Is Air Products Bill Ackman's Big Target?

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Since the beginning of July, Air Products & Chemicals (NYSE: APD) has jumped significantly, from around $91.40 per share to more than $104.10 per share. Its share price has hit its 5-year high, partly due to its recent announcement of adopting a stockholder-rights plan, which leads to the market speculation that Air Products could be an activist target of hedge fund manager Bill Ackman.

According to Ackman, his fund, Pershing Square Capital Management, would invest as much as $1 billion in a large-cap and investment-grade U.S. company. However, the company’s name remained unknown. Bill Ackman described the business as “simple, predictable, and free cash flow generative, and enjoys high barriers to entry, high customer switching costs and substantial pricing power.” It seems to me that this company has quite a wide moat and has strong cash-flow generation capability.

FedEx target rumor

Previously, some in the investment community had speculated that Ackman’s target was FedEx (NYSE: FDX). Right after the rumor, FedEx’s share price was up by 4.4% to more than $103.10 per share. At the time of writing, it was trading higher, at $104.60 per share. However, FedEx’s cash flow is not predictable like Ackman’s description. Since 2004, the company’s operating cash flow has been consistently positive but fluctuating. Its free cash flow has not become positive until fiscal 2008. In fiscal 2013, FedEx generated around $1.3 billion in free cash flow.

Looking forward, FedEx expects to grow its adjusted EPS by 7%-13%, with the current fuel price outlook. In the current environment, customers prefer cheaper international services, thus pushing down the average market pricing. The outlook for FedEx is not so promising. The company decided to lower capacity in both the U.S. and Asia. FedEx has a total market cap of around $33.10 billion. The market values the company at 5.6 times its trailing EBITDA (earnings before interest, taxes, depreciation and amortization). At the current price, FedEx offers investors a low dividend yield at only 0.6%. Consequently, I personally do not think Ackman targeted FedEx, as the business is not predictable and free-cash-flow generative. Moreover, the sluggish outlook for the company does not excite investors at all.

How about Air Products?

Air Products is the provider of atmospheric gases, performance materials and equipment in more than 50 countries. In the past 10 years, Air Products has generated consistent positive free cash flow, fluctuating in the range of $85 million to $595 million. In the past 12 months, its operating cash flow was $1.57 billion while the free cash flow came in at $102 million. The company employed some leverage in its operations. As of June 2013, it had $6.54 billion in equity, $419 million in cash and as much as $6.1 billion in both long- and short-term debt.

For the full year, Air Products expects its outlook to be “tempered by the modest economic growth.” However, the company would keep delivering shareholder value by focusing on cost savings and productivity improvement. The continuing operating EPS was estimated to be in the range of $5.47-$5.53 per share. Trading at $104.10 per share, Air Products is worth $21.80 billion on the market. The market values the company at as much as 11.40 times its trailing EBITDA. Income investors might like Air Products with its high dividend yield at 2.70%.

Air Products is valued more expensively than its peer, Airgas (NYSE: ARG). Airgas is trading at $100.30 per share, with the total market cap of around $7.35 billion. The market values Airgas at 10.90 times its trailing EBITDA. Airgas is the leader in the U.S. packaged gas market, having the broadest geographic footprint, with around 1,100 locations including 900 branches and 300 cylinder fill plants. The company has quite a diverse customer base, with the largest customer accounting for only 0.5% of its total revenue.

The company reported that its operating results would be quite favorable in the future, along with the U.S. early stage of recovery. Moreover, it will streamline the supply chain, improve operational efficiencies and optimize sales channels for all customers. For the full year 2014, the company expects to grow its diluted EPS by 15%-18%, from $4.35 to a range of $5.00 - $5.15. The company offers a lower dividend yield than Air Products, at only 1.90%.

My Foolish take

The rumor of Bill Ackman’s activism on Air Products is pure speculation. Despite the recent announcement of a shareholder plan, I also do not think that the company is Bill Ackman’s target either. Of course, I might be wrong though. However, with the high valuation and the cyclical business, I personally would not come in Air Products at its current trading price.

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Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends FedEx. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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