Linde's ability to manage inflation was on display in the industrial gas giant's strong quarter

Published Thu, Oct 27 20222:14 PM EDT

Linde (LIN), a U.K.-based global industrial gas and engineering company, reported strong third-quarter results before the opening bell Thursday. We're like how the firm continues to grow its profits despite inflation. Revenue increased 15% from the year-ago period to $8.8 billion, outpacing the $8.3 billion consensus estimate, according to Refinitiv. Adjusted earnings of $3.10 per share — up 14% year over year — exceeded the $2.93 estimate and was well above guidance of $2.85 to $2.95. Additionally, operating profit rose 11% to $2.01 billion, beating expectations of $1.9 billion. Excluding cost pass throughs, which we will define later, company wide margins expanded 90 basis points year over year but were down 20 basis points sequentially. Linde's after-tax return on capital (ROC) was a record 21.8%, up 180 basis points from the second quarter and 510 basis points from last year. Bottom line Another under-promise, over-deliver quarter from Linde as the company continues to demonstrate strong pricing power (up 8% year over year) and great inflation management that more than offsets unfavorable impacts from the strong dollar and elevated energy pricing in Europe. We view Linde as a high quality, defensive company that can grow its earnings no matter the twists and turns the economy takes, with the business generating its highest after-tax ROC ever. Longer term, management believes (1) clean energy opportunities — especially after the passage of the Inflation Reduction Act — as a secular growth kicker, (2) continued operating discipline, and (3) a "relentless" focus on pricing and productivity gives them confidence in its ability to keep delivering +10% EPS growth over the next few years. For those reasons, we continue to stick by the name and are looking to upgrade our rating from the current 2 to a 1 on a pullback. Companywide Q3 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 third-quarter sequential sales growth numbers for each category. Consumer-oriented (viewed as more resilient; about a third of total company sales) Health care up 3% Food & Beverage up 5% Electronics up 5% Industrial-oriented (viewed as more cyclical; accounts for the rest of sales) Manufacturing up 4% Chemicals & Energy flat Metals & Mining up 8% Other up 6% Although about one third of company sales are in resilient end-markets, Linde has a very defensive business model. A significant portion of the company's sales have fixed payment structures that don't change based on customer volumes. Even when volumes are down, which certainly could happen next year if the global economy slows as many predict, Linde believes it can preserve much of its top-line and profit. Linde also has many long-term supply agreements with high quality customers. Operating cash flow was $2.64 billion for the quarter, a solid beat compared to the $2.25 billion consensus. The company repurchased about $1.1 billion worth of shares in the third quarter. Management said it plans on recapitalizing its balance sheet given its strong credit rating, and that could mean more share repurchases in the future. As for some general commentary around the backlog, Linde's total electronics project backlog increased to $1.4 billion after recently being awarded a second large sale of gas contract for a major semiconductor manufacturer in the United States. Linde also continues to see some of the highest levels of investment activity in the Gulf Coast. Additionally, management thinks its backlog could increase $7 billon to $9 billion over the next few years due to the Inflation Reduction Act, which will accelerate the U.S. clean energy transition. Q3 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 higher energy cost charges to customers. While this pass-through does not impact actual profit dollars, it does dilute reported margins due to the adjustments made to both sales and costs. Gases Sales in the Americas of $3.69 billion, up 20% year over year, beat out expectations of $3.53 billion, driven by growth in all end markets aside from Health Care with the strongest growth being seen Chemicals & Energy. Operating profit of $974 million, up 13% over last year, was higher than estimates of $937 million. Excluding cost pass through, operating margins were up 50 basis points from last year. Asia Pacific sales of $1.66 billion, up 6% year over year, was in line with expectations. Sales growth was led by Electronics and Chemicals & Energy, while volume growth was equally split between base business and project startups. Operating profit of $429 million was up 12% from last year and roughly in line with the $424 million estimate. Excluding cost pass throughs, margins increased 180 basis points year over year. Sales in Europe, Middle East & Africa (EMEA) of $2.13 billion, up 11% year over year, was higher than expectations of $2.04 billion, with growth seen in all end markets except Health care and led by the Food & Beverage and manufacturing. Operating Profit was $465 million, a miss versus estimates of $481 million and down 2% year over year and 13% sequentially as leverage was impacted by the deconsolidation of its Russian business and market concerns about a collapse in margins due to rising energy costs in Europe. Linde's margins, excluding cost pass throughs, expanded 60 basis points year over year, a sign that continues to show those fears to be overblown. Engineering (not geography specific) Sales of $828 million, up 38% year over year, were a beat versus $595 million, while operating profit of $150 million, up 42% year over year, exceeded estimates of $89 million. One reason for the significant growth in the quarter was favorable timing of Americas' projects, so that will create a small headwind for the fourth quarter. Global Other (not geography specific) Sales of $490 million was ahead of expectations for $467 million, while an operating loss of $8 million was slightly better than the $20 million loss expected. Guidance Looking ahead to the fourth quarter, management forecasted adjusted earnings of $2.80 to $2.90 per share, 8 cents short at the midpoint versus the $2.93 per share consensus. Keep in mind that this guidance assumes zero economic growth at the top end of the range and recessionary conditions at the midpoint. So it's de-risked, so to speak, if economic conditions worsen. This outlook represents an increase of 1% to 5% versus 2021 figures despite the impact of the strong dollar (an 8% headwind). But it also represents an 8% falloff at the midpoint from the third quarter to the fourth and that's due to a 4% headwind due to timing of some Engineering sales, 2% on foreign (FX), 1% on the divestiture of its non-core temperature-controlled logistics business, Gist Limited, and also a consideration of recessionary considerations. Still, Linde's ability to grow earnings year over year despite FX and broader economic uncertainty speaks to the strength and resiliency of its business models. As for the full year 2022, management raised its adjusted EPS range to $11.93 to $12.03 from $11.73 to $11.93. This new figure represents growth of 12% to 13% year over year or 17% to 18% excluding FX. This assumes outlook assumes zero economic growth. German delisting thoughts We also want to provide some follow up on a development we discussed on Tuesday's "Morning Meeting" for Club members. Linde management held a call Wednesday to explain the rationale behind its proposal to delist from the Frankfurt Stock Exchange. After listening to management, we continue to believe the long-term benefits of delisting from the German exchange outweighs any future noise and forced-selling that may occur from European fund managers and index funds. (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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A liquid hydrogen tanker truck taking a fuel delivery at the Linde hydrogen plant in Leuna, Germany, on Tuesday, July 14, 2020.

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