* Our preference is Linde (O/P, €151.5) over Air Liquide (U/P, €85.5). This is a function of:
1) Valuation: Linde trades at a 16% discount (12% discount historically), despite having a similar proportion of tonnage (take or pay) earnings (post Airgas);
2) Financial Leverage – we forecast (post equity raise) Air Liquide's ND/EBITDA of 3.4x, Linde of 1.9x;
3) We forecast Air Liquide's ROCE at a 50bps premium to Linde (historically 350bps).
* We believe industrial gases contract bidding discipline will be maintained in a low growth environment. As a result, the industry's defensive revenue stream, FCF yield, and return premium over WACC are sustainable. We review a decade of gas contract awards to ascertain end market demand, contract risk profiles, and changes in return metrics across the sector. Our preferred European Industrial Gas exposure is Linde (O/P, €151.5/share).
* Why are Industrial Gas returns lower? 1) Gas suppliers are passing through lower cost of financing to customers. However, ROCE/WACC spreads are holding; 2) Longer average project ramp up/larger projects: We estimate the average project size is +15% over the last eight years, average project construction time +20%. This weighs on the capital employed (ie: larger construction in progress on balance sheets); and 3) Underwhelming merchant activity – average utilization rates in the low 70's.
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