Praxair's Gases: Rising with the Economy?
By Richard O'Reilly
Industrial-gas producers, like other economically sensitive industries, appear ready to benefit from the continued modest recovery in the U.S. (Standard & Poor's expects real gross domestic product to rise by more than 3% in 2002's second half.) And our favorite in that industry is Praxair (PX ), the largest producer of industrial gases in North America and third-largest globally. The shares carry S&P's highest investment ranking, 5 STARS (buy).
Praxair's industrial-gases business involves producing, distributing, and selling atmospheric gases (oxygen, nitrogen, argon, and rare gases), carbon dioxide, hydrogen, helium, acetylene, and specialty gases. This business accounts for approximately 90% of Praxair's total sales. It serves customers in a variety of industries, including aerospace, chemicals, electronics, energy, food and beverage, health care, manufacturing, and metals.
Major competitors of Praxair in the U.S. include Air Products & Chemicals, Air Liquide America (a unit of France's L'Air Liquide), BOC Group, Linde, and Aventis' majority-owned Messer Group. Since its 1992 spin-off from Union Carbide, Praxair has expanded operations to 40 countries, with foreign sales now accounting for nearly half of its total.
BETTER DAYS COMING.
The economic signs look positive for Praxair. S&P anticipates continued recovery in the manufacturing sector along with the rest of the U.S. economy. Industrial production has picked up since the end of 2001, after declining from its last peak in June, 2000. And although S&P projects industrial production in 2002 to be only on par with the average level for 2001, we expect a mid-single-digit increase for 2003.
Praxair, with its broad exposure to manufacturing, may benefit from this scenario. Any ramp-up in factory activity will likely result in increased overall demand for industrial gases, which has typically grown at a faster rate than the overall economy.
At S&P, we expect Praxair's sales to reach $5.2 billion in 2002, with favorable year-over-year comparisons in the second half. U.S. sales of industrial gases should continue to rebound, while Europe and Asia should also keep growing.
The industrial-gas industry is enjoying its best pricing environment in many years, thanks to a renewed emphasis on return on capital by industry players. Returns are rising in response to the industry's improving capital-spending discipline and tighter capacity conditions.
Praxair should post a healthy 11% increase in earnings per share in 2002, to $3.32 (excluding 20 cents of goodwill expense), from the prior year's $2.99. In 2003, we forecast a further rise to $3.60. S&P views Praxair's earnings to be of relatively high quality. The adoption of accounting regulation FAS 123 for expensing options would have reduced its 2001 EPS by approximately 20 cents per share, and management expects to have a small pension expense this year in contrast to pension income of 33 cents a share in 2001.
Owing to its steady generation of free cash flow, Praxair's finances are sound in spite of a long-term-debt-to-total-capitalization ratio of 51% at yearend 2001. The company has raised its dividend every year since 1992. The current 76 cent annual dividend represents less than 25% of expected EPS and equates to a current yield of 1.4%.
At its current quote of $54, the stock trades at approximately 16 times S&P's estimated 2002 EPS figure, a discount of approximately 20% to that of the S&P 500-stock index. In light of our expectations of improving earnings growth through 2003, and a good chance that its p-e multiple will rise toward that of the S&P 500, we've set a 6- to 12-month target of $65, a 20% appreciation from its recent price.
Analyst O'Reilly follows chemicals stocks for Standard & Poor's