Linde: TSMC Phoenix Facility Begins to Contribute to Profits (NASDAQ:LIN)

I presented my “Buy” thesis for Linde (NASDAQ:LIN) in March 2024, highlighting double-digit EPS growth and effective cost management. Linde released its Q2 result on August 2^whenreporting a 3% increase in core earnings and a 6% increase. in adjusted operating profits, guiding EPS growth of 9%-11% for FY24. The guidance reaffirmed my analysis of the potential for double-digit revenue growth. Linde demonstrated strong price and productivity growth despite uneven volume growth. I am encouraged by Linde’s project wins for large semiconductor manufacturing facilities. I reiterate a “Buy” rating on Linde, with a one-year price target of $520 per share.

Strong pricing and productivity despite weak volume growth

As shown in the chart below, Linde posted organic revenue growth of 3%, comprising a 3% price increase and flat volume growth during the quarter. My biggest takeaway from the quarter is their strong price and productivity growth, which contributed to strong earnings growth.

Linde guides flat volume growth for full year due to weak US industrial market; however, double-digit EPS growth is still anticipated for FY24. Key growth drivers include:

• As mentioned in the previous article, Linde maintains a consistent capital allocation policy, returning capital to shareholders through dividends and share buybacks. Year to date, Linde has repurchased $2.48 billion of its own stock and paid out $1.33 billion in dividends. We estimate that share buybacks could increase EPS by 2% in the near term.
• Pricing and productivity are crucial to expanding their gross margin. During the earnings call, management anticipated that 4%-6% of EPS growth would come from their pricing and productivity initiatives. The company has done a great job optimizing fixed costs in recent years, which has helped improve productivity.
• Finally, Linde operates a cost pass-through model with their customers that helps reduce the volatility associated with commodity inflation.

Backlog of high quality projects

As shown in the slide below, Linde has a backlog of high-quality projects totaling $8.5 billion. In my view, these backlogs pave the way for short-term business growth. Specifically, 37% of the total projects are related to new energy initiatives such as hydrogen and renewable energies.

Linde began building on-site plants to supply ultra-high purity nitrogen for TSMC’s (TSM) Phoenix manufacturing facility. During the earnings call, management revealed that the first phase is already underway, with the project expected to contribute to Linde’s profits in the coming quarters. In addition, Linde has made progress on their construction project for Samsung in Texas. With more global semiconductor companies building manufacturing plants in the US, I anticipate Line will become a major beneficiary.

On May 1st^St2024, Linde signed a long-term agreement with H2 Green Steel to supply industrial gases to the world’s first large-scale green steel production plant. As indicated in the release, these projects can help reduce carbon emissions by up to 95% compared to traditional steel production. I anticipate that Linde will secure more contracts of this kind due to the global push towards clean energy and ESG initiatives.

Outlook and assessment

Linde is guiding for 8%-10% EPS growth for FY24 as detailed in the slide below. The guidance is fairly consistent with their historical performance.

I consider the following factors for their growth:

• Overall industrial production was quite weak in 2024 due to high interest rate and weak consumer sentiments. As shown in the chart below, there has been almost no growth in industrial production in the first two quarters of 2024. As such, I do not anticipate any volume growth for Linde in FY24. If the Fed enters a rate-cutting cycle in 2025, we forecast that Linde’s volume growth will gradually return to their historical average of 3%.

• As previously discussed, pricing and productivity improvements are crucial to Linde’s overall growth. I anticipate that they will support a 3% price increase in the near future. Because the supply of industrial gas is critical to manufacturing activities, customers tend to have less price bargaining power once the gas supply infrastructure is established.
• For cost pass-through growth, we forecast a contribution of 2% in FY24, moderated to 1.5% as inflation moderates.
• Finally, I anticipate Linde will allocate 0.3% of total revenue to small acquisitions, contributing 10bp to overall growth.

As such, I calculate that Linde will deliver 5% revenue growth for FY24, accelerating to 7.6% from FY25 onwards. I model an average annual margin expansion of 50 bps for Linde assuming: 15 bps from pricing; 15 bp from improving productivity; 10 bps from SG&A operating leverage and 10 bps from reduced amortization costs.

With these assumptions, my DCF can be summarized as follows:

Free cash flow from equity (FCFE) is calculated as follows:

The cost of equity is calculated at 8.6% as follows:

Discounting all FCFE, the one-year price target is estimated at $520 per share, according to my calculations.

Key risks

During the earnings call, management expressed concern about the growth of their business in China. As China enters a deflationary macro environment, Linde has focused on their pricing initiatives to improve profitability in China. Management does not have confidence in the recovery of the industrial market in China, and in the near future I anticipate that Linde will continue to face growth challenges in China.

Final note

I agree with Linde’s high-quality project backlog, which has significant exposure to renewables and clean energy. The TSMC project is expected to generate profits for Linde soon. Despite smooth volume growth, I reiterate a “Buy” rating on Linde, with a one-year price target of $520 per share.