Air Products and Chemicals, Inc. (APD) Earnings Call Transcript & Summary

Hey, good morning, everyone -- or actually, I apologize, good afternoon. This is Mike Sison with Wells Fargo. I'm going to conduct the fireside chat here with Air Products. On the line, we have Simon Moore, Vice President, Investor Relations; as well as Mun Shieh, Director of Investor Relations. I wanted to thank Simon and Mun for participating in our conference this year and everyone on the line for participating as well. I hope everybody is safe and sound. And if anyone would like to e-mail me a question, I'd be happy to get those on the line. My e-mail is [email protected]. So why don't we get started here. Simon, maybe you can quickly summarize sort of the impact of COVID-19 on how you, Seifi, Scott are managing the business near term and what you think maybe some of the changes you'll make to the strategy, if any, longer term because of the pandemic.

Well, great. Thanks a lot, Mike. I really appreciate the opportunity to participate in this conference, and thanks to everybody who's listening on the phone. We look forward to the day that we're all back live together, hopefully, sometime soon. But thank you very much. So a great question, Mike. Let me summarize this, and then I'll go into a few more details, is, to be blunt, we don't see a change in our long-term strategy. Seifi has laid out a clear long-term strategy for Air Products. We're focused on our industrial gas business. We're very excited about the capital deployment opportunities in the large projects around the world. We continue to see those large opportunities even as we work through these complicated times. And so we don't fundamentally see any change to Air Products' long-term strategy. A couple of things that we're focused on in the short term, as Seifi said on the call, again, to quote Seifi, the true character and leadership of individuals and companies is revealed during times of crisis, and he's very proud of the team at Air Products. A couple of things we've been very focused on at Air Products is safety. Again, consistent with our previously articulated strategy, we've always been focused on safety. We continue to be focused on safety, and particularly the aspects -- the newer aspects of safety by keeping our plants running, providing our people with the right PPE needs. So we continue to focus on that. We moved to a work-from-home environment, I think, as most people did very quickly in March, and we've been able to conduct business very successfully. We're able to close our quarter, close our books, conduct an earnings call. We were also able to raise $5 billion of debt last week, and we'll talk about that a little bit more. So we've been able to leverage our systems and conduct business very effectively from home. Very focused on the financial strength that Air Products has, the very high-quality of our balance sheet, the very high and stable cash flows, particularly driven by our onsite business. And that has allowed Seifi and the team to reassure our team that they should be comfortable with the financial security from our people, meaning that, as Seifi said on the call, we haven't laid anybody off or cut salaries as a result of the crisis. Looking after our customers. All of our plants, we've kept running. We were deemed a critical industry by most governments around the world as we supply critical products to enable manufacturing. And with a lot of hard work by the team, we were able to keep our plants running and keep our customers supplied. And finally, in this time, again, consistent with our long-term strategy, our relationships from the communities that we operate in are very important. So our teams have done some great work to install temporary oxygen systems to support the critical hospitals that were put together. We've made financial contributions around the world. We've donated equipments, and we've offered our talents to nonprofit organizations around the world. So again, none of those things are a new strategy. They are the impacts of this crisis and some things we've been focused on in the short term. Maybe just make a couple of comments on the business impact. Again, as we said, overall, we did not expect to see and did not see any impact on our onsite business. That was true in China, Asia and the rest of the world. In China, we saw our merchant business down pretty significantly, about 25% for about 6 weeks. But by the end of the quarter, by the end of March, that had pretty much returned to pre-crisis levels. During the quarter, we had very limited impact on Europe and Americas volumes. We really only started to see some impact at the end of March. And as we shared on the call, our April volumes in Europe, our merchant volumes in Europe were down about 25%, and our Americas merchant volumes were down about 15%, again, reiterating the point that our merchant volumes are going to be impacted by underlying industrial production kind of follow what's going on in the manufacturing economies, whereas the onsite business continues to be very stable. So again, as I said, no change to the strategy and excited about the capital deployment opportunities in large onsite deals, driven by the world's appetite and need for cleaner energy. And certainly, I'm sure we'll dive into a little bit, we've executed on one, but we do see perhaps a little bit of an increased interest by our customers and the opportunities for us to acquire industrial gas assets and turn those into long-term onsite deals.

Great. Thanks for the opening there, Simon.

Maybe can you talk a little bit about the onsite business? At 52% of your company, very stable. And just for the benefit of folks on the line, maybe describe why those are so stable. And I think, as you said last week, even if your customer operates fall, that your business will still -- you will still get paid and do well in that environment.

