Industrial Gas: Pressure Pays Off

Keeping the lid on capital spending and capacity is lifting this group's prospects

By Sam Stovall

Industrial-gas producers are now breathing the rarified air of those industries with top Standard & Poor's . Stocks in this group have put in solid performances recently, in contrast to the steady liquidation seen in the broader market. The S&P Industrial Gases subindex rose 21.6% in 2001, vs. an 11.8% drop in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600). Year-to-date through Sept. 20, the gases subindex was down 6.2%, vs. a 25.5% decline for the 1500.

The subindex consists of Praxair, Air Products & Chemicals -- the world's third- and fourth-largest producers of industrial gases, respectively -- and Airgas Inc., the largest U.S. distributor of packaged gases. S&P's investment outlook for the Industrial Gases group is now positive, as analyst Richard O'Reilly recently upgraded Praxair to buy on prospects of improving demand for gases.

$40 BILLION MARKET.

  Industrial gases are produced primarily by air separation. In the dominant cryogenic air-separation process, air is cooled and pressurized until it becomes liquid, with the various gases extracted through fractional distillation. Gases produced in this manner include nitrogen, oxygen, argon, and the rare gases.

However, noncryogenic production technologies are a growing source of nitrogen and oxygen. Some gases, including hydrogen, acetylene, and carbon dioxide, are co-products or by-products of other processes. The three basic distribution methods for industrial gases are on-site plants, bulk (merchant) supply, and cylinder (small-volume packaged gas).

The worldwide market for industrial gases is about $40 billion a year, with the U.S. accounting for one-third of it. Historically, consumption has grown 1.5 to 2 times faster than production. Industries that are major users of gases include metals and metal fabrication, chemicals processing, petroleum refining, electronics, food and beverage, and health care.

STRONGER PRICING.

  The major industrial-gas producers in the U.S. are Praxair, Air Products, Air Liquide America (a unit of France's L'Air Liquide), and Britain's BOC Group. These companies, along with Airgas and a large number of independents, also serve the packaged-gases market.

S&P's O'Reilly says industrial-gas producers, like other economically sensitive industries, appear ready to benefit from the continued modest recovery in the U.S. He also notes that the industry is enjoying its best pricing environment in many years, thanks to its improving capital-spending discipline and tighter capacity conditions.

Even so, Praxair (PX ) is the only issue in the group that O'Reilly rates 5 STARS, or buy (see BW Online, 9/23/02, "Praxair's Gases: Rising with the Economy?"). He likes the stock's attractive valuation compared to its industry peers. He maintains 3 STARS (hold) ratings on Air Products (APD ) and Airgas (ARG ).

S&P Relative Strength Rankings

These industries carry 12-month relative strength rankings of "5" as of Sept. 20, 2002 -- meaning that they're in the top 10% of the 114 industries in the S&P Super 1500 (the combined S&P 500, S&P MidCap 400, and S&P SmallCap 600) based on prior 12-month price performance.

Industry/Sector Largest Company (Market Cap.) S&P STARS* Rank
Apparel, Accessories & Luxury Goods/Consumer Discretionary Quiksilver (ZQK) 5 STARS
Casinos & Gaming/Consumer Discretionary Harrah's Entertainment (HET) 4 STARS
Commodity Chemicals/Materials Lyondell (LYO) 3 STARS
Consumer Electronics/Consumer Discretionary Harman International (HAR) Not Ranked
Fertilizers & Agricultural Chemical/Materials IMC Global (IGL) 5 STARS
Home Furnishings/Consumer Discretionary Mohawk Industries (MHK) 5 STARS
Homebuilding/Consumer Discretionary KB Home (KBH) 5 STARS
Housewares & Specialties/Consumer Discretionary Fortune Brands (FO) 5 STARS
Industrial Gases/Materials Praxair (PX) 5 STARS
Managed Health Care/Health Care UnitedHealth (UNH) 5 STARS
Metal & Glass Containers/Materials Pactiv (PTV) 5 STARS

*S&P's ranking system for the appreciation potential of stocks over a 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell).

Stovall is chief sector strategist for Standard & Poor's

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