Air Products and Chemicals (APD: Hold, $148 PT)
Capital Deployment Kickoff; Raising Numbers on Lu’An JV
• Let the capital deployment begin! Air Products announced on Sunday a new $1.3bn, 60%-owned JV with Lu'An Clean Energy for production of coal-based synthesis gas in China (syngas is a combination of hydrogen and carbon monoxide or "CO"). We view the move as strategically sensible and consistent with hints dropped on the company's F3Q17 earnings call on 1 August. While investment of the company's excess capital is a highly anticipated event, we would nevertheless expect APD shares to perform relatively well on today’s session based on forward progress and positive revisions to earnings as we outline below.
• Deal economics appear attractive. We estimate ROC of approximately 12% and EPS accretion of $0.25 per annum on a 100%-owned basis. However, Air Product’s previously announced investment of $300mn to fund construction of four large air separation units (ASU) for Lu’An, which was already in the company’s project backlog and indeed close to start-up, so we need to be wary of double counting. In this context, we assess incremental EPS accretion of...
• Focus on China is unsurprising. We estimate that consolidation of JV sales of $0.5bn will serve to increase Air Products' exposure to China to 21-22% by F2019. We note that "plan A" for deployment of the company's excess capital also entailed China via the...
• Plenty of dry powder remains. Following the new JV with Lu’An, we estimate that Air Products' ratio of net debt to F2018 EBITDA will rise to 0.4x from 0.2x leaving ample excess capital of $6.2bn still to be deployed. With net debt of only $577mn as of 30 June, or just 0.2x our F2018 EBITDA, Air Products’ balance sheet is under-leveraged by...
• We raise our F2018 EPS estimate and affirm our rating of Hold. We raise our F2018 EPS estimate to $6.90 from $6.80 to reflect estimated EPS accretion from the new JV. Likewise, our F2019 estimate goes to $7.40 from $7.25. Our price target rises by $2 to $148, which suggests limited potential for upside, including a dividend yield of 2.6%. We value APD based on an average of our DCF analysis and a relative P/E-based framework. Our DCF analysis suggests a warranted stock price of $140 and includes a weighted-average cost of capital (WACC) estimate of 7.9% and a terminal growth rate of 2.5%. Our relative P/E multiple applies a 25% premium to the S&P 500 multiple and implies a stock price of $155. At current multiples of 21.2x our CY18 EPS estimate of $7.00 and 11.1x our CY18 estimate of EBITDA, we maintain a relatively balanced posture as we believe that APD’s multiples already reflect substantial margin improvement and a portion of the company’s latent earnings power resident in an under-leveraged balance sheet. We now estimate the latter at +11-16% in terms of our F2018 EPS estimate of $6.90.
"We view the move as strategically sensible and consistent with hints dropped on the company's F3Q17 earnings call," said Kevin McCarthy, Vertical Research Partners chemicals analyst.
