Inflation, the old villain of market economies, is back on Wall Street’s radar. Broadly followed price gauges are hovering at around 5%, well above the Federal Reserve’s 2% conventional target, raising the prospect of higher interest rates. That’s a bad thing for listed shares, as higher interest rates make alternative investments more appealing.
In addition, higher inflation raises the cost of producing goods and services, undermining the bottom line of listed companies. However, there are exemptions to this rule: companies that operate in an oligopolistic environment, and therefore, have the power to pass on the higher costs to consumers. These companies can maintain a solid cash flow that can be used for dividend hikes and share repurchases. Linde plc. (LIN) is one of these companies. (See Linde stock charts on TipRanks)
A Global Industrial Giant with Little Competition
Linde is a global industrial gas giant that has little competition in products with inelastic demand, which means that the company has strong pricing power in good times and bad times and can offset rising costs on the supply chain.
Last week, Linde reported Q2 2021 income from continuing operations of $840 million and diluted earnings per share of $1.60. That’s an increase of 84% versus the prior year. Excluding Linde AG purchase accounting impacts and other charges, adjusted income from continuing operations was $1,415 million, up 41% from last year and 8% sequentially. Likewise, adjusted earnings per share were $2.70, 42% above the prior year and 8% higher sequentially.
Linde’s strong performance is driven by a strong pricing cycle, which boosts profit margins and free cash flow.
On August 1, Deutsche Bank analyst David Begleiter raised the price target on Linde to $350.00 (from $345.00), and maintained a Buy rating. He noted that Linde benefits from the “industry’s best pricing cycle in a decade,” and is also helped by the recent inflation trend.
The analyst continued his praise for Linde, mentioning that the company had raised prices in the Americas, Europe, Middle East, Africa and Asia-Pacific.
Wall Street analysts are bullish on Linde’s prospects. The 15 Wall Street analysts following Linde see its shares reaching $343.41 over the next 12 months, with a high forecast of $387.32 and a low forecast of $293.43. The average Linde price target represents a 12.12% change from the last price of $306.30.
Societe General highlighted the company’s high margins and cash flow as the main drivers for bullishness. Indeed, Q1 adjusted EPS rose 32% to $2.49, and adjusted Ebit grew 25% year-over-year to $1.688 billion. In addition, Q1 operating cash flow was $2.109 billion. Free cash flow rose 148% to $1.347 billion, representing 18.6% of sales. As a result, the operating cash flow ratio to Ebitda was 87%, above the five-year average of the mid-60s.
Moreover, since Linde merged with Praxair, Inc. in 2012, it has raised its dividend every year, thanks to solid free cash flow. Shareholder income can be protected from inflation by this dividend, thanks to strong cash returns.
Additionally, Linde’s $5 billion share repurchase program, which was announced on January 25, can provide even more downward protection, if the value of the company’s shares drop, thanks to higher inflation.
Summary and Conclusions
Rising inflation can be a big problem for Wall Street, as listed companies with little or no pricing power are likely to pass on their rising costs to consumers. That is not the case for companies with plenty of pricing power, such as Linde. Operating in an oligopolistic environment, the company can raise its prices to beat inflation, maintaining high-profit margins, which translates to strong free cash flow that can eventually boost shareholder value.
Disclosure: The author owns shares of Linde.
Disclaimer: The opinions expressed in this article are solely those of the featured analyst. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.