Air Products and Chemicals, Inc.

Moat: 3/5

Understandability: 4/5

Balance Sheet Health: 4/5

Air Products and Chemicals, Inc. is a global industrial gases company, supplying a range of gases, equipment and related services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Air Products (APD) is an industrial gas giant with a long history. Although it doesn’t have the kind of brand power you might see in consumer-goods companies, it has carved out an impressive business through its operational excellence, and a focus on specialized technologies.

Business Overview

Air Products and Chemicals, Inc. (APD) is a global industrial gases company that serves customers in various sectors like chemicals, refining, manufacturing, electronics, metals, and food. It provides gases like atmospheric gases (oxygen, nitrogen, argon), process gases (hydrogen, carbon monoxide, syngas), and specialty gases, along with related equipment and services.

Revenue Distribution

APD operates its business regionally:

  • Americas: Primarily in North America and South America. A large portion of sales is in merchant gases.
  • Asia: Includes operations in countries like China, South Korea, India and others in the Asia region. A large focus on electronics production.
  • Europe: Includes countries in Europe and the UK.
  • Middle East and India: These regions encompass a mix of existing and greenfield investment.

A large portion of sales are “take or pay” or “take and pay”, meaning customers are obligated to pay for fixed volumes of gas, and therefore revenues are highly stable. In general, this company is largely shielded from demand and macroeconomic fluctuations.

The majority of the company’s sales come from industrial gases sold to a variety of end users, but they also derive revenue from equipment sales, engineering, and service activities.

The Hydrogen business, a big part of the future, is being led by an investment of $16.8 billion in hydrogen and associated infrastructure.

The industrial gas industry is characterized by several key trends:

  • Growing demand for hydrogen: Clean energy transition will drive demand for green hydrogen for applications in transportation, power, and industry.
  • Need for energy efficiency: Industries are seeking technologies to reduce operating costs and waste.
  • Increased digitalization: Companies are seeking improved data connectivity and traceability across their operations and supply chains.
  • Consolidation and competition: The industry has been consolidating in recent years through M&A. A lot of competition is being seen in emerging markets and from players focusing on niche market segments.
  • Emphasis on sustainability: The desire for sustainable production and reduction of carbon emissions have influenced the business, with customers demanding more environmental and economical ways of procuring resources.

Competitive Landscape

The industrial gases industry is dominated by a few major players, including Air Products, Linde, and Air Liquide. These companies are often referred to as “the big three” in the industrial gases space. They compete on factors such as:

  • Price: A commodity aspect to these gases means it often comes down to price.
  • Reliability and quality: Companies compete through consistency and reliability in delivery of high-quality gasses.
  • Network scale and efficiency: Companies with extensive distribution networks can supply more efficiently.
  • Technology and innovation: In an effort to provide cost effective products for the consumer and create high return on investment opportunities, companies invest in R&D.
  • Local presence and regulations: The regulations and local political climate of a country, influence the operation of the company in the local market.

What makes Air Products different is how vertically integrated it is across the value chain of gas production and distribution; and its high focus on process and technology innovation which gives them an operational edge over competitors.

Moat: 3/5

APD possesses a narrow economic moat. It does not have the brand recognition to charge premium prices that many other companies can. It lacks the powerful network effects that some businesses in the modern age have. However, it has 3 characteristics that give it a competitive edge:

  1. Barriers to Entry: The high capital and technical expertise required to build large-scale industrial gas facilities and the difficulty in obtaining government approvals creates a barrier for new entrants. It would take a massive company with a lot of backing to break into the current scene.

A lot of APD’s revenues come from “take or pay” and “take and pay” contracts. These are agreements where the customer pays for fixed volumes of gas regardless of its use. This greatly increases the stability of APD’s revenues.

  1. Economies of Scale: APD benefits from the economies of scale that a large distribution network provides. It operates an enormous network of factories, pipelines, and terminals. Also, APD benefits from scale in that its operations can leverage fixed expenses more efficiently. This allows for lower average costs per unit than their competition can provide.
  2. Unique Assets/Locations: Specific locations such as the Godech salt mine, that allows the company Compass Minerals to sell rock salt at one of the lowest prices on the globe, or the oil wells that allow Ultra Petroleum to produce and sell natural gas at low prices, are what helps drive profits in industries with high competition. APD has many similar such situations, such as a huge pipeline networks and access to the natural resources in the Middle East.

These strengths provide some barriers to new entrants and help the company maintain its place in the industry. However, the commodity nature of the products and the presence of strong competitors keeps the company from having a wide moat.

