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

Good afternoon, everybody. This is Bob Koort at Goldman Sachs. I head up our U.S. equity research effort on the chemical space. And thanks, everybody, for joining us today. I've also got from my team, Dylan Campbell, who works with me covering Air Products. The format of the discussion, there will be a Q&A, where Dyland and I will be asking Seifi Ghasemi, the Chairman, President and CEO of Air Products questions. But as clients of the firm, you'll also notice in the web portal, there is a spot where you can submit questions that we're happy to ask as well and frankly, prefer that, so don't be bashful. We'll put our clients' questions first. But we certainly have 35 minutes of good questions to ask if you don't.

Without further ado then, let me ask Seifi to join us. And maybe Seifi had a very big announcement or maybe 2 today on an Indonesian coal-to-methanol plant and an agreement with Haldor Topsoe on some technology. Can you maybe tell us exact what's going on? And why you're so excited about it?

Bob, thank you very much, Bob, and good afternoon to everybody who is on the line. It's great to participate in the meeting. Bob, you are asking me an excellent question. We are obviously very excited about the projects that we announced today. We have been working on this project for 3.5 years. And the way I look at it is that, number one, it's a validation of our strategy about gasification, that look, gasification is not just about doing projects in China. I've been saying very clearly to the customers that look opportunities exist in other parts of the world. And this is all about national security and converting indigenous coal reserves to finished products that can be used in the country. And the timing is actually validates the theory and the strategy in the sense that people do these -- will do these projects even at when the oil price is $20 a ton. The second thing is that the way we have structured this business, please, just to make sure that there is no confusion, Air Products is not getting into the methanol business. We are going to get the raw material from our partners in Indonesia, and we are converting it to methanol but we are not in the business of selling methanol. We are going to get a fixed fee for doing this thing, like we do when we supply hydrogen to Exxon or like when we supply oxygen to U.S. Steel. So it is still our business model. The benefit of doing it like this, the way we have done it, is that can you imagine if our -- if the partners in Indonesia wanted to do this thing the standard way, they would have to get somebody to supply them oxygen. Then they would get a FEED study to do the feasibility. Then they would have somebody to build them the gasifiers, then they have to have somebody to do the cleanup, then they have somebody else to do their methanol plant. And all of this would add cost at the construction side, you'll have 5, 6, 10 different contractors and all of that. And then they have to go finance this way. What we are doing, and our strategy has been based on this thing, fundamentally, is that we are a one-stop shop. You give us coal. We have the technology and the know-how to do the rest of it. We'll build the ASUs to supply the oxygen, we'll build the gasifiers because we have the technology. We've built the methanol plant for you because now with the agreement that we have with Haldor Topsoe, we have that technology. And therefore, you get the methanol and then you go sell the methanol. So it becomes a one-stop shop, and then it reduces -- this is the important part. It reduces the total cost of the project, of the conversion. And therefore, you can produce methanol at a very competitive price. The way we are structured, we can produce methanol even in the United States of America, using petroleum coke cheaper than you can do it in natural gas. That is what our business model is capable of delivering. And that is why we are successful in doing these things, and that is why we have been able to sell this thing to the government of Indonesia and to the parties here. And I wish some of you were able to join us for the virtual signing that we have of this project yesterday. On the call, on video conference, there were 4 of the ministers, the senior ministers of the Government of Indonesia and General Luhut, who is the Coordinating Minister, almost acting like the Prime Minister, he made a beautiful speech about why this project, why it is a national security thing, why are they doing that, why is it that they have always been trying to do these kind of projects, they've been not successful because it was fragmented and how much they appreciate the Air Product business model. So that is why we are excited about this thing, and we think this is a winning business model, and you're going to see us do a lot more projects like this around the world. Because it is fundamentally making -- converting raw material, which has very low value to chemical, which has a lot of high value, and it makes people independent of importing basically oil. So that -- in general, that's what I wanted to say, Bob, but obviously, I'll be more than happy to answer any other questions you have.

Yes. Obviously, very exciting stuff. I don't know how much gasification -- coal gasification's gone on in Indonesia to date. Certainly, there are dozens and dozens of those kind of facilities, gasification of coal in China. But is Indonesia as far along? And is this the first of what could be several opportunities in Indonesia? And/or where else are you looking beyond Indonesia and China for coal gasification?

