APD Materials Spin – The Right Strategic Move, But Not Much Value Add

gcopley

APD’s long expected announcement to spin off its Materials and Electronics came after the close last night. The company expects to complete the spin by the end of its 2016 fiscal year (September), which seems like a long lead time, given that the business has been run independently for many months already. We like this business and we like its leadership. Since Guillermo Novo has managed this business it has been the greatest driver of growth at APD with slight growth in the top line and significant margin expansion – the business had EBIT in fiscal 2014 which was almost 70% higher than in 2010 and through the first three quarters of fiscal 2015 is 40% higher than the prior year. The business has seen some top line growth, but most of the gains have been from margin expansion through cost control, both people and manufacturing/raw materials.

It is good that the company is choosing to spin off the business, as it will allow APD to focus on its core gases business, but there is also a negative conclusion which could be drawn. It is possible that the electronics and materials business has reached the end of its useful life as a driver of growth at APD, i.e. we might be concerned that the business has tough compares going forward.

Overall, we would not be jumping on this as an investible moment. APD trades at a high multiple of forward earnings and it is debatable whether NewCo should trade at such a multiple unless it can continue to put up the growth. The standouts on the specialty chemical side are ECL and SHW, but they are standouts because they are growing both top line and bottom line and consequently they command the higher multiples in the group (Chart).

NewCo is going to have to find a way to grow top line and this likely means an M&A plan, given the global economic malaise and deflationary pressures. We like NewCo’s chances here.

APD is going to have to find a way to grow without NewCo. Revenue growth will come from projects under construction rather than growth in existing geographies given the slow manufacturing recovery. The revenue growth is likely to be dilutive to margins, given the nature of the new projects and the delays, and APD will have to keep its foot on the cost cutting pedal to drive the growth reflected in consensus earnings and the share price.

This is still a more interesting, though more expensive, story than PX, because of the change in leadership and direction. However, as we have said consistently, you are paying for that greater interest already and we would still prefer PX on the basis of leverage to a manufacturing recovery, particularly in the Americas.

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