Some of the greatest returns of the last quarter century have come from boring, little known, industrial stocks whose only claim to fame is their penchant for consistently and quickly growing dividends. As I was putting together an experimental real world Dividend Growth portfolio (you can see my portfolio here), I came across one such company that I believe holds immense promise for excellent long term returns.
Praxair (NYSE:PX) is a specialty chemical company which provides atmospheric and specialty industrial gases to businesses. Atmospheric gases are gases produced when air is cooled, compressed, purified and distilled. Examples include Oxygen, Nitrogen, Argon, Xenon and Krypton. Specialty gases are by-products of chemical production and include Carbon Dioxide, Helium and Hydrogen.
These simple gases are vital for many important economic activities such as:
-cutting, welding, glass production
-steel production, metal finishing/coating
-refining, natural gas fracking, enhanced oil recovery, liquid natural gas transportation
-chemical production, coal gasification
-production of semiconductors and photovoltaic panels
-medical uses such as gaseous sterilization
-MRI cooling with liquid helium
-Food and beverage production
None of these things are very exciting but are all vitally important to the smooth functioning of the global economy. Praxair has built itself into the largest industrial gas company in the western hemisphere. Across North America, which accounts for 52% of sales, the company has 500 gas production plants and 3000 transportation vehicles. Within its North American operations the company foresees $1-$2 billion in organic cap-ex investment opportunity.
The important thing to know about Praxair is that their management is very disciplined when it comes to cap-ex investment. The company will only invest in projects if they have guaranteed positive returns on capital (ROC) within 5 years. Typically they will have contracts signed with very favorable terms ensuring annual pricing increases(to counter inflation) to ensure that the new project remains profitable throughout the length of the contract.
In South America, which makes up 17% of their sales, they are the #1 or #2 industrial gas provider in 8/9 countries. The catalyst for growth in South America is the continent's extensive mineral wealth, which will require industrial gases during the extraction process.
In Europe, which provides 13% of sales, growth is occurring in the Germany. Spain and Portugal on the other hand struggle and the company streamlines operations. Russia is a challenge but promising new market for the company because of its booming energy production. The company foresees growth in Russia from $20 million in 2013 sales to $250 million in 2017.
Asia represents 13% of sales and is the largest potential source of growth - other than the US and Canadian fracking booms. The company operates in India, China, Thailand and South Korea. The company anticipates potential 67% growth in sales through 2017.
Praxair has a strong backlog of $2.2 billion in projects going into 2014, mostly energy related sites in the US, Russia and China.
Over the last 20 years the company has grown revenues at an 8% CAGR.
Earnings have grown even faster, 13% CAGR, because of management's tireless goal of cutting 5% costs annually.
|Rev Growth (3 Yr Avg)||5.6||19.4|
|Net Income Growth (3 Yr Avg)||13.7||33.5|
|Operating Margin % TTM||22||11.1|
|Net Margin % TTM||14.7||8.9|
The disciplined growth approach has allowed management to generate cash flow from operations at a projected rate of 24% of sales from 2013-2017 which is a total of $17 billion. Of this, $10 billion will be reinvested back into the company and about half into the US to support fracking and energy extraction projects. The rest will be returned to shareholders at a 55% to 45% dividend to share buyback ratio.
Praxair is a dividend growth champion. It has grown the dividend by nearly 20 fold over the last 22 years. Management has a record of 21 consecutive years of dividend increases and has grown the dividend at a CAGR of 15.15% over this time. Over the last 5 years the growth rate has slowed to 9.85%.
About the only thing I can criticize the company for is its buyback program. Over the last 7 years it's been moderately good, reducing share count by 1.4% annually, however, over the last 5 years the efficiency of the buyback could have been better. From 2008-2013, the company issued $945 million in stock and bought back $3.563 billion. This represents 73.1% buyback efficiency, meaning that for 73.1% of the shares bought back were retired but 27% was to offset dilution. Over the last 5 years $285 million in share based compensation has been issued, which means that 9.7% of all the money spent on buybacks went to offset shares issued to employees. In 2013, it was 11.9%. In 2013, Chairman and CEO Stephen Angel, had nearly $17 million in stock options exercised; yet, today he only owns $10 million in stock.
It makes me uncomfortable when I see executives being paid so lavishly in stock, (25% of 2013 stock based compensation went to the CEO). If they are paid in stock I would like to see them hold onto their shares so that their interests are better aligned with shareholders. After all, $17 million worth of shares pays about $340,000/year in dividends and that would represent a 10% boost to Mr. Angel's regular salary. Instead, he sold $7 million worth of stock. Though I would not advise against purchasing the stock for this reason, going forward I would certainly keep an eye on executive compensation and the buyback efficiency.
Overall, long term shareholders have done well. Over the last 23 years Praxair investors have been rewarded with 16.6% CAGR which rises to 18.8% CAGR with dividend reinvestment. $10,000 invested in 1990 would be worth $252,000 today or $373,000 with dividend reinvestment. The $121,000 difference in returns illustrates the importance of both growing dividends and their reinvestment.
Over the last year Praxair has risen 14% compared to the market's 22%. The 5 year average PE is 22.42, while the current PE is 21.82. Similarly, the average 5 year dividend is 1.9%, while the current yield is 2%. Both PE and dividend yield indicate that Praxair is trading around its historical averages.
Assumptions: $5.87 TTM PE
5 year EPS growth: 11.5%
20 year terminal rate: 7% (half of the 20 year historical performance)
Discount rate 9%, (the 1871-2013 historical CAGR of the stock market)
The current fair value of Praxair, under these assumptions is $188.59, indicating a 31% margin of safety.
One way to model future performance is with earnings growth. If we model the expected 11.5% EPS growth, we get 2018 EPS of $10.09. Using the 5 year average PE multiple we anticipated a 2018 share price of $226.03. Adding in 5 years of dividends we get a total share value of $240.64. This results in a CAGR of 13.45%, rising to 15.6% CAGR with dividends reinvested.
If we model future returns based on dividends, we can project 5 years of 9.85% dividend growth, the most recent 5 year average. This results in a 2018 annual dividend of $3.5/share and assuming a historical 1.9% yield, we get an anticipated price of $183.93. To this we add the $14.61 of projected dividends to reach a total value of $198.54. This results in 5 year total returns of 9.2% CAGR and rising to 11.2% CAGR with dividend reinvestment.
Finally, if we use the DCF fair value of $188.59 and add in the dividends, assuming that the stock reaches this fair value by 2018, then we find a total return of 9.4% CAGR, rising to 11.1% with dividend reinvestment.
If we average all 3 models we get a 5 year projected total return of 12.18% CAGR rising to 14.3% CAGR with dividends reinvested.
This is pretty close to the 15 year performance CAGR of 15.19%, which thoroughly thrashed the market's 4.62% over the same time period.
Technical analysis indicates a neutral short term price action. There is very strong support at $127.77, with only slight resistance above.
Overall, I feel that Praxair is a little known giant in its field with a long history of excellent management, a dedication to maximizing efficiencies and a strong dividend growth record. Given the current likely 5 year returns and the large margin of safety, I would recommend that interested investors buy at the current price.
Disclosure: I 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.