The company hiked by 9% to $1.275 per share per quarter, which implies a 1.4% dividend yield.
While a 1.4% yield isn't something to write home about, it's the only downside that comes with owning Linde for its dividends. As the Seeking Alpha dividend scorecard below shows, the company scores high on dividend growth and very high on dividend safety and consistency.
Over the past ten years, the average annual dividend growth rate was 7.8%. That number has improved to 10.0% over the past three years.
Furthermore, if we assume that the company is able to do $5.8 billion in free cash flow this year, we're dealing with an implied free cash flow yield of 3.2%, which implies a cash payout ratio of 43%. In 2025, these numbers could be 3.7% and 38%.
Moreover, the company engages in buybacks. Last year, buybacks were $5.1 billion last year, bringing total distributions to $7 billion, which was 5% of the company's market cap last year.
Now, let's take a closer look at the valuation.
Valuation
Thanks to its pricing power, the company's stock price has done well despite the pressure of rising energy prices on chemical production. It has also ignored the recent decline in economic growth expectations.
LIN shares are trading at an all-time high. Shares are up 12% year-to-date and up 39% from their 52-week lows.
FINVIZ
While this confirms the company's quality, it's bad news for the valuation, as I cannot make the case that LIN shares are a buy at these levels.
Historically speaking, the free cash flow yield is close to 3.4%, which implies that the current valuation is fair. The company is trading at 19.4x EBITDA and 16.6x NTM EBITDA. This valuation is fair. After all, the company is expected to maintain strong single-digit free cash flow growth on a prolonged basis.
However, the valuation isn't attractive.
I would put the fair value of LIN at $380, which is in line with the consensus forecast of $380.
Investors looking to buy LIN might benefit from waiting for a correction. While waiting comes with the risk of missing the next rally, I believe it's worth the wait as the risk/reward is just not attractive. Also, given economic conditions, I would not bet against a stock price decline toward $300.
Takeaway
Linde is a stock that would fit well in my portfolio. The company has a very wide moat thanks to its operations in a wide range of supply chains, growth projects in hydrogen, and the ability to offset risks related to inflation.
While Linde is one of the oldest companies on the market, it is still expected to maintain high growth rates, boosted by pricing and strong secular demand.
The company has hiked its dividend for 30 consecutive years and is in a good spot to maintain high dividend growth rates.
Unfortunately, shares are far from attractive, as I believe that LIN trades less than 5% below its fair value.
Investors interested in buying LIN might benefit from waiting for a correction, which seems likely to happen given the state of the global economy.
For further details see:
Linde: What To Make Of This Dividend Aristocrat