Air Products & Chemicals, Inc. (APD): A Dividend Aristocrat Distributing Higher Dividends For 38 Straight Years by Simply Safe Dividends
Air Products & Chemicals’ business is sensitive to the economy. When global economic growth slows and commodity prices drop, fewer metals need to be manufactured, demand for chemicals drops, and gas and oil refining activity slows.
APD is also the world’s largest supplier of hydrogen gases, which accounted for about 20% of sales last year and will be closer to 25% of total revenue after the Materials Technologies spin-off is completed. Hydrogen is used by refiners to facilitate the conversion of heavy crude feedstock and lower the sulfur content of gasoline and diesel fuels. The plunge in oil prices will likely have some impact on APD’s hydrogen business.
With the majority of its sales taking place overseas, APD’s near-term results are also impacted by currency fluctuations. Altogether, the risk is that many of the growth drivers for industrial gases are heading the wrong way and could persist for quite some time.
If growth prospects remain low, bidding for incremental projects could intensify. If conditions became really bad, some customers in industries plagued by excess capacity could see their credit conditions deteriorate.
If some customers cancel projects or are unable to make full payments to Air Products & Chemicals, the company could run into some cash flow problems because of its low cash balance ($279 million) relative to its debt on hand ($4.3 billion) and dividend commitments (about $700 million). This is a very low probability type of risk, but it shows the potential dangers of a highly geared balance sheet.
Dividend Analysis: Air Products & Chemicals, Inc. (APD)
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. APD’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
APD has a Dividend Safety Score of 45, which suggests that its dividend safety is about average. The company’s earnings and free cash flow payout ratios are reasonable at 54% and 64%, respectively. As seen below, APD’s earnings payout ratio has increased by about 10% over the last decade but has generally remained stable.
However, we can see that its payout ratio spiked up in 2009, highlighting the cyclicality of the business. We would prefer APD’s payout ratio remain below 50% because of its sensitivity to the economy, but its situation could be much worse.
Source: Simply Safe Dividends
APD’s sales fell by 21% in 2009, and its free cash flow per share plunged by more than 50%. The company is obviously not resistant to recessions, and its stock returned a very disappointing -48% in 2008. This sensitivity lowers APD’s Dividend Safety Score.
Source: Simply Safe Dividends
However, regardless of business conditions, we can see that APD has generated very reliable returns on invested capital. Management claims that every capital investment of more than $3 million is reviewed at the corporate level and must meet a strict 10% internal rate of return. The company appears to be allocating capital reasonably effectively.
Source: Simply Safe Dividends
APD has generated free cash flow every year, which is great, but it’s been volatile. This is because the projects APD invests in are very expensive and lumpy – they take years to build before generating any meaningful amount of cash flow. We expect free cash flow to keep trending higher as the company’s productivity improvements are made.
Source: Simply Safe Dividends
Reviewing Air Products & Chemicals’ balance sheet is very important given the company’s cyclicality. APD says it is committed to maintaining a balance sheet that deserves an A credit rating, but it has more debt than we like to see. The company will use some of the proceeds from the Materials Technologies spin-off to reduce debt.
Source: Simply Safe Dividends
Overall, APD’s Dividend Safety Score is only about average because of the company’s cyclicality, high debt, and relatively high payout ratios (by our standards for a cyclical business).
Dividend Growth Score
Our Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
APD has increased its dividend for 38 straight years and is a dividend aristocrat. The company has a Dividend Growth Score of 56, which suggests its dividend growth potential is about average.
It’s uncertain how Air Products & Chemicals’ current dividend will be split between its Materials Technologies spin-off and its industrial gases business. However, management has stated that the total amount of dividends will be the same and that the company will continue targeting a 2.5% to 3% yield.
As seen below, APD’s dividend has grown at a high-single digit rate over the last decade, although growth has slowed into the mid-single digits more recently. Until we have more clarity on the spin-off’s impact on the dividend, we expect no more than a mid-single digit growth rate going forward.
Source: Simply Safe Dividends
Valuation
Air Products & Chemicals trades at 18x forward earnings and has a dividend yield of 2.5%, which is slightly lower than its five year average of 2.7%.
We believe this business can compound its earnings by 5-7% per year over the long term, resulting in a potential total return of 8-10% per year.
However, at 18x earnings and a dividend yield somewhat below its five-year average, we believe the stock is at least fairly valued today. We would be more interested in owning it below $120 per share.
Conclusion
Air Products & Chemicals is a durable business with numerous competitive advantages. We would be interested in owning this blue chip dividend stock at a better price, which would potentially be caused by a continued slowdown in global growth prospects.