This coal gasification in Indonesia is the first of its kind. This is a landmark project for Indonesia. And I think once we get involved and we do this project, other people will be very interested. Indonesia imports a lot of DME that one can make from coal. Indonesia needs a lot more methanol to put the methanol in the gasoline stream. So we are optimistic about other opportunities. But then another country, which obviously has a lot of coal and it's not doing a lot of coal gasification is India. And we obviously are working there to try to develop projects and any other country. But in addition to that, this gasification is not just about coal. It is -- the gasification technology is about bottom of the barrier from the refineries, the high sulfur content, which is the basis of our huge project in Saudi Arabia. Gasification is about taking petroleum coke which is going to be a difficult thing to sell for the refineries to their end users with 6% sulfur petroleum coke, gasification is a solution for that. So fundamentally, gasification is a technology that you can take raw material, which is very difficult to process, do it in a clean way and produce syngas from which we can produce all kinds of chemicals. So the opportunities are all over the world, and we have the technology. And now we have a complete set of technologies with the ASU with gasification with GE and Shell. And now we have the technologies for ammonia, methanol, DME and all of that with the agreement with Haldor Topsoe. So as a result, we have the whole thing covered.

Seifi, I'm pleased to say our clients are quite proactive. You got a bunch of questions here all around some of these issues. Maybe the first one, you've historically talked about a 10% EBIT return on your capital investment. Can we assume that the Indonesian project will meet or exceed that hurdle?

The Indonesian project will exceed that target. And the numbers that we are giving you is, we say 10% internal rate of return that converts to approximately $0.10 of operating income for every dollar of investment. But please also know that, that means at least 15% on capital employed, which is the target for the company. That is another important thing to keep in mind. The project in Indonesia, the way we have done it, if we complete it successfully with what we have said, it will have returns better than the 10%.

And there's a question, I guess, more broadly on the gasification of coal. What are the environmental impacts and considerations of these kind of projects?

Well, if people are referring to the CO2, please note the way we have structured this thing. The CO2 belongs to the people who own the carbon. We don't own the coal. We are processing the coal. So the responsibility for any CO2 and any tax or anything else that might come later is with the customer. We don't own the coal. We are not taking the coal out of the ground, and we are just processing it. It's just like if you put the coal on a ship and the ship delivers it to another location, then the ship owner is not responsible for the coal producing CO2. So that is the small thing that we have put in these things that we don't own the coal. We are not buying the coal. And even with our projects that we are doing in the U.S. in the old times, and Air Products did a hydrogen plant, they could buy the natural gas and then charge it to the customer. But buying the natural gas then you own the CO2, and then people would say that you have to report the CO2 because you owned it. But we don't do that. We just are processing this thing. We don't own the carb, so we are not responsible for the carb.

There are a couple questions inquiring about your Jazan project. So I was wondering, firstly, maybe if you could give us an update on it? How close you are to closing and finalizing it? And is there any risk or angst around what lower oil prices might mean, if anything, for that project?

Bob, thank you for the question. There is really no change to what we gave -- we told the people at the end of April during our results announcement. We have completed all of the agreements with Saudi Aramco. There's a huge amount of -- that's almost -- I said I'm not exaggerating, but I say, it's almost 5,000 pages. And that agreement has been given to the lenders' legal adviser. Because the people who are lending us, they have an adviser to take a look at these contracts and have their own view of what these contracts mean. That review is scheduled to be finished by the end of this month. And then after that, we will go to the market to raise the money, considering the complexity and all of that, it is going to take 2 or 4 months to do that. And we expect to complete the signing by the end of -- sometime in October. In terms of any risk with low oil prices, quite frankly, the lower oil price is, the Saudi Aramco will be more interested to get their hand on the $1 billion. So that actually works in favor of the push to close this thing rather than the other way around.

And I'll get quite a clever client who's asking around specifics on the quality or type of coal in Indonesia. And if that requires any technology adjustment in your GE or Shell technology that you've got?

