(APD) Air Products and Chemicals Analyst Maintains Neutral on Shares

We maintain our Neutral recommendation on Air Products and Chemicals Inc. (APD) as it is well positioned to capitalize on the cyclical recovery in its core industrial end-markets. The company has sufficient capacity to meet the expected upturn in demand without incurring additional capital expenditures and has a leading position in the gases business.

Air Products delivered second-quarter 2011 earnings of $1.41 per share, exceeding the Zacks Consensus Estimate of $1.39. Net sales of $2.5 billion were also ahead of the Zacks Consensus Estimate of $2.4 billion. Management seems confident and committed to improve its operating performance. The company expects to deliver double-digit earnings growth, improved return on capital and a 17% margin. Air Products also raised its full-year 2011 guidance between $5.65 and $5.75 per share. The company’s productivity gains were more than offset by higher operating, maintenance and distribution costs, particularly in its Merchant segment.

Electronic gases continue to be the primary growth driver, with a robust liquid crystal display (LCD) market being the major demand driver for electronic gases. We believe refinery hydrogen represents a tremendous opportunity, where refiners are required to meet lower sulfur specifications. Air Products remains focused on refinery hydrogen, which yields 30% of its revenue. Over the next 10 years, the company foresees incremental global hydrogen demand and has 7 refinery projects in its pipeline.

Air Products recently announced a joint venture based in Sichuan, China to build a hydrogen production facility for PetroChina Company Limited by 2012. This is a huge positive as it is the first time a state-owned refinery in China has outsourced its hydrogen supply. Oxygen demand is also expected to grow, driven by demand in the emerging markets. Asian infrastructure growth (steel), coal gasification in China and CO2 capture worldwide provides significant opportunities for oxygen. The company sees operating margins of 15% from the Electronics and Performance Material segment in 2011.

New business wins in the Merchant Gases segment should drive results in the near term. To consolidate its position, Air products is planning to fully acquire the French SAGA group, where it already holds 57.47%. Under the terms of these agreements, Air Products purchased 51.47% of the shares of SAGA on 1 March, 2010 for €34.5 million or $47.2 ($25.0 net of cash acquired of $22.2). The remaining shares were purchased on 30 November, 2010 for a fixed price of €44.8 million, or approximately $62. The group is engaged in packaged gases, liquid bulk and medical businesses. The acquisition increases the segment’s market share in Southwest and Central France.

In addition, Air Products has also entered into agreements to purchase 25% of CryoService Limited, a cryogenic and specialty gases company in the U.K. This increased Air Products’ ownership from 72% to 97%.

Air Products faces stiff competition from Praxair Inc. (PX).

Currently, Air Products has a short-term (1 to 3 months) Zacks #2 Rank (Buy) but a long- term Neutral recommendation.

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