Air Products & Chemicals (APD) has offered about $60 per share for rival industrial gas company Airgas (ARG), plus the assumption of about $1.9 billion in debt.  The two Pennsylvania based companies have reportedly been in contact since October regarding a possible deal, and two subsequent offers were unanimously rejected by the CEO and Board of the smaller Air Gas.  In October, Airgas was trading right around $50 per share and the management team believed the offers of roughly the same amount as today’s offer undervalued the company.  APD was disappointed by the lack of flexibility in previous negotiations saying in a letter to Airgas, “In our prior correspondence, we clearly and repeatedly stated our flexibility as to both value and form of consideration, yet you have continued to refuse even to discuss our offers.  Your unwillingness to engage has delayed the ability of your shareholders to receive a substantial premium.”

Earlier this month, Airgas issued earnings guidance for fiscal fourth quarter 2010 of $.67 to $.71 cents per share, well below the $.74 that Wall Street had hoped to see.  Full year guidance was $2.66 to $2.70 versus analysts’ expectations of $2.77.  So, earlier this month the stock dropped more than 10% shortly after the cautious guidance, and of course APD hopes to take advantage of the recent weakness making their offer look more attractive.

Air Products & Chemicals is coming back to the board with an offer of $60 per share, which represents a 38% premium over yesterday’s closing price.  However, this bid should be more attractive to ARG because it is an all cash deal rather than the half cash half stock offer from October.  The bid was delivered in a letter to Airgas management, and it stated that they would entertain the idea of raising the offer if Airgas could demonstrate “incremental value”.  The potential for an increased bid or a competing offer has Airgas trading slightly higher than the offered price on Friday morning.  The letter also detailed APD expectations of $250 million in cost savings that the combined entity could see annually.  Were the two companies to merge, it would create the largest industrial gas maker in North America by revenue with fiscal 2010 sales expected to top $13 billion.

The two companies seem to be a reasonably good match, with Airgas specializing in packaged gases and Air Products & Chemicals focused primarily on bulk sales.  At Ockham, we have both stocks rated as Fairly Valued as the both are trading within their historically normal valuation ranges coming into the day.  We had Airgas rated slightly more attractively because of its consistent growth over the past few years, and the market has awarded it slightly less of a premium for a given set of fundamentals.  For example, APD trades at 1.96x sales per share while (coming into the day) ARG traded for .88x sales per share.  Price-to-cash earnings is a similar story although less extreme as APD commands 9.6x cash earnings per share versus ARG’s cash earnings multiple of 7.6x coming into the day.

Considering Airgas’ more attractive growth and valuation, we can understand why APD has been in hot pursuit of their cross state rival.  If the board rebuffs this offer, there is a good chance that Air Products will go straight to the shareholders in hopes of pushing it through.  Based on current fundamentals, our methodology suggests that this offer is a fair price and anything more would be stretching.

Steel Dynamics (STLD) has had a rough couple of weeks as the shares are trading 23% lower since January 8th.  On Wednesday. the nation’s fifth largest producer of carbon steel products reported net income of $26.7 million which equates to 12 cents per share and missed analysts’ estimates by five cents.  With that said, the company did grow production by 31% and topped analysts’ view of revenue which totaled $1.18 billion.  The company also lowered production costs 18%, but this was trumped by declines in steel prices.

For the year, revenue fell by 51% to $4 billion, and earnings per share showed a four cent loss.  However, analysts have projected a much stronger fiscal 2010 as they expect to see $1.37 per share in earnings, and the median price target is $22.75, a full 50% higher than the current price.  Steel Dynamics was able to greatly expand their tonnage produced in the last quarter while lowering production costs, but clearly these analysts’ projections are forecasting steel prices to rise as the global recovery continues.

Steel stocks have benefited greatly from hopes of recovery, particularly relating to resource hungry China.  However, there are growing concerns that both the Chinese and U.S. economies may not yet be out of the woods.  China’s GDP in the last quarter topped double digits which leads many to believe that their central bank will restrict the flow of cheap capital.  Furthermore, an executive for a Chinese steel producer recently said that domestic capacity is “reasonable” to meet demands.  In the United States, demand for steel used in building projects remains very weak, and continued trouble in the labor market dampens the perception of robust economic recovery.  For a stock like Steel Dynamics, which at one time had quadrupled from the lows, the renewed economic concerns are troubling investors.

