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On Feb 5, we reaffirmed our Neutral recommendation on Air Products (APD - Analyst Report). While the company should continue to gain from its cost reduction measures, new business deals and strategic investments, we maintain a cautious view considering high energy costs and weakness in its tonnage gases business.

Why a Hold Rating?

The industrial gas giant’s earnings for first-quarter fiscal 2014 (ended Dec 31, 2013), reported on Jan 28, narrowly beat the Zacks Consensus Estimate while sales missed. Profit rose year over year on the company’s cost reduction initiatives. Decline in the Tonnage Gases division was offset by gains in other businesses. The company backed its earnings guidance for the full year.

Air Products, a Zacks Rank #3 (Hold) stock, 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 its goal of expanding its portfolio of industrial gases offerings in North America.

We are also encouraged by the incremental opportunities in the liquefied natural gas (LNG) space. Air Products has been chosen for a major off-shore LNG project in Malaysia, representing a major opportunity for its LNG technology and equipment. Moreover, it recently agreed to supply technology and equipment for the largest LNG production and exports facility in Russia.

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 is constructing 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’ tonnage gases business continues to face challenges due to maintenance outages. Profits are expected to fall in this 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 may weigh on Air Products’ bottom line. In addition, shutdown of the polyurethane intermediates (PUI) business is expected to have an earnings headwind of 10 cents per share in fiscal 2014. We also take into account the company’s high debt level.
 
Other Stocks to Consider

Some better-ranked chemical stocks include Methanex Corp. (MEOH - Analyst Report), Northern Technologies International Corp. and The Dow Chemical Co. (DOW - Analyst Report). While both Methanex and Northern Technologies International hold a Zacks Rank #1 (Strong Buy), Dow Chemical retains a Zacks Rank #2 (Buy). 

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