Great. Thanks. Good question. Let's step back and think about what creates this framework for the onsite relationship. And if you think about it, from a customer standpoint, in most of these cases, the customer has made a choice between building the plant themselves or outsourcing it to an industrial gas company, to Air Products. And so when you come on it from that standpoint, you can see that if the customer was to buy and build and operate the plant for themselves, they essentially would have to put out all the capital. So our discussion with the customer says, look, we're happy to do this for you. We're happy to build, own and operate the plant for you. We think the significant value creation in that for the customer comes from our operating expertise. We believe and, in general, customers support the idea that we will be able to run those assets at higher reliability, create more product availability for the customer, which will allow them to leverage their downstream assets, whether that be a refinery or a steel mill. So that's the value creation. And when the alternative is for the customer to do it themselves, we're going to say to the customer, look, we're happy to build this plant for you, but we can't go anywhere else with this product. There's no physical way to take this product to anybody else. We're happy to take the risks, what we say, within our fence line. So the construction cost of operating the plant, the operating cost of the plant, the reliability of the plant, those are risks that we're comfortable with and we're happy to take. But what we're not interested in taking is risks outside the fence line of the plant. So we're not interested in taking risks on the feedstock cost or availability. We're not interested in taking risks on the amount of volume the customer demands or the price of that may be. So if you really think of it as it starts from the idea of a customer outsourcing this critical need for them, our comfort level is the risk within the plant. And so you end up with a contract structure that, in most cases, has the customer providing a fixed monthly payment to Air Products regardless of the amount of product they take. And that concept is why we say that, as we look at the onsite business, and again, we saw it play out this quarter in China, in Asia, we really don't see an impact in our onsite business despite some of the economic challenges around the world. So as you pointed out, they tend to be very long-term contracts, 15 to 20 years. Very stable cash flows. When we say a fixed monthly fee, we typically have a small piece of that, that escalates to cover inflationary increases. But overall, hallmark of the onsite business is the very, very stable cash flows this business generates. And again, just a little bit of a proof point, as you saw last quarter, our Asia volumes were up 6% despite a negative 4% impact, driven by a downturn in the merchant business. And so you can see there was no way we could have delivered that volume growth without strong stability in the onsite business. So hopefully, that covers our view of the onsite business, Mike.

Yes. Thanks for that, Simon. Operator, there's a little bit of feedback. I don't know if we can mute the lines on that, but -- okay. Well, we'll just sort of move on here. Simon, on merchant volumes, can you just walk us through Europe? I think you mentioned on the call that they're down around 25%. Maybe a little bit of the difference between package and your base merchant contracts. And can you maybe talk about some of the end markets those are impacting in Europe?

Sure. Yes. Happy to do so. So again, the merchant business is an important part of Air Products business. We talk a lot about the onsite business because that's where the significant growth opportunities come from. Let me just emphasize that we are happy about the merchant business. We're going to continue to invest in and support the merchant business. We just think that in the long run, the merchant business is going to grow about what underlying industrial production will grow. So whatever you think that might be in the long term, that's where that business is going to grow. So in the short term, again, as we said on the call, in Europe, we saw the merchant business down about 25%. And yes, that was kind of a mix of maybe down around 15% or so on the liquid bulk side and about 40% on the packaged gas side. And as everybody knows, we do have a significant packaged gas business in Europe. And why is that? Well, fundamentally, I think the packaged gas business just generally tends to support the smaller customers, the smaller manufacturers who have a greater chance of being shut down when you have a situation like this. In terms of end markets, as we talk about, the merchant business really provides a broad spectrum of the manufacturing economy. Let me give you a couple of examples. If people are running a welding shop and they have 1 shift a day, and it's that type of basic manufacturing, it wouldn't be a surprise to see them shut down completely. So that would create 0 demand, if you will. Maybe at the other end of the spectrum is the demand for medical oxygen. And of course, nobody wishes we were in the situation we are in now, but the crisis has created an increase in demand for medical oxygen. Another application in the merchant business is food freezing. And food freezing is kind of interesting. If the customer is freezing food that is designed to support home cooking, well, guess what, their business is probably running pretty well. If the food freezing is to a customer who's designed to support restaurants, well, obviously, that demand has dropped off significantly. So I just shared a couple of the examples of the end market demand in the merchant business, and you can see why you have a variety of demand changes in that merchant business. And when you put it all together, we would say, overall, we'd expect that to follow the underlying industrial production or manufacturing. Then let me flip over and make a comment about the Americas. Although not fundamentally much different, again, we saw the Americas merchant business down about 15%. I think as everybody knows, we don't have a packaged gas business in North America, so the vast majority of that is liquid bulk. So it's actually fairly consistent with what we saw in Europe. And again, similar pattern, not much impact in the previous quarter, a little bit at the end of March and then down in April. And I recognize, we often get asked, what do you think the recovery is going to look like? And the real answer, to be honest with you, Mike, and others is we don't know. Again, the merchant business is going to be driven by that underlying manufacturing. It's certainly a positive sign that in many places in the world, discussions have certainly started and some actions have begun to be taken about restarting and reopening the economies. Obviously, that needs to be done very, very carefully. And we'll just have to watch and see what that -- what impact it has on our merchant business going forward.

