Key points

• Praxair operates in an industry (industrial gasses) with high barriers to entry. It has been thorough in choosing its clients to minimise risk.
• Praxair has underperformed its three major competitors over the past 12 months and is now trading at a discount of one to three times 2016 earnings.
• Wingate values Praxair at US$136 per share.

Stuart Morgan is an analyst at Wingate Asset Management.

How long have you held the stock?

Since March 2015. Praxair is a low-volatile stock but was down around 7% in a strongly rising market. It has dropped another 9% since then, allowing our fund to increase its position in the stock. It is currently the fund’s second largest position.

What do you like about it?

Industrial gases are an essential component of a wide range of applications including food and beverage, healthcare, energy, metals, chemicals and electronics. Gases are either extracted from the air (nitrogen, oxygen, argon) or from natural gas (hydrogen, carbon dioxide). They are usually a very small cost of the end-client’s expenses but the client typically cannot produce their goods without the gas in question.

Industrial gas companies have built thousands of kilometres of pipeline to link their plants together in a particular heavy-industrial area such as the Gulf Coast in the US or around Rotterdam in Europe. New plants are built on-site for clients, who sign long-term take-or-pay contracts, and linked to the existing pipeline, thus guaranteeing supply.

The industrial gases industry is a rational oligopoly with only four global players and a handful of (much smaller) regionals. The barriers to entry are high – thanks to the pipeline networks built up over decades. Intellectual property and client risk-aversion makes it exceedingly difficult for new players to enter the industry in, say, a newly-developing geographical area.

The industry typically grows at a low single digit premium to industrial production in each geography and, since consolidating over the last decade or so, is relatively resilient during economic downturns.

How is it better than its competitors?

All four industrial gas majors are of high quality, but two stand out in particular: Praxair and Air Liquide. Praxair consistently posts around a 4% higher EBIT margin and around a 6% higher return on equity than Air Liquide, which in turn is consistently higher than the other two majors. A clear indication of the two companies’ differing strategies is the fact that Praxair operates in only about a dozen countries, whereas Air Liquide is present in over 100 countries.

We expect Praxair’s superior margins and returns to persist. Over the past 15 years Praxair has consistently been the price-leader out of the four majors. However, Praxair has underperformed the other three majors over the past 12 months and is now trading at a discount of one to three times 2016 earnings. The relative weakness is largely due to cyclical factors, in our view.

What do you like about its management?

Industrial production has been recently weak in some of Praxair’s key markets such as Brazil and metal-production clients in the US. The key risk for industrial gas companies is that some of their on-site customers go bankrupt. Praxair’s due diligence in choosing their clients has ensured that this risk is minimal.

Praxair has been pro-active in rationalising costs and should experience favourable operating leverage once the excess capacity is taken up. Additionally, Praxair has increased the return of operating cash flow to shareholders rather than seeking growth at any cost.

What is your target price on Praxair?

We value Praxair at US$136 per share.

At what point would you sell it?

Should the stock approach our assessment of intrinsic value of $136 in the next 12 months we would start to exit the stock. If, however, the outlook for 2016 improves then we would likely increase our assessment of intrinsic value.

How much has it added (subtracted) to your overall portfolio over the last 12 months?

The stock has dropped since our initial purchase however it has not materially affected the fund’s performance. We continue to build the position at these attractive prices.

Is it a liquid stock?

The stock is highly liquid with a market cap of $33 billion.

Where do you see the value?

Praxair is a high-quality company with an excellent operating record and steady and strong growth prospects. Wingate will always look to get exposure to this stock whenever there is significant weakness that is cyclical in nature, such as the current weakness in Brazil and some of their US customers.

Praxair (NYSE:PX)

Source: Yahoo!7 Finance, 6 August 2015

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