Bob, they are asking a very good question. The coal that we are going to use is going to be the blend of several mines in order to improve the quality. But the great thing is that the technologies that we have with Shell and with GE, we are able to process high-ash coal. And so we can actually process up to 40% ash coal. So therefore, we have obviously studied that. We have studied that with our customers and all of that, and they are fully aware of that, and we don't see any risk in that. And we, obviously, have samples of the coke and all of that -- of the coal and all of that. As I said, we have been working on this project for close to 3 years.

And Seifi, does the methanol produced in that project get blended in the gasoline? Or is it used to make DME? Do you know or does it matter to you?

Well, it doesn't matter. But right now, the intention currently, I believe, is for the customers that they think that there is a ready market for it -- for blending it into the gasoline stream. But at some point in time, somebody can decide to take that and go one step further and convert it to DME. But the demand is huge. And if somebody wants to do that, we would advise them that well, why don't we have another project where we build the duplicate of this and make DME.

Is there any update -- question asking of any update on the YK project. Where that stands or what the hurdles might be to progressing that project?

Well, that project status is the same as what we said at the end of April. We have given the -- our investors a deadline that by October, we either will kind of announce that, that project for us is a go-ahead or not. As I have always said, the issue is the issue of coal supply. And we will not proceed with that project unless we are assured that there will be coal allocated to that specific project. Those issues are supposed to be resolved, then I was going to go to China in March, but obviously, I didn't, and we are still talking to the customer about that. And I'm sure we will resolve it one way or another by the end of October. And please, in the numbers that we have given you, we have made a -- right now, with this project, we are -- have a backlog of more than $14 billion. So that's only $1.6 billion of this. It's not even if that project gets canceled, it doesn't change our story that much.

Seifi, this is Dylan Campbell on Bob's team. You guys have a unique advantage point to get a really good real-time indicator in terms of demand trends across the world. I love to just quickly grab your thoughts on kind of what you're seeing in terms of industrial demand on a regional basis and kind of how that's trended into May here from April levels?

Sure. As we said, we usually don't get into that detail in the middle of a quarter, but I understand these are different circumstances and the investors are very focused on that. So I'll be happy to give you an update. On the 25th of April, we told people that the way we see things is that in -- during the month of April, up to that time, our business in China was back to pre-crisis level and actually, with some of the products we are ahead of last year. That has -- is still is the case. We see that in the month of May, China has gone back to normal. Our people are going to their offices. Our customers are taking the product. And still, as I said, they are back to normal levels and actually some products higher. In Europe, we said that we see our merchant volume being down 20% -- 25%, and that is still the case, about 25%. And the reason that it is 25% is obviously because we have a lot of exposure to packaged gases business in Europe. Our on-site business in Europe is holding up very well, but it is just the merchant business, and it is mainly the packaged gases business, which is down significantly, which makes the whole merchant business in total about 25% down. In the U.S., we said at that time that our business -- our merchant business in the U.S. was down 15%, and that continues to be the case. And again, I want to stress people say, well, what's the difference if Europe was shutdown, U.S. was shut down, why are you down only 15% in the U.S. versus 25%? And the answer to that is that we do not have a packaged gases business in the U.S. and therefore, it's only our merchant business, which is -- which is not in cylinders and all of that. That's why we are lower in the U.S. than in Europe. That's where we are as of right now.

That's helpful. And I guess -- I mean, for investors that are on the call, that are probably less familiar with your business model, can you just kind of walk through the defensive business model that Air Products has? And how that may insulate you from much of the volume weakness, maybe outside the package gas business, but more so on the on-site business side of things?

Sure. Thank you very much. We have always said during the year that Air Products is a very good defensive stock. Because during the times that you have a crisis, our bottom line doesn't dip as much as other people. That is holding up to be true because our business about 52% of our business -- 52% is our on-site business, where it is contracts that is more than take-or-pay. It's not as if the customer says, okay, you produce 1 ton and give you, they are fixed fee. So we'll get the fixed fee, whether the economy is up or down. This is why we like the on-site business so much. That's why the project in Indonesia is an on-site project. That's why we like these projects. So 52% of our business around the world is on-site. And that business has held up very well in the first quarter, and it is holding up in the month of April and May. So we don't have too many issues with that at all. The other part of our business which is about the other 48% is our merchant business. But out of that 48%, you have China that is holding up pretty well. So if you take out of our total sales, our exposure to significant economic impact in Europe and in the U.S. is about $3 billion a year. So we kind of -- the way we look at it, we say that $3 billion is $750 million a quarter. So if you assume that on the average, that is down 20%. Then it is -- for us, it is $150 million of sales. The margin on that business is about 50%, so that's $75 million. And therefore, that's around $0.25 per quarter. That's how you can look at it in terms of the impact. So really, 70% of our business is right now is insulated from the current crisis.

