Airgas Inc. Presents at Morgan Stanley Global Chemicals Conference, Nov-17-2011 02:40 PM

Nov.17.11 | About: Airgas, Inc. (ARG)

Airgas, Inc. (NYSE:ARG)

November 17, 2011 2:40 pm ET

Executives

Barry Strzelec -

Peter McCausland - Founder, Chairman, Chief Executive Officer, President and Member of Executive Committee

Analysts

Unknown Analyst

Vincent Andrews - Morgan Stanley, Research Division

Vincent Andrews - Morgan Stanley, Research Division

Thank you, and welcome back to the Morgan Stanley chemicals conference. I'm Vincent Andrews, Morgan Stanley's chemical analyst, and I am pleased to welcome Airgas to the conference. And today from Airgas, we have Peter McCausland, the CEO, and we also have Barry Strzelec from Investor Relations. I think we're going to let Peter make some opening remarks and then we'll have some discussion, and then hopefully some Q&A. So please welcome Peter.

Peter McCausland

Thank you, Vincent. Well, let me start by answering the question that I usually get asked in the first instance, and that's how the business is doing. We try to stay focused at Airgas on the long term, and I think we've done a good job with that over the years. I think we rank in the top 3% of S&P 500 companies in total return to shareholders since going -- we went public in 1986.

That said, we live in the present and I can say to you that our business is pretty strong. Manufacturing is very strong in the United States right now, and that strength is giving companies confidence. They're building plants and expanding in several industries.

Metal fabrication business is very strong, and that is driven by mostly things that have wheels, like mining equipment, ag equipment, locomotives, tractors, trailers, railcars and things of that nature.

The energy business is very strong and that's driven by new technology, horizontal drilling and frac-ing, and then all the support industries that help with that exploration and development of gas and oil wells. One thing I will mention is that the infrastructure has lagged, and you can see this with the announcements concerning certain pipelines. But in terms of gathering systems and interstate pipelines, I think that's -- will be coming very shortly.

The petrochemical industry remains strong, I think partly because of the low-cost natural gas and natural gas liquids feedstocks that are made available by this new drilling technology. We find it interesting that there's so many plans for new plants or expansions in the West Virginia chemical corridor. There hasn't been anything going on in there for 20 or 25 years, and all of a sudden, because of the Marcellus Shale gas and natural gas liquids, we're seeing activity.

A lot of our customers have plans to hire people. One problem with that is that it's hard to find trained people. Over the course of 10 or 15 years, we took our trained people and closed down the plants that they worked in and replaced them with fast food restaurants. And most of the people are -- serve burger flippers right now, so they have to be retrained.

Within our business, our product mix, the hardgoods are growing a lot faster than the gas, which is typical of the early stages of a recovery. Within the hardgoods sector, automation equipment, welling equipment and cutting equipment is very strong. And we view that as a good sign, because in the usual recovery, customers buy these kinds of capital investments, capital equipment to gear up for production. And then the gases and the consumables, the welding wire, the tips and things like that, will follow. So we're optimistic that, that is so strong.

And then the middle part of the country, which is the Upper Midwest manufacturing belt, extending all the way through the auto belt to Ohio, and then down in the Gulf with the petrochemical business, that's stronger than the coasts. And that's typical of the early stages of a recovery because the coasts have more high-tech industries and more service industries and research institutes and things like that. So it looks to us like the third inning. But if you read the newspapers, it looks like the bottom of the 16th, I guess. And so we try not to do too much of that.

We remain very flexible. And in the last downturn -- going into that downturn, we never had a down year in our gas and rent same-store sales, which represents 65% of our business and the highest margin part of our business. But we did -- in that recession, it was so severe. Sales actually fell 13%, but EPS only went down 16%. We took $60 million of cost out in 9 months, and we have a very resilient rental stream. We have over 10 million cylinders, and cylinders charged out to customers only went down around 2.5% during the last recession despite its severity. So we had all that cylinder rental revenue stream plus the bulk tank -- 14,000 bulk tanks are out to customers, and we get the rent regardless of how much gas goes through the various tanks.

So -- well, the other thing I'd mention, I've been asked a lot of times to compare this to 2008, and I just told you how we performed, but the external environment in 2008 was little different. Capacity utilization in U.S. manufacturing was much higher than it is today. We're down around 77%. Within the industry itself, the air separation plants capacity utilization was in the high 80s, and it's about 82% right now.

Back in 2006, volume had peaked by then, and we had steady business from -- in terms of volume from '06 to '08 and a good pricing environment. Now if you look at our last quarter, same-store sales were 10%. It was 6% volume and 4% price. In this recovery, larger customers are doing a lot better than small customers, and I think that's a function of capacity utilization. As companies start to reach full capacity, they start to outsource, and then the little customers get healthier.

