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On Nov 5, we retained our Neutral recommendation on Air Products (APD - Analyst Report). While the company should gain from its cost reduction measures, new business deals and strategic investments, we remain on the sidelines considering high energy costs and weakness in its electronics and performance materials business.

Why Held?

The industrial gas giant’s fourth-quarter fiscal 2013 (ended Sep 30, 2013) adjusted earnings from continued operations of $1.47 a share, reported on Oct 29, met the Zacks Consensus Estimate. Profit was dragged down by sizable charges associated with the company’s cost reduction program.

Sales edged down 0.7% year over year to $2,586.5 million as gain in the core merchant gases franchise was masked by declines in other businesses. It missed the Zacks Consensus Estimate of $2,681 million.

Air Products benefits from a diverse customer base, sustained pricing power and cost-reduction measures. New business deals and strategic investments are expected to support results in fiscal 2014. The acquisition of a 67% stake in Chilean industrial gas company, Indura S.A., has ushered in substantial growth opportunity for Air Products. Moreover, the EPCO buyout complements Air Products’ goal of expanding its portfolio of industrial gases offerings in North America.

We are also encouraged by the incremental opportunities in liquefied natural gas (LNG) market. Air Products has been chosen for a major off-shore LNG project in Malaysia, representing a major opportunity for its LNG technology and equipment.

Air Products is also actively engaged in project development activities in its Tonnage Gases division. The company is making significant progress in its hydrogen business and recently announced its plans to build a new world-scale hydrogen production plant in Canada.

Air Products is also keeping a tight control on expenses and undertaking work process improvement initiatives. Moreover, it remains committed to maximize returns to shareholders.

However, Air Products’ Electronics and Performance Materials segment is expected to witness soft demand with delays in new fab construction and weak outlook for silicon processing. Profits are expected to fall in the Tonnage Gases division due to lower volume and higher maintenance spending. Helium volumes also remain weak due to feedstock supply constraints and weak packaged gases demand in Europe.

Moreover, higher energy costs pose a threat to margin expansion. Higher power costs in the merchant business and maintenance costs is weighing on Air Products’ bottom line. Shutdown of the polyurethane intermediates (PUI) business and higher maintenance costs are expected to have a combined earnings headwind of 15 cents per share in fiscal 2014. We also take into account the company’s high debt level.

Other Stocks to Consider

Other companies in the chemical industry with favorable Zacks Rank are Asahi Kasei Corp. (AHKSY), Methanex Corp. (MEOH - Analyst Report) and PPG Industries Inc. (PPG - Analyst Report). While both Asahi Kasei and Methanex hold a Zacks Rank #1 (Strong Buy), PPG Industries retains a Zacks Rank #2 (Buy).

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