Simon, I've covered the gases for quite some time. I remember the downturn in '08, '09, and also '01. Have you seen -- is this -- is sort of April what you're seeing in merchant historically the worst that you've ever seen? In addition, is it really going to -- is it really driven in terms of the recovery potential, whether these -- whether your customers start up? And if they do start up, when will you know? Is that something you'll feel right away given you're on their plant? And -- or does it lag a little bit?

Yes, great question. Again, around the merchant business, right? So the way this actually works, by the way, just to be clear, particularly on the liquid bulk side, on the liquid side, we'll actually own a tank at the customer's site, and that will be a cryogenic storage vessel. We will actually bring a truck in which delivers the product as a liquid. It's vaporized, and it's used by the customer. So in normal times, the customer doesn't actually order product from us, if you will. We have a telemetry system on the tank which will notify our systems that another order is needed, and we'll schedule that within our system. So that's kind of how the normal course of action works. And the reason I share that is, let's say we had a customer who is running 2 shifts a day and they drop back down to 1 shift a day, they might not even necessarily call us, but we can just tell from the telemetry system that there's a lower demand, a lower draw on the tank, and we'll adjust accordingly. If a customer is literally going to shut down their facility, they will typically let us know just to make things simpler. And when they're planning to restart, they'll probably give us a call. But it's probably fair to say that we have many, many, many customers in the merchant business, particularly on the packaged gas side. So I'm not sure we always have tremendous insight into exactly what their plans are. So whether it's customers restarting from a full shutdown or turning back up their operation or not, we'll certainly be available to supply our customers as they need, but it's pretty difficult for us to make an assessment of what the shape of recovery is going to look like at this point.

Right. And then you did give us some sensitivity in terms of earnings. I was hoping maybe you could just share that with investors real quick. And then what do you think the incremental margin is? Would it be better than the decremental that you've talked about? You may take some costs out of the system, so on and so forth. Or will it be sort of in line with what the decline would be?

Yes. Great question, Mike. So let me just provide that -- go over that again. So what we said is, if you look around our business, a little bit more than half of it is the onsite business, which as I said and we said on the call, we expect to be very stable. We talked about our merchant business in Asia essentially returned to pre-crisis levels. So if we take a look at what's left, and again, that's the Americas and the Europe merchant business. So we wanted to provide a sensitivity for people. We don't know what's going to happen in the economy this quarter or next quarter, but we think that the folks on the call and other folks out there have a view of this. So if we had a drop in merchant demand in Americas and Europe for a whole quarter of 25%, so again, that would likely be something close to a 25% drop in manufacturing industrial production. So drop in those 2 businesses, America and Europe merchant for a whole quarter, a 25% decline would impact our EPS by about $0.30 to $0.35. So the reason we wanted to share that was we wanted to provide a way for investors who have a variety of opinions about what's going to happen in the underlying economy to be able to translate what does that mean to Air Products. And you can have a view of a V, a W, a swoosh, whatever shape of recovery you think is going to happen, hopefully, that framework allows investors to think about that a little bit as we go forward. And so again, hopefully, that's helpful and reinforces the stability of the onsite business.

Great. Thanks, Simon. I wanted to shift a little bit of gear -- shift gears a little bit, I apologize. Your backlog, your projects, these have been areas of good growth for you. I think there might be a little bit of misunderstanding on coal gasification as it relates to falling oil prices. Your coal gas projects are basically won. And then longer term, you have a couple -- I think 3 coming on '22 to '24. So maybe step back a little bit, talk about gasification. Jazan, as you noted on the call, has no impact with oil for what it's worth. Well, I mean I'll let you explain that. And then why is gasification still a good long-term potential for you at any oil price?

