Industrial gas giant Linde's guidance highlights the perils of trading initial headlines

Published Thu, Jul 28 20222:05 PM EDT

Linde , a leading industrial gas and engineering company, reported strong second-quarter results before the opening bell Thursday, and the Club stock moved higher. Revenue increased 12% from the year-ago period to $8.46 billion, outpacing the $8.36 billion consensus estimate, according to FactSet. Adjusted earnings of $3.10 per share — up 15% year over year — exceeded the $2.96 estimate. Additionally, operating profit rose 8% to $1.99 billion, beating expectations of $1.95 billion. Excluding cost pass throughs, which we will get into later, company wide margins expanded 80 basis points sequentially and 100 basis points year over year. Bottom line Even in the face of an uncertain macro environment and rising energy prices, especially in Europe, U.K.-based Linde posted strong results Thursday morning and management did an excellent job on the conference call explaining the resilience of its business model. Regarding guidance, what must be kept in mind is that Linde never incorporates economic growth into its outlook. It's not the job of management to predict the economy. What ends up happening is that if the economy grows, Linde will likely beat expectations at the top end. And if the economy worsens, earnings will likely fall somewhere near the bottom of the range, though mitigating actions could protect earnings. Now, of course, you could come back and say the U.S. economy just printed a negative GDP reading for the second quarter after contracting in Q1, why should we expect growth next quarter? What we would come back with is that Linde outperformed in both the first and second quarters this year, likely due to the fact that most of its business is defensive, and it has the pricing power to offset energy inflation. It took a little time Thursday for the market to understand this, explaining why the stock initially looked down premarket and pushed higher as the day progressed. This is a good example of why it is misguided to simply trade the headlines. Companywide Q2 results In addition to providing gas processing solutions, Linde's industrial gases are used in numerous settings, including hospitals, electronics manufacturing and clean fuels. The company also serves both consumer and industrial end markets. The following is a look at second-quarter sequential sales growth numbers for each category. Consumer-oriented (viewed as more resilient) Health care down 5%, Food & beverage up 8% Electronics up 6% Industrial-oriented (viewed as more cyclicals) Manufacturing up 7% Chemicals & energy up 4% Metals & mining up 3% Other up 12% Operating cash flow was $2.13 billion for the quarter, a small miss compared to the $2.17 billion consensus. After backing out slightly higher than expected capital expenditures of $826 million, free cash flow of $1.3 billion was about in line with the $1.33 billion consensus. The company repurchased $1.8 billion worth of shares in the second quarter. Recall the company recently announced a new $10 billion share repurchase program, of which about $3.5 billion has been used. Linde exited the second-quarter with a $3.6 billion gas backlog and a $2.9 billion sale of plant backlog. Some recent wins in the United States have come from electronics, but the company is seeing progress on new potential projects, especially for blue hydrogen on the Gulf Coast. Linde also spent time on its conference call highlighting the defensiveness of its business model. About two thirds of Linde's total business is what they call defensive, meaning it has long-term supply agreements with high quality customers and fixed fee elements, it operates in a resilient end market, and has steady rental payments. Linde also provided some insight into its exposure to Germany, which seems especially relevant because the country is in an energy crisis right now due to Russia's ongoing war in Ukraine. Linde pointed out that Germany represents about 5% of total company sales, but two thirds of that Linde would define as defensive. Q2 segment results First off, when discussing operating margin performance, note that several times we mention the concept of "cost pass-through," which represents the contractual billing of energy cost charges to customers. While this pass-through does not impact actual profit dollars, it does affect reported margins due to the adjustments made to both sales and costs. Gases Sales in the Americas of $3.52 billion, up 16% year over year, edged out expectations of $3.42 billion, driven by growth in all end markets aside from health care with the greatest strongest growth being seen in manufacturing, chemicals and energy. Operating profit of $910 million missed estimates of $950 million. Excluding cost pass through, operating margins were disappointingly down 90 basis points due to a one time charge of 100 basis points, but are expected to recover in the third quarter. Asia Pacific sales of $1.65 billion, up 7% year over year, was in line with expectations of $1.65 billion, driven by project startups in electronics, chemicals, and energy end markets. Operating profit of $426 million was better than the $420 million the Street was looking for. Excluding cost pass throughs, margins increased on a year over year and sequential basis by 160 and 100 basis points, respectively. Sales in Europe, Middle East & Africa of $2.11 billion, up 14% year over year, in line with expectations of $2.11 billion, with growth seen in all end markets except health care and led by the food & beverage and metals & mining. Despite concerns about increased costs due to energy prices, operating profit was a nice surprise at $536 million, up 12% year over year, and better than the $503 million consensus. Excluding cost pass throughs, margins expanded 220 basis points year over year and 190 basis points sequentially. Engineering (not geography specific) Sales of $644 million, flat year over year, came up short versus the $664 million the Street was anticipating, while operating profit of $105 million, down 3% year over year, missed the consensus by $2 million. Global Other (not geography specific) Sales of $500 million was a little light versus expectations of $508 million, while an operating profit of $11 million was much better than the $21 million expectation. Guidance Looking ahead to the third quarter, management forecasted adjusted earnings of $2.85 to $2.95 per share, 8 cents short at the midpoint versus the $2.98 per share consensus. Keep in mind that this guidance assumes zero economic growth and no contribution from Linde's operations in Russia as of July 1. As for the EMEA region, importantly Linde said it has seen no material trends in July from June despite the energy crisis. As for the full year 2022, management raised its adjusted EPS forecast to $11.73 to $11.93 from $11.65 to $11.93. This too assumes no economic growth ad contribution from Russia. Excluding the impact of foreign exchange, Linde expects earnings per share to grow 15% to 17% year over year. On the expense side, guidance for $3 billion to $3.4 billion in capital expenditures is consistent with prior commentary. (Jim Cramer's Charitable Trust is long LIN. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. 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Tanks of hydrogen stand near a hydrogen electrolysis plant.

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