Solid F4Q; F2018 EPS Range Good and Even Better PF for Lu’An
• APD finishes the year on a high note. APD posted adjusted F4Q17 EPS of $1.76A vs. our $1.69E, consensus of $1.68, and management’s implied 4Q range of $1.65-1.70. Sales increased 13.1% to $2.2bn, which represents ~2% higher growth than our forecast of $2.16bn. Strength was broad-based and mix is favorable. Adjusted EBIT of $493mn contributed $0.07 of positive EPS variance vs. our $473mn with earnings upside in Industrial Gases - Americas, EMEA and Asia, partially offset by weaker than expected earnings in the Global segment and higher than expected corporate costs. Management had updated the street on this quarter’s performance on 11 September, following the Lu’An joint venture announcement, and indicated strength in the quarter despite headwinds associated with hurricanes. That said, the magnitude of F4Q upside is beyond what we had anticipated. EBITDA margin improved 85ps q-q to 34.9% vs. our forecast of 33.9%, the F2Q16 “high water” mark of 35.1%, and Praxair’s 3Q17 margin of 32.6%. Net debt declined by $292mn from $577mn to $285mn, or 0.1x the F2017 EBITDA as management remain patient stewards of excess capital.
• Management initiates a F2018 EPS range; F1Q EPS looks strong. APD sees F2018 EPS in a range of $6.85-7.05, reflecting 9% to 12% growth over the F2017 results. The guidance range midpoint of $6.95E exceeds our $6.90E and the Street’s $6.94. For F1Q18, APD is forecasting an EPS of $1.60-1.70 vs. the street at $1.59. Importantly, the company noted that the range excludes any accretion from the recent Lu’An JV or any other significant acquisitions, which we’d estimate at $0.10-0.15. We continue to see Air Products as a likely acquirer of non-US assets that will likely be divested through the Praxair-Linde merger of equals. However, patience will indeed be necessary as we do not expect those assets to come to market for several quarters.
• Industrial Gases – Asia comes in ahead of elevated expectations. In EPS terms, Gases Asia represents a $0.03 tailwind vs. our estimate. On the company’s 11 September update, management flagged better results in Asia, and we increased our EBIT estimate for the segment by $9mn accordingly. Evidently, we did not raise estimates enough, as EBIT of $152mn was still $9mn better than our $143mn. Strength in Asia is consistent with the company’s stance exiting F3Q as growth in the region remains robust. Volume grew 17% vs. the 20% growth reported in F3Q (or 10% after stripping out equipment sales on the quarter.) The company continues to highlight pricing tailwinds in Asia, particularly in China, which remains encouraging after years of sub-par returns. This strong sales profile helped drive EBIT margins up 300bps y-y to 27.5%, 20bps better than our estimate.
• Industrial Gases – Americas shows resilience despite hurricane headwinds. EBIT on the quarter of $266mn is a beat vs. our $231mn. We had been a bit cautious on the segment heading in to earnings given the potential headwinds associated with Hurricane Harvey. Accordingly, we had cut our EBIT estimate for this segment by $10mn ahead of earnings from $241mn. However, even if we had left our estimates unchanged, results would have still beaten handily. Net sales of $953mn came in ahead of the $939mn we had penciled in, as 7% volume growth was better than anticipated. However, the real driver of results was EBIT margins, in at 27.9% and up 250bps sequentially vs. our estimate of 24.6%.
• Industrial Gases – EMEA beats on new project startup while Global lags. Sales in Gases – EMEA of $515mn came in well ahead of the $471mn we had penciled in, driven by volume growth of 18% y-y, primarily the result of a new project start-up in India and an improvement off of the impressive 6% reported in F3Q17. EBIT of $119mn was a net EPS tailwind of $0.05 as results outperformed our $105mn estimate. Looking ahead, incremental USD weakness should aid earnings in coming quarters (USD has climbed above $1.18 vs. the Euro). Meanwhile, the Global segment reported EBIT of $12mn, which was well below our $33mn estimate and represented a net $0.07 headwind.
