Praxair – One Last Airing of Our Model

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SEE LAST PAGE OF THIS REPORT Graham Copley / Anthony Salzillo

FOR IMPORTANT DISCLOSURES 203.901.1629 / 203.901.1627

gcopley@ / asalzillo@ssrllc.com

October 23rd 2018

Praxair – One Last Airing of Our Model

  • Everything will change with Praxair next week as the merger takes place, Praxair stops trading and a new UK based Linde emerges. We have dusted off our original pro-forma model one last time
    • This will be the last quarter of comparable data that we get, and we are assuming the numbers will be a mess for a while, making it very difficult to make an apples-to-apples comparison with the old Praxair and Linde
    • To be clear – our model is wrong! The combined company will likely include the same sort of purchase accounting that we saw for DWDP, with s significant Goodwill addition to the balance sheet – however – this should not impact earnings power, which is what matters.
  • In Exhibit 1 we show the earnings bridge that we first produced in August of 2017 adjusted for several pieces of new data:
    • 2017 and 2018 results to date – better numbers based on the better global economy.
    • Larger than expected divestments – more share buyback but lower pro-forma 2019 earnings
  • We remain well above all other estimates for the combined company and consequently have a 2022 target price that is almost double the current PX price. Our model is ambitious – but the PX that we have known for the last 20 years is ambitious.
    • EPS growth will come from a substantial share buyback – almost 20% of the current outstanding share base by 2022
    • Growth will also come from substantial synergies, which we think will top company guidance over the longer-term – i.e. more synergies will be achieved in years 3 through 5.
    • New Linde will win more than its fair share of new industrial gas business because of a more competitive offering in almost every sub-segment – leading to higher revenue growth at better margins.
  • This remains our best idea in Industrials and Materials

Exhibit 1

Source: Capital IQ and SSR Analysis

Details and Questions

Tomorrow will be the last PX earnings call – a little sad for those of us that have covered the company from the start – but the beginning of a new chapter and one we remain very bullish about. We continue to think that the opportunity presented by this merger is unique within Industrials and Materials and consequently offers the most interesting investment idea in the space.

In Exhibit 2 we show how we think recurring earnings could look, if the asset sales and integration are executed well. Relative to our initial model of August 2017 we have changed very little – only the better results that the companies have shown since then and the higher divestment accommodations. We are assuming that 50% of the divestment proceeds will be a taxable gain, hence the earnings step up in 2019. The key drivers of earnings growth through 2022 are:

  • Buyback – as much as $25 billion over 4 years
  • Synergies – more than expected but because of a longer tail. Opportunities in Germany will take time but are only a small slice of the overall pie
  • Accelerated growth from more profitable capital investment ($17-18 billion) from 2019 to 2022. High return because of the leading cost position and gaining share on both Air Liquide and particularly Air Products. Not much of an earnings driver before 2022.
  • The original report from August 2017 is linked here.

Exhibit 2

Source: Capital IQ and SSR Analysis

We have no doubt that “New Linde” has a slick marketing/PR agenda, targeting employees, customers and investors and that this will start working almost immediately.

Faced with the new management team we would be looking for clarity on the following – assuming it is not given by the end of this week – some of this stuff is fairly obvious:

  • Dividend policy
  • Given the tax-free nature of the combination are there any timing restrictions on share buyback or other transactions outside the required divestments.
  • Is end-January 2019 a reasonable target to see all of the required divestments completed, allowing the company to make a start on integration and synergies during Q1 2019 (or is Q2 a better modeling assumption).
  • Have the companies seen any fall off in project wins over the last 6 months – has the transaction caused any distractions that have benefitted others.
  • Has there been much of a “brain drain” – skilled employees being poached by others – people that the new entity would have like to have kept.
  • Strategy for Linde Engineering – is it a keeper or is it for sale. To us it looks like one of the better engineering businesses and has a much higher multiple within the company than it would get outside.
  • Milestones in terms of integration and synergy targets – we assume there are plenty; will they be shared in some form with investors
  • Size of the inevitable one-time charge for the deal/integration. Will it be a one-time charge or are we likely to see charges each quarter for a while

Praxair is not that expensive as measured by our “normalized framework” – Exhibit 3, which does not take into account any of the earnings drivers we expect to arise from the merger – in other words, not much is priced in.

Exhibit 3

Source: Capital IQ and SSR Analysis

The company looks a little more expensive on and EV/EBITDA basis – Exhibit 4. However, we have pro-forma EBITDA growing from $8.5 billion in 2019 to $13.4 billion in 2022, an annualized growth rate of 16%.

Exhibit 4

Source: Capital IQ and SSR Analysis

©2018, SSR LLC, 225 High Ridge Road, Stamford, CT 06905. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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