Risks to the Moat

While APD has several competitive advantages, there are also risks to their moat:

  1. Technological Disruption: New technologies, such as alternative sources of gases, fuel cell technology, and carbon capture technology could change the industry landscape and make a company’s technology obsolete.
  2. Increased Competition: As industries consolidate and new competitors emerge from the developing world, the company could face additional competition for business. The business also competes with customers, many of whom have vertically integrated.
  3. Economic Downturns: Reduced industrial activity during economic downturns would affect demand for gases and profits for APD, as companies pull back on production and investments. The company is somewhat shielded from recession due to “take or pay” contracts, but this is not absolute.
  4. Political and Regulatory Risks: Many of the company’s facilities are located in areas with political instability and government regulations. Change in regulatory policies or international political relations might hurt the business.
  5. Supply Chain Disruptions: A global supply chain disruption could affect the manufacturing of equipment, the distribution of gases, and cost of raw materials.
  6. Loss of key personnel: The company relies on the skills and talent of its personnel to succeed. A loss of key management or operations staff could harm growth prospects.
  7. Increased interest rates: High interest rates might make the long term debt more expensive. High long term debt, which needs to be renewed constantly, is something to watch out for, especially in a high rate environment.
  8. Cybersecurity risks: Cybersecurity breaches could disrupt operations or lead to financial or reputational loss.
  9. Project execution risks: Projects need to be executed on time and on budget. Failing that, could create considerable setbacks for the company.

Business Resilience

Air Products demonstrates reasonably high resilience, due to:

  • Defensive Industry: The industrial gases industry is essential to numerous sectors of the economy. Its essentiality will ensure strong demand in any economic environment.
  • Long Term Contracts: A large part of APD’s revenues are secured through long-term contracts that are both take-or-pay or take-and-pay, which further increases revenue stability.
  • Diversified Customer Base: Serving different industries and geographies minimizes the impact of problems arising in one specific sector.
  • Focus on sustainability: Green hydrogen and other sustainable production processes will continue to drive demand, as companies focus more on reducing their carbon footprint.

Financial Analysis

Air Products’ latest financial statements shows the power of operational leverage-with increased sales volume and lower expenses, the earnings and profits have increased significantly more than the sales.

Income Statement

  • Revenue: APD generated revenue of about $12.1 billion for fiscal year 2023, a small increase from $12.0 billion in the fiscal year 2022. This is a continuation of the very slow growth trend in sales.
  • Operating Income: Operating income increased significantly to $2.56 billion in fiscal year 2023 from $2.16 billion in 2022. This jump was partially attributable to a one-time loss from discontinued operations in the previous year. The operating income margin also increased from 17.6% in 2022 to 21.1% in 2023.
  • Net income: Net income jumped significantly to 2.42 billion in 2023 compared to $2.25 billion in 2022, largely due to lower costs and higher sales volume.
  • Adjusted EBITDA: Adjusted EBITDA increased by 18% from $3.47 billion in 2022 to $4.78 billion in 2023. The adjusted EBITDA margin increased significantly.

The company has consistently improved operating efficiency over the past few years. Operating margins have increased from 13.5% in 2020 to 21.1% in 2023

Balance Sheet

  • Assets: The company has $32.8 billion in assets. A large portion of this comes from property, plant, and equipment.
  • Liabilities: APD has $18.0 billion in liabilities which are composed of current liabilities and a great deal of debt. There is $7.7 billion in current liabilities and $8.7 billion in long-term debt, not including lease liabilities.
  • Shareholders’ Equity: With a total equity of $14.7 Billion, the company is mostly debt funded.

While the company has a great deal of debt, the debt repayment schedule is well distributed over a number of years. Moreover, the interest rate is either fixed or low.

Cash Flows

  • Cash from Operations: The company generated $3.7 billion from operations in fiscal year 2023. This is a great sign of operating strength and is up from about $3 billion in 2022 and $3.1 billion in 2021.
  • Cash from investing activities: APD is investing quite heavily in their hydrogen operations.
  • Cash from financing activities: The company mostly relies on long term debt for new funding, also repaying existing debt and dividend payments.

Understandability: 4/5

Although the company produces a variety of products, its business model of selling gasses and related services is easy to grasp. Moreover, the value drivers and financial reports are generally well understood and easy to comprehend for people that have a financial background. However, some of its more unique contracts, and certain accounting procedures are difficult to understand for a layman.

Balance Sheet Health: 4 / 5

Air Products has a mostly reasonable balance sheet- a solid equity base with a moderate to high leverage.

  • Strong Assets: The company has a strong base of diverse assets which produce stable returns.
  • Manageable debt: Although high, the debt levels are well distributed for time, and interest rates are reasonable. However, a high debt load makes the company more vulnerable to rising interest rates and financial shocks. The management should attempt to bring it back to lower levels.
  • Positive Cash Flows: Strong cash from operations give them flexibility and sustainability during all market conditions.

Recent Controversies and Problems

  • The Russian invasion of Ukraine: has impacted operations for some time and will continue to affect the company in the near future.
  • Rising cost of operations: While the management has been successful in lowering some costs, higher input prices, energy prices, and wages may increase the cost of operations, making the company less profitable.
  • Higher interest rates: Rising interest rates may increase the company’s borrowing costs, and hurt profits.
  • Supply chain issues: Global supply chain disruptions could delay production and shipments, which could hurt sales and profitability.

The company stated in its latest report that while inflation and supply chain challenges may have some short term effects, there are no long-term negative implications to the company.

Overall Summary

APD is a decent company with a narrow moat, reasonably good financial health, and strong operations. The company’s hydrogen investments make it extremely attractive to investors who want a company that will capitalize on energy transition, making them a good bet for a future with increasingly more demand for green energy. However, a high debt load is a concerning factor, coupled with the constant threat of economic shocks. The management needs to keep an eye on competitive threats, changes in customer trends and global conditions to continue delivering long-term shareholder value.