While share prices have been expanding, S&P is neutral on the industry's fundamentals. But it thinks one player, Airgas, is a strong buy
From Standard & Poor's Equity ResearchA recent addition to Standard & Poor's High Momentum List (below) is the S&P 1500 Industrial Gases subindustry index, which consists of three large and midcap companies: Air Products & Chemicals (APD), Airgas, and Praxair (PX).
Year to date through Aug. 10, the subindustry index rose 29.6%, vs. a 2.8% advance for the S&P 1500 index. What's more, the move has been broad-based, as all three companies posted price increases of 13% to 36%. In 2006, the subindustry index gained 15.6%, vs. a 13.3% advance for the broader market.
Could this be a new up-leg for the subindustry? S&P equity analyst Richard O'Reilly, CFA, says that S&P has a neutral fundamental outlook for the group. O'Reilly expects industrial gas companies to continue to enjoy further volume gains in 2007 as the U.S. manufacturing sector expands and key markets such as energy boost consumption.
Good Growth in Asia
S&P believes selling prices for these products rose in the first half of 2007 on relatively tight industry capacity, excluding the pass-through of lower energy prices. O'Reilly thinks that consumption of industrial gases over the longer term will continue to increase at the historical rate of 1.5 to 2 times that of industrial production.
The two major U.S.-based producers of industrial gases, Air Products and Praxair, posted increased operating income for the second quarter of 2007, exceeding expectations. Both companies had higher volumes in North America, vs. the year-earlier period and were able to achieve higher selling prices. S&P believes industry production in 2005 was limited as a result of facility shutdowns by gas producers and by disruptions caused by Gulf Coast hurricanes. Both companies also had good volume growth in Asia, reflecting strong economic growth in that region.
Industrial gases are produced primarily by air separation, that is, extracted from the atmosphere. Examples of gases produced in this manner are nitrogen, oxygen, argon, and other rare gases. However, some gases, including hydrogen, acetylene, and carbon dioxide, are co-products or by-products of other processes. The worldwide market for industrial gases is about $40 billion a year, with the U.S. alone at $13 billion.
Large Number of Independent Producers
In the dominant cryogenic air separation process, air is cooled and pressurized until it becomes a liquid, with the various gases extracted through fractional distillation. However, noncryogenic production technologies are a rising source of nitrogen and oxygen.
There are three basic distribution methods for industrial gases: on-site plants, bulk (merchant) supply, and cylinder (small volume packaged gas). Most of the industrial gases producers, along with Airgas and a large number of independent companies, also serve the packaged gases market.
So there you have it. Despite the group's strong relative strength, it appears as if the overall fundamental outlook does not support this optimism. One index component issue carries a strong buy recommendation, however: Airgas. On July 27, Christopher Lippincott, who covers this stock for S&P, upgraded his opinion from buy to strong buy. Lippincott expects continued sales growth from strong demand in the nonresidential construction, energy, and infrastructure markets over the next several years, which should help its profit margins expand.
INDUSTRY MOMENTUM LIST UPDATE
Here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of 5 (price performances in the past 12 months that were among the top 10% of subindustries in the S&P 1500), along with a stock with the highest S&P STARS rank (tie goes to the highest market value).
S&P STARS Rank
Auto Parts & Equipment
Johnson Controls (JCI)
Lyondell Chemical (LYO)
Construction & Engineering
Jacobs Engineering (JEC)
Vulcan Materials (VMC)
Harman Intl. (HAR)
Diversified Metals & Mining
Freeport-McMoRan Copper (FCX)
Fertilizers & Agr. Chem.
Eastman Kodak (EK)
MKS Instruments (MKSI)
Tires & Rubber
Goodyear Tire (GT)
Source: Standard & Poor's Equity Research