Linde - Tax Structures Aside, It's Overvalued And A 'Hold'
Summary
- Linde is the largest chemical company in the entire world and a company I've had on my watchlist since I started investing.
- I never pulled the trigger unfortunately, either due to overvaluation or due to other companies being more appealing.
- While Linde is an excellent stock, its valuation and upside are not excellent. On the basis of valuation, it's doubtful if you should buy Linde here.
I haven't written about Linde (NYSE:LIN) before, so I thought now was a good time to start. This is a truly massive company - the largest in terms of market share and revenue. It serves customers in virtually every industry directly or indirectly, and it's been around for over 140 years.
In this article, we'll look at the company as an investment, and a long-term one. Trading in Linde stock is something I believe to be foolhardy - nor is it a high-yielder that will quickly reward you with dividends. This is a very slow-growth stock.
Let's see how the valuation lines up with the future thesis.
(Source: Linde)
Linde - What does the company do?
Linde plc, formerly known as Linde AG, is a company that was formed by merging the German Linde with Praxair, which was founded over 100 years ago as the Linde Air Products Company. The resulting PLC was incorporated in Ireland.
Its primary business is the manufacturing and distribution of atmospheric gases. This includes oxygen, nitrogen, argon, rare gases, and process gases such as CO2, helium, hydrogen, and acetylene. In terms of size, it's the 444th ranked company on the Global 500, and has a market cap of over $150B, making it the largest market cap of any British company in existence.
(Source: Linde)
The company splits its operations in the following fashion. First, we have Gases, which in turn and on a reporting basis are split into geographical segments of Americas, APAC, and EMEA. Secondly, we have the Engineering segment. This segment focuses on the construction through the expertise of large-scale chemical plants for the production of the gases that the company offers, as well as plants for LNG and olefin manufacturing. Over the course of its history, the company has constructed 4,000 completed projects - so this isn't just some side project for this company.
Fundamentally speaking, Linde has a long history of outperforming its peers and the market overall. This is both in terms of Sales, EPS growth, dividend growth, and operational cash flow growth. EPS gives us a very clear picture here.
(Source: Linde)
Linde is, simply put, a company that consistently delivers best-in-class results. Its future strategy is very simple as well, being a mix of optimizing current operations, leveraging the current ongoing recovery through FX/volume, cost management, as well as use this to capitalize on growth in Electronics, healthcare, Backlogs, and Clean energy. The company expects these combined upsides to result in an EPS growth of above 10% p.a.
(Source: Linde)
Linde is also one of two companies in the world that focus on hydrogen-powered vehicle research and is in a market situation of capitalizing on this increased demand either through adding vehicles, or simply volume demand increases due to increased population and use (but no vehicle shift towards hydrogen). Its market-leading position gives it a clear advantage to any other operator here.
(Source: Linde)
The company also has a large number of projects related to the clean energy strategy, with investments in H2 infrastructure in South Korea, the world's largest PEM Electrolyzer in Germany, and clean mobility H2 investments located in California.
The company has also provided investors with guidance for 2021, which includes not only 2019, but also 2020 YoY growth, with up to 34% EPS growth from 2019, a 2% FX upside, and around $3B worth of annual CapEx. The company, if it fulfills these targets, will have managed a double-digit EPS growth for the 3rd consecutive year running, and this is of course despite the pandemic. I feel that I can stay objective and say that these are some stellar results for an amazing company.
Fundamentally speaking, the company has a solid A grade credit, less than 17% long-term debt to cap, and an impressive, long-standing dividend tradition even before the Praxair merger.
So, the company is a business that makes money by manufacturing and distributing important gases, in addition to engineering projects. They have done this for going on 140-150 years, and they're the biggest company in the world at what they do, as well as the best-in-class in terms of overall returns. The company's credit is sound, and its dividend is well-covered. Together with a positive outlook due to green energy and the economic recovery, it's fair to say that things for Linde are looking up.
Let's look at recent results.
Linde - How has the company been doing?
The latest results we have are the 2Q21 results. These results came in at excellent overall levels, showcasing the company's enormous backlog and plans for growth projects.
(Source: Linde)
On a quarterly basis, sales were up 19%, profit was up 39%, income was up over 40% compared to 2020. The company also saw reduced CapEx despite these earnings increases, and saw increased overall margins by over 3.3%, with ongoing sequential margin increases of 1.2%. The company is continuing to distribute cash to shareholders and allocate capital very conservatively.
(Source: Linde)
As of 2Q21, the company even increased its earlier guidance, to where the EPS increase YoY is now expected to be at 40% above earlier levels on a YoY basis.
On a geographical basis, results were up impressively in all geographies, with 40% profit increase in NA, 32% in APAC, and a whopping 61% in EMEA.
(Source: Linde)
The overall picture from the various segments and geographies is overall excellent and growing, margins led by good execution from Linde's operations worldwide. The company has a substantial backlog in its engineering segment as well, executing on time and on budget (which is a wonder on the order of a miracle in the construction industry), with a current backlog of around $4.1B with more projects incoming.
The market trends for Linde are nothing short of amazing.
(Source: Linde)
And combining this with the project backlog that the company currently has, as well as the overall excellent ESG performance, it's no real wonder why the company is enjoying the sort of valuation and tailwinds that it currently is.
There is, to my mind, very little else to say about the company's recent performance. It's excellent, and expectations are continued to be excellent. A look into the company's current valuation trends will go a long way to shed more light upon this.
Linde - What is the valuation
Valuation for Linde is perhaps to be compared to other excessively valued stocks at this point. Linde is currently trading at an average weighted P/E of over 33x, 12-13x above normal levels, and more than double the "fair" levels that are considered 15x P/E.
