Linde Plc: A Winner As Demand For Industrial Gases Heats Up
- Linde reported Q2 results that beat expectations while management revised higher its full-year earnings guidance.
- Demand for industrial gases is growing across all end-markets with an increasing use in high-tech applications.
- The company is leading the industry with "clean hydrogen" manufacturing technologies, representing a significant growth opportunity in the long term.
- We are bullish on the stock which is supported by solid fundamentals and a positive long-term outlook.
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Linde plc (NYSE:LIN) is a leading industrial gas supplier with global operations including an engineering group. The products here, including atmospheric oxygen, nitrogen, and argon along with process gases like hydrogen, and helium, are in high demand with wide-ranging applications. Indeed, even as the business faced some disruptions in 2020 due to the pandemic, Linde just reported its latest quarterly result highlighted by strong growth, climbing profitability, and positive guidance from management. While the stock has already been a big winner this year and is trading near an all-time high, we are bullish on the stock which continues to benefit from several tailwinds. The combination of solid fundamentals with continued operating and financial momentum can push shares of LIN higher.
LIN Q2 Earnings Recap
Linde reported its Q2 results on July 30th with non-GAAP EPS of $2.70, $0.17 ahead of expectations. Revenue at $7.6 billion climbed 19.1% year over year, and also 5% from the Q1 level on a sequential basis. A big theme for the company is its gain from operating leverage, meaning profitability is climbing above the top-line momentum. Efforts at cost reductions initiated during the pandemic have paid off. SG&A as a percentage of revenue declined to 10.8% in Q2 from 12% in the period last year. This has supported a higher operating margin of 24.2% that has been improving for Linde over the last several years and up from 20.7% in Q2 2020.
(Source: company IR)
This was an otherwise blowout quarter with strength in all regions and operating segments. The Americas region which represents about 40% of total sales saw 25% y/y growth and 6% sequentially from Q1. Volumes were up 18% while management highlighted its ability to pass along higher costs with pricing power as a strength in the quarter. The trends were similar in the EMEA region "Europe, Middle East, Asia" as well as AsiaPac, both with higher volumes as well as a boost from an FX gain.
The company breaks down the demand drivers between some consumer-oriented categories which are less cyclical like healthcare, food & beverage, and electronics. On the other hand, the understanding is that industrial end markets like manufacturing, chemicals & refining, along with metals are more exposed to global growth trends. This is particularly positive considering the current environment of the ongoing post-pandemic macro recovery.
(Source: company IR)
One of the lagging parts of the company continues to be the engineering segment which covers planning, design, and construction of third-party facilities for the production and processing of gases. Here the group continues to see some challenges related to the pandemic impacting the timing of new projects. Still, the company was able to capture $355 million in new order adding to a company backlog reaching $7.5 billion across all segments, providing some visibility for continued growth.
(Source: company IR)
The company ended the quarter with $3.1 billion in cash against $10 billion in long-term debt. Considering EBITDA over the last twelve months about $9 billion and a leverage ratio under 1x, we view the balance sheet and liquidity profile as a strength for the company profile. Earlier this year, Linde hiked its quarterly dividend rate by 10% to the current $1.06 per share payout. The annualized rate represents a forward dividend yield of around 1.4%. The company has also repurchased nearly $2 billion in stock this year under its share repurchasing program.
Linde management is guiding for full-year adjusted EPS between $10.10 and $10.30, revised higher from the $9.70 midpoint target issued at the end of Q1. The outlook here represents a 23% to 25% y/y gain as well as 38% to 40% above the pre-pandemic 2019 results. The main driver here is the underlying demand across core markets along with a tailwind seen from stronger foreign currencies. CEO Sanjiv Lamba projected an optimistic tone during the conference call:
We are currently reviewing a pipeline of hundreds of prospective projects, not included in this backlog, which easily represent more than $10 billion of potential investment opportunities, including a significant number of electronics and clean energy projects and, of course, sale of planned projects. Both sale of gas and sale of plant are great ways for us to grow, while maintaining our investment discipline.
Given our strong execution capability, I remain bullish on Linde's outlook and growth prospects. Regardless of what happens with inflation or macroeconomic trends or the pace of secular growth drivers, we have a proven business model that can generate compound value growth for our shareholders today and decades into the future.
