Following the institutional investors can be a useful strategy for retail investors.
Institutional investors are so big, they move the market. This is a form of “bottom feeding” investing, where retail investors can lurk in the shadows of “whales” (institutional investors) and get fat on the leftovers. The same principle can be used by following “sharks” (activists).
The likes of activist investors, including big names such as Carl Icahn and Bill Ackman, have been reforming companies for decades now. And for those investors who followed Icahn into Chesapeake Energy Corporation (NYSE:CHK) or Netflix, Inc. (NASDAQ:NFLX), they were handsomely rewarded. These sharks take meaningful stakes in companies and then push for management shakeups, restructurings, spinoffs, operational improvements, etc.
Icahn has been the talk of the activist circle of late, overshadowing some other notable activist campaigns. It appears that a combination of Ackman’s own recent shortcomings and Icahn’s high-profile Apple Inc. (NASDAQ:AAPL) investment has overshadowed Ackman’s activist bet on the less-than-sexy industrial space. Since Ackman announced his 9.8% ownership of Air Products & Chemicals, Inc. (NYSE:APD) at the end of July, the stock is relatively flat.
Has the market lost faith in Ackman that quickly? Granted, the media has had a field day over the J.C. Penney Company, Inc. (NYSE:JCP) debacle, not to mention the virtual implosion of his Herbalife Ltd. (NYSE:HLF) short. However, Ackman is coming off one of his biggest wins with Canadian Pacific Railway Limited (USA) (NYSE:CP), which also happens to be in the industrials sector. His Pershing Square hedge fund managed to make 2.5 times its money in just around two years at Canadian Pacific.
While Ackman emphasized the need for operational reform and efficiency improvement at Canadian Pacific, the campaign at Air Products could prove to be a bit different. Ackman hasn’t laid out his exact plans, but he has called Air Products’ business “simple, predictable, and free-cash-flow-generative, and enjoys high barriers to entry, high customer switching costs and substantial pricing power.”
All characteristics of a great investment, but the valuation alone does not appear to be a viable investment thesis. Air Products trades at a price-to-earnings (P/E) ratio of 23.2, in line with its peer Airgas’ 24.3 and Praxair’s 21.7.
As well, Air Products has grossly underperformed its peers over the past decade, with its stock up only 118%, compared with Airgas’ 477% return and Praxair’s 275%. This is, in part, because the company continues to underperform in terms of its return on invested capital (ROIC) and return on equity (ROE). Air Products has an ROIC of 7.6% and ROE of 15.3%. Compare this to Praxair’s ROIC of 11.3% and ROE of 29%, and Airgas’ ROIC of 8.3% and ROE of 19.4%.
Air Product’s dividend is already the highest among the three major gas companies, paying a 2.7% yield, compared with Praxair’s 2% and Airgas’ 1.8%. The payout ratio is 60%, leaving little room for a dividend increase.
|Copyright © Air Products and Chemicals, Inc.|
|Ackman has called Air Products’ business “simple, predictable, and free-cash-flow-generative, and enjoys high barriers to entry, high customer switching costs and substantial pricing power.”|
So what does Ackman see as the real catalyst?