In the beginning of February, Airgas (ARG) price per share declined to $100. At that level the ownership of this stock makes sense for various reasons. The Price to Sales multiple (see below) is below the lowest levels attained during entire 2013 as well as between the average and highest levels of several quarters between 2010 and 2012. Price to Earnings has eased off even more (also below) as did the Price to Self-financing (i.e. Cash Flow from Operations before changes to Working Capital). The only multiple that remains elevated is Price to Book (not shown here) but ARG bought back app. $600 mil. of its stock at 2012 end and 2013 beginning, which translates into a lower equity and a higher P/B. The financial performance remains strong (from margin and cash flow perspective) although the sales growth has slowed to a low single digit rate, which during the 3Q conference call the management attributed to sluggish economic conditions (as per the transcript provided by seekingalpha). Nevertheless to a long-term investor who is looking to pick up a reliable and growing business, the recent price decline presents a buy opportunity.
ARG is in business of manufacturing industrial gases used in metal fabrication, construction, food and beverage retail and others.. The itemization of the wide variety of the gases that ARG produces is too prohibitive for this article but suffice it to say that its five main products (bulk, medical, specialty, CO2 and dry ice and safety gases) tend to grow faster than the economy and are counter-cyclical (as per the transcript of 2008 interview with the CEO provided by seekingalpha). Although the interview took place more than five years ago, a comparison of the business segments as detailed in 2008 and 2013 annual reports suggests that ARG's product portfolio has remained substantially the same and therefore one can assume that the CEO's observations are still relevant and enticing to an investor in 2014.
Despite the counter-cyclical nature of its products, ARG's business is reliant on the welfare of the general industrial production. Thus the drop in ARG price in the beginning of February can be explained by the slowing industrial production resulting from the unusually cold Winter (on February 3rd the ISM Index dropped more than expected to 51.3). Similar declines in both price and multiples were recorded by ARG's peers, Air Products & Chemicals (NYSE:APD) and Praxair (NYSE:PX) (see below) but ARG's decline was most pronounced.
The short-term outlook remains clouded, which was also confirmed by the management during the 3Q conference call but the ARG's financial performance remains stable. What is more encouraging is the fact that this was the case during the Great Recession of 2009 (see below for performance indicators). The Sales Growth was severely halted in 2009 but the margins remained strong testament to ARG's ability to rein in costs when business slows (this was also highlighted by the CEO during the 2008 interview). To be fair, APD and PX retained their strong margins during the crises as well, which prompts me to consider them investment-worthy but only after their multiples undergo the same adjustment that ARG just did.
Although the above P/E chart demonstrates that the business that during 2010 was selling on average at 25 times the earnings is now selling at slightly above 20 fetching a reasonable margin of safety, it is always prudent to compare the valuation to cash flows as well. I use the P/Self-financing, which contains all non-cash and one-off Income Statement items added back and tends to be more stable than P/E. At 10, ARG is clearly cheaper than during entire 2013 and hovering above the average levels of 2010 through 2012. The margin of safety is not as pronounced here as it is using the P/E, but in my opinion at $100 it is sufficient.
The one negative sign, aside from the slow down in Sales, is the increasing Debt to Equity Ratio. The 2013 annual report notes that $400 million in principal is due by 2014 end. In 2013 ARG generated $360 mil. in Free Cash Flow. If I assume that it will generate about as much in 2014 and use some of it to pay dividends, then it should be able to cover about half of the upcoming obligation. New debt then is inevitable. If it is any consolation, PX has similar indebtedness but APD relies on debt financing far less, which again prompt me to conclude that it too would be a good investment only if its valuations were a bit more reasonable. Returning to ARG's debt level, I am comfortable with it; ARG had even greater indebtedness in the past and was able to manage.
For all the reasons stated above I recently went long on ARG and plan to add if the price will decline some more; the business is indispensable now and into the future and the financial performance reliable enough.
All financial data is sourced from sec.gov and all stock prices from finance.yahoo.com.
Disclosure: I am long ARG.