The Obama Administration began August by proposing new rules for the EPA to cut carbon dioxide (CO2) emissions at U.S. coal-fired electricity plants by 32% from the 2005 levels through 2030. This was followed last week by another proposal to cut methane emissions from oil and gas drilling by 40% through 2025.
Much of these emissions proposals depend on the development of some form of Carbon Capture & Storage (CCS) technology: the process of capturing the carbon dioxide released by burning fossil fuels could finally end the battle between the environment and a growing global economy hungry for cheap fuel sources like oil and coal.
The technology has been expensive to develop, limiting the players that could be involved. And because of the expense to research and development and the uncertainty around CCS technology, few companies have built a name in the space.
But one company has regularly been a recipient of government funding for large-scale CCS projects and holds a dominant role in the global market for industrial gasses.
A Best of Breed Buy With An Option On The Future Of Energy
Air Products & Chemicals (NYSE: APD) provides 40% of the global hydrogen capacity, a market that is expected to double to 11 billion cubic feet per day over the next decade. The company owns the only major hydrogen pipeline in the Canadian oil sands region and supplies hydrogen to 90% of the U.S. gulf coast refiners. APD has a $3.2 billion project backlog, along with several large-scale projects in China, and smoothes sales with long-term supply contracts that span decades. It also recently signed a deal with Korea's largest manufacturer of glass bottles to supply another emission control technology in their factories.
Not only is APD a leader in industrial gases but it has the size and capital to research heavily into new technologies. The company was one of only three companies to get the green-light for the second phase large-scale CCS projects funded by $575 million in American Recovery and Reinvestment Act (ARRA) funds. Air Products went operational with its Port Author plant in 2013 and is on the leading edge of CCS for both capture and storage technology.
The company is also a leader in other emission control technologies and announced recently that it had been chosen by Korean glass maker Techpack Solutions to supply its oxy-fuel combustion technology which reduces nitrogen oxide emissions by 50% and generates up to 20% energy savings.
The smart money is already positioning in Air Products for its leadership in the space and potential to change the game of energy emissions in the future. Institutional owners hold 88% of the shares outstanding and Bill Ackman of Pershing Square holds a $2.4 billion investment or 10% of the shares.
Under the leadership of CEO Seifi Ghasemi and two new directors last year, the company has undergone a major restructuring and has talked about divesting underperforming units. Besides the long-term upside, there's a chance for a near-term bounce on news of an asset sale.
Shares of APD trade for 21.5 times trailing earnings, just over the five year average of 19.5 times trailing. Earnings are expected higher by 16% to $7.47 per share through fiscal 2016, ending September of next year.
The company did not repurchase shares last year but has done so in seven of the last 10 years. Free cash flow grew to a new record of $626 million over the last four quarters, and cost cutting around the new restructuring leads me to believe that cash may be sufficient for a new repurchase program soon, which would also support higher investor sentiment.
My near-term target of $168 per share is based on a multiple of 22.5 times expected 2016 earnings and the potential for upside surprises on asset sales and a buyback program. The longer-term return could be even better as the company locks up the future of energy.
Risks to Consider: Carbon capture technology is still in its development stage with a few years before commercial viability. Fundamentals support near-term investment but be ready to wait long-term for upside on environmental regulation.
Action to Take: Long-term catalysts in CCS technology could put APD in the lead for the future of energy while near-term catalysts around the restructuring and its dominance of the hydrogen market make for a strong buy.
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