Yes. Great question. So as you said, let's take gasification. Let's step back for a little bit. Forget our products involvement in gasification for just a second. Let's talk about why does the world want to gasify products? Why are countries and large companies and state-owned entities around the world interested in gasification? Well, the answer is, it's a technology, it's a process that allows them to utilize the natural resources that exist in many countries and do it in an environmentally friendly way that creates a flexible product. So what this really means is countries around the world that have large resources of coal that maybe don't have as much oil or natural gas can use gasification to take that coal, create syngas, and then from that syngas, create transportation fuels and various types of chemicals. So what we have is a situation where -- the reason China's 13th 5-year plan emphasized the positive aspects of gasification is what we just said. It allows China to utilize the natural resource coal that China has in abundance, do it in a more environmentally friendly way and create transportation fuels and chemicals that are very much needed to support the growth in China. But it's not just a China story. We have a similar situation, see similar opportunities, as we said, around the world, places like India and Indonesia where the countries are fundamentally looking for the opportunity to take advantage of the coal resources that they have. So that's one aspect of gasification. Another exciting aspect of it is the opportunity to gasify the bottom of the barrel. In the case of the Jazan project in Saudi Arabia, it's the vacuum resid. It's the heavy bottom of the barrel kind of the nasty stuff that's left over after the good stuff has been taken out. And as the world becomes more and more environmentally focused, the value of that bottom of the barrel shrinks. So the opportunity of what am I going to do, what does a refiner going to do with that bottom of the barrel? They can put it in a coker and make pet coke out of it, but now I've got a big pile of pet coke, I got to do something with it. So I either take that heavy liquid bottom of the barrel or the more solid pet coke, and I can gasify that. And again, I create syngas, which is a very flexible product, which can be made into, in this case, in the case of the Jazan project, power. And again, can be made into -- the syngas can be made into transportation fuels or chemicals. So everything I just told you has nothing to do with Air Products. That's why the world continues to be very interested in gasification. What we've done is we've gone to the customers who are looking at the gasification project, looking at a coal-to-chemicals project or a vacuum resid-to-power project and said to them, look, just like you've gotten comfortable outsourcing your hydrogen requirements or your oxygen requirements, why don't you think about the idea of outsourcing your syngas requirements? And we'll own and operate the ASU, the gasifier, the syngas cleanup for you under this onsite business model. Mike, this goes back to one of the things we were just talking about a few minutes ago, the long-term solid cash flow nature of the onsite business model, that's how we're doing this. We're taking this business model that's been very successful for us into the gasification market. So specifically, what that means is the customer pays us this fixed monthly fee, and we own and operate the assets for them. So from a contract structure standpoint, we don't have any involvement in the cost of raw materials. We don't have any involvement in the price or the volume requirement of the end customer. We get paid a fixed monthly fee. So as a result of that, Air Products clearly has no exposure to whether it's oil or chemical or coal prices in these projects because it's our onsite business model. Now in terms of what do our customers do as the prices of these products in the world move around a little bit, our experience is they continue to run hard. We just saw this in the last quarter in China. If we go back a few years ago, when oil dropped to $30 or $40 a barrel, we weren't really involved in the gasification per se market then, but we were supplying oxygen to customers who were running their own gasifiers, and we saw them continue to run hard. So if we look at the existing plants that are in the ground, we would have expected to and have absolutely seen them continue to run hard. We're protected by our onsite contracts. If we look at the projects in the backlog, like you mentioned, that we're in the process of executing, it's full speed ahead on those projects. We're not seeing our customers slow down or ask us to delay their projects or anything like that. And then the third bucket is potential projects that we're working on. We continue to see people pushing forward with their interest level in gasification projects. So these are multi-decade, multibillion-dollar, long-term strategic decisions by countries, large companies around the world. And we absolutely believe and, more importantly, we continue to see these folks be very interested in gasification going forward. So that's one of the reasons why Air Products is so excited about this has been -- continues to feel very, very good about the capital deployment opportunities in gasification as well as other areas.

Great. Thanks, Simon. And then I think what's interesting, the PBF hydrogen asset acquisition, I think you talked about maybe more asset acquisitions potentially in your opening remarks. Can you maybe talk about -- I think a lot of folks worry about refining industry now with oil prices. Why does PBF deal makes so much sense? Maybe talk about what you look for in a refinery. And then are there other opportunities with other refiners as well as maybe other industries? Are there ASUs out there that people would like to sell to raise some cash during this environment?