(Source: company IR)
LIN Stock Forecast
The key to understanding Linde is recognizing the growing importance of industrial gases, which is increasingly playing a critical role in various sectors. From the use of carbon dioxide and nitrogen in packaged food preparation and transport to the various applications within healthcare from drug development to hospital settings, the demand for specialty gas solutions grows organically. Gases are also a component of chemical processing and metals refinery often requiring on-site processing. Linde is an industry pioneer with proprietary methods of gas extraction and purification. The company's leadership position has helped it consolidate market share while benefiting from global growth opportunities.
One particularly exciting area is the outlook for hydrogen with Linde involved with the construction of several new manufacturing facilities in the United States. Historically, hydrogen has been manufactured primarily by extraction from fossil fuels. Linde has developed a "clean" or carbon-free hydrogen manufacturing technology based on steam electrolysis. A growing infrastructure of over 1,000 km of dedicated hydrogen pipeline, including 200 hydrogen fueling stations worldwide, is facilitating advancements in the industry recognized as the future of clean energy.
Just in the United States, the expectation is for hydrogen demand to increase from 10 million metric tonnes in 2020 to quadruple to upwards of 41 million tons by 2050. This will be driven in part by the growing adoption of hydrogen as an alternative to fossil fuels and electric vehicles. The National Renewable Energy Laboratory "NREL" sees a scenario where hydrogen would fuel 18% of cars and 26% of light-duty trucks, and 22% of the medium- and heavy-duty vehicle fleet in the next 30 years. The point here is that this represents a major opportunity for Linde with similar trends worldwide.
The outlook for hydrogen is part of Linde's broader strategy that targets +10% EPS growth per year over the long run. The company sees a combination of improving internal efficiencies while capitalizing on growth areas like hydrogen clean energy as adding to shareholder value.
(Source: company IR)
According to consensus estimates, the forecast is for revenue to reach $29.6 billion this year, representing an 8.6% increase over 2020. The context here is that as we get into the second half, the year-over-year comparables will be more difficult compared to the strong Q2 report. The 2021 market EPS estimate at $10.23 is in line with management guidance. Looking ahead, the market expects top-line growth to average around 5% per year over the next two years while EPS trends are higher, 8% in 2022 and 11% for 2023 supported by firming margins.
The bullish case for Linde is simply that these estimates are too conservative, setting up the company to continue outperforming expectations. Stronger than expected results over the coming quarters can represent a bullish catalyst for the stock. In terms of valuation, LIN is trading at a 30x forward P/E, which is compelling in our view considering the long-term growth opportunity in a segment that captures themes like renewables and clean energy. A repricing of the stock beyond its "industrial" roots and more related to high-tech and renewables can support an expansion of the valuation multiples.
In terms of competitors, Air Products and Chemicals, Inc. (APD) is a smaller industrial gas supplier generating about $10 billion in sales each year. While APD plays a major role in global hydrogen supply chains, the advantage for us with LIN is its scale and diversification. We note that LIN trades at a discount in terms of its earnings and price to free cash flow multiple. The efforts from Linde at developing "clean hydrogen" manufacturing technology warrant a premium between the two companies in our view adding to the upside in shares if and when the current spread converges higher.
Is LIN a Buy?
There's a lot to like about Linde plc with the solid Q2 reinforcing the bullish long-term outlook. We rate shares of LIN as a buy with a price target for the year ahead of $360 representing a 35x forward P/E multiple on the current consensus 2021 EPS. Linde is a high-quality stock with several positive tailwinds supporting a long growth runway. The exposure to opportunities in hydrogen can support a higher valuation premium which can drive shares higher.
The risk here comes down to macro uncertainties. The potential that the global economic outlook deteriorates would likely pressure demand for industrial gases, reflected in weaker results over the coming quarters. The latest development in the market regarding the impact of rising Delta variant COVID has added to concerns that the global economic growth can slow down. It will be important for Linde to maintain the trend of elevated margins while the results by region will be a key monitoring point.
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This article was written by
BOOX Research is now Dan Victor, CFA
15 years of professional experience in capital markets and investment management at major financial institutions.
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Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in LIN over 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.
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