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driving today's global industrial gas industry

Wall Street Views
By Fred H. Siemer, CFA
2007.11
AIRGAS FINANCES — POST LINDE BULK GAS ACQUISITION
The growth story at Airgas has always been about acquisitions. This history of successful integration of a stream of added businesses was highlighted at the 2007 Airgas Analyst Meeting on September 6th in Philadelphia. Over the 25 years of the company’s history, there have been more than 350 deals, with the acquisition of Linde’s bulk and packaged gas businesses in ’07/’08 being the largest. In Fiscal 2007 (3/31 following), thirteen transactions added $335MM to sales. Packaged gases, to close in FY’08, will add $393MM to sales, which should total about $4 billion for the year. Average compounded sales growth for the six years FY’01 – FY’07 was 12 percent and 14 percent per year, for adjusted operating cash flow. With the cost of acquisitions in the US industrial gas industry in the general range of 5x-9x EBITDA during this period, the natural question is the affordability of these purchases and the impact on the company’s balance sheet.

As of March 31, 2007, the balance sheet shows long term debt of some $1.3 billion and stockholders equity of $1.1 billion at 116 percent — a highly leveraged balance sheet even by the standards of the capital intensive industrial gas industry. (This ratio at Praxair was some 65.5 percent on 12/31/07). With the financing for the Packaged Gas Business on the books in FQ1 these ratios have deteriorated somewhat, which could lead to some shareholder concern. While the Cash at the end of FQ1 was $41.5MM, an increase from the $33.1MM in the prior year’s quarter, some $30.3MM of the Cash from operations was provided by securitization of trade receivables. This source of cash is variable and can decline in periods where the economy is weak or business is depressed. As an example, securitization provided only $3.4MM in FY’04. Some 60 percent of the company’s debt is variable with much tied to LIBOR rates. There can be periods where world interest rates rise dramatically, which would be an element of risk to Interest Coverage. Standard financial ratios for ARG are shown in Figure 1.

To be sure, we are viewing the financial picture at Airgas at a peak in its acquisition cycle and in the debt load needed to finance such a major step-up in the company’s operations. Airgas has traditionally been a highly leveraged company. Perhaps a more “normalized” view of its financial structure can be appreciated by some Industrial Gas (IG) company financial comparisons for the year 2006, as shown in Figure 2.

Airgas has been able to carry high levels of debt throughout its history because of the ability to consistently generate large amounts operating and free cash flows. It can be seen from Figure 1, that even though debt is at a peak in FQ1’08, the Current Ratio and Debt/EBITDA all improved from year end 2007. Operating cash flow grew at an average compounded rate of some 14 percent in the period FY’01 to FY’07. Free cash flow rose fairly consistently throughout this period despite some cyclicality in same store sales. The relationship between Cash Flows and Capex can be seen graphically in Figure 3. The company has adjusted both the free cash flow and debt used in Figure 1, primarily to account for securitization of A/R’s and cash flows from the past JV with National Welders. The reconciliation of operating cash, capital expenditures and debt can be found on p. 54 of the presentation materials used at the 2007 Analyst Meeting. We think these adjustments are reasonable and any change to GAAP results would not be material.

Airgas has a long history of successfully making and integrating acquisitions. Large peaks in debt have historically been worked off after each major acquisition over time. This history is graphically displayed in Figure 4. The consistent improvement in operating earnings and cash flows has also worked to dramatically lower the ratio of Debt to EBITDA. Despite the current record long-term debt level of$1.5 billion, the Debt/EBITDA ratio is probably less than 3x on a proforma basis after the Linde Packaged Gas acquisition.

Conclusion: The largest series of acquisitions in the 25 year history of Airgas has also produced one of the largest debt burdens and strained financial coverage ratios. Given some cyclicality in same store sales for the industrial gas distribution business, the investor could be quite concerned if we were heading into a recession in the  US. Luckily this does not seem to be the case. Although the housing and auto sectors are weak and the financial crisis caused by mismanagement in these sectors could spread to the economy overall, recent actions by the Fed seem to have eased the psychological panic associated with these developments and markets seem to be returning to normal. Also, ARG’s business is heavily dependent on the non-residential construction markets. This sector was running at a seasonally adjusted rate of $353 billion in August, up 15.2 percent yty. Industrial gases are typically a lagging indicator in US GDP, so the outlook is positive well into 2008. Some argue that world infrastructure repair and new construction has entered a secular long-term improvement trend that will hold for many years. I would continue to hold the shares of ARG.

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