As for the Ockham valuation, we continue to have an Overvalued stance coming into this week.  This stock had advanced well ahead of actual fundamental improvements, which is a key reason for the sell off today.  Generally, we look to find stocks that have seen their revenue and earnings grow but that improvement has yet to be reflected in the price.  With Steal Dynamics it is the inverse situation, so we believe there is still some downside risk as the price was being supported largely by sentiment.

“In Friday’s game plan, I told you to keep an eye on International Paper, which just reported its fourth quarter today. This manufacturer of all kinds of paper from loose leaf and industrial package and container board, is a fabulous indicator of the global economy’s health. Given the stock took a shellacking today, down 5.6%, you might think it’s signaling bad things about the recovery, not just its own business. Even with the tough decline, International Paper is up 4% since the last time we spoke to the CEO on September 25th. Then the stock was at $21.71.

What happened? Company earned 24 cents. That’s a penny better than Wall Street expected. It did have a 4 cent benefit from a lower tax rate. Some people would say it fell short of the bean counting analysts, what they were looking for.” — CNBC’s Mad Money 2/3/2010

Following the interview with International Paper (IP) CEO John Faraci, Cramer boasted that IP is currently the cheapest stock in the world and is “ready to roll”.  Of course, there is no way that this claim can be proven without the benefit of hindsight, but we beg to differ as we believe the current valuation is entirely fair.  Remember that the stock has nearly tripled in the last twelve months, and is about 6x higher than its lows for the year last March.  As Cramer mentioned they reported fiscal fourth quarter and full year 2009 results which at first glance appeared to be better than expectations.  However, the earnings beat was aided by favorable tax rates as sales were 8.7% lower than a year ago, and the market sold off in reaction.

Faraci noted that International Paper’s business is short-cycle and benefits from the initial signs of recovery, and that certainly seems to be the case for most basic materials bellwethers.  The first signs of recovery, no matter how faint, were about a year ago now (when we had the stock rated Undervalued) which somewhat explains the stock’s rapid rise.  Now, we are at the point where the market has rallied so strongly over the past year that current valuations are having a harder time being justified by the potentially slower than hoped recovery.  In our opinion, the past quarter was the weakest of their past year, and even the CEO himself admitted to being disappointed as his company, “left a few pennies on the table.”

At Ockham, we have the stock currently rated as Fairly Valued, and can think of many stocks that have a more attractive valuation than IP.  Cramer said that he has been following this stock for 30 years and believes the cash flow has never been more attractive.  We utilize cash earnings in our analysis which are reported earnings that strip out non-cash items rather than cash flow.  Our historical analysis shows that IP traditional trades for anywhere from 17.5x to 30.4x cash earnings, and the current price-to-cash earnings is within that range at 21.6x. 

IP has yet to start raising its dividend that was hacked when the company needed to conserve cash last spring.  Full year sales were down 5.5% from a year ago and the stock rose quite a bit last year, we think there are plenty of more attractive stocks for long term value investors.  Unlike Cramer, we found the CEO admitting sub-optimal performance in the last quarter a bit worrisome.  We would hold off unless the stock fell back down below $20, which would make the valuation far more attractive.

“…EQT is up a whopping 610% over the last 20 years, S&P is up 231%. I’m sorry, that’s truly incredible out-performance which is why I keep featuring these stocks.

EQT is one of the lowest cost producers of natural gas out there. With total production costs of $2.30 per thousand cubic feet, an average finding development cost of just $1.14 per 1,000 cubic feet over the last years…They can sell it for four times of that… EQT is also growing its production, up 19.5% year over year for the fourth quarter. 20% production growth for 2010. It’s a growth stock. Much of the growth comes from the shale in Appalachia where EQT is drilling like crazy.

