Stock Profile: Industrial gas giant Linde has the pricing power to thrive in periods of higher inflation

Linde (LIN) has a lot to like: a top management team, new projects on the horizon and an intense focus on reducing costs. But most importantly, in the face of inflation, it has the ability to pass additional costs onto customers.

Introduction

Linde is a U.K.-based industrial gas and engineering company that produces atmospheric gases such as oxygen, nitrogen, and argon as well as rare gases such as krypton, neon, and xenon. It also sells process gases such as carbon dioxide, helium, hydrogen, electronic gases, specialty gases, and acetylene. These products are used in many industries, including health care, petroleum refining, manufacturing, food, beverage carbonation, fiber-optics, steel making, aerospace, chemicals, electronics, and water treatment. Because these products are so high up in the supply chain, Linde has a unique ability to pass costs through to customers — in fact, it’s even written into contracts with customers.

Additionally, the company designs, builds, and operates industrial plants for other companies to process gases. In February, for example, Linde announced a deal to supply industrial gases to a leading chipmaker in Singapore. It will build, own and operate a generator there to produce nitrogen and oxygen for its new semiconductor fabrication plant. In September, Linde announced a $600 million investment to supply gases to a manufacturing facility in Phoenix, Arizona. Both plants are expected to start up in the back half of 2022.

Delivery methods

The delivery of these products is done in one of three ways:

  • On-site: Customers requiring consistent, large supplies of gas are supplied via on-site plants built adjacent to customer sites and are supplied via pipelines. Contracts for this delivery method generally range from 10 to 20 years.

  • Merchant: Generally associated with distributable liquid oxygen, nitrogen, argon, carbon dioxide, hydrogen, and helium, deliveries are made via tanker trucks to on-site storage containers owned and maintained by Linde and leased to customers. Contracts for this delivery method generally range from three to seven years.

  • Packaged Gases: Generally reserved for smaller volumes, gases are supplied in metal cylinders. Contracts for this delivery method generally range from one to three years.

Costs

Linde’s largest cost in the production and distribution of its industrial gases is energy in form of electricity, natural gas, and diesel fuel. While these costs can fluctuate greatly, they’re managed via formulas, surcharges and cost pass–throughs, and tolling arrangements. It’s important to note that while cost pass-throughs have zero effect on profit dollars, they impact profit margins because Linde grosses up or down sales and variable costs.

Catalysts

  • The realization of cost pass-throughs

  • Potential pullback in energy costs combined with the staying power of higher prices, leading to margin improvement

  • Easing of supply chain bottle necks providing a boost to demand

  • Execution on a contractually secured $13 billion backlog

  • The addition of new project to the backlog — none of the roughly 300 decarbonization projects are currently included in the backlog and management estimates the probability weighted value of these projects to be about $4 billion (over $20 billion on an absolute basis)

  • Overall improvement in the economy – midpoint of current guidance assumes no economic improvement

Risks

  • Ongoing rise in energy costs that hits margins near-term

  • Economic slowdown

  • Geopolitical events impacting the supply chain and energy costs

Looking ahead, speaking to the management’s confidence in the company’s future cash flow and earnings power, Linde recently announced a new $10 billion share repurchase authorization and increased the quarterly dividend payout by 10% to $1.17 per share.

Financials