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Overview

Air Products and Chemicals (APD) is an industrial gas manufacturer and distributor that was founded in 1940. The company’s core industrial gases business provides its products to manufacturers, including those in the refining and chemical markets, metal producers, electronics sectors, and food and beverage makers. The company gets to benefit from the growth in all these sectors as its products are necessary for its customers to operate. Air Products is the world’s leading supplier of LNG process technology and has limited competition due to its operational complexity. The moat around its business is the highly specialized storage facilities it operates and the level of knowledge needed to operate in the space. The company had 2019 sales of $8.9 billion and operates in 50 countries, making the company truly global. The business continues to grow as the world economy develops and expands. However, shares have risen to new highs and aren’t in line with historical valuation levels for the stock. While the company continues to perform well, I prefer to add shares when discounted to historical levels. That being said, sometimes you miss the opportunity to get the stock in your portfolio by waiting for the perfect price. Any notable pullback in the market or stock itself may be an opportunity. Investors with a long-term picture may be able to find a spot for this company in their portfolio and benefit from long-term compounding its shares can deliver.

Quarterly Review

APD reported second quarter earnings in April that beat revenue estimates but had a slight miss on the bottom line.

Source: Seeking Alpha

Second-quarter sales of $2.2 billion increased only 1% year over year. While volumes and pricing both helped increase revenue 8%; this was offset by 2% due to currency headwinds and another 5% from energy pass-through savings.

These were decent results by any measure considering ongoing macroeconomic conditions. The company estimated that the impact from COVID-19 negatively impacted earnings by $0.06 to $0.08 per share. Despite this, the company was still able to report earnings per share growth of 6% and GAAP net income growth of 13%.

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The company along with most this year has withdrawn any guidance and is not providing insight into where results may come in.

While earnings may be impacted this year, it is clear the company can continue to grow earnings as the compound machine it has been.

Source: Earnings Presentation

While we are unsure of what 2020 will bring, we know APD has reported impressive earnings growth for years. This type of track record is perhaps why shares trade at such a premium.

The company is quick to point out its strong financial position as well.

Source: Earnings Presentation

With net debt of only $1.1 billion, the company can withstand a temporary impact on earnings. However, given the necessity of its products, the company is unlikely to see a dramatic drop in revenue that would cause management to have to borrow to fund operations.

The company likes to point to its strong cash flow as well which it shows below.

Source: Earnings Presentation

The company had a healthy $1.67 billion in leftover cash flow produced in the last year. This is after paying dividends and all other necessary expenses. With strong cash flow, the company can continue to return cash to shareholders in the form of dividends and share repurchases. The company maintains a safe payout ratio with only 40% of cash flow being paid in the form of dividends.

The management team has been moving forward with a plan to ensure a successful future.

The company continues to strategically invest in operations that will give it greater end market exposure and product offering capabilities. As the company does this, they can win customers over with a broader portfolio of products. This once again should help the company expand margins and improve customer retention. From a competitive position, it will improve its profile materially.

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The company also has plenty of capacity should it need to borrow more.

Source: Earnings Slides

I presume we may see the company take advantage of this at some point due to the large cash flows it has and the low rates it can borrow this at.

As the company continues to perform and accelerate, investors should consider valuation and what a fair price is to pay for Air Products and Chemicals.

Valuation

I like to look at historical valuation levels to see where shares currently lie with respect to their average.

Source: Morningstar

The company currently is trading above its 5-year average for most metrics, meaning the shares are probably overpriced at this time. We see the shares trade above their average P/S, P/E, P/CF, P/B, and forward P/E. Since there is no significant growth expected to occur, it is safe to presume shares might pull back to their averages. If shares were to pull back to their average forward P/E, we would see about a 20% decline in the share price.

As we can see below, the yield is below its average despite a recent dividend hike.

Source: Yield Chart

Shares typically yield 2.17% or have averaged so in the last 25 years. Considering the 38 years of dividend increases, it is safe to use the average as a guiding part for when to purchase shares at a discount. With shares around $220, you can start to get an abnormally high yield. However, should they fall to $215 and offer a 2.5% yield, I would become a bit more compelled as this is an above-average yield. And as we can expect with shares returning to their average yield when overpriced, the same can be expected when under-priced.

Below, we can see a snapshot of the dividend history for APD.

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Source: Earnings Presentation

Currently, the company has a dividend of $5.36 per share, this is after a recent raise. The company has a healthy and attractive history of increasing returns to shareholders. The 10%+ CAGR makes it an attractive choice for an investor with a long-term time horizon who can let the miracles of dividend growth investing do wonders for them. Investors should sleep well knowing the company has plenty of room for growth with a safe payout ratio and growing earnings. Any short-term decline in sales could withstand a dividend cut from happening.

Conclusion

For investors looking for a company with a long history of performance, dividend raises, and successful execution at a reasonable price, Air Products is one to keep an eye on. The company serves many industries and isn’t reliant upon the performance or success of any particular customer or segment for it to survive. Going forward, a pullback in the shares of 10% or more should be used to enter a position. If shares pulled back roughly 20%, they would be trading below almost all of its 5-year historical valuation metrics. As the company continues to grow and reinvest its accelerating earnings into new projects, investors should expect to see a rising stock price. The company is a dividend aristocrat and usually is not found on sale, so a long-term picture is extremely important for those looking to invest. I would expect over the next 5 years and greater, the shares should outperform the market if acquired at reasonable levels. However, at current highs, investors would be better off waiting for now.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.