The LNG Boom Isn't The Windfall APD Investors Think It Is
The LNG Boom Isn't The Windfall APD Investors Think It Is
A follow up on the APD "catalyst"
Air Products and Chemicals (APD) is a leading supplier of liquefied natural gas, and related technology, so to many investors it would seem natural that they would be one of the primary beneficiaries of the European Unions push to wean themselves off Russian gas.
Unfortunately this push will likely not give investors the returns they expect, and so it's important to ignore the noise and hype around such initiatives and focus heavily on what actually matters, the earnings that the business in question will generate.
For something like the replacement of Russian gas pipelines with Liquefied Natural Gas terminals the impact on APDs bottom line will simply not be a big as a lot of investors believe, and that's primarily the result of a few things:
LNG is a lower margin business
APDs role will be primarily as an equipment manufacturer and supplier
What do I mean by this exactly?
Let's take it step by step:
LNG is a lower margin business
This is simply a reality, LNG and its related business are quite honestly the least profitable section of the company.
We can see from their investor presentation that APDs bread and butter is their on-site business. These are long-term (15-20+ year) contracts that require heavy capital expenditures to get started, but minimal maintenance costs, and with limited volume risk and no energy/raw material risk.
This is a business that quite simply cannot be competed with, if only because any would be competitor would have to spend billions of dollars and quite a few years just to get the ability to supply the gases to the customers. All the while APD can simply temporarily reduce their prices to make any attempt at competition not viable.
LNG does not have this moat.
APD can set up an LNG terminal in the Netherlands to supply the whole of the European Union, but any one of its competitors can set up their own terminal anywhere, and start directly competing with APD on price with every single one of its clients.
This is really the core problem here, with LNG you can spend billions of dollars getting a facility set up, and at the end of the day all you got is an undifferentiated commodity business that's competing with everyone on price alone.
This is not a recipe for a profitable business with high returns on capital, unlike their bread and butter on-site business.
And this shows in their earnings today, you can see in their own presentation that in the region where Packaged and Liquid Bulk gases comprise most of the revenue, their EBITDA suffers.
APDs role will be primarily as an equipment manufacturer and supplier
APDs greatest advantage here will be its ability to provide effective and innovative equipment that will allow European governments to quickly build up LNG terminals.
This is actually something that the company is well suited for, they are already a leading provider of LNG equipment, and so providing this equipment would be a good way to make some revenue and benefit from these policies.
The key problem here is that providing equipment is primarily a "one-off" type of business, and will not generate the levels of ongoing revenue that the company needs to provide good returns over the long term, and sustain its growing dividend.
Additionally, equipment manufacturing requires heavy R&D expenditures just to maintain feature parity with competitors, and competitors from all over the world can jump in to any part of the LNG supply chain, and specifically tailor their equipment offerings to compete only in that segment.
This means that equipment manufacturing, design and maintenance is something that is constantly under threat from competitors and is unlikely to be the source for a long term moat for APD.
Additionally, the revenue to be expected from this business is comparatively low, the companies equipment segment comprises a paltry 8% of their business, and even with heavy investments and strong demand it's unlikely that it will ever be more than a side show to the gas production segments and particularly the on-site business.
In summary
The push for greater usage of LNG and the European Unions Energy Union Strategy will likely result in new business and temporarily increased revenues for APD, but will not prove to be a durable business in which the company can enjoy the profit margins and returns that it currently sees.
Therefore, it's important that investors don't let themselves be blinded by the hype and grand announcements of "LNG Strategies" and "Massive Liquid Natural Gas Demand", and instead be cautious about the prospective benefits.
The company will likely benefit from this push, but its effect will be minor and ephemeral.
What do you think? Will the LNG boom be more important than I’m considering it to be?
Let me know in the comments below!