If the previous management of Air Products had delivered a quarter that included the following, the stock would have been down meaningfully on the day:
- A year on year decline in operating income from its core gases business
- A write down of around a third of the value of a business acquired only two years ago
- A suggestion that two of the (much questioned) China based on-site projects have been delayed by 2 quarters
However, the current management was able to announce exactly this and the stock closed up almost 4%, while already commanding a significant multiple premium to Praxair, which over the last 12 months has delivered growth in its gases portfolio – Exhibit.
What is going on here is “belief”. Belief that the newly focused APD can drive down costs, allocate capital better and drive better EPS growth than it has in the past. There were signs of this in the quarter as APD beat estimates, despite the weaker gas numbers. Very strong results from its Materials and Equipment businesses were largely the cause, but there was also significant focus on cost allowing the company to increase margins. We are assured that the cost focus will continue.
While we are skeptical as to whether APD can cut costs fast enough to deliver positive earnings surprises given a weaker gas business (which we think will take a couple of years to turn around) that is not the point of this short note.
The point is to highlight the power of a change in sentiment. APD has almost a 3x multiple premium over PX on 2015 earnings, unheard of at any point in recent history. The market believes that the change in focus at APD will deliver outsized returns and the stock has been one of the best performers in the space over the last two years.
This change of sentiment will likely take place at DuPont also. The activist fund in DuPont has the right story in our view – just as the activist fund at APD had 18 months ago.
The issues are what will be the catalyst and when will it happen? And the answer is simple – we do not know! What we do know is that there will need to be a catalyst. DuPont is resisting Trian’s suggestions and, in our view putting up weak numbers and a weak defense. The war of words has begun.
Catalysts could be: (we are just making stuff up here)
- A public proxy fight where Trian nominates a couple of very strong board candidates (unlikely that it will come to this)
- DuPont continues to disappoint on the growth story – increasing shareholder pressure to act
- A change of management at DD
- A second activist fund taking a large stake
- A private equity bid for the company (it is smaller than KO!)
Once the catalyst arrives the stock will stop discounting Trian’s likely failure and start discounting Trian’s likely success. The stock could appreciate quickly. We generated a value of $100 per share in a piece that we did on the cost opportunity at the beginning of this month.
The risk to holding the stock is that the company makes a large and poor tactical acquisition to change the game.