(Source: F.A.S.T. Graphs)
What this means is very simple. Despite expected earnings growth nearly in the double digits, this company's sub-1.4% dividend and the market tailwinds, on a fair value premium basis, this company will net returns of less than 10% in 4 years, if the 24-25x P/E of its 5-year average is upheld.
(Source: F.A.S.T. Graphs)
Of course, at this point, it seems downright ridiculous to expect that Linde would trade at anything except massive premiums. But that's always the way it looks during extreme bull markets. This is nothing new, and as such, it's expected. For you to net some impressive, 8-9% annual RoR here, including dividends, you'd have to assume the company trades at an average P/E of not 30x, but at 33x, for the next few years. That's the current overvaluation the company is in. Meaning at anything below that, your returns would be less than 9% annually, if assuming current guidance is correct.
This is a problem.
It's a problem because the only way for you to make respectable returns from a solid investment like Linde is for that company to keep its current market premium of over 33x.
Let me go on record and say this clearly - Linde has never done that for 4 years running. Not during the Financial crisis. Not during the dot-com bubble. Its current valuation is a tip that's not been recorded for this long a period before - and I'm always hesitant when investors start spouting off about the "new normal". The new normal is only new until the old normal makes a reappearance, and things come crashing down, often with disastrous consequences for investors who put money to work at valuations above 30x P/E.
(Source: TIKR.com)
Unsurprisingly, we don't find much help from analysts here. They always seem to have a premium on Linde, and consider the company undervalued even here due to a combination of solid EPS growth and potential expansion - none of which I by the way argue with. All of those things are entirely possible, just not worth what the market is asking for Linde at this time.
Perhaps it would be better to say that when the market is demanding 30x for a chemical major, I'd rather put it to work at a BBB-rated financial at 7-8x, simply because I think it offers me better opportunities to make money.
We're, after all, not talking about locking money away safely at a superb yield. That would be one thing. We're talking about investing money at overvaluation, and a yield that's lower than the current real rate of inflation, depending on where you live.
That's something completely different, and not something I'm all that interested in. I also want to point out that Linde actually has a bit of potential volatility to its results, with times of trading lower (though not for all that extended periods of time).
The bottom line is that Linde is a grade A, solid, superb company. It's simply too expensive though. There are tons of solid, excellent companies on the market - most of them currently trading at overvaluation. Linde is absolutely no different here, to my mind. All of the advantages and upsides discussed only slightly dent this overvaluation, but none of it, even together, is enough to make me reconsider the basics here.
Here are the analysts' (over)valuations.
(Source: S&P Global, Google Sheets)
While it's not impossible for Linde to continue to trade at, or even grow to valuations above the current level, I view it as problematic investing in companies at this valuation. Even market-leading ones.
I view Linde as a "HOLD" with a 5-year average 20-25x P/E target range of $215-268. I would not pay more than $275 for Linde at this stage.
Thesis
I will conclude my current stance on Linde as follows:
- Linde is a best-in-breed and the world's largest chemical major in its field. In my view, there's really nothing negative or significant in terms of risk to convey when it comes to this company. The market is positive, and the company is extremely well-run. The future should be bright.
- However, this creates a scenario similar to other overvalued, excellent companies where the question becomes; How much should we pay for excellence?
- As an investor, I say that no amount of prospective excellence is worth 30-35x P/E or above in the long term. I, therefore, say that this is not buyable here.
Some investors contacted me when I sold 94% of my Norsk Hydro (OTCQX:NHYDY) holdings and told me I was being foolish, as the company would go far higher than my 51-55 NOK/share sales price. It trades at 58 NOK today. However, that's 6-7 months later. My rotation into undervalued investments for the tens of thousands of dollars that I harvested from Hydro has, in turn, already grown between 25-40% since that time. Therefore the sale and reinvestment was, to me, undoubtedly the "right" choice. Even if a company can and might go higher, that in itself is not an argument for investing.
Look instead at the comparative potential upside/total ROR over time. Hydro has reached a sort of limit, as evidenced by the trends during the last 6 months. Linde, I believe, is approaching similar levels.
Remember, I'm all about:
- Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
- If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
- If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
- I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
This process has allowed me to triple my net worth in less than 7 years - and that is all I intend to continue doing (even if I don't expect the same rates of return for the next few years).
If you're interested in significantly higher returns, then I'm probably not for you. If you're interested in 10% yields, I'm not for you either. I'm not interested in those potential 1,000-5,000% returns. They're too risky. I'm interested in consistently not making mistakes (or as few as possible), by investing in well-covered, undervalued cash flows and dividends.
If you want to grow your money conservatively, safely, and harvest well-covered dividends while doing so, and your timeframe is 5-30 years, then I might be for you.
LIN is a "HOLD". It's simply too expensive. If I held it, I might consider #2, though not for the entire position, because it might go higher as profits continue to grow.
Thank you for reading.
This article was written by
Mid-thirties DGI investor/senior analyst in private portfolio management/wealth management for a select number of clients. Invests in USA, Canada, Germany, Scandinavia, France, UK, BeNeLux. My aim is to only buy undervalued/fairly valued stocks and to be an authority on value investments as well as related topics.
I am a contributor for iREIT on Alpha as well as Dividend Kings here on Seeking Alpha and work as a Senior Research Analyst for Wide Moat Research LLC.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of NHYDY either through stock ownership, options, or other derivatives. 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.
While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved.
I own the European/Scandinavian tickers (not the ADRs) of all European/Scandinavian companies listed in my articles. I own the Canadian tickers of all Canadian stocks i write about.
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Comments (7)
'this time it's different' "
- Sir John TempletonI know it's really dangerous, we can't repeat it enough, unfortunately only a few others still don't know. Upside trend is another dangerous word for it.History repeats itself again and again, in this respect everything stays the same. It never seems to be any different.