Air Liquide: Margin Improvements Could Weigh Heavier Than Tough Economic Times

French specialty gases giant Air Liquide (OTCPK:AIQUF) is a company which has been on my radar since long. I have been an investor myself in the company since about 5 years, and as such am following its development closely. In this article I want to share my recent insights about the company, its growth and its likely future.

I wrote an article about Air Liquide about a year ago, praising their business model and consistent dividend growth and recommending the company to dividend growth investors. Since then, the company experienced some very healthy growth and shareholders were rewarded with total returns of more than 35% during the timespan of less than a year. In this article I will try to analyze how much upside is left, and I will look at upcoming economic developments and compare Air Liquide to some of its direct peers.

Performance

First, let us take a quick glance at the key figures of the most recent financial report of Air Liquide, as found on their website:

Figure 1: Key Figures from Air Liquide H1 2023 financial report

A couple of things which I found interesting while reading these key figures:

• The real revenue of Air Liquide actually decreased during the first half year of 2023. When reading the footnotes, it becomes apparent that, while including currency, energy and other impacts, the comparable revenue was 4.9% higher than previous year. As such, energy prices and currencies had a large negative influence on the annual revenue. As can be read further in their report (see also figure 2), this negative influence was mostly felt in Europe.
• The margin of Air Liquide is where the good news is. Operating margin increased by 80 basis points excluding energy impact and much more including it. Air Liquide mentions their ADVANCE strategic plan as reason why they were able to increase their margin to such an extent.
• Their net profit and earnings per share grew by more than 30%, which seems a real feat. Also, ROCE and recurring ROCE both show healthy growth of more than 10%.

Shares of Air Liquide have performed equally well, rising with about 40% since last year:

Graph 1: Air Liquide share price performance during the last year

I have written extensively about the company's dividend, free share attribution (which is in fact a stock dividend) and their loyalty bonus in my previous article, so I won't go into detail here. Let me suffice to say that their current 1.75% yield does not tell the whole picture. If you factor in their stock dividend and loyalty bonus, this stock can be a very nice pick for dividend growth investors, having enjoyed an average annual growth of more than 8% during the last decade.

Economic developments and the specialty gas market

A bit surprisingly, the specialty gas market is much less cyclical than you would expect when comparing it to, for instance, the natural gas market. This has to do with the consumers of these specialty gases. Of course, specialty gas is used in the petrochemical and fertilizer industry, but also in biotechnology, materials processing, the food industry, medical technology and semiconductor production. This rich diversification of end users means that the specialty gas market is relatively well insulated from cyclicality. In their financial report, Air Liquide mentions the business lines 'large industries', 'industrial merchants', 'healthcare' and 'electronics', of which the first two are by far the largest with regard to revenue.

Even though there is some decent diversification in their customer base, a broad economic slowdown or a recession will be able to hit many of the end consumers of specialty gases. Currently, Europe is not doing so well economically, with Germany even officially entering a recession recently. More than a third of the revenue of Air Liquide is Europe-based, so a European recession will likely trickle down to Air Liquide as well. As shown in figure 2 below, including energy and currency effects, Air Liquide's revenue in Europe already dropped by more than 8% in the first half year of 2023. It is only after filtering out these factors that total revenue shows growth of 4.8%.

Figure 2: Revenue by geography and business line from Air Liquide H1 2023 financial report

A worldwide recession is not out of the question during the next year. For this reason, I believe it is prudent to take a cautious approach with companies like Air Liquide, which have translated decent growth into nice share price growth during the last couple of years. In case of a real recession, this has the potential to result in both slowing revenue growth and decreasing multiples for the stock. These two combined can decrease potential future returns for investors in the stock.

Comparison with peers

Air Liquide, Linde (LIN) and Air Products and Chemicals (APD) are three of the largest specialty gases producers worldwide. No article about Air Liquide is truly complete without at least a short look at some of its peers. Of course, next to Linde and APD, more peers exist, like Mitsui Chemicals (OTCPK:MITUY), Messer Group (private), or Showa Denko. But these last-mentioned peers are all quite a bit smaller with regard to market capitalization and production quantities. So we focus our comparison here on the big three.

Graph 2: Share price and EBITDA change of Air Liquide, Linde and APD during the last decade.

As you can see in graph 2, Air Liquide seems to be the laggard with regard to share price growth during the last decade. Also, they have been the slowest grower of EBITDA. Note that the data from Linde is influenced heavily by their merger with Praxair which happened at the end of 2018, so especially their EBITDA will not be comparable for this reason.

Graph 3: PE ratio of Air Liquide, Linde and APD during the last decade.

In graph 3 you can see the price-to-earnings ratio of Air Liquide, Linde and APD. Again, Linde is influenced by their Praxair merger but seems to have returned to 'normal' values right now. The three PE ratios are more or less in the same realm with still some decent differences. Air Liquide is currently the cheapest of the three companies, though I would question whether you can call a price-to-earnings ratio of almost 28 cheap. If you glance over the graph, there were not many moments during the last decade when the stock was more expensive than right now.

Graph 4: Operating margins of Air Liquide, Linde and APD during the last decade.

Graph 4 is the most interesting in my opinion, since I think it shows the main reason why Air Liquide is the cheapest company of the three: its margins. Even though the company achieved a nice margin improvement in the last half year, margins seem to have been hovering around 17-18% during the last decade. In comparison, APD's and Linde's margins are much higher.

These graphs lead to some interesting conclusions:

• Air Liquide seems expensive right now, trading at a PE ratio of almost 28
• But the company looks cheapest among its direct peers
• Their (operating and EBITDA) margins are the lowest, which is likely contributing to this low valuation
• Their growth has been slowest as well
• All these aspects make me think there is ample room for improvement left, especially with regard to Air Liquide's margins

Conclusion

Air Liquide has performed well during the last couple of years, increasing their revenue, profits and share price. But they were outperformed on multiple levels by their closest peers Linde and APD. The company seems to be the least expensive of the three, with ample room for improvement, especially with regard to their margins, which have been more or less stagnant during the last decade.

The current economic environment however does not look beneficial for short-term growth and margin improvement, so as an investor, I do not think the company is a buy right now. And even though they are cheapest among peers, their shares look quite expensive at a PE ratio of almost 28. Therefore, I think Air Liquide is a hold at this moment. But if the company will be able to significantly improve their operating margins, this hold could turn into a buy.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.