Air Liquide: H2 Hype Priced In

Last time we teased about Air Liquide about eighteen months ago, we wrote that a naturally boring stock could be rewarding on the odd occasion. This has proven true with a c. +33% absolute performance in a flattish market. This performance also comes with a c.2% dividend yield that looks thin but is a price to pay for a rising annuity.

No real upheaval in the recent decades

Born more than a century ago, the group has slowly developed into its current form. Its shape has not really changed for the past thirty years though. The core-business is easy to summarize: industrial gases. This encompasses three segments: Gas & Services, Engineering & Construction and Global Markets & Technologies. The first one is by far the biggest (95% of revenues) and consists of the production, transportation and delivery of gases. The second one consists of the design and construction of gas production units, from the feasibility study stage through to the delivery of the installation. Lastly, the third business delivers technological solutions (molecules, equipment and services) to support the development of markets related to the energy transition or to what the group calls “deep tech” (e.g. the aerospace industry, quantum computing, etc.). The core Gas & Services business comprises four types of customers: Large Industries and Industrial Merchant, the historical ones, to which were added Electronics in 1985 and Healthcare in 1990. This is probably part of the reason why the group is sometimes considered to be “boring” in terms of story telling.

No change? Really?

The significant change has been AL’s internationalization, with around 60% of its business now outside Europe, where Air Liquide is duplicating its know-how mainly through acquisitions. To name but a few, the group acquired Big Three (USA, 1986), part of German Messer Griesheim's activities in Europe (2004) or US Airgas (USA, 2016). These three transactions alone added c.€6bn in sales (at the time of the acquisitions) for a total consideration of €15bn, to which must be added a host of smaller deals. It has also refocussed on Gas & Services, by exiting the diving and welding businesses, and invested in Asia (mostly brownfield). 

Another change worth highlighting is the “departure” of the long-standing CEO Mr. B.Potier (66), who left his position of CEO in FY22 (after 16 years in the job) to remain Chairman of the Board. François Jackow took over at the helm of the group. He has been with Air Liquide for almost 30 years, having spent most of his career as head of strategy and CEO of AI Japan. One might argue that this is not exactly fresh blood, but Jackow is relatively young (54) and will certainly be keen to demonstrate that he was the right choice. The tectonic shift is that the group has at last separated the roles of CEO and Chairman. This cannot hurt. That said, the same Board is still not independent according to AV’s metrics despite its reshuffling in FY22. Conservatism is an Air Liquide hallmark.

That H2 tint

The field of hydrogen is not just an emerging and fashionable businesses for Air Liquide: the group extended its oxygen and nitrogen businesses to steam and hydrogen in the 90s for the steel, chemicals, refining and aerospace industries. Meaningfully in FY17, the group co-founded the “Hydrogen Council” (together with 12 other groups such as Toyota, Shell, Engie, etc.), a lobby now bringing together 150 members around the globe. With the new frenzy for this gas, Air Liquide has further invested with a target of reaching 15-25% of “hydrogen revenues” by FY35 (vs 10% today) to help the energy transition.

The group will not only act as a distributor of hydrogen but also invest in technologies and enter into partnerships, with two goals in mind: benefit from part of the technological value-added and secure long-term contracts with end-clients. We earlier wrote that the transition could well benefit companies that offer technologies to generate green hydrogen rather than the producers/distributors of the end-product. The group’s management is aware of this. As a result, the group has entered into a manufacturing partnership with Siemens Energy for the production of renewable hydrogen electrolysers in Europe. In the Netherlands/Belgium, it is developing two electrolyser projects, which will each have capacity of 200 MW, to contribute to the decarbonization of local industries. In France, the group will commission in FY25 the Normand'Hy large scale renewable hydrogen production project. This electrolyzer of an initial 200 MW capacity will use Siemens Energy's PEM technology. The group has signed a MoU with TotalEnergies for a long-term Power Purchase Agreement, illustrating this strategy. Overall, Air Liquide is looking to invest as much as €8bn in its hydrogen business in the next 10 years. Significantly, in the last twelve months, no fewer than 15 press releases to the financial community were directly dealing with the hydrogen opportunity, not to mention the ones that only touched on the topic among other things. If needed, this shows the group’s focus and ambitions in this field. 

A few clouds in sight though

Despite its profitability in an oligopolistic market (25% EBITDA margin), its net debt/EBITDA ratio still stands at 1.5x (with debt at over €10bn) and is not likely to fall quickly because of the investment needs outlined above and the ongoing projects for the core business. This means that interest rate hikes are not good news. Then, some of its businesses seem to have suffered a bit as of late: the Healthcare segment will be “transformed” in the group’s words. Understand restructured. Air Liquide blames the continuing erosion of reimbursement levels, rising costs linked to the regulatory framework and the adoption of new and more expensive technologies. True, this segment is fairly small (c.15% sales) but it reminds investors that not all businesses run so smoothly including for that so-called growth sector (AlphaValue has repeatedly expressed its doubts on that matter for Health-related stocks). Also, the group is not immune to GDP growth hesitancy. If some segments are at least partly protected with long-term contracts including minimum ‘take or pay’ volumes (Large Industries and Electronics) this is not the case for the rest of the business (55% of group sales in Industrial Merchant and Healthcare). In a context where Europe (40% of sales) is still weak, this may not bode well for the short to mid-term outlook. Lastly, while the group is targeting a 10% ROCE as of FY23 (9.4% last year), it has never been able to achieve more since 2006, so the upside on that front may be limited. These observations suggest that more time may be needed for a further leg up in the share price at a time when the prospects of hydrogen still seem more hype than deeds.

Fully valued

The valuation is saved by the “instant” ratios, owing to the high profitability of the group, even if earnings growth has not been very spectacular recently (c. 6% yearly over FY19-22). The intrinsic methods suggest staying away. The combined upside potential is minimal, at least until such time as investors see the hydrogen hopes turn to substance, and the promises of the “Advance” plan really paying off (organic top-line growth of 5-6%, a ROCE above 10% and a 160bps margin improvement). It is also true that the stock is cheaper than perennial peer Linde (Germany, Reduce), which is no longer a ‘listed in Europe’ proposition. The French group has thus become the only vehicle to surf the industry for many investors. To some extent this scarcity may have supported the share price.