• We rate shares of APD Hold. Our published price target of $148 suggests limited potential for upside, including a dividend yield of 2.5%. 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 8.0% and a terminal growth rate of 2.5%. Our relative P/E multiple applies a 30% premium to the S&P 500 multiple and implies a stock price of $155.
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Praxair, Inc. (PX: Hold, $132 PT)
Strong Volume Drives 3Q EPS Upside
• Praxair’s 3Q EPS prints above the high end of guided range. Praxair reported 3Q EPS of $1.50 vs. our $1.46E, consensus of $1.44, and the company’s prior range of $1.40-1.46. Sales of $2.92bn came in ahead our $2.78bn, driven primarily by better volumes in North America and Asia. Volume growth of 5% is the strongest performance in over 4 years, and a sequential improvement from the 3% growth posted in 2Q17. In EPS terms, consolidated EBITDA of $953mn was a $0.10 beat against the $915mn we had penciled in. On a segment basis, EBIT outperformed our expectations in North America and Asia, while Europe and South America lagged. Exiting 2Q17, we thought that management had been overly cautious in regards to 2H17 guidance. With Air Products flagging continued strength in Asia on its market update call and US SAAR posting strong September rebounds thanks to the Harvey rebuild, it seemed to verify our view that the company’s two sources of caution/concern – US autos and Asia -- were perhaps overblown. Praxair’s project backlog increased modestly q-q to $1.5bn as the company secured four new project wins in the US and Asia. We look forward to the call for any updates regarding the pending merger with Linde.
• Company is raising 2017 guidance. Praxair raised its 2017 EPS guidance range to $5.78 to $5.83 from $5.63 to $5.75 previously. The new range is more in line with our $5.80E, although ahead of the street’s $5.74. The guidance implies 4Q EPS of $1.45-1.50 vs. our $1.50E and the Street at $1.45.
• North America impresses. EBIT on the quarter of $386mn drove a $0.07 positive EPS variance vs. the $357mn we had penciled; a result of better top line growth and margins. Heading into the quarter, we were cautious on the results for the North America segment given the company’s large exposure to the US Gulf Coast and sizeable packaged gas business, both of which were likely impacted by Hurricane Harvey. That said, US SAAR did rebound in September (good for PX steel customers) and it appears aerospace, electronics and beverage markets also performed well. Sales volumes of 3% were a modest sequential increase vs. the 2% y-y growth reported in 2Q17. The growth acceleration is encouraging given the aforementioned Hurricane headwinds, though comps remain fairly easy for the segment as PX reported negative volume growth throughout 2016.
• Asia outperforms. Sales in Asia were $451mn, up 15% y-y, well ahead of the $409mn we had anticipated. In EPS terms, EBIT on the quarter was a $0.02 per share tailwind as the top line was able to overpower the impacts of slightly weaker margins. After a strong start to the year in Asia, Praxair had issued a more cautious tone towards the second half on its 2Q17 call. However this had seemed incongruous with Air Products’ decision to increase guidance for the year following its 2Q release, in part due to expected strength in that market. Volumes of +13% and price/mix of +2% do reflect some new project start-ups, though largely point to a market that is building momentum.
• Europe and South America drag. Combined, these two segments represented a net $0.03 per share headwind to our numbers, largely due to weaker margin performance. Europe in particular suffered as sales growth of 11% was ahead of our estimates, though sequential margin improvement lagged. Meanwhile, the South American market could be showing signs of recovery despite the modest miss. We believe business conditions continue to be challenging, though with y-y volume growth of 2% and sequential volumes up 4%, perhaps things are stabilizing.
• We maintain our rating of Hold and our $132 price target. Our price target suggests shares offer limited upside, including a dividend yield of 2.2%. As a reminder, we value PX based on an average of our DCF analysis and a relative P/E-based framework. Our DCF analysis suggests a warranted stock price of $103, and includes a weighted-average cost of capital (WACC) estimate of 7.8% and a terminal growth rate of 2.5%. Our relative P/E-based framework indicates a warranted value of $131 per share based on a 20% premium to the S&P500 index’s multiple as applied to our 2018 EPS estimate of $6.10. Finally, we continue to attribute additional value of $15 per share to reflect the expected value to be created from Praxair’s pending MOE with Linde.
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