Industrial Gas Companies

Industrial Gas Companies are businesses that manufacture and distribute essential industrial gases—such as oxygen, nitrogen, argon, hydrogen, and helium—to a vast array of industries. These aren't the companies filling party balloons; they are the invisible backbone of the modern economy. Their products are critical inputs for processes ranging from steel manufacturing and semiconductor fabrication to food preservation and hospital life-support systems. The business model typically involves producing these gases through processes like air separation at large, capital-intensive facilities. They are then delivered to customers through one of three main channels: high-volume pipelines directly to a customer's site, cryogenic tankers for bulk liquid delivery, or smaller, high-pressure cylinders. This operational structure creates a business with high barriers to entry and, for the best operators, a very durable competitive advantage.

At first glance, selling air might sound like a joke. In reality, it's a sophisticated, high-tech, and often highly profitable business built on physics and logistics.

The core of the business is the Air Separation Unit (ASU), a massive facility that cools air to cryogenic temperatures (-196°C / -320°F) to liquefy and separate it into its core components. Building an ASU requires immense capital expenditures (CapEx), immediately creating a significant hurdle for new competitors. Once produced, the gas has to get to the customer, and the method of delivery defines the customer relationship and profitability:

• On-Site: For very large customers (like a steel mill or refinery), the gas company will often build a mini-production plant right on the customer's property. This is governed by a very long-term contract (typically 15-20 years), creating an incredibly sticky relationship and predictable cash flow.
• Merchant (Bulk): Mid-sized customers are supplied with liquid gas via specialized tanker trucks. The key to profitability here is route density—the more customers you can serve on a single delivery route, the lower your transportation costs per unit, creating a powerful local economic moat.
• Packaged Gases: The smallest customers receive their gas in high-pressure metal cylinders. This is the highest-margin part of the business, often run through a local distribution network.

The beauty of the industrial gas business is its incredible diversification. These companies are not beholden to the fortunes of a single industry. Their customer list is a “who's who” of the global economy:

• Manufacturing & Metals: Oxygen for steelmaking, argon for welding.
• Healthcare: Medical-grade oxygen for hospitals.
• Electronics: Ultra-pure nitrogen for creating the sterile environments needed for semiconductor manufacturing.
• Food & Beverage: Carbon dioxide for fizzy drinks, nitrogen for modified atmosphere packaging to keep your salad fresh.
• Energy: Hydrogen for refining crude oil.

This wide diversification means that while they are sensitive to the overall industrial economy, a downturn in one sector can be offset by stability or growth in another.

For value investors like Warren Buffett, industrial gas companies are a classic example of a “boring” business with extraordinary economics. Their strength lies in their powerful and durable economic moats.

The competitive advantages enjoyed by the major industrial gas players are formidable and multi-faceted.

• High Switching Costs: If a gas company has built an on-site plant at a customer's factory, the cost and disruption of switching suppliers are astronomical. The customer is effectively locked in for decades. Even for bulk customers, switching can involve new contracts, new storage tanks, and technical validation, making it a pain they would rather avoid.
• Economies of Scale and Capital Intensity: The sheer cost of production and distribution networks means only a few large players can compete on a global or even regional scale. This naturally leads to an oligopoly where a few firms (like Linde plc, Air Liquide, and Air Products and Chemicals) dominate the market.
• Route Density: This is a crucial, underappreciated moat source. In a given city or industrial park, the company with the most customers can operate its delivery trucks most efficiently. A new competitor would have to burn cash for years to build up a similar customer density, all while losing money on every delivery.

When analyzing an industrial gas company, here are a few key things to keep in mind.

• Pricing Power: These companies sell an essential, non-discretionary product that is often a tiny fraction of their customer's total costs. This gives them the ability to pass on increases in their own costs (mainly electricity) to customers, protecting their profit margins.
• Return on Capital Employed (ROCE): Because the business is so capital-intensive, Return on Capital Employed (ROCE) is a critical metric. A high and stable ROCE indicates that management is investing shareholder capital wisely and generating strong profits from its assets.
• Stable Margins: Look for a long history of consistent and high operating margins. This is the clearest sign of a strong competitive advantage at work.

• Economic Cyclicality: While diversified, the business is not immune to a deep global recession that hits all industrial sectors simultaneously.
• Energy Costs: The air separation process is incredibly energy-intensive. A sharp, sustained spike in electricity prices can squeeze margins if the company is unable to pass the costs on quickly enough.
• Capital Allocation: Management must be disciplined. Pouring money into low-return projects can destroy value and weigh on free cash flow.