Morningstar | APD Updated Forecasts and Estimates from 20 Nov 2018
After taking a fresh look at narrow-moat industrial gas producer Air Products, we are raising our fair value estimate to $187 from $160 and think the market is missing the company’s tremendous revenue growth potential. Management has made great strides in its ambitious plan to deploy roughly $15 billion of capital over the next five years, having committed almost $8 billion thus far. We expect that as new projects come on line and start contributing to the bottom line over the next few years, the market will eventually take notice.Furthermore, we are increasing our moat trend rating to positive and stewardship to Exemplary, as CEO Seifi Ghasemi has orchestrated a remarkable turnaround since he took the helm in 2014, raising EBITDA margins by over 1,000 basis points. Several moves made by management contributed to this strong performance, including divestments of low-margin noncore operations (including the spin-off of the electronic materials division as Versum Materials in 2016 and the sale of the special additives business to Evonik in 2017), massive cost cuts, and huge investments in on-site projects in emerging markets.
We think management’s focus on on-site projects will fortify Air Products’ moat, since the segment benefits from long-term customer contracts and high switching costs. On-site customers typically sign 10- to 20-year contracts, often including take-or-pay clauses and prices indexed to the cost of electricity, which leads to a more stable and predictable cash flow stream to Air Products. Also, after acquiring Shell’s and GE’s gasification businesses in 2018, Air Products is a leader in the space, and we think it’s poised to capitalize on a plethora of gasification opportunities in China and India over the next few years.
Air Products is our favorite pick in the industrial gas sector, and the stock is currently in 4-star territory, trading at a roughly 15% discount to our fair value estimate, which we view as an attractive entry point.
Air Products and Chemicals serves customers globally with a portfolio of products, services, and solutions that include atmospheric gases, process and other gases, equipment, and services. The company is a supplier of hydrogen and is engaged in helium and liquefied natural gas (LNG) process technology and equipment. The company also develops, engineers, builds, owns and operates industrial gas projects, including gasification projects that convert abundant natural resources into syngas for the production of power, fuels and chemicals. The company designs and manufactures equipment for air separation, hydrocarbon recovery and purification, LNG, and liquid helium and liquid hydrogen transport and storage.
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