Air Products Slips to Underperform

We are downgrading our rating on Industrial gas giant Air Products and Chemicals Inc. (APD - Analyst Report) to Underperform factoring in the challenges it may face in fiscal 2013. Adjusted earnings (from continued operations) of $1.42 a share for fourth-quarter fiscal 2012 missed the Zacks Consensus Estimate by a couple of cents. Profit, as reported, slid 57% year over year on account of hefty impairment charges related to the restructuring of the company’s photovoltaic business.

Revenues, however, rose 4% year over year to $2,606 million and beat the Zacks Consensus Estimate. The company witnessed sluggish manufacturing activity in the quarter. Management’s guidance for fiscal 2013 reflected economic uncertainty and depressed growth.

Air Products benefits from a long-term take-or-pay contract, a consolidated industry structure, diverse customer base and sustained pricing power. The company’s healthy project backlog strongly positions it to achieve its long-term growth target.

New business wins in the Merchant Gases segment should support results in fiscal 2013. Moreover, Air Products continues with its global cost reduction plan. The company is also offering healthy returns to its shareholders in the form of incremental dividends.

However, sluggish economic conditions across the U.S. and Europe may continue to impact the demand for the company’s products. Volume in the Merchant Gases division is expected to remain under pressure, partly due to the recessionary conditions in Europe.

Moreover, the Electronics and Performance Materials segment is expected to witness lower seasonal demand in first-quarter fiscal 2013 while profits are expected to fall in the Tonnage Gases division due to lower volume and higher maintenance spending. Sluggish U.S. manufacturing growth due to high unemployment and the concerns over the U.S. fiscal cliff coupled with the slowdown in Asia is expected to impinge results in fiscal 2013.

In addition, currency headwinds and pension expenses are expected to weigh on earnings moving ahead. Air Products generates a considerable amount of revenues outside the U.S., and therefore, remains exposed to foreign exchange fluctuations. Higher energy costs also pose a threat to margin expansion. These factors are reflected in our rating revision on the stock.

Air Products, which competes with Praxair Inc. (PX - Analyst Report) among others, currently retains a Zacks #4 Rank, which translates into a short-term Sell rating.