Praxair: Can This Strong Dividend Payer Distribute More In The Future?

| About: Praxair, Inc. (PX)

Summary

Praxair shows 23 years of consecutive dividend growth history. Its low payout ratio leads us to think more growth is coming.

Over the past 2 years, the company has struggled to find more growth. Short term horizon is more about efficiency than growing.

While being a very strong company, the PX stock seems overvalued in our view.

DSR Quick Stats

  • Sector: basic materials
  • 5 Year Revenue Growth: 1.27%
  • 5 Year EPS Growth: 6.60%
  • 5 Year Dividend Growth: 9.70%
  • Current Dividend Yield: 2.55%

What Makes Praxair (NYSE:PX) a Good Business?

Click to enlarge

Source: Praxair presentation

PX builds long term partnerships with its clients enabling the company to benefit from continuous new cash flow. It also makes it more complicated and difficult for clients to switch for another distributor. It also makes sense for Praxair clients to stay with the same distributor since gas is part of their costs. The best way to keep such expenses at a low level is to keep the same distributor and build a strong relationship with him. As a pure industrial gas company, PX also generates a lot of revenue from equipment sales. These are repetitive sales and makes their business model even stickier.

Ratios

Price to Earnings: 22.19 Price to Free Cash Flow: 26.18 Price to Book: 6.696 Return on Equity: 31.61%

Revenue

Click to enlarge

Revenue Graph from Ycharts

How PX fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I've been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let's take a closer look at them.

Click to enlarge

Source: Ycharts

Principle #1: High Dividend Yield Doesn't Equal High Returns

My first investment principle goes against many income seeking investors' rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it's because the market thinks it's a risky investment… or that the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly come with dividend growth and this is what I am seeking most.

Click to enlarge

Source: data from Ycharts.

As you can see, Praxair's dividend has been consistently increasing for at least the past 10 years. At the same time, the dividend yield was relatively stable under 2% between 2010 and 2015. During this period, it would have likely passed under my radar as I'm not too keen on very low dividend payers either. However, at a dividend rate around 2.50%, PX meets my 1st principle.

Principle#2: Focus on Dividend Growth

My second investing principle relates to dividend growth as being the most important metric of all. It proves management's trust in the company's future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can't be derived from anything else but increasing revenue. Who doesn't want to own a company that shows rising revenues and earnings?

Click to enlarge

Source: Ycharts

PX has consistently shown a strong dividend growth since the early 90s. The company is currently posting a 23rd year with a consecutive dividend increase and seems quite comfortable at keeping a similar growth pace as it did during this dividend increase streak. PG meets my 2nd principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. this is why it is important to find companies that will be able to sustain their dividend growth.

Click to enlarge

Source: data from Ycharts.

The cash payout ratio was quite high in 2011 and 2012 but it has been brought to a reasonable level since the beginning of 2014. With a cash payout ratio and a payout ratio both below 70%, PX shows a great dividend growth potential in the upcoming year. There is definitely more room for growth. PX meets my 3rd principle.

Principle #4: The Business Model Ensure Future Growth

As previously mentioned, the company offers an "essential" service for many businesses. As the company aims to build contracts of 15 to 20 years in length, it ensures a great stability in cash flow. PX benefits from a great name across the U.S. and intends to use its brand recognition to improve its revenues through more economic resilient industries such as healthcare, food & beverage, environmental, specialty gases and aerospace.

What Praxair does with its cash?

PX is currently optimizing its business model in order to improve its productivity and show a leaner organization. This is usually what companies do when their revenues (and cash flow) is starting to slowdown:

Click to enlarge

Source: Ycharts

However, PX also plans to include growth by acquisition in the more economic resilient industries. They use 25% of their operating cash flow to make these acquisitions, growing their dividend and maintaining the same debt level in order to keep their strong credit rating.

PX shows a strong business model and therefore meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand - At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn't mean that you should buy everything you see because you have some savings aside. There is a valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Click to enlarge

Source: data from Ycharts.

So far, I can say that PX seems to be fairly valued. It has been showing a relatively stable PE ratio since 2010 with peaks at 26 and lows at 18. At a PE ratio around 22, there isn't any obvious deal.

Let's dig a little bit further with a double stage dividend discount model. For the first 10 years, I will use a dividend growth of 5%. In 2016 the company has increased its dividend by $0.03 or 4.16%. I think PX will not be able to increase its dividend over 5% per year mainly because it is going through a slower period of business. Since the company has a strong dividend growth history and can grow through acquisition and gain additional market shares in other markets, I think the long term dividend growth will be 7% (closer to the average of their past 5 years).

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$3.00

Enter Expected Dividend Growth Rate Years 1-10:

5.00%

Enter Expected Terminal Dividend Growth Rate:

7.00%

Enter Discount Rate:

10.00%

Click to enlarge

Here are the results of my calculations:

Calculated Intrinsic Value OUTPUT 15-Cell Matrix

Discount Rate (Horizontal)

Margin of Safety

9.00%

10.00%

11.00%

20% Premium

$162.00

$108.76

$82.10

10% Premium

$148.50

$99.70

$75.26

Intrinsic Value

$135.00

$90.63

$68.42

10% Discount

$121.50

$81.57

$61.58

20% Discount

$108.00

$72.51

$54.74

Click to enlarge

Source: Dividend Monk Toolkit Excel Calculation Spreadsheet

At this point, the company seems to be overvalued by more than 20%. I would explain this due to the fact that I was fairly conservative in my dividend growth assumptions. The appetite for strong dividend growth companies might also explains PX current price. In both cases, PX doesn't meet my 5th investing principle as they are no buying opportunities at the moment.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I've found that one of the biggest investor struggles is to know when to buy and sell his holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by the fact that the company confirms or not my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company are not valid anymore, I sell and never look back.

Investment thesis

The reason to invest in PX is primarily due to its solid business model. It sells repetitive products used by various industries. Through long term contracts, it secures both their client cost structure and their own cash flow structure. PX has shown a particularly strong dividend growth history and the company will definitely continue to post future growth.

Risks

While reviewing Praxair, I was a bit disappointed by the company's growth vectors. Management is looking for acquisitions to boost their revenue over the next few years and they are patiently waiting for the next emerging market cycle to pick-up more steam. Long term contracts are great for existing ones, but PX doesn't seem to have a strong economic moat protecting other competitors to gain new clients as emerging markets rise again. Therefore, dividend growth rate may be lower than expected.

Overall, PX investment thesis is strong enough to support my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the "dividend growth stock addition" where I may ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

Having both segment helps me to categorize my investments into a "conservative" or "core" section or into a "growth" section. I then know exactly what to expect from it; a steady dividend payment or higher fluctuation with a great growth potential.

An investment in PX is obviously not an investment in a fast growing company. However, PX shows a very stable business model and we can already count on many clients to stay with them for several decades. This situation gives more room for management to look for acquisitions and think about the future as a solid part of their revenues is guaranteed through contract. PX is a core holding.

Final Thoughts on PX - Buy, Hold or Sell?

Overall, I think PX could definitely be on a watch list as it proves to be a solid dividend growth company. The price to pay for it seems too high at the moment, or at best, fully valued. There is no hurry to add PX in my portfolio, but I will keep an eye on it as I really like its business model.

Disclosure: I do not hold PX in my DividendStocksRock portfolios.

Disclaimer: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Disclosure: I/we 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.