Air & Chemical Stock: Strike While the Iron is Hot (NYSE: APD)

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A number of growth names have become attractive with the recent market turmoil. However, it is difficult to predict a bottom with so much uncertainty in the market. This is why it may be preferable to invest in growth stocks that offer a significant return, so that investors are literally paid to wait out the market storm and not have to worry about the market price in the short to medium term.

This brings me to Air Products and Chemicals (NYSE: ODA), whose share price has become rather attractive. This article highlights what makes it a great investment for income and growth, so let’s get started.

Why ADP?

Air Products and Chemicals is one of the world’s leading industrial gases companies that has been around for over 80 years and has increased its dividend every year for 39 consecutive years, making it a dividend aristocrat. Its essential industrial gases have applications in dozens of industries, including chemicals, electronics, refining, metals, manufacturing, food and beverages. It operates in more than 50 countries and, in 2021, generated $10 billion in revenue.

APD has a strong track record of shareholder return, producing an Adjusted EPS CAGR of 11% since 2014. This includes the 14% Adjusted EPS growth management expects for the current fiscal year 2022.

The company appears to be on track to meet these targets, as it produced adjusted EPS growth of 14% in the fiscal second quarter. Sales were also up an impressive 18% year-on-year, driven by higher volumes, prices and energy cost pass-through, partially offset by unfavorable currency effects of 2%. Additionally, prices improved in ODA’s three largest geographies, the Americas, Asia and Europe.

These results underline APD’s pricing power in a difficult macroeconomic context. Morningstar assigns APD a narrow economic moat given its favorable positioning, as noted in its recent analyst report:

Air Products has the advantage of operating in a sector with a very favorable structure. Despite selling industrial gases, which are essentially commodities, state-owned industrial gas companies have always generated lucrative returns due to their economic moats. Industrial gases typically represent a relatively small fraction of customer costs, but are a vital input to ensure uninterrupted production. Thus, customers are often willing to pay a premium and sign long-term contracts to keep their business running smoothly. Long-term contracts and high switching costs contribute to industrial gas producers’ moats, helping them generate predictable cash flow and lucrative returns.

Going forward, APD stands to benefit from favorable trends in the semiconductor industry as recent chip shortages have highlighted the need for players to speed up their manufacturing processes. This is reflected in a recent major long-term supply agreement with a world leader in semiconductor manufacturing in Asia.

Also encouraging, APD is playing a pivotal role in sustainable aviation fuel with the recent announcement of a $2 billion hydrogen, pipeline and SAF project in Paramount, California, and a recently announced to produce green liquid hydrogen in Casa Grande, Arizona. Notably, APD was named one of Barron’s 100 Most Sustainable Companies for the fourth consecutive year.

Meanwhile, APD maintains a respectable A-rated balance sheet, which supports its 2.7% dividend yield, protected by a safe 63% payout ratio. Although the dividend is not considered a high yield, it is worth mentioning that it comes with an impressive 12% CAGR over 5 years, which should reward long-term investors if this trend continues.

Near-term risks for APD include higher input costs due to higher natural gas prices, which played a role in lowering APD’s adjusted EBITDA margin by 270 basis points to 34, 6% in the second trimester. In addition, increased competition in emerging markets in Asia could lead to lower returns in these markets.

I consider these concerns to have been more than priced into the current share price of $237, which sits well below the 52-week ODA high of $316 from November. APD is by no means cheap at its current P/E of 23. However, I think the valuation is justified by the company’s moat-worthy quality, solid execution and bright outlook.

Analysts estimate EPS growth of 10% to 16% over the next 4 quarters and have a consensus rating of Buy, with an average price target of $293, while Morningstar has a fair value estimate of 317 $. This implies a potential total return of 26% to 36% over one year, including dividends.

Key takeaway for investors

Air Products & Chemicals is a diversified industrial gases company with an economic moat. The company has strong execution, a favorable outlook and is trading at a discount to analyst estimates. For these reasons, I believe APD is an attractive investment for long-term investors seeking the growth and income of an economically essential business.

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