Where is the Growth? – Try Industrial Gas
Looking through a number of earnings releases and transcripts this week and listening to several of the calls, the overwhelming factor that grabs our attention is the total lack of any expectation of industrial growth anywhere in the world in the second half.
Companies that have guided to improved sequential or year on year earnings growth have pointed to one of two things – either cost initiatives (DOW this morning) or the start-up of new capacity with new customer demand or the introduction of new products (PX and APD and to an extend DOW and DD). Where these opportunities are not available, we have seen some significant negative guidance – CYT, CAT and others.
Positive and negative surprises appear to have had more correlation with companies that set very conservative expectations early in the year versus those that did not, rather than one sector or end-market exposure versus another.
Some end markets continue to do well, but the list is getting shorter and you have to start with an “a”: aerospace, automotive and some parts of agriculture. Otherwise the tone is negative or neutral; construction, consumer spending, Europe, Asia, and traditional agriculture.
We have written many times about the main peril of suppressed growth, which is not reduced volumes, but increased price competition as companies try to find incremental loading for their facilities. We would argue that this is the biggest risk for almost all companies where there is global competition, across all sectors and could impact all of the large cap names that we think offer interesting relative value today.
The exception – as appropriately reflected in post earnings performance – is the Industrial Gas space. Here the companies are global, but the logistic issues make the competition very limited once the decision to build has been made. These companies do have some price pressure, especially in the depressed markets, in their liquid distribution businesses and packaged businesses, but it is more often pressure from a customer with reduced demand and deteriorating economics than it is another supplier trying to take the business. The growth opportunity for these companies – even in a depressed world, is the new capital projects and the capital backlog, all of which has committed take or pay minimum off take agreements – in a slow world PX and APD grow – in a faster paced world they grow really well.
By almost every metric we look at, the industrial gas sub-sector is fairly valued, which is why you have not seen us write about it. However, in a zero growth world, the group will grow, while there is real risk that everyone else goes backwards for a while. On that basis you should get outperformance. We have no preference for one name versus the other today. ARG has some of the same opportunities, but a lower capital spend and much more exposure to US industrial production (which appears to have lost some near-term momentum). Outside the US, both Air Liquide and Linde have similar dynamics to PX and APD.