Linde: The Investment Case That Might Work (NYSE:LIN) (2023)

Introduction

The merger with the American company Praxair made Linde (NYSE:LIN) the world market leader for industrial gases, replacing its competitor Air Liquide. Even if Praxair once belonged to Linde (which was over 100 years ago), such a merger can quickly cause serious problems (see Bayer (OTCPK:BAYRY, OTCPK:BAYZF)/Monsanto).

However, after the merger was completed in 2018, it quickly became apparent that the two companies would successfully integrate. Still, investors who want to invest in Linde should know their thesis. Just saying that Linde is the market leader and will be active in future fields such as hydrogen is not enough. Linde shares are highly cyclical. The current level, therefore, offers considerable downside potential. In the long term, however, I am bullish.

The company

The roots of Linde and Praxair go back to 1870. The amazing thing is that Linde uses a product that has been around for thousands of years and is available to everyone: air.

Segments

Linde has created a strong position for itself in using this resource, which is essentially attributable to two business activities. The company is a leading supplier of medical and industrial gases. In medicine, the gases are used, for example, in endoscopy and ventilation. The food industry uses the gases for cooling and freezing groceries (nitrogen and carbon dioxide). You can also find the products in metallurgy (freshening steel with oxygen, heat treatment), in the rubber and plastics industry, construction industry, and other areas.

Besides that, Linde is active in consulting, marketing, and the construction of large-scale plants. The company performs logistical tasks such as the purchase of the necessary equipment up to the production and construction supervision.

Broken down, Linde has the following business segments. I have taken the following description from the 10-K filing and modified it for the sake of better readability:

Industrial Gases Products and Manufacturing Processes

Atmospheric gases are the highest volume products produced by Linde. Using air as its raw material, Linde produces oxygen, nitrogen, and argon through several air separation processes of which cryogenic air separation is the most prevalent. Rare gases, such as krypton, neon, and xenon, are also produced through cryogenic air separation.

Industrial Gases Distribution

(Video) Linde Stock Analysis | LIN Stock Earnings Q4 2022 Dividend Stocks

There are three basic distribution methods for industrial gases: (i) on-site or tonnage; (ii) merchant or bulk liquid; and (iii) packaged or cylinder gases.

(i) On-site: Customers that require the largest volumes of the product (typically oxygen, nitrogen, and hydrogen) and that have a relatively constant demand pattern are supplied by cryogenic and process gas on-site plants. Linde constructs plants on or adjacent to these customers’ sites and supplies the product directly to customers by pipeline.

(ii) Merchant: The merchant business is generally associated with distributable liquid oxygen, nitrogen, argon, carbon dioxide, hydrogen, and helium. The deliveries generally are made from Linde’s plants by tanker trucks to storage containers at the customer's site which is owned and maintained by Linde and leased to the customer.

See Also

Duell der Gas-Giganten: Warum ich nach dem DAX-Abschied die Hände von Linde lasse und mich auf Air Liquide konzentriereL'Air Liquide Vs. Linde: Which Is The More Attractive Stock?

(iii) Packaged Gases: Customers requiring small volumes are supplied products in metal containers called cylinders, under medium to high pressure. Packaged gases include atmospheric gases, carbon dioxide, hydrogen, helium, acetylene, and related products.

Engineering

Linde’s Engineering business has a global presence, with its focus on market segments such as olefin, natural gas, air separation, hydrogen, and synthesis gas plants. The company utilizes its own extensive process engineering know-how in the planning, project development, and construction of turnkey industrial plants and associated services.

Linde plants are used in a wide variety of fields: in the petrochemical and chemical industries, in refineries and fertilizer plants, to recover air gases, to produce hydrogen and synthesis gases, to treat natural gas, and to produce noble gases. The Engineering business either supplies plant components and services directly to the customer or to the industrial gas business of Linde which operates the plants on behalf of the customer under a long-term gases supply contract.

In short, the world as we know it would not work without Linde. Linde is an excellent example of how complex a simple principle (using air as a resource) can be. As is often the case in industrial production, economies of scale are enormously important. When benefiting from such economies, costs will be lower, and market barriers will be higher. Linde has this advantage and thus a moat that value investors like Warren Buffett love.

Sales split by end market and region

The company's size and its market position also become apparent when you look at the revenue splits. No market is more important than 20 percent (Healthcare) of revenues, which is very conservative. The three largest markets (Healthcare; Manufacturing; Chemicals & Refining) are relatively independent of each other, which also provides stability.

Source: Taken from 3Q2020 presentation, adjusted by the author

Digesting a merger with success

With the merger, many investors were afraid that it would do more harm than good. The new Linde was seen as a hybrid. A German and an American company merge, choose to be headquartered in Ireland and be managed from England. Besides, the companies had to work hard to get clearance from authorities. Linde had to give up almost all of its U.S. business, and Praxair was forced to sell its entire European business. In the meantime, however, it has become clear that the merger was a success. Below you can see how revenue increased from EUR 13 billion in 2018 to 25 EUR billion, while at the same time margins collapsed. A merger like this is costly. However, margins have improved (revenue declined due to COVID-19, of course).

