Monday, July 23, 2012

Air Products & Chemicals Stock Analysis

As mentioned in my previous post, I'm going to try and have 1 stock analysis report for some popular dividend growth stocks come out prior to their latest earnings release this week. Today we'll look at Air Products & Chemicals (APD). Air Products & Chemicals closed on Friday 7/20/12 at $80.43.

Company Background:

Air Products and Chemicals, Inc. provides atmospheric gases, process and specialty gases, performance materials, equipment, and services worldwide. The company’s Merchant Gases segment sells atmospheric gases, such as oxygen, nitrogen, and argon; process gases, including hydrogen and helium; and medical and specialty gases for the metal, glass, chemical processing, food processing, healthcare, steel, general manufacturing, and petroleum and natural gas industries. Its Tonnage Gases segment provides hydrogen, carbon monoxide, nitrogen, oxygen, and synthesis to the energy production and refining, chemical, and metallurgical industries; and produces dinitrotoluene which is converted to toluene diamine. The company’s Electronics and Performance Materials segment offers nitrogen trifluoride, silane, arsine, phosphine, white ammonia, silicon tetrafluoride, carbon tetrafluoride, hexafluoromethane, critical etch gases, and tungsten hexafluoride; and tonnage gases, specialty chemicals, and services and equipment for the manufacture of silicon and compound semiconductors, thin film transistor liquid crystal displays, and photovoltaic devices. This segment also provides performance materials for a range of products, including coatings, inks, adhesives, civil engineering, personal care, institutional and industrial cleaning, mining, oil refining, and polyurethanes. Its Equipment and Energy segment designs and manufactures cryogenic equipment for air separation, hydrocarbon recovery and purification, natural gas liquefaction, and helium distribution; and offers plant design, engineering, procurement, and construction management services for the chemical and petrochemical manufacturing, oil and gas recovery and processing, and steel and primary metals processing industries.

DCF Valuation:

Analysts expect APD to grow earnings 7.13% per year for the next five years and I've assumed they can continue to grow at 3.50% per year thereafter. Running these numbers through a DCF analysis with a 10% discount rate yields a fair value price of $104.43. This means that at $80.43 the shares are undervalued by 23.0%.



Graham Number:

Over the last 12 months, APD's EPS were $5.55 and it's current book value per share is $29.62. The Graham Number is calculated to be $60.82 which means that at $80.43 the shares are overvalued by 32.3%.

Average High Dividend Yield:

APD's average high dividend yield for the past 5 years is 3.10% and for the past 10 years is 2.73%. This gives target prices of $82.58 and $93.85 respectively based on the current annual dividend of $2.56. These are undervalued by 2.6% and 14.3%, respectively.


Average Low PE Ratio:

APD's average low PE ratio for the past 5 years is 14.64 and for the past 10 years is 16.04. This would correspond to a price per share of $80.69 and $88.40 respectively based off the analyst estimate of $5.51 per share for the fiscal year ending in September 2012. The 5 year and 10 year low PE price targets are fairly valued and undervalued by 9.0%, respectively.

Average Low P/S Ratio:

APD's average low PS ratio for the past 5 years is 2.03 and for the past 10 years is 1.91. This would correspond to a price per share of $93.94 and $88.76 respectively based off the analyst estimate for revenue growth from 2011 to 2012. The 5 year and 10 year low PS price targets are overvalued by 18.2% and 21.0%, respectively.

Dividend Discount Model:

For the DDM I assumed that APD will be able to grow dividends for the next 5 years at the minimum of 15% or the lowest of the 1, 3, 5 or 10 year growth rates. In this case that would be 11.66%. After that I assumed APD can continue to raise dividends by 3.50% annually and used a discount rate of 8%. Based on this APD is worth $73.49 meaning it's overvalued by 9.5%

PE Ratios:

APD's trailing PE is 14.49 and it's forward PE is 12.71. The PE3 based on the average earnings for the last 3 years is 18.10. I prefer for the PE3 to be less than 15, which in this case means that APD is currently overvalued. Compared to it's industry, APD seems to be undervalued versus Airgas (20.85) and Praxair (19.41) but overvalued versus the industry as a whole (11.39). All industry and competitor comparisons are on a TTM EPS basis.

