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We looked at the Industrial Gas market in January. At the time, there were some interesting developments and I made the statement that it was a better business to be in than oil refining. It is time to see what actually happened and see if we can learn anything that might apply elsewhere to value investors who are looking for opportunity.

The Market

The Industrial gas business is similar to oil refining in that it is a capital intense conversion industry, dependent on the overall economy. Unlike the oil refining business, distribution is much simpler since there is only a minimal consumer market. There is some growth in this industry because of expansion into medical and food applications, as well as some global opportunities. All of the major participants are expanding into China.

Consolidation

The four largest companies, Praxair (NYSE:PX), Air Products (NYSE:APD), Airgas (NYSE:ARG) and Air Liquide (OTCPK:AIQUY), hold about 60 percent of the market. The operating margins are much higher than in oil refining, Praxair, the industry leader, has a gross operating margin of 21% of sales, vs. the oil refiners at under 5%.

About eighteen months ago, Air Products made an attempt to purchase Airgas in an effort to become the industry leader. The original $60 offer was made in February of 2010, with the Airgas stock price at $42. Eighteen months later, Airgas stock is at $62, and the most recent offer acceptable to the Airgas management is in the $70s. The situation has landed both parties in court because of shareholder rights issues.

Price Performance

Praxair stock has gone from $72 the day of the Air Products/Airgas announcement to around $100, up nearly 1/3 in eighteen months, although it is suffering with the rest of the stocks in the recent correction. Air Liquide did nearly as well, and Air Products has gone from about $70 to $82.

(Click charts to enlarge)


Values

At the moment, based on the analyst estimates and PEs as posted by Yahoo, Praxair is being valued in the marketplace at a premium, which is probably correct considering its higher operating margins. Some of the potential post-takeover speculation is probably included in the price of Air Products as well.

2011 EPS Est PE Proj Price Current
Praxair 5.48 15.8 86 98
Air Products 5.76 12.6 73 81
Air Liquide 5.79 16.7 97 89
Airgas 5.02 13.4 67 62


Note: The Air Liquide PE is the trailing PE, the rest are forward PEs as listed in Yahoo. I've used the 2010 Air Liquide EPS and applied the same growth rate as Airgas for the 2011 estimate.

Airgas is roughly correctly valued in the marketplace or may have a bit of upside at $67, the management theory that the company is worth somewhere in the $70s is a bit optimistic.

If Air Products were to be valued in the marketplace at the same multiple as Praxair, which is 15 times earnings, as opposed to the current 12.6, the stock would be around $90 per share.

I have posted a "what if" calculation on the Air Products/Airgas potential post-takeover value in the marketplace. The opportunity to increase market share and revenue, while at the same time reduce duplications in STA expense and distribution costs could be extremely beneficial to APD - and it is small wonder that the management is pursuing the takeover so vigorously.

Praxair vs. Valero

Valero (NYSE:VLO) was the largest independent refiner for most of the time period we are talking about, and the company and the stock benefited from the rally in oil prices and refining margins that existed in late 2010, and early 2011.



At the current time, an investor would have been better off to be long Praxair instead of Valero based on the two-year chart, notwithstanding the price rally this spring. Praxair's stock price seems not to have been affected as much by the correction.

So, what are we to make of all of this?

  1. Praxair, the industry leader, is valued at a premium right now based on the current pricing and earnings estimates.
  2. The upside for the Air Products company if the takeover can be accomplished is much higher than it is for Airgas. The post-takeover premium is built into both stocks already.
  3. A conservative investment in Praxair would have done better at the present moment than in the leading independent oil refiner, Valero, although this was not the case through most of the spring.
  4. If you are inclined, an investment, Air Liquide might be the best in the current situation: Same market, better price upside, no drama.
  5. All of these companies are vulnerable to a downdraft/correction in the marketplace.

The world is chaotic, and full of peril. There are no guarantees on anything

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Industrial Gases: A Performance Review