David Silver: We recently launched coverage of the industrial-gases industry. These are the companies that supply oxygen to steelmakers and petrochemical makers. They supply nitrogen to chipmakers and food processors. They supply argon to glassmakers and welders, and they supply hydrogen to oil refiners and fuel-cell makers. The four largest companies in the industry--Praxair (PX), Air Products (APD), Air Liquide (AI), and Linde (LIN)--account for 80% of industry revenues.
Industrial-gas suppliers possess sturdy economic moats, based on the long-term relationships they forge with their main customers. This, in turn, leads to meaningful barriers to entry, high switching costs, and valuable intangible assets.
Our report touches on three main themes that we consider nonconsensus. The first is growth. We expect revenue and earnings growth to accelerate beginning later this year, in step with an accelerating pace of new project startups. In agricultural parlance, it's harvest time, and industrial-gas producers are poised to reap what was sown with their major investments over the past several years.
Second: flat pricing. We expect merchant gas prices to remain mostly stable for the next several years. Two main reasons for our view: The first is the depressing effect of new production capacity on industry operating rates. The second is the growing industry trend toward geographic density, where companies pursue rising regional market shares at the expense of higher selling prices.
Third, top stock pick: For us, this is an easy choice. Praxair has the highest margins and returns on capital in the industry, yet its underperforming stock now trades at the bottom of the peer group. Its close peer, Air Products, has lower margins yet trades at a higher valuation--10% above our fair value estimate.
Among European majors, we prefer Linde over Air Liquide. Both will benefit from a weaker euro and internal cost-cutting, but Linde has a new CEO and a cheaper market valuation. We think that translates into greater upside [potential] and lower downside risk.