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Praxair, Inc. (PX): Strong Moat, 20+ Years of Dividend Growth, But Macro Headwinds Persist

While market players do consumer significant amounts of natural gas and electricity in their manufacturing process, they also have a unique raw material cost benefit. Many industrial gases are produced by air separation – literally using air from the atmosphere and cleaning, purifying, processing, and separating it into useful gases. It’s hard to find a cheaper input cost than air!

Altogether, PX’s substantial economies of scale, dense distribution networks, long-term supply contracts, and strong pricing power result in good returns on invested capital, predictable cash flows, and consistent long-term growth opportunities.

Of the major gas players (ARG, APD, Air Liquide, Linde), PX has the highest operating margin, return on capital, and cash flow margin. PX’s financial leadership seems to suggest that the company has been one of the most disciplined capital allocators and/or dominates some of the most attractive regions. This durable business isn’t going away anytime soon.

Key Risks

While PX’s business model has many strengths and defensive qualities, it is sensitive to economic activity. When GDP growth slows and commodity prices fall, fewer metals need to be manufactured, demand for chemicals drops, gas and oil refining activity slows, and more.

PX’s stock price is down over 20% in 2015 for many of these reasons. Upstream energy markets are weakening (13% of sales), Brazil (18% in 2011, closer to 9% today) is in a recession, China (6%) continues slowing down, and the strong dollar is hurting sales and earnings growth (over 50% of sales are outside the U.S.).

As long-term dividend growth investors, we would normally be licking our chops after seeing these transitory headwinds, which should ultimately reverse and lead to brighter times for PX.

However, we fear that some of these headwinds could persist for a very long time and potentially cause larger risks in the next year or two. While we wouldn’t expect any sort of dramatic fallout like the one that rippled through the master limited partnerships sector, some of the defensive characteristics of PX’s business model could be increasingly challenged.

For example, if commodity prices remain low and continue pressuring demand for steel, some customers could be unprofitable. If their production volumes drop below the minimum level in their take-or-pay contracts with PX and they don’t have the cash flow to pay, what happens?

After years of rapid buildouts, many of these manufacturing, energy, and chemical markets could be oversupplied for several years in countries such as China and Brazil. How safe is the cash flow from some of these customers as they grapple with capacity rationalization? We also wonder if PX’s backlog could start to contract if things get really bad, creating more fears around the stock, or if it will experience delays when it starts to ramp up some of its major new projects in the next 1-2 years (these are from major investments made during 2011 through 2014).

Furthermore, fewer new growth opportunities in developing countries could lead to higher competition and lower returns for the remaining pool of projects that do exist. If the battle for market share intensifies between incumbents, future returns on capital could contract or PX will see less growth. The industry has historically acted rationally, but desperate times could call for desperate measures.

We would also prefer if PX had a healthier balance sheet to provide greater flexibility in case some of these risks materialize. The company has an “A” credit rating, but it only has $136 million in cash on hand compared to $9.5 billion in debt.

Dividend Analysis

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. PX’s long-term dividend and fundamental data charts can all be seen by clicking here.

Dividend Safety Score

Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

Praxair, Inc. (NYSE:PX) recorded a dividend Safety Score of 44, suggesting that its dividend is about as safe as the average stock in the market. Despite the company’s high quality level, its debt situation ($136 million in cash compared to $9.5 billion in debt) and the current macro headwinds add to its risk profile. However, assuming PX’s cash flow generation remains steady, there shouldn’t be anything to worry about.

Using 2016 earnings estimates, PX’s earnings payout ratio is a healthy 47%. Given the stability of PX’s free cash flow, the company has plenty of room to continue paying and growing its dividend.

Looking below, we can see that PX’s earnings payout ratio has remained between 30% and 50% over the past 10 years. Its free cash flow payout ratio has been more volatile because the company’s growth investments are costly with cash flow benefits spread over many years but the price of the project paid over just several years. Even with continued macro pressures, PX’s dividend looks safe.

PX EPS Payout Ratio

Source: Simply Safe Dividends

PX FCF Payout Ratio

Source: Simply Safe Dividends

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