Analysis: Wall Street sees growth for Praxair, Air Products

01 April 2005 18:01  [Source: ICIS news]

NEW YORK (CNI)--In an age of earnings volatility, strong and steady growth is the hallmark of an attractive investment. Within the cyclical chemical and other industrial sectors, the industrial gases group offers the unique combination of high growth and low earnings variability.


"The industrial gases sector is structurally one of the most attractive marketplaces, not only among chemicals or basic materials, but also among a much broader field of industrials," said Lehman Brothers analyst Sergey Vasnetsov. "The unique nature of the business - making commodity products but selling them in a specialty-like way - is the envy of many chemical producers."


Comparing the 10-year performance (1994-2004) of leading industrial gases companies Praxair and Air Products with 25 leading industrial companies in nine different sectors, the Lehman Brothers analyst discovered the industrial gases group was in the top two by every measure - earnings/share (eps) growth (+10.5%), net income margins (9.2%) and operating cash flow growth (+9%).


Along with healthy growth and strong margins, the group exhibited steadiness with the lowest volatility in net income margins, eps growth rate and operating cash flow growth. Earnings rose even during the last US and global industrial recession - an anomaly within the industrial group.


"Praxair and Air Products represent very attractive investment opportunities due to their consistent growth in eps and cash flow generation, and their low volatility, which are particularly appreciated in the current environment of expensive and highly volatile energy costs," said Vasnetsov.


Only the industrial gases and energy sectors were able to maintain or increase operating cash flows during the global recession after 2000, noted the analyst.


While the industrial gases group demonstrated high growth over the past decade and the lowest volatility among industrials, the sector has historically traded at low relative price/earnings (p/e) multiple of under 20 times eps.


Shares of Praxair and Air Products have taken off in the past year as the industrial recovery gained further traction. Both companies are trading near their all-time highs with Praxair at around $48 and Air Products nearing $64.


On a valuation basis, the group appears fully valued, with Praxair trading at 19.8 times Wall Street’s estimated 2005 earnings and 17.5 times estimated 2006 eps, and Air Products at 20.3 times fiscal 2005 (ending September) estimates and 17.9 times fiscal 2006 forecasts. That compares to around 14 times the estimated 2005 eps for chemical companies and about 17 times estimated 2005 eps for the broader market as measured by the Standard & Poor's 500.


However, because the industrial gases companies have higher growth than other industrials and the S&P 500, and lower volatility than most industrials, they should trade at a premium.


"Praxair and Air Products are growing significantly faster than the S&P, so they should trade at significantly higher multiples," Vasnetsov maintained. "I think they should trade in the low 20 times forward p/e range comfortably."


The analyst estimated Praxair will grow eps by 19% in 2005 to $2.50 and another 16% to $2.90 in 2006. For Air Products, he forecasts eps to rise 22% in fiscal 2005 to $3.21 and another 17% in fiscal 2006 to $3.76.


Merrill Lynch analyst Donald Carson recently raised his rating on Praxair from "neutral" to "buy" on attractive valuation and a peerless track record of sustained earnings growth.


"Praxair’s 10-year compounded annual growth rate of 15% is twice that of the overall market," Carson said. "With leverage to an improving industrial economy, secular growth from its five key growth platforms and a relentless focus on productivity, we expect this pattern of superior earnings growth to continue."


The analyst also raised his 2006 eps estimate on Praxair by 15 cents to $2.85.


"We like the industrial gases sector on both a near-term and long-term basis," said Carson. "The industry has disciplined producers and a concentrated industry structure. Consolidation and an unwavering focus on return on capital have created an attractive combination of earnings growth and free cash flow generation."


Impressed by Praxair securing a long-term hydrogen supply contract with refining giant Valero and overall strong demand for hydrogen on the Gulf Coast, Deutsche Bank analyst David Begleiter recently reiterated his "buy" rating on Praxair, raised his 2006 eps estimate by 10 cents to $2.80, and boosted his target price on the stock by $5 to $55.


"With a 100m standard-cubic-feet-per-day hydrogen HyCO supply agreement with Valero, Praxair continues to lock in projects that will sustain its growth through the end of the decade without increasing its risk profile," Begleiter said.


The analyst estimated that the plant, which is expected to come on line in the third quarter of 2006, will cost $60-70m and generate around $170m/year in sales, adding 3 cents/share to 2007 earnings.


"We expect Praxair’s $900m hydrogen business to grow over 10% annually through 2010, driven by a 23% near-term compounded annual growth rate in Gulf Coast sales to $1.1 billion by 2008, in part due to an additional two to three contract wins expected by mid 2005," said Begleiter. The analyst also has a "buy" rating on Air Products.


While much of Wall Street is bullish on industrial gases stocks, some analysts believe they have become pricey. JPMorgan analyst Jeffrey Zekauskas recently cut his rating on Air Products from "overweight" to "neutral" based on valuation. He also has a "neutral" rating on Praxair.


"Air Products trades at a 2005 price/earnings ratio of 21 times and 9.1 times 2005 enterprise value/cash flow [EV/EBITDA] versus 18.4 times and 9 times for the average chemical company and 19.6 times and 10 times for Praxair," said Zekauskas on 7 March. "We believe that Air Products is fairly valued. Moreover, we believe that the values of Air Products and Praxair are approaching their private market values."


The industrial gases business is booming, with strong volume gains and decent pricing strength in recent months. Praxair’s February sales gained 19% from year-ago levels after a 20% year-over-year increase in January. Merrill Lynch’s Carson estimated the February sales gain was driven by a 7% rise in volumes, 7% from acquisitions, 2% higher prices, 2% from favourable currency effects and 1% from higher natural gas pass-through charges.


Air Products’ sales rose 9% in the January-February period, aided by 5% higher volumes, 1% higher prices and 3% from pass-through charges, said Carson. With chemical volumes flat, gases volumes were up 7%.


While the industrial gases companies forge ahead with strong growth, they maintain pristine balance sheets. Praxair is rated A- by Standard & Poor’s while Air Products sports an A rating.


Air Products is using its strong cash flow to return cash to shareholders. In mid-March, the company authorized a $500m stock buyback program and boosted its quarterly dividend by 10% to 32 cents. Shares of Air Products have a dividend yield of 2% while Praxair yields 1.5%.

By: Joseph Chang
+1 713 525 2653

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