That's helpful. And I guess for the on-site of things, can you give a little bit more detail in terms of -- I think in the past, industrial gas companies have talked about minimum volume commitment and then some opportunistic sales kind of above that minimum volume commitment. Is that still the case? Or has that changed to some degree in terms of that analysis?

Well, I'm not sure, I really support that characterization of our business. When we build the plant, a hydrogen plant or an on-site plant for a customer, we charge them a fixed fee. So if they use 100% of the demand -- their demand, we charge them $10. And if you use 50%, we still charge them $10. And if you use 10%, we still charge them $10. So I don't want to characterize our business in the sense that but if it goes down -- if it goes some down, and I've heard people talking about 70% and so on. I don't know what other people are talking about, contracts or the way that I described.

Seifi, there is a question, maybe it dovetails with that. The refining industry is obviously on some pretty rough times in the short run. Does that suggest there isn't that much collateral damage to your hydrogen business because of that? Or is there some pressure there?

I think what you said is accurate. There is not much of a collateral damage on our oxygen business.

Could we move to -- outside of the volume side, how about pricing? The industry has been on a pretty good run here in the last couple of years. Can you talk about pricing and the sustainability of continuous pricing for this industry?

Well, as you know, we are very, very reluctant to talk about pricing. I can always -- I'll be happy to talk to you about what has happened with pricing in the past. But in terms of any kind of opinion about what will happen to the price in the future, I shouldn't talk about it. I cannot talk about it because of the nature of our industry and all of that. And we just -- we should stay away from making any comments on that. But I can talk to you about the fact that you saw our numbers for the first quarter. And for our merchant business, we had 6% in Asia, 5% in Europe and U.S. So those are the things that has actually happened. Now for the next quarter and next quarter, we'll see what happens. But I really should not make any comments about future pricing trends.

Got you. Maybe we can turn over to the capital allocation. Couple questions that have come in. Maybe first, your CapEx has escalated more recently into the $2 billion range. And what should we think about future CapEx maybe over the next several years?

Well, the thing is that we keep telling people that we -- I mean, in 2018, we told people that we are going to deploy about $15 billion in the next 5 years. So that by itself says that our capital expenditure is go to about $3 billion to $4 billion a year. And that is what I expect. Because how else are we going to deploy the capital? We see opportunities. We see significant opportunities for us to invest. We do have the cash. We have the capability. We have the organization. We have the projects, we have the technology. And I can see us spending that kind of money, not that we want to spend money, we want to spend money on good projects, but that would be the order of magnitude of our capital expenditure as we go forward.

And do you -- is there some toggle or balance at some point where you need to keep your investment-grade rating, so it does limit how much you can spend? And what are the balance sheet targets for the company?

Absolutely. Our balance sheet target for the company is to maintain our A rating. That has always been the case. And therefore, the numbers that you see in some of our presentations, and as Scott talks about them, is that approximately, with our current portfolio, we think we can lever the company up to about 3x and still maintain our A rating. And that is how we come with the fact -- come up with the fact that we have $18 billion that we can commit between 2018 to 2023. So that is our target. Now if we deploy the capital in the areas that we are talking about, and our business instead of being 52% on-site, close to 75% on-site, then I think we can lever the company more and still maintain A rating because we will have a stable cash flow. So at that time, is that number going to be 3.5 or 4? I don't know. It depends on the rating agencies and all of that. But the ratio is going to be determined by maintaining an A rating. Obviously, debt is cheaper than equity, and we want to have an efficient balance sheet, and we want to lever this -- the company to leverage that is appropriate, but the appropriateness is defined by maintaining our A rating. We don't want to lose our A rating. We cannot lose our A rating.