The company plans to have 40 to 50 new wells in the Marcellus shale in 2010 and expects production to double for the year. This stuff is incredible. Thanks to the Marcellus that EQT’s proven reserves hit 4.1 trillion feet at the end of 2009, up 31%. The company also has a total of 26 trillion cubic feet of potential resources…” –CNBC’s Mad Money 2/1/2010

Cramer has crusaded on the behalf of natural gas a lot recently believing that domestic natural gas production could go a long way towards solving some of the difficult energy problems we face.  He is a proponent of using natural gas as a bridge fuel to transition the U.S. economy away from crude oil and coal towards greener alternatives which are not able to carry the load yet.  On Monday evening, he has brought forth yet another stock that he thinks could have huge upside when he interviewed Murray Gerber, CEO of EQT Corp. (EQT), formerly known as Equitable Resources.

He points to EQT’s solid out-performance of the broad market over both short and long term time frames, and the fact that production is growing at a very rapid rate as reasons to excite investors.  Furthermore, the company has successfully grown production while keeping costs low, which is a positive reflection on management.  Last week, the firm delivered an impressive earnings beat, earning 52 cents per share versus analysts’ estimates of 39 cents.  The market has started to take notice of this performance and the earnings report last week provided a catalyst to boost the stock about 7%.  Cramer, who is never shy about making a bold statement, said he wouldn’t be surprised to see this stock triple.

At Ockham, we cannot share the same optimism for EQT Corp. because our methodology already shows the stock is Overvalued.  We downgraded the company coming into this week, as it is currently trading above its historically normal valuation ranges.  For example, price-to-cash earnings is currently 18.3x, which is well above this company’s historical range of 9.5x to 17.1x.  Similarly, price-to-sales normally ranges between 2.3x and 4.1x, but at the current price level yields 4.7x revenue per share.  Cramer would argue that EQT’s growth accounts for the significant premium that the shares are being given, but current estimates show revenue declining slightly in fiscal 2010 (then a large bump up in 2011).

We share Cramer’s aspirations for increased usage of domestic natural gas, but it will take quite a bit of effort and some of that would surely be directed from Washington.  Right now it does not appear to be near the top of the political agenda, and may not be until something knocks us out of our comfort zone (geopolitical threat, spike in oil prices, etc).  At this point, we would advise waiting for a dip in EQT before it becomes an attractive stock for value investors.

“Look at one of our key export companies, Ultra Petroleum. This one a bit of a laggard lately, up only 15% since we had on the CEO…Companies like Exxon recently validated our vision on this show. Second, the company has a average working interest of 50% in Wyoming’s Pinedale Anticline, which despite of drilling delays and higher costs is moving forward.” — CNBC’s Mad Money 1/14/2010

Jim Cramer is nothing if not persistent and over the last few months he has constantly recommended stocks in the natural gas space.  His natural gas investment thesis has seemed to be justified with recent price appreciation in many of these companies and additionally some huge M&A activity from the likes of Exxon Mobil (XOM).  Cramer invited the CEO of Ultra Petroleum (UPL) onto his show in order to explain why the stock has lagged its competitors and how that will change soon.

Cramer expressed optimism for Ultra Petroleum’s new acquisition of a substantial amount of land in the gas-rich Marcellus Shale, and that purchase has yet to be reflected in the stock’s price.  XTO was a major player in the Marcellus Shale and obviously that was a key factor in Exxon’s decision to acquire them.  In addition to their growing exposure to Marcellus, they were able to increase production by 27% in the third quarter.  That sort of production increase made Cramer exclaim, “That makes it a growth stock with fabulous margins.”

The biggest problem with Ultra Petroleum is the current valuation, as the company receives our Fairly Valued rating despite its lack of appreciation recently.  As Cramer mentioned, UPL has been a high-flier over the past 5 years and 10 year time periods, although our price data shows far lower returns than he claimed on his show.  Still the numbers are heady, as UPL has grown 3400% in the last ten years (Cramer said more than 14000%). 

As we see it, the stock is still attempting to justify its former growth premium as a more mature company.  Normally when a stock has been valued so richly by the market in the past, its current valuation tends to look undervalued when compared to historical valuation multiples such as price-to-sales and price-to-cash earnings.  It is just the opposite for UPL and it is actually approaching overvalued territory based on our methodology.  We will need to see further improvement to fundamentals like sales and cash earnings before we start to look more favorably on this company.  Perhaps the new acreage in the Marcellus Shale will provide the fundamental growth that we need to see, but for now there are more attractive natural gas stocks.