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Summary

  • The company is being pressured by an activist investor to restructure their operations to become more profitable.
  • The company has a long history of yearly dividend increases.
  • The incoming CEO purchased millions of dollars of the company’s shares.

Air Products and Chemicals (NYSE:APD) is a company that is most known to investors for their very long history of dividend increases. This global industrial gas producer has become far more exciting to investors in the last year due to activist investor Bill Ackman taking a significant stake in the company, pushing out APD's CEO at the time and meeting with management to improve the company's profitability. APD's shares have risen about 40 percent since Mr. Ackman's involvement. Even though the shares are more expensive now, the shares could rise even further. A multi-million dollar insider purchase of APD shares by the incoming CEO is a good sign that the company's shares have further room to move upward.

Background

Air Products & Chemicals is one of the largest global producers of industrial gases, and has a large specialty chemicals business. The company has 4 divisions set forth as follows (with their percent of sales and profits for the for 2013 fiscal year shown respectively): 1) merchant gases (40 percent of sales; 43 percent of profit) sells atmospheric gases such as oxygen, nitrogen and argon; process gases such as hydrogen and helium; and medical and specialty gases, along with certain services and equipment; and 2) tonnage gases (33 percent of sales; 33 percent of profits) provides hydrogen, carbon monoxide, nitrogen, oxygen and syngas; 3) electronics and performance materials (22 percent of sales; 20 percent of profits) provides specialty and tonnage gases, specialty chemicals, services, and equipment to the electronics industry; 4) equipment and energy (4 percent of sales; 4 percent of profits) includes cryogenic and gas processing equipment for air separation, natural gas liquefaction (NYSEMKT:LNG), helium distribution, and hydrogen purification.

Second quarter earnings

In July 2014, APD posted 2014 fiscal third-quarter earnings from continued operations of $1.46 a share, up about 7 percent from $1.36 a share from the same quarter a year ago. Net income from continuing operations increased 9 percent to $314 million in the quarter from $287.8 million recorded in the year-ago quarter. Revenues rose 3 percent year over year to about $2.63 billion driven by higher volumes across all businesses.

Revenues from the merchant gases division increased 4 percent from the year ago quarter to $1.077 billion. Increase in volumes of Liquid oxygen and nitrogen was seen in all regions but was partly offset by lower helium volumes due to continued global supply restrictions. Sales from the tonnage gases division declined 1 percent from the year ago quarter year to $835 million. Revenues from the electronics and performance materials division increased 9 percent from the year ago quarter to $618 million on increased volumes. In the equipment and energy division, sales were up 1 percent from the year ago quarter to $104 million. The company's sales backlog increased 78 percent to $584 million. APD revised their fiscal 2014 earnings guidance and now anticipates earnings from continuing operations to be in the range of $5.72-$5.77 per share versus its previous guidance of $5.70 to $5.85 per share. The company also expects earnings from continuing operations for the 2014 fourth quarter to be in the range of $1.60-$1.65.

Activist investor activity

In July 2013, activist investor Bill Ackman initiated a 9.8 percent stake in APD. The CEO of APD at the time then agreed to step down within a year and a new search began. In addition, the Board of Directors of APD agreed to enter discussions with Mr. Ackman on how to improve APD's business so that their performance would be more in line with competitors. The company then hired a new CEO, Mr. Seifi Ghasemi, who then stated that APD needs to change its corporate culture and to make better investment decisions. Mr. Ackman believes that APD's shares could rise to $200 in 3 years.

At APD's last earnings conference call the new CEO indicated that, in his first public comments, the company will focus on projects that generate more cash flow and on improving returns on invested capital. He indicated further that workers need a greater sense of urgency and plans to decentralize the headquarters-based decision-making process to improve the company's entrepreneurial capabilities. "Simplicity, speed of execution and empowerment are some of the issues we will address," Ghasemi said. "Nothing is for sale right now," Ghasemi said. "It would be premature to take action before you get these businesses performing to the best of their ability." The CEO summed up their conference call statements by stating that APD can retake its position as an industry leader with a strategy that he will describe in greater detail in mid-September 2014.

Competitors

APD is one of the largest international producers of industrial gases. The main competitors for the company include: Basf Se (OTCQX:BASFY); EI Du Pont de Nemours & Co (NYSE:DD); Air Liquide (OTCPK:AIQUY); Praxair (PX); Dow Chemical Co (NYSE:DOW); Airgas Inc (NYSE:ARG). The industrial gases industry has historically grown up to twice as fast as the overall economy and is in a capital-intensive and annually spends almost $50 billion on research and development. The industry is cyclical and affected by costs for basic commodities, especially oil and gas. Price fluctuations also impact dependent industries such as resins, plastics, synthetic fibers, etc. Further, high crude oil prices may raise production costs, and lackluster demand in emerging economies may offset certain positives. The industry may also see increased consolidation due to intense competition, the need for cost efficiencies, and economies of scale.

Insider Purchases

One of the most positive signs to a potential investor in a company's stock is an insider purchase of shares on the open market that is substantial and not just a mandatory token purchase required by the company. In August 2014, an insider made a substantial purchase of APD shares on the open market. On August 1, 2014, APD's recently appointed CEO Seifi Ghasemi bought 25,000 shares of the stock on the open market. The stock was purchased at an average price of $131.19 to $133.55 per share, for a total transaction of $3,317,000. This is in addition to his October 2013 open market purchase of 15,000 APD shares at an average cost of $108.09. Following the transaction, the director now directly owns 77,026 shares of the company's stock, valued at about $10 million.

Analysts' views and our views

Analysts have ratings from neutral to buy with price targets for APD in the range of $105 to $150. Analysts note that APD management has cut the upper end of 2014 fiscal year guidance to $5.70-5.85 (down from earlier guidance) and issued 2014 fiscal third quarter guidance in the range of $1.42 to $1.47. Analysts believe that the 2014 fiscal quarter guidance is reasonably obtainable but the 2014 fiscal fourth quarter estimates will be more difficult to achieve.

Analysts have also positively commented specifically on APD's hiring of their new CEO Seifi Ghasemi from Rockwood Holdings' (ROC). They noted that Mr. Ghasemi led Rockwood Holdings through its divestiture of seven "non-strategic" businesses. They indicate further that the hiring of Mr. Ghasemi could be a signal that APD will now be open to divestitures. APD has not yet indicated any intention to divest any of its businesses, but investors have in the past asked whether APD should sell their volatile electronics business (17 percent of sales), which is more cyclical than their core industrial gases business. Analysts note that APD's share price was in the low $90s when activist Bill Ackman in July 2013 had taken a major position in APD. Since Mr. Ackman initiated a stake in APD, APD's has closed its valuation gap with their competitors in the industry even though APD has not engaged in major restructuring to date.

We agree with analysts for the most part. With a new CEO with a history of improving profitability through divestitures, APD is likely to benefit from the CEO's yet-to-be announced new action plan. Shares of APD are trading at a forward price to earnings ratio of 20.7 based on fiscal year 2015 earnings estimates. With the overall market at or near all time highs and APD shares near 52-week highs, we believe investors should wait for a pull back in APD's share price to a range of $110 to $120 (a price to earnings ratio ranging from 17 to 19 based on 2015 fiscal year earnings estimates) before establishing a position. With an activist investor pressuring APD and a new CEO who has purchased millions of dollars of the company's stock, we believe that APD investors will continue to be rewarded.

Source: Air Products & Chemicals: An Activist Investor Play And A Large Insider Purchase