Fundamentals:

APD's gross margin for FY 2009/10 and FY 2010/11 was 27.95% and 27.44% respectively. Their gross margin is pretty solid around 30%, but I would prefer for it to be higher. Their net income margin for the same years were 11.68% and 12.51% respectively. I like the net income margin to be at least 10% and preferably rising. APD passes both of the net income margin criteria. Air Products & Chemicals has averaged a 9.19% net income margin since 2001 with a general uptrend in the values. The cash-to-debt ratio for the same years were 0.10 and 0.11. Their cash-to-debt ratio is what worries me, especially given that their debt is most likely what's leading to their free cash flow issues as you'll see below.

Share Buyback:

APD's shares outstanding have been on a fairly steady decrase since 2001. They have bought back an average of 1.34% of their shares outstanding each year. As long as their shares outstanding remains relatively flat to decreasing that's a good sign since the money they earn and payout as dividends goes further with a smaller share base.


A negative number for the % change value means shares were bought back by the company and a positive value means the shares outstanding increased.

Dividend Analysis:

APD is a dividend champion with 30 consecutive years of dividend increases. Their annual increase for the last 1, 3, 5 and 10 years has been 12.11%, 11.78%, 11.66% and 11.93%. Their payout ratio is looking good at 39.6% for FY 2010/11. The average payout ratio since 2001 is 40.40% and has ranged from a low of 31.03% to a high of 60.47%.


Their FCF however is quite troubling. They have had negative FCF for 5 years since 2001 and has averaged a -$0.33 per share FCF in that time. Things were looking okay with Air Products & Chemicals as an investment until this huge question mark came up.


Return on Equity and Return on Capital Invested:

APD's ROE and ROCI have been in a general uptrend since 2001 except for in 2009 when they took a big hit to both. Things seems to be back on the right track as their ROE for 2011 was 21.6% and their ROCI was 12.9%.


Revenue and Net Income:

Since the basis of dividend growth is revenue and net income growth I've added a new section to my stock analysis. Here you can see APD's history of revenue and net income since 2001. Their revenue took a big hit from 2008 to 2009 but has been trending positive since then. Their net income and net income margin appear to be more cyclical in nature than their revenue. As the business cycle slows their net income and margin get squeezed but then they expand again as the business cycle grows again. This could be a good sign of things to come as their numbers have started growing again. If you believe the economy is going to get better before it gets worse then now could be a decent time to get in with APD on this basis.


Average Price and EPS:


APD's average share price has been following the growth in EPS relatively closely since 2001, meaning it hasn't had much PE expansion or shrinkage. Currently APD is on the lower end of it's typical PE range.

Forecast:


The chart shows the historical prices for the previous 10 years and the forecast based on the average PE ratios and the expected EPS values. I have also included a forecast based off a PE ratio that is only 75% of the average low PE ratio for the previous 5 years, 10 years or 16 whichever is least. I like to the look to buy at the 75% Low PE price or lower to provide for additional margin of safety. In this case the target PE is 10.98. This corresponds to a entry price of $60.52, meaning that APD is currently trading at a $19.91 premium to the forecast entry price. I think based of PE alone, the current price of $80.43 is a decent entry since it is trading on the lower end of it's normal PE.

Conclusion:

The average of all the valuation models gives a fair value of $81.24 which means that Air Products & Chemicals is currently trading at a 1.00% discount to the average fair value.

There's still plenty of question marks about the economy as a whole and about the cash-to-debt and FCF of Air Products & Chemicals. I would be interested to see where APD comes in at on these issues with their earnings report due out on Tuesday. Improvement in these could mean that it's time to pick up some shares but at Friday's price I don't think you're getting a great value. I'm fairly conservative in my calculations meaning that their fair value is probably higher than what I've calculated, but there's way too many assumptions made to be very accurate. Given that they have increased dividends at a good rate while keeping their payout ratio low it could be a good investment years down the line. I would be tempted to get make a small purchase, probably a 1/4 position in APD and hope for a big pullback in the markets to give a better entry price. A 3.25% yield corresponds to a price of $78.77 and a 3.75% yield gives a price of $68.27. These would be undervalued to my calculated fair value by 3.04% and 15.96%. Another option is to try and sell puts to get a premium that would lower your cost basis. However, unless you can find a great put option with corresponding premium I'm not sure that would be the route I would take.

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