The pricing environment is pretty good right now. And as an indication of why -- or an indicator of the large customers doing better, our national accounts business, we call it our strategic accounts business, was up 14% last quarter compared to 10% overall same-store sales. And that's because after severe -- any recession but especially severe ones, big companies get religious about their supply chain management. And Airgas with the broadest product and service offering in the industry and the biggest platform can offer the most to customers in terms of vendor consolidation and transaction cost reduction.

Question-and-Answer Session

Vincent Andrews - Morgan Stanley, Research Division

Okay. So maybe follow up on that. If you think about current period versus the last period, maybe you can talk a little bit more about how you've aligned your sales force by customer end market in the last 1 or 2 years, and how that sort of differentiates you now going forward.

Peter McCausland

Yes, I'd say there's a few things that I've -- that I think people should take note of when it comes to Airgas, and one is that segmentation of our sales force. The other one would be SAP that we can talk about in a minute. But what we have done is we've taken our strategic account team and we've aligned them into 10 customer segments. And we have energy and utilities in one, petrochemical in another, healthcare, metal fabrication, food and beverage, and there's 10 of them. And what we're seeing is a tremendous increase in efficiency, reduction in cycle time from approaching the customers to actually closing business. Take for instance, oil service companies. We have a team of people and we serve 3 of these companies. And if we go after the other 4 or 5, we have people who know the industry, who know the requirements on the ground and also the supply chain requirements. Same thing in the refining business or pet chem business and same thing with hospitals and clinics and things like that. So because of that and because of all the service offerings that we've wrapped around each of these customer segments, we're seeing an increase in effectiveness and efficiency, and I think it's indicated by our strategic accounts growing 14% last quarter versus overall 10%.

Vincent Andrews - Morgan Stanley, Research Division

Do you want to talk a little bit more about converting to SAP and...

Peter McCausland

Well, back when we were under fire about a year ago, we were forced to come out and put out some numbers for calendar '12 to defend Airgas, and we did. And we came out with $4.20 a share EPS for calendar '12, and we came out with our SAP program, which we always intended to share with our shareholders. But there was a new urgency because Air Products was saying that they were going to get $250 million of synergies, primarily driven by SAP. And we knew their SAP system wouldn't work in the U.S. That's why they never put in their packaged gas business in the U.S. when they had it. But you didn't, and so we wanted to -- we thought our shareholders deserved the credit for the 4 years of work that we did to develop and customize our SAP. So we went out and put forth our program. And we -- in that program, we identified just 3 areas: price management, increased sales through telesales and administrative expense savings. And they were the targets, high and low end targets. Their low-to-high end targets for price management was $40 million to $60 million in operating income. I think it was $25 million to $50 million and -- as a result of higher sales and $10 million to $15 million in administrative savings. Well, we've already converted 1/3 of our company, all of the hardgoods infrastructure and 3 regional companies, total 1/3 of our company to SAP. It's going very well. The first conversion, we had to make 20 software customizations, added to the 460 that we developed in the 3 or 4 years. After the second one, we didn't have to make any. After the third, we didn't have to make any. It's going very well. We're on track. We're on schedule. We've begun the pricing work at the first company that converted, Airgas South, and the initial indications are very strong. We've begun the telesales work and also at Airgas South, because the telesales group and Airgas South are now in the same system. So in the Southeast, we're working that and the results are very encouraging. So I'm confirming our schedule. I'm confirming the minimum benefits that we expect to receive from the 3 areas that we've identified. And we're confident there are other areas, including working capital management. And I could say that we're going to have a hit of about $0.35 a share this year as a result of SAP, and that flips in fiscal '15 to, what is it, $0.65 positive?

Barry Strzelec

[indiscernible]

Peter McCausland

Oh, okay. So in 24 months, we have a $0.65 swing in our earnings from SAP regardless of how the economy performs.

Vincent Andrews - Morgan Stanley, Research Division

Maybe we should talk about the M&A environment, and tell us if you think there are incremental opportunities to purchase independent packaged gas companies. And what do you consider a good deal or the right deal environment? And how does the seller decide to hand over the assets to you, other than price, obviously?

Peter McCausland

Well, we started in 1982 and went public in 1986, and we're the only company that's been a continuous buyer of these independent distributors since then. If you look at the Slide 3 in your book, you can see that pie chart and there's a blue shadow that comes down from the pie. And that covers a $13-billion packaged gas market, which is cylinder gases and less-than-truckload quantities of bulk gases, about half of that, and then welding equipment is the other half. And 50% of that market is still in the hands of the independents, and half of that 50%, or 25%, is in the hands of 100 larger independents. And about 9 months ago, we had a big uptick in activity. We have a target this year of $150 million of acquired sales before the end of March. We are at about $75 million or $80 million right now. I think we have a reasonable chance of making that target. The target was just a plug number, but there are a lot of companies that are holding back, and I think they're holding back because they're not back to even. If you look at Airgas, our gas sales, volume wise, are still 5% below peak, and hardgoods are even further below the peak. And these are good, strong cash businesses, and people are content to wait and sell off higher numbers. So I think what'll happen, sometime in the next 24 months, there'll be a lot of sellers hitting it at the same time. And so there'll be good opportunities. But right now, they're sitting and waiting. And I think they also rationalize, "Well, what the heck am I going to do with the money?" The stock markets have been flat for 10 years and this volatility in the market is kind of scary, so I'd rather just collect cylinder rent.

