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Danger Zone 3/11/2013: Praxair Inc. (PX)

Tuesday, March 12th, 2013

Check out this week’s Danger Zone interview with Chuck Jaffe of Money Life and

Praxair Inc. (PX) is in the Danger Zone this week. This conglomerate has run out of ways to fuel profitable growth. The company is turning to acquisitions to try to maintain top line and EPS growth, but that growth is diluting shareholder value.

PX spent $294 million on acquisitions of several small packaged gas distributors in 2011, including American Gas Group and Texas Welders Supply Company. The company had an almost identical outlay in acquisition spending for 2012.

This acquisition spending does not appear to be aiding growth in the way management hoped, as PX saw after-tax profit (NOPAT) increase by a paltry 2.6% in 2012. This small growth fell far short of the increase in invested capital in 2012, leading to a decline in return on invested capital (ROIC) to 10%. Another example of the high-low fallacy masking overpayment for cash flows with rising EPS.

This track record should temper investors’ enthusiasm over Praxair’s recently announced acquisition of NuCO2, a provider of beverage carbonation solutions, for $1.1 billion from Aurora Capital Group.

While larger in scale than PX’s past acquisitions, it looks to have a similar effect of slightly increasing earnings while dragging down on ROIC. NuCO2 is expected to generate an EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization) of $115 in 2013. If one assumes NuCO2 will have a similar ratio of NOPAT to EBITDA to PX (about 50%), those earnings should translate to about $57 million in after-tax profit next year. Since ROIC equals invested capital divided by NOPAT, those profits would translate to a 5.2% return on invested capital, well below PX’s current ROIC and weighted-average cost of capital (WACC) of 6.3%.

Praxair has offered all the usual platitudes about how synergy will allow NuCO2 to generate more revenue in the future than it did on its own. Executive vice president Eduardo Menezes said of the deal, “We plan to continue to grow the business in the United States, enhance distribution efficiency utilizing Praxair’s competencies in logistics, and extend NuCO2’s offerings to customers in other regions of the world.”

That all sounds nice, but I’m skeptical as to how much PX can generate profits from expanding NuCO2’s product around the world as that business is increasingly commoditized. To create shareholder value, PX has to grow economic earnings, not revenue or EPS.

The lack of economic earnings growth is not enough to put a company in the Danger Zone. The bigger issue it PX’s high valuation. Investors needs to beware Wall Street’s proclivity to hype stocks that do lots of acquisitions that are accretive to bankers but not shareholders.

At ~$112.67/share, PX’s current valuation implies 7% growth in NOPAT compounded annually for the next 11 years. Those expectations set the bar awfully high for a large conglomerate operating in increasingly commoditized businesses. I expect the company will disappoint.

PX may be a good company, but it is a dangerous investment.

I also recommend avoiding the following ETFs and mutual funds because of their large allocation to PX and Neutral or worse rating.

  1. ING Corporate Leaders Trust Fund (LEXCX) – 9% allocation to PX – Neutral Rating
  2. iShares Dow Jones U.S. Basic Materials Index (IYM) – 7% allocation to PX – Neutral Rating
  3. ProShares Ultra Basic Materials (UYM) – 7% allocation to PX – Neutral Rating
  4. Materials Select Sector SPDR (XLB) – 7% allocation to PX – Neutral Rating
  5. Vanguard World Funds: Vanguard Materials Index Fund (VMIAX) – 5% allocation to PX – Dangerous Rating

Sam McBride contributed to this report.

Disclosure: David Trainer and Sam McBride receive no compensation to write about any specific stock, sector, or theme.

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  1. varadha says:

    Terrific, yet simple analysis. I’ve always been a fan of ROIC as a measure of capital efficiency and believe that no size/growth outperformance can replace the quest for efficiency.

    Sort of like a big gas guzzling v8 that needs ever increasing gallons of fuel to keep its engine running

  2. David says:

    But Angie’s $90 per user acquisition cost is going to go away. That’s what their approach probably is. How would their outlook be if that $90 cost dropped down to a total cost of $3 per user?

  3. David:

    That would be great, but cost per user acquisition is not something that’s very easy for a company to fix. ANGI can slash their marketing budget to the bone, but then they would stop acquiring new members. They would probably lose members in fact, as their membership renewal rate is at ~75% and declining. If they cut marketing expense by ~95% as you seem to be suggesting, ANGI might be able to eke out 1 year of slight profits, but they would start shedding members and losing money very quickly. ANGI’s only hope is to keep its marketing budget high and hope it can reach the scale and brand awareness to be able to sustain its business while scaling back marketing costs enough to turn a profit. The fact that ANGI’s revenue growth is slowing down even as its marketing costs keep increasing makes it very unlikely it will achieve that goal.

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