Got you. Maybe a couple of related questions came in. One, you guys just announced that $0.5 billion hydrogen plant decap from PBF. So do we see more opportunities like that? And maybe in particular, given the pressure in the U.S. midstream sector, do you think there'll be more things popping up for you to buy?

Obviously, we hope so. And obviously, we talked to -- we have been talking to everybody. I'd just like to stress that with PBF, the first time I talked to their CEO about the opportunity to buy their steam methane reformer was 2 years ago. It wasn't as if we were waiting for a crisis. It is logical for these people to sell us their noncore assets even at normal times. They do that anyway, and that's how we have our on-site business. So this is a conversation we have been having with these people. And now because of the current situation, would they look at it more favorably or not? We'll find out. But we are talking to everybody. You can be assured that anybody, anywhere in the world who is operating an air separation unit that they own, steam methane reformer that they own or a gasification facility that they own, we have been talking to them about the possibility of buying those assets and converting it to sale of gas. That is strategically what we said we're going to do 3 years ago, and we are doing that. We have been successful in a bigger scale with Jazan when we are buying the gasifiers, it's the same kind of thing. And we were successful with PBF. And we have been successful on other things where the customers didn't want to announce. So this is not that we've just done these 2 projects. We have done other ones too.

I guess looking a little bit longer term here in terms of the next 5 to 10 years, what do you think are most significant pieces of innovation or change that you see happening in the industrial gas market? Obviously, you talked a little bit earlier about gasification and the trend and need there. But maybe other markets such as hydrogen or carbon capture or even -- is there an emerging trend right now that you think might be underappreciated by the market currently?

The biggest opportunity for the industry in the long term is hydrogen. There is no question about that. And as I kid people, if you follow us around, and we are talking together on a conference call like this on 2035, you'll probably find out that 80% of Air Products portfolio is hydrogen. Hydrogen is the future, and the companies who get on top of it right now will benefit 10 years, 15 years from now. The way we see it is exactly what we have laid it out for you, gasification today, carbon capture tomorrow and hydrogen the day after tomorrow. Hydrogen is the future in the long term. In the midterm, we think there is a lot of opportunities for carbon capture, which can be realized, and that is something that, I think, we should be focused on because it might be a good opportunity, and it is a good opportunity. Gasification, we are doing that. There is a fair space, carbon capture, but in the very longer term for growth is hydrogen. And I'm very happy to say that despite what some other people were talking about at 8:00 this morning, and I don't know where they get their data, Air Products is by far the leader in hydrogen and hydrogen for mobility. And we intend to maintain that lead and significantly expand on it.

Seifi, we have a question come in about your willingness to do a fractionation or pipelines or other things beyond sort of the core gasification, would you be interested in the other sort of ancillary processes where you could do the same sort of decaps?

What we are interested in buying air separation units, hydrogen units, gasification units and hydrogen pipelines. Yes, we have bought hydrogen pipelines, and we'll be interested in doing that. But in terms of going -- and then we will obviously build methanol plants or ammonia plants or DME plants in the sense of having a complete package to supply to the customer, not that we want to get into those businesses. But we are very good engineers. We know process industries very well. So I mean carbon capture is going to require a lot of the kind of things that you're talking about. So I think in that context -- yes, sir.

Sorry. Are there any opportunities to get into de-capping ammonium plants? I mean certainly, they have reformers in the sort of process technologies you do, is that possible? I know you've got 1 project already.

If they are part of an integrated unit, that means that if there is a unit where there is air separation unit, gasification, and then an ammonia plant attached to the whole thing, we'll be very interested in buying the whole package and then having a take-or-pay contract for somebody to take the ammonia. Yes, that's what we are doing in Gulf Coast. Yes, that would be something we would be in -- sure

Got you. Well, unfortunately, Seifi, we didn't get to have our chat live and in-person. I look forward to our next opportunity there. Great. We're out of time for the day, but I always appreciate your insights and candor, and have a safe day, and take care.

Thank you very much for including us in your program. We always enjoy talking to you. And hopefully, next time, it will be in-person without masks, hopefully.

Yes, sir. Thanks.

Thank you.