Revenue and margins, www.dividendsstocks.cash

CEO Steve Angel is responsible for this. He is one of those managers who trim companies for efficiency (he was Executive Vice President at Praxair before the merger). So he's the right man for digesting a merger.

Outlook

It is clear that margins cannot be improved forever. Current board member Sanjiv Lamba could succeed Steve Angel as CEO and set new accents. Fundamentally, the prospects for Linde are reasonably good. After Air Liquide took over Airgas, the market is more or less oligopolistic following Linde and Praxair's merger. From the current comfortable situation, Linde can devote itself to the challenges of the future.

Stable balance sheet and stock repurchases

The financial foundation is stable. With a debt ratio of slightly above 40 percent, a conservative balance sheet, and an A2 rating (Moody's), I'm not worried on this front.

Debt to total assets and amortization power, www.dividendsstocks.cash

The solid balance sheet allows Linde to use available cash to buy outstanding shares. Linde announced that it intends to buy back shares worth up to USD 5, which follows the existing USD 6 billion buyback program, which expires on February 1.

Linde is one of the most promising candidates in the hydrogen market

Besides medicine (Linde's Lincare Holdings played an essential role in supplying oxygen during the COVID-19 pandemic), I see hydrogen in particular as a possible driver here. It is not even necessarily a question of whether hydrogen will become established in the automotive industry or not. Hydrogen emits no emissions when it is burned, making it an ideal substitute for coal, oil, and natural gas, not only in the automotive sector but also in other industries such as steel production (one of the most significant greenhouse gas emitters). Linde is active along the entire value chain - from generation and liquefaction to solutions for transport and storage. Linde generates more than USD 2 billion from these activities today and plans to multiply this amount in the future. The prospects are good. By 2040, the hydrogen market could even reach a volume of USD 380 billion.

Using economies of scale for further growth

Due to its oligopolistic position, Linde has competitive advantages here. Although other companies such trying to enter the market, Linde is likely to remain clearly one of the biggest players in transport and storage due to economies of scale. In this respect, I think it is likely that Linde will participate in the growth of hydrogen with at least stable market shares. This aspect also applies to Linde's other segments. Industries characterized by strong economies of scale tend toward "the winner takes it all" scenarios. So it doesn't come as a surprise that analysts expect Linde not only to increase profitability in the coming years but also to boost revenues from the current EUR 21.9 billion to EUR 29.1 billion in 2024.

Outlook regarding revenue and margins, www.dividendsstocks.cash

Prospect of higher dividend

Linde will use its increased profitability to further increase dividends and buy back shares. Just recently, the company increased its annual dividend by 10 percent to EUR 1.06. This corresponds to a yield of 1.7 percent. The payout ratio should be between 50 and 60 percent in the next few years which provides enough room for further increases in the upcoming years.

Quantities

Linde is currently valued at a P/E ratio of 56 and an adjusted P/E ratio of 31. Both are relatively high. The P/C ratio of 20 also indicates an overvaluation. However, if we look at the historical development, Linde's valuation has always been relatively high. Based on the average valuation multiples and the expected earnings and cash flows for 2024, there is still solid upside potential with an annual yield of 13.4 percent. Of course, this does not guarantee but is only based on a calculation using historical values and expected figures.

Fair value calculation, www.dividendsstocks.cash

Based on the current figures, there are indeed risks. Linde's share price is quite volatile in times of crisis and recession. I've marked the phases of stock price corrections in red in the graphic above. Please note: The course is shown logarithmically. The share price fell sharply, in some cases by up to 48 percent. These were, of course, excellent buying opportunities but certainly challenging times for short-term thinking investors. Therefore, a setback potential accompanies the current high valuation if the markets correct broadly or a recession does occur (even if there are currently few signs of this).

Conclusion

Overall, Linde is a very stable company with a good market position. The merger with Praxair has been successful. Hydrogen could unfold as a growth catalyst but is still in its infancy. In addition, the company benefits from economies of scale. For long-term investors that are also looking for growing dividends, Linde is still a good investment. Short-term investors should bear in mind that the share is highly volatile during recessions or market correction phases.

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Runner of the TEV Blog | Private InvestorI am a long-term oriented investor and in my early thirties. I hold a law degree and a doctorate in law and love investing and talking about my and others' investments. I regularly write about my research and investments on various investor platforms and the TEV Blog. **My articles represent my opinion only and in no way constitute professional investment advice. It is the responsibility of the reader to conduct their due diligence and seek investment advice from a licensed professional before making any investment decisions.**