On the surface, specialty gases producer Air Products & Chemicals (NYSE:APD) seems like an ideal choice for value investors. Through good economic times and bad, Air Products & Chemicals is able to produce steady results. The company is a dividend stalwart that has a long track record of increasing cash returns to shareholders. And, even better, it now counts one of the world's most famous investors as a financial backer.
At the same time, lofty valuations across the industry and a noticeable lack of growth potential may mean Air Products isn't an ideal choice after all. As occurs so often when the market keeps breaking new highs, Air Products appears to be a classic case of a great company, but a not-so-great stock.
A marvel of consistency
It's easy to appreciate Air Products' business model and its value proposition to shareholders. Air Products generates consistent profits, even during the recent financial crisis. In its recently concluded fiscal 2013, Air Products grew revenues by 6% to more than $10 billion. This was driven mostly by acquisitions, which accounted for 5% of its revenue growth. Meanwhile, adjusted earnings per share clocked in at $5.50, representing just 2% growth versus fiscal 2012.
The lack of strong growth in the specialty gas industry is clear from the results so far this year from not just Air Products, but from major competitors Airgas (UNKNOWN:ARG.DL) and Praxair (NYSE:LIN).
Airgas grew sales and diluted earnings per share by 3% and 10%, respectively, over the first half of its fiscal 2014. The company generated earnings growth through cost controls, but management warned investors that many of its end customers are encountering difficulty due to the government shutdown.
CEO Michael Molinini stated that "sales volumes were challenged to a greater degree than expected. Customer activity levels softened during the back half of September, which is normally a time when activity picks up meaningfully." This is the primary driver behind the company's modest forward guidance, which calls for single-digit organic revenue growth for both the third-quarter and full fiscal 2014.
Meanwhile, Praxair has a similarly cautious take on the specialty gases industry. Sales and diluted earnings per share are up 6% and 1%, respectively, through the first nine months of the year. And, going forward, fiscal 2013 isn't expected to be a banner year. At the midpoint of its full-year earnings guidance, Praxair expects just 3% growth in diluted EPS for fiscal 2013 versus the prior year.
Air Products' remarkable consistency is reflected in its commitment to providing cash to shareholders. Air Products provides a strong dividend that yields 2.5% at recent prices. Making things even better, Air Products has actually increased its dividend for 31 years in a row.
Perhaps it was this remarkable commitment to shareholders that caught the attention of noted investor Bill Ackman. His firm Pershing Square purchased over 10 million shares of the industrial gas producer earlier this year. In all, Pershing Square now holds a 9.8% stake, and is now Air Products' largest shareholder.
Is Air Products full of hot air?
While there's no doubting Air Products' business quality, it's easy to poke holes in the stock as an investment candidate. Air Products trades for 20 times trailing earnings, which is a fairly lofty multiple for a company with questionable growth opportunities ahead. Earnings growth is being achieved largely through cost cuts and not organic sales growth. Moreover, the stock trades for a premium to the broader market. The S&P 500 Index holds a trailing P/E multiple in the high teens.
Valuations seem stretched across the specialty gas industry, as Airgas and Praxair also trade at similar multiples as Air Products. Each of these three companies is highly profitable and rewards shareholders with rising dividends, but none of them appears to present a meaningful margin of safety. While Air Products, Airgas, and Praxair are high-quality companies, investors may want to wait for a pullback before jumping in.