Linde Should Definitely Be High On Your Watchlist (NYSE:LIN)

Introduction

As a dividend growth investor, I seek new investment opportunities in income-producing assets. I often add to my existing positions when I find them attractive. I also use market volatility to my advantage by starting new positions to diversify my holdings and increase my dividend income for less capital.

The basic materials sector is exciting, particularly Linde (NYSE:LIN). There is a higher demand for industrial gases and basic materials. The transition to renewable energy requires more chemical elements, and companies that can provide them may enjoy increased demand in the foreseeable future.

I will analyze Linde using my methodology for analyzing dividend growth stocks. I am using the same method to make it easier to compare researched companies. I will examine the company’s fundamentals, valuation, growth opportunities, and risks. I will then try to determine if it’s a good investment.

Seeking Alpha’s company overview shows that:

Linde operates as an industrial gas company in North and South America, Europe, the Middle East, Africa, and the Asia Pacific. It offers atmospheric gases, including oxygen, nitrogen, argon, and rare gases, and process gases, such as carbon dioxide, helium, hydrogen, electronic gases, specialty gases, and acetylene. The company also designs and constructs turnkey process plants for third-party customers and gas businesses in various locations, such as air separation, hydrogen, synthesis, olefin, and natural gas plants. It serves a range of industries, including healthcare, chemicals and energy, manufacturing, metals and mining, food and beverage, and electronics.

Fundamentals

The revenues of Linde have increased by 178% over the last decade, which means they have almost tripled. The sales increase can be associated with the acquisition of Praxair, but since then, the company has shown significant organic growth based on higher volumes and more substantial pricing power. In the future, as seen on Seeking Alpha, the analyst consensus expects Linde to keep growing sales at an annual rate of ~11% in the medium term.

Linde’s EPS (earnings per share) during the same decade has almost doubled with a 95% increase. The company dealt with lower EPS growth compared to sales growth. While the sales and margins were up, the number of shares increased due to the Praxair acquisition. Therefore, the company enjoyed a lower EPS growth on a per-share basis. In the future, as seen on Seeking Alpha, the analyst consensus expects Linde to keep growing EPS at an annual rate of ~4% in the medium term.

The dividend is the company’s crown jewel when rewarding long-term investors. The company has been increasing the dividend annually for 30 years, making it a dividend aristocrat. The average CAGR (compound annual growth rate) over the last two decades is 13%, which outpaces inflation significantly. The dividend is relatively safe, with a payout ratio of 42%, making it unlikely to be cut in the short or medium term.

In addition to dividends, the company also returns capital to shareholders via buybacks. Buybacks are a great tool to support EPS growth, as they lower the number of shares. Linde has been buying back aggressively, yet its share count has increased by 66% due to the acquisition of Praxair in 2018. Since then, the company has repurchased shares, and the increase has declined from over 80% to only 66%.

Valuation

Linde’s P/E (price to earnings) ratio sits at around 26 when using the 2023 EPS forecast. Paying 26 times earnings for a company means that the shares are not cheap. When taking into consideration the fact that the risk-free rate is above 5%, the current valuation seems a bit high. The company is a blue-chip, yet with an EPS yield of less than 4%, it must show significant growth opportunities to justify it.

The graph below from Fast Graphs also shows that the shares of Linde are expensive at the moment. The average P/E ratio of the company over the last two decades is 22. The average growth rate during that period was 10.7% annually. While the growth rate aligns with the medium-term forecasts, the valuation is more than 20% higher than average. Therefore, the shares are overvalued.

Opportunities

Linde’s robust global diversification in its supply chains across the Americas (71%), APAC (25%), and EMEA (4%) provide it with a substantial advantage in terms of leveraging economies of scale, especially in markets where cost structures are pivotal. This geographical diversification also mitigates the risk of over-reliance on any single market, contributing to the company’s overall stability.

The versatility of Linde’s client base is another notable advantage. The company caters to a diverse array of end markets, including manufacturing (constituting 22% of its sales), chemicals and energy (making up 21% of its sales), and the relatively stable healthcare sector (contributing 17% of its sales). This diversified clientele empowers Linde to weather economic fluctuations by drawing upon stable sectors like healthcare even during periods of economic downturn.

Geopolitical tensions, particularly those involving China, represent an intriguing opportunity for Linde. Given that China currently accounts for approximately 30% of the world’s hydrogen production, the growing global emphasis on diversifying supply chains due to geopolitical concerns and the lesson of the Russian gas crisis aligns well with Linde’s expertise in industrial gas production and distribution. This positions Linde to capitalize on the evolving landscape of international trade potentially.

Risks

Linde faces intense competition in the industrial gases sector. Not only does it contend with established rivals like Air Products and Chemicals in the USA, but it also encounters highly cost-efficient Chinese competitors. The competition is not extremely intense, allowing Linde to reach an operating margin of 23%, but if it intensifies, it could potentially erode Linde’s market share and profitability.

The prospect of higher interest rates poses a significant risk to Linde’s growth trajectory. Elevated interest rates can lead to a slower transition toward green energy, impacting Linde’s revenue as companies like NextEra Energy (NEE) and NextEra Energy Partners (NEP) have already scaled back their growth expectations in response to higher rates. This could reduce the demand for Linde’s expertise in building green energy infrastructure, affecting its growth prospects.

Linde’s stock currently lacks a margin of safety, with a P/E ratio of 26, significantly higher than the industry average. This suggests the stock may decline by as much as 25% to reach an average valuation level. Such a correction could result in a long period of limited stock price growth, potentially frustrating investors for two and a half years.

Conclusions

To conclude, Linde is a blue chip for a reason. The company sells industrial gases and has grown sales and EPS for decades. It then rewards shareholders with generous dividend increases as well as buybacks. The company keeps growing both through organic opportunities and mergers and acquisitions. That supports long-term growth and value proposition expansion.

However, the company has several risks to its investment thesis, from higher interest rates that may decrease the speed of economic expansion to competition with firms with a better cost structure. The most significant risk for me is the current valuation, which leaves little margin of safety. A decent valuation is my priority in volatile eras like the ones we experience. Therefore, the shares are a HOLD, in my opinion. Investors should focus on the company as volatile times and declining markets may offer an attractive valuation if the forward P/E is around 20-22.