Linde: an elementary choice

Its roots trace back to 1879 when it was founded in Germany by inventor Carl von Linde. A US subsidiary – Linde Air Products – was established in 1907, but was expropriated during the First World War, joining what was then known as Union Carbide. Much later, Linde Air Products was spun out and listed in New York as ‘Praxair’. It wasn’t until October 2018 that the descendants of the original business – Praxair and the German ‘Linde AG’ – reunited in an All-Share merger to become today's Linde with a primary listing in Frankfurt. The deal consolidated the industry from four to three big players – Linde, Air Liquide (FR:AI) and Air Products & Chemicals (US:APD).

More than 80 per cent of sales are derived from supplying industrial gases, primarily ‘atmospheric gases’ – such as oxygen and nitrogen – and ‘process gases’ such as carbon dioxide and hydrogen. Depending on costs, these are distributed in three ways – onsite, in wholesale liquid form or in cylinders. The remaining fifth of total revenue comes from onsite delivery – building a production plant on or near a customer’s facility for direct supply via a pipeline. Onsite contracts are typically 10 to 20 years long with minimum purchase requirements. These plants are designed by Linde’s smaller engineering business, which also provides ‘turnkey’ gas facilities for customers to operate themselves.

While Linde has cyclical vulnerability, almost two-thirds of sales are underpinned by fixed fees, long-term contracts or defensive end markets – for example, healthcare comprises around a fifth of overall revenue. Earnings are also protected from downturns by certain contract terms – “take-or-pay” means that regardless of demand, customers must pay for any product Linde delivers at an agreed date or face penalty costs, making it expensive to cancel orders. By sourcing, producing and selling its products locally, Linde is also more insulated from global supply chain disruptions.

Its resilience was evident in the second quarter of 2020. Sales dropped by 11 per cent year on year to $6.4bn (£4.9bn), as Covid-19 hit overall gas volumes. But cost-cutting and higher prices kept adjusted operating profit flat at $1.3bn and boosted the margin by 2.3 percentage points to 20.7 per cent. Margins could expand further as the company targets up to $1.2bn of merger savings within three years. “We forecast margins improving by almost 10 percentage points over five years as a result of the ongoing synergies”, says Zehrid Osmani, manager of the Martin Currie Global Portfolio Trust (MNP) in which Linde is a top 10 holding. Mr Osmani views Linde as “an attractive self-improvement investment opportunity”.

He’s not the only fan – Linde is a top sustainability pick among global fund managers. Norway’s sovereign wealth fund has a 3 per cent stake, while the BMO Responsible Global Equity Fund (GB0033145045) has Linde as its number three holding. Andy Penman, director of BMO Global Asset Management’s global equities team, is particularly bullish on its hydrogen prospects: “Linde’s ability and appetite to participate in this high growth market should accelerate its already impressive long-term growth profile.”

Hydrogen is gaining popularity among investors and governments as it increasingly looks like part of the solution to address climate change. Linde offers a less risky way to exploit the hydrogen trend than speculative, loss-making pure plays. It already has a leading $2bn business in hydrogen production, processing, storage and distribution, although this is currently weighted towards using fossil fuels as a source. Positioning itself for the rise of ‘green’ hydrogen – made by splitting water using electricity from renewable sources – it purchased a 20 per cent stake in electrolyser manufacturer ITM Power (ITM) last year and formed a joint venture to target large-scale industrial projects.

The group had $12.5bn of net debt at the end of June, up 11 per cent from the December year-end and equivalent to 1.6 times cash profits (Ebitda). Strong free cash flow generation has continued since the merger, coming in at $981m in the three months to 30 June. It’s worth noting that Praxair remained free cash flow positive during the global financial crisis and its profits had surpassed 2008 levels by 2010. Linde lifted its 2020 second-quarter dividend by 10 per cent and combined with Praxair’s history, the annual payout has increased for 27 consecutive years. It says it has “no intention of breaking that streak now”.