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Morningstar | We Initiate Coverage of Linde plc with $173 FVE, Narrow Moat, and Stable Moat Trend Rating

After evaluating the impact of the Praxair-Linde merger, we are initiating coverage of the new combined firm, Linde plc, with narrow-moat and stable moat trend ratings and a fair value estimate of $173 per share. After the recent market pullback, shares are trading at a roughly 10% discount from our fair value estimate.

Linde is the largest company in an industrial gas sector that we think has a favorable industry structure due to long-term customer contracts and high switching costs. Despite significant divestments (including the majority of Linde’s business in North America and Praxair’s business in Europe), the combined company has a strong footprint in all key regions.

We expect Linde to expand its operating margins thanks to cost synergies, including corporate rightsizing and reduction of duplicate resources. Management is targeting $1 billion in annual run-rate cost reduction over the next three years, and we think that goal is attainable. However, while rival Air Liquide has been able to achieve meaningful revenue synergies from its acquisition of Airgas in 2016, we are skeptical Linde will be able to reap similar benefits from the recent merger. We think that significant divestments in key markets will hamper the company’s ability to take advantage of cross-selling opportunities and shared distribution channels.

Based on our analysis, the merger should create shareholder value. We project that the synergies will take about three years to achieve and cost approximately $1 billion to implement, which is consistent with management’s expectations. As such, we are forecasting operating margins to expand from roughly 22% in 2017 to about 26.5% in 2022, after the restructuring is complete. If management can achieve its target synergies and apply the strategies that drove Praxair’s industry-leading operating margins to Linde’s low-earning EUR 33 billion asset base (nearly twice the size of Praxair’s), the merger should create meaningful value for shareholders.