We reiterate our Neutral recommendation on Air Products and Chemicals Inc. (APD).
We believe that this industrial gas producer is benefiting from long-term take-or-pay contracts, a consolidated industry structure, a diverse customer base and sustained pricing power. The company’s Electronics and Performance Chemicals business is expected to show a meaningful rebound in 2010 based on a solid cyclical recovery in the Asian semiconductor and LCD markets.
Air Products’ aggressive cost cutting and productivity initiatives, combined with portfolio realignment efforts, have helped mitigate fixed cost headwinds. We are also encouraged by the new contract wins across the industrial gas space in recent months, reflecting a robust growth momentum across the emerging economies in Asia, where the company has a strong presence. We are also optimistic on the proposed Airgas acquisition.
Airgas Acquisition
To venture into the North American packaged gas business, Air Products made a hostile bid for rival Airgas Inc. (ARG), the largest U.S. distributor of industrial, medical and specialty gases, for an all-stock deal at $60.00 per share in October last year. After being rejected twice by Airgas, Air Products upgraded its proposal to an all-cash deal of $60.00 per share of Airgas, representing a premium of 38% from the closing price on February 4, 2010 and an 18% cash premium over the 52-week high. The total value of the transaction was approximately $7 billion, including $5.1 billion of equity and $1.9 billon of assumed debt.
We believe Air Products’ offer of $60.00 per share does undervalue Airgas when compared with the Zacks target price of $60.86 and Airgas’ average traded price of $63.24 over the last three months. We believe the Airgas deal, if acquired at the current offer price, would drive Air Products margins. However, any further hike in offer price would make the deal less lucrative.
Value Fundamentals
Currently, Air Products’ shares are trading at 14.2x our 2010 earnings estimate of $4.99. Over the last five years, the company’s shares have traded in a wide range of 9.6x to 22.6x trailing 12-month earnings. On a P/E basis, the stock is trading at an 11% discount to the peer group. The company is seeing higher sales in its gases business, led by rising demand for electronics and hydrogen. The chemicals business is also seeing higher volumes, with a possibility of margin expansion going forward. Additionally, the company’s cost-saving measures are on track.
In view of these factors, we are quite confident about Air Products’ earnings prospects, which are the primary drivers of its stock price. Our long-term Neutral recommendation on the stock indicates that it will perform in line with the market. Our target price is $75.00 or 15.0x 2010 EPS.
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Read the full analyst report on “ARG”
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