Linde

Linde's second-quarter adjusted earnings per share of $4.50 came in a penny above FactSet consensus expectations. Despite the earnings beat, the stock was down 5% on July 31 as the updated full-year adjusted EPS guidance midpoint of $17.80 fell short of the $17.93 consensus estimate.

Why it matters: Management raised the bottom end of its full-year adjusted EPS guidance range by $0.10, but we think the market was anticipating a more significant outlook increase. Second-quarter adjusted operating margin compressed 60 basis points year over year to 29.5%, mostly driven by headwinds in the US home healthcare business (Lincare) due to cost inflation and regulatory changes. Excluding the Lincare drag, margins would've increased 20 basis points. Linde expects sequential margin expansion in Lincare in the third quarter driven by operational improvements, but management is also evaluating the long-term strategic fit of the business. We see the headwinds as transitory and remain confident of Linde's long-term margin expansion potential.

The bottom line: We maintain our $540 fair value estimate for wide-moat Linde. Shares are trading at a rare 11% discount to our fair value estimate, which we see as an attractive entry point. We think the market doesn't give Linde enough credit for potential upside in space and electronics. Second-quarter underlying sales increased 4% from the prior-year period, with equal contributions from volume and price. Linde grew its backlog by $1 billion, to $8.1 billion, thanks to a new electronics contract in the US. The end market remains hot, and we expect Linde to capitalize on significant new opportunities in electronics.

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We are maintaining our $540 fair value estimate after second-quarter results. Management raised the bottom end of its guidance range and now expects full-year adjusted earnings per share of $17.70-$17.90 (previously $17.60-$17.90).

The company has delivered strong operating margin expansion since the Praxair-Linde merger closed, and we see room for further improvement. Furthermore, we are optimistic about Linde's long-term revenue growth prospects. We think the firm is well positioned to benefit from growth in its traditional industrial gas business as well as new opportunities such as blue and green hydrogen.

Our fair value estimate is driven by projected expansion of the adjusted operating margin from 29.5% in 2025 to approximately 32.5% by 2029, driven by volume leverage, price attainment, and productivity improvements. We forecast an organic revenue compound annual growth rate of roughly 7% from 2025 to 2030.

We assign Linde a Wide Morningstar Economic Moat Rating due to switching costs and intangible assets. Linde 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 might require a substantial cost to convert or purchase new equipment. Large customers often sign 10- to 20-year contracts with take-or-pay clauses and prices indexed to the cost of electricity, and we estimate that 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. Lastly, 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 providing industrial gases through all three supply modes.

In addition to switching costs, Linde 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, as they offer a full spectrum of engineering and consulting services. They can create value for their customers through optimization programs aimed at improving throughput rates, enhancing quality, and increasing safety.

We believe that Linde’s 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 Linde’s wide moat will help the company continue to deliver attractive returns on invested capital throughout the next two decades.

The merger with Praxair has made Linde the largest industrial gas company in the world, strengthening its competitive positioning.

Management has done a commendable job driving margin expansion since the merger.

We expect Linde to capitalize on new investment opportunities in blue and green hydrogen.

Cost inflation and energy price volatility could pressure short-term margins.

Strong competition from other industrial gas majors and local companies for new contracts in emerging countries, especially China and India, could result in depressed returns in those markets.

A reversal to sluggish industrial production growth in North America and Europe could lead to slower growth and earnings uncertainty.