Air Products & Chemicals

Air Products' fiscal third-quarter adjusted EPS of $3.47 beat the FactSet consensus estimate by $0.13. GAAP results included a $2.9 billion, or $9.92 per share, pretax charge related to terminating the Louisiana project as well as other smaller clean energy projects, which was announced on June 30.

Why it matters: Management raised its outlook and now expects full-year adjusted EPS of $13.39-$13.49, up from $13.00-$13.25, which reflects expected contribution from new projects, as well as benefits from pricing and productivity. Following the project exits announced on June 30, management expects fiscal 2026 capex of $3.5 billion, down from $4 billion. The slide deck now also shows a long-term capex target range of $2.0 billion to $2.5 billion, down from $2.5 billion. We believe Air Products can find alternative opportunities to deploy capital. Electronics is currently the hottest end market, accounting for $2.4 billion of the firm's overall $3 billion traditional industrial gas backlog.

The bottom line: We raised our fair value estimate for wide-moat Air Products to $325 from $306, driven by a slightly improved near-term outlook. We see the name as fairly valued. Fiscal third-quarter underlying sales increased by 4%, on 3% volume growth and 1% higher pricing. Air Products expanded its adjusted operating margin by 110 basis points year over year to 25.6%, as volume and price were partially offset by higher costs.

Big picture: Air Products finalized an agreement with Yara to commercialize the renewable ammonia from the NEOM project (excluding the amount sold as renewable hydrogen in Europe) on a commission basis. Although the Yara deal will help the industrial gas firm manage volume risk and reduce the need to invest in its own ammonia distribution network, Air Products will retain the price risk. As such, we think that management would prefer to secure long-term on-site contracts to sell green hydrogen from NEOM to European customers.

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We’ve raised our fair value estimate to $325 per share from $306 following fiscal third-quarter results, driven by a slightly improved near-term outlook and the time value of money. Management raised its outlook and now expects full-year adjusted EPS of $13.39-$13.49, up from $13.00-$13.25, which reflects expected contribution from new projects, as well as benefits from pricing and productivity.

We project average sales growth of roughly 4.5% per year in the core industrial gas business. Additionally, we model a significant contribution from new blue and green hydrogen projects coming onstream, helping boost revenue growth to a compound annual growth rate of around 8% over the next five years.

The company has already aggressively reduced fixed costs, which led to adjusted operating margin growing from 16% in fiscal 2014 to 23.7% in fiscal 2025, a nearly 800-basis-point improvement. We project further operating margin expansion to around 29% by fiscal 2035.

We assign Air Products a Wide Morningstar Economic Moat Rating due to switching costs and intangible assets. Air Products benefits from operating in an industry that is inherently moaty because of high switching costs. Although industrial gases are essentially commodities, they are a crucial input in many industries. Since gas typically represents only a fraction of total costs, customers are often willing to pay a premium and enter into long-term contracts with reputable distributors to ensure uninterrupted supply. As such, public industrial gas companies have historically earned returns in excess of their cost of capital, and we believe these lucrative profits will persist.

Industrial gases are distributed through three supply modes: on-site, merchant, and packaged. Operations are often tightly integrated across all three supply modes: An industrial gas company will build an on-site plant (either adjacent to a customer’s facility or connected through pipelines) and sell excess capacity through merchant (tanker trucks) and packaged (cylinders and dewars) supply channels.

Switching costs vary by supply mode. The on-site segment has the highest switching costs because switching to another supplier may require substantial costs to convert or purchase new equipment. Large customers often sign 10- to 20-year contracts with take-or-pay clauses and prices indexed to electricity costs, and we estimate customer retention rates exceed 95%. Merchant customers also face switching costs, as they typically enter into three- to seven-year contracts and often rely on industrial gas companies for storage and vaporization. We don’t see any meaningful switching costs in packaged gases. That said, the three supply modes are often tightly integrated, with the same plant supplying industrial gases across all three.

Air Products also benefits from intangible assets, consisting primarily of customer relationships, patents, and engineering know-how. Industrial gas companies often develop strong relationships with their on-site customers by offering a full spectrum of engineering and consulting services. They can create value for their customers through optimization programs that improve throughput, enhance quality, and increase safety.

We believe that Air Products’ wide moat rests on the strength of its on-site and merchant segments, which benefit from long-term contracts and high switching costs. We believe that the company benefits from a resilient business model, as take-or-pay clauses and cost pass-through mechanisms in the on-site contracts allow the firm to withstand macroeconomic headwinds. We expect its wide moat will help the company continue to deliver attractive returns on invested capital throughout the next two decades.

Air Products is poised for rapid growth due to business opportunities that drive its ambitious capital-allocation plan.

Air Products has emerged as a leader in green and blue hydrogen, with several multibillion-dollar projects in development.

The company’s focus on on-site investments will result in a derisked portfolio with more stable cash flows.

After Air Liquide’s 2016 acquisition of Airgas and the Praxair-Linde merger in 2018, Air Products is a distant third in terms of market share among industrial gas majors and may struggle to regain share.

Strong competition for new contracts in emerging countries, especially China and India, could result in depressed returns in those markets.

Given its large backlog of blue and green hydrogen projects, Air Products faces elevated execution risk, which could include project delays, cost overruns, and returns falling short of expectations.