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Pulling Profits Out of Thin Air

How economic moats help industrial gas producers consistently deliver lucrative returns.

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Industrial gas producers’ strong records highlight the importance of economic moats: All three industrial gas companies we cover-- Air Liquide,  Air Products, and  Linde--have consistently earned excess economic profits despite selling what are essentially commodities. The industrial gas sector benefits from high switching costs and long-term customer agreements, which often include take-or-pay clauses and indexed electricity costs. These favorable contracts allow the companies to carve out economic moats that help them consistently generate strong and relatively stable cash flow streams. We believe that all three public industrial gas companies we cover will continue to outearn their cost of capital throughout the next decade, thanks to their narrow economic moats.

Industrial gases typically account for a relatively small fraction of customers’ costs but are a vital input to ensure uninterrupted production. As such, customers are often willing to pay a premium and sign long-term contracts to ensure that their businesses run smoothly. Long-term contracts and high switching costs contribute to industrial gas producers’ moats, helping them generate a predictable cash flow stream and lucrative returns.

Krzysztof Smalec does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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