Yes. So this goes right back to the place you started, Mike, which is wonderful, which is Air Products hasn't changed its strategy as a result of this. We had a strategy that included the opportunity to do these asset acquisitions. We've done some over the last few years, but quite frankly, what's happened in this crisis is some of those customers that we've been talking to have become a little bit more interested. As Seifi said, and in terms of PBF, they're a valued customer of ours. They're a large customer. We have an ongoing discussion, relationship with them. We've known they've had these 5 hydrogen plants for many years. We've talked to them about it. They know that we're interested. As Seifi said, we happened to make a proposal to them last October. And they didn't say yes, but they didn't say no. Maybe it wasn't the highest priority for them. And then obviously, the world got a little bit more complicated, and they saw this as a great opportunity. But it's not like, hey, there's a crisis, PBF has a challenge, they're looking to sell assets, and they call us. We've been working with them for a long time about this. And that's just one example. There are other companies out there who have assets that we're aware of, that we're interested in, that we've talked to them over the years about. And as Seifi said on the call, we're having a number of interesting discussions that could result in additional asset acquisitions. Obviously, we don't know until we get a final deal, but we're happy to utilize our very available amount of capital to support these projects. It's another great example of the onsite business model. We're very cognizant of who the customers are that we're doing this business with. We take a very good hard look at the credit quality of the customer, but as equally as important, we take a good hard look at the quality of the asset we're serving. So whether that be a refinery or whatever the asset might be is, what's the quality of that asset? And particularly, if we look at the PBF refineries, particularly the 2 refineries in California, we feel very, very good about those refineries' operations in the long term, and that's why we're comfortable to do these deals. So again, asset acquisitions have been part of our strategy. Perhaps the current environment creates more of these opportunities, and we'll see where that goes.

Great. Thanks, Simon. And then last couple of questions here. Can you maybe help people frame up your earnings growth sort of formula over the next -- you sort of have a formula to grow 10%-plus. And then when you think about the impact of COVID in 2020, what's the best way for investors to rebuild the earnings power of Air Products post what's likely going to be a more difficult year than we thought?

Yes. Great question. And again, I think maybe 2 parts of that point about shareholder returns. I mean, obviously, we're looking to grow EPS over the long term, greater than 10% a year. We delivered on that over the last 5 or 6 years, growing at about 13% average. We want to complement that EPS growth with a robust dividend payout. As folks know, we've raised the dividend every year for 38 years. As Seifi said on the call, there's never a question at Air Products about will we raise the dividend? The only question is how much will we raise the dividend. And of course, the Board will take that under advisement next year with the next opportunity. So we want to complement the EPS growth with returning roughly about half of our investable cash flow, is where we're at now, as a dividend. So then back to the earnings growth, I mean, obviously, we'll have -- going to have to see what happens this year. But I think you have an appreciation that it's the merchant side of the business that creates some of that variability in the short term. And you'll have to think for yourself about how you believe that's going to recover. But we absolutely feel good about the long-term capital deployment opportunities. You know the projects that we've got laid out, when they're expected to come on stream. The Jazan project is a very, very large project. As Seifi said on the call, we expect to reach financial closing of that in October of this year. When we do that, we'll begin to get paid immediately on that project. So that should create a significant earnings tailwind for next year. Another part of the business that we haven't talked about yet today is our LNG business. As folks know, we supply equipment to the LNG projects around the world. We've got 2 large projects that we're working on right now. Air Products has a very leading position in supplying the heat exchangers to these LNG opportunities. So we'd anticipate that being supportive of earnings growth over the next few years as well. So perhaps not as specific as a framework, but a recovery in the merchant volume, growth from the onsite business and a tailwind from the LNG business over the next few years.

Great. Thanks, Simon. There's about 30, 40 seconds left. I just wanted to thank you and everybody on the line for listening. If you have a quick closing remark, we can end with that.

Mike, we appreciate the opportunity. And as Seifi said, we're very, very proud of our team over this last difficult times that stayed safe, kept our plants running, supplied our customers and were helpful in our communities. So very, very proud of the great team at Air Products who has delivered in this past quarter and will continue to deliver into the future. Mike, again, thanks a lot for the opportunity to be here today, and thanks for everybody being on the line.

Great. Thanks, everyone, and be safe. Have a good day.