Vincent Andrews - Morgan Stanley, Research Division

Why don't we open up to any investor questions, sir? Can you wait for a microphone, actually -- it's for the webcast. In the front.

Unknown Analyst

Okay. I was just at another meeting with a specialty chemical guy, although a little different than you. And for their -- and just -- I know you're on different fiscal year but for calendar year '12, you -- he was pretty optimistic. He didn't say that the near earnings are going to be crazy, but he felt it would be a positive year. Do you guys feel that -- I'm not asking to put a number, but do you feel, from where you sit right now, next year will be positive growth?

Peter McCausland

Definitely. We're -- and we base that on our customers' plans to expand and to hire and to the momentum we're seeing in our business, and we're keeping a weather eye out on Europe. And we do worry about how that might impact us, but we're planning on having a strong year in earnings growth and sales.

Unknown Analyst

And just another question just for curiosity. If you are looking across your spectrum of customers, who would you say are surprisingly stronger -- strong? And conversely, who do you think are somewhat weaker than maybe you expected?

Peter McCausland

Well, for years we all thought that research and healthcare and food and beverage were noncyclical businesses. In fact, we worked very hard to increase our presence in those customer segments, but the last recession hit everyone because -- partly because there was a big credit crunch as well. Those sectors are coming back now, but they're coming back very slowly. So that's one surprise. The automobile business is very strong right now. A lot of foreign and domestic companies are building new auto plants and then all the support industries, batteries and things like that, they're building plants. And I think the outlook -- I don't know what car production got down to. It was somewhere around 9 million vehicles I think, and now we're like up to 13 million or something. I think the auto industry is counting maybe not on significant growth from here, but sustaining those higher levels of production for several years. So that's a positive because that's been sick for so long. The infrastructure construction that we need so badly in this country isn't happening, and we're really geared up. We have a national construction group and we have local construction specialists. And we're really geared up to meet the needs of the top engineering and construction companies. But we don't expect until late '12 or maybe even '13 to see any significant change in new projects there. Sure.

Vincent Andrews - Morgan Stanley, Research Division

Any other questions? Do you want to talk a little bit more about sort of use of cash and shareholder remuneration and things like that or...

Peter McCausland

Well, our cash flow this year was -- has been negatively impacted -- well, I would say positively, I guess, by the fact that we spent $300 million this year on share repurchases just -- and $300 million toward the end of last fiscal year. So $600 million in the span of 4 months, as we said we would do, to facilitate the transition in our shareholder base after Air Products went through its bid. And we're also -- we've been buying new cylinders and tanks for new business, which is a good thing, and building a new air separation plant in Tennessee. We have grown our dividend this year by 25%, I think it is. We have been an aggressive increaser of our dividend over the last 4 years, and we intend to keep increasing our dividend along with our -- as our earnings increase. I don't think -- we look at share buybacks and dividends at every board meeting, and that's at least once a quarter. We're -- given the acquisition, what we think is pent-up sellers demand and some of the CapEx projects, I would be surprised if we were to rush in and buy a lot of shares anytime soon. It's really not our focus right now. But we do look at it every quarter.

Vincent Andrews - Morgan Stanley, Research Division

Anything else? Sir?

Unknown Analyst

You mentioned earlier about the strength that you're seeing in some of your end markets that's different than what else we're hearing in the macroeconomy. And I want to see now how much of that was driven from changes in the investment cycle. And has anything changed in the United States in the investment cycle in sectors such as chemicals and energy that would shift that going forward?

Peter McCausland

Well, I do think that there was very little investment here for a long time, so there is a lot of catch up. And then we have, as part of this overall manufacturing renaissance, we -- certainly the automobile industry is a part of that. In terms of what's changed, I think low-cost natural gas and natural gas feedstocks is really going to have a positive effect on the petrochemical industry going forward. And so that's kind of an important change, I would say. But I think politically, the country is tired of sending all the jobs offshore, I think. But whether you're a Republican or a Democrat, you're in favor of anything that brings the jobs back here, so I think there's that kind of secular trend that we're going to benefit from. And I really do believe that there's going to be -- that the renaissance that's starting in industrial -- in U.S. manufacturing is going to become more and more evident as time goes on. And we're glad because it's -- we're a business-to-business kind of industry, and we've been able to grow our business over the last 10 years by diversifying into food and beverage and healthcare and research and all these noncyclical, nonmanufacturing businesses. But it's nice to see the core come back and to come back strong.

Vincent Andrews - Morgan Stanley, Research Division

There are no further questions. We thank you very much for joining us today.

Peter McCausland

Thank you, Vince.

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