Many investors might focus too much on quarterly earnings and short-term economic trends. I prefer companies with good business models which equips them with the ability to weather recessions. Praxair, Inc. (NYSE:PX), one of the largest producers and distributors of industrial gases in the world, is one of the stocks that caught my eye.
It boasts of strong recurring revenue and pricing power that is validated by its stellar financial track record. Although it is valued at a premium to its peers, this is justified by a higher relative profitability vis-à-vis its peers. I like Praxair, Inc. (NYSE:PX) for its defensiveness, given current uncertain economic conditions.
Strong recurring revenue underpinned by long-term contracts
Praxair, Inc. (NYSE:PX) typically signs 15 year take-or-pay contracts with industrial companies and constructs on-site air-separation plants supplying gases directly to their client’s facilities. In addition to the long tenure of the contracts, renewal rates tend to be high. This is because there is an element of “stickness” in this business, with alternative suppliers having to build new on-site separation plants from the scratch.
This on-site business segment accounts for about a quarter of Praxair, Inc. (NYSE:PX)’s revenue. Its merchant liquid business, representing about 30% of its revenue, is governed by exclusive supply agreements with customers located in the vicinity of its plants.
Praxair, Inc. (NYSE:PX) grew revenue by an impressive 10-year CAGR of 8.2%, with revenue increasing in every single year for the past decade except for 2009. During the Global Financial Crisis, Praxair’s revenue fell 17% in 2009, before rebounding strongly by 13% the following year.
Products have high benefit-cost ratios
Praxair, Inc. (NYSE:PX)has not suffered any loss in the past 10 years from 2003 to 2012. It has also demonstrated high gross margin stability, with gross margin staying within a narrow range of between 39%-43%. This is reflective of the pricing power enjoyed by Praxair as a result of the high benefit-cost ratio of its products.
Industrial gases are vital in the operation of customers’ facilities such as steel mills and oil refineries, but make up a very small proportion of the total manufacturing cost of its products. Consequently, customers are less price-sensitive and Praxair, Inc. (NYSE:PX) is able to maintain its gross margin in both good and bad times.
Growth drivers
Increasing intensity of gases will be the key organic growth driver for Praxair. For example, U.S. steel producers are increasingly substituting natural gas for pulverized coal or coke as a source of carbon in their production process because natural gas is cheaper. Management estimates that there is a 25% increase in oxygen usage if natural gas is used instead of pulverized coal.
In terms of inorganic growth, Praxair, Inc. (NYSE:PX) acquired NuCO2, U.S.’ largest provider of fountain beverage carbonation, in March this year. This acquisition provides two major benefits. Firstly, Praxair was previously a supplier to NuCO2; this vertical integration effort should result in positive cost synergies. Secondly, there are opportunities for Praxair to introduce this fountain beverage carbonation model in other countries where beverage carbonation cylinders are still the norm.
Peer comparison
Praxair’s peers include Air Products & Chemicals, Inc. (NYSE:APD) and Airgas, Inc. (NYSE:ARG). Praxair is valued at a premium to its peers with a forward P/E of 17.4, but it also has the highest ROA of the three at 8.3%.
Air Products is Praxair, Inc. (NYSE:PX)’s closest comparable, being the second largest U.S. industrial gases producer behind Praxair. I prefer Praxair over Air Products because Air Products & Chemicals, Inc. (NYSE:APD) has a relatively higher exposure to the under-performing electronics sector and the European region, which were responsible for a 4%-5% downward revision of full year 2013 EPS guidance at its fiscal second-quarter 2013 results call.
