APD plans to spin-off its materials technologies segment by September of 2016. The spin-off will make APD a ‘pure play’ industrial gas supplier.
The spin-off makes sense strategically. It will allow the industrial gases business to allocate capital in the most efficient way it can, while allowing the materials technologies business to pursue its own course.
APD’s management has informed shareholders that the sum of dividends from the 2 separate companies will be the same as APD’s current dividend. There is no word yet on how the dividend will be divided between the core gas business and the new materials technology spin-off.
Competitive Advantage
The industrial gas industry is mature. In the United States, just 3 business cover the majority of the market:
– APD – Market cap of $27.4 billion
– Praxair, Inc. (NYSE:PX) – Market cap of $28.9 billion
– Airgas, Inc. (NYSE:ARG) – Market cap of $10.0 billion
Air Liquide (AIQUY) – which is based in France – is acquiring Airgas. Air Liquide has a market cap of $34.0 billion.
The gas business is highly consolidated because it has strong competitive advantages for incumbent businesses. Large projects require technical know-how and high up-front costs which make competing difficult for a start-up business.
Additionally, gas suppliers have well established gas distribution networks. Once a customer is supplied by a gas company, it is unlikely they switch. Even if a customer wanted to switch, there are very few competitors in any one geographical region that can compete on price in the same distribution network.
As a result, the well established gas companies (like APD) maintain their customers and grow business year after year.
Growth Prospects & Expected Total Returns
Air Products & Chemicals, Inc. (NYSE:APD) has grown its earnings-per-share at 7.2% a year over the last decade. The company had an above average year in 2015; earnings-per-share increased 14%.
The company is realizing faster growth thanks to a focus on efficiency. Most mature business talk about raising margins. APD has actually done it.
Source: APD 4th Quarter 2015 Presentation, slide 8
The company’s margin growth is a direct result of management’s focus on cash, capital allocation, decentralization, and rewarding performance.
CEO Seifi Ghasemi has done an excellent job of allocating capital and increasing efficiency since becoming CEO in June of 2014.
The planned materials technologies spin-off will likely also be a positive for shareholders. APD’s management has shown a dedication to increasing shareholder value rather than empire building.
Based on management’s positive moves and APD’s competitive advantage and historical growth rate, I expect the company to compound earnings-per-share at between 7% and 10% a year over the next several years.
This growth combined with the company’s current 2.6% dividend yield gives investors in APD expected total returns of 9.6% to 12.6% a year over the next several years.
Valuation
APD currently has a price-to-earnings ratio of 19.0 using adjusted earnings. APD is a bit cheaper than the S&P 500’s current price-to-earnings ratio of 21.0.
Additionally, the company’s 2.6% dividend yield compares favorably to its historical average dividend yield of 2.2%.
Valuation is more art than science. High quality businesses with growth rates in the high single digits should trade for a price-to-earnings ratio of around 20 in today’s low interest rate environment.
APD stock has declined over 7% in the last year. I believe the company to be slightly undervalued at current prices, perhaps by around 10% or so. I’d place fair value for the stock at between $130 and $140 a share. APD is currently trading for ~$124 a share.
Final Thoughts
Air Products & Chemicals, Inc. (NYSE:APD) has a strong competitive advantage and operates in an industry dominated by only a few companies.
As a result, the company has a long growth runway ahead. Air Products and Chemicals cost cutting and growth plans have returned the company to double-digit earnings-per-share growth (for now).
APD is a hold at current prices using The 8 Rules of Dividend Investing. With steep declines in other sectors of the economy, there are simply other high quality businesses available at bigger discounts right now.
With that said, dividend growth investors should be very happy with APD’s business performance and CEO leadership. The company’s performance over the next decade looks more promising than performance over the previous decade.
Disclosure: None
