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

Good morning. My name is David Begleiter of Deutsche Bank's U.S. Chemicals Equity Research team. Thanks for joining us for the Deutsche Bank's Virtual Global Industrials & Materials Summit. I'm very pleased to have with us today Seifi Ghasemi, Chairman, President and CEO of Air Products. The format of today's session is a fireside chat. [Operator Instructions] So with that, we'll jump right into it. Seifi, good morning. How are you?

Good morning, David. I'm fine, and it's a pleasure to be talking to you and the rest of the investors who are listening.

So first question is most topical. Business update, business trends, do you have an update on your merchant volumes? You talked on the April call about volumes being down about 25% in Europe and down about 15% in the U.S. Do these trends continue through May? And what are you seeing in June?

The trends continue to be, as we have discussed before, our volumes in Europe, our merchant volumes in Europe are down about 25%. And in the U.S., depending on the product, the volumes are down 15% to 20%. Haven't seen any change or any improvement in those numbers as we talk today.

You mentioned back on the call that packaged gas volumes were down a little bit more in Europe. Are they still down at 40% type range?

That is correct. In the -- in Europe, our packaged gases business is down about 45%. In the U.S., we do not have a packaged gas business. So I don't have a number for that.

Got it. Switching -- moving around to the other side of the world, China. How is demand trending in China? Is it back to normal or getting close to back to normal?

Volumes in China are approximately back to normal. Yes, that is correct. And it is continuing to be like that.

And how about the rest of Asia? How is that trending?

In places like Taiwan, South Korea, where they have gotten control of the COVID-19 situation, it's about the same as in China.

And overall, how would you characterize your merchant operating rates by region, similar to what they were in April? And do you have a number for that?

Well, in terms of utilization, before the COVID-19, utilization in China was -- in terms of total capacity was about 50% -- 55%, but it varies by region. Some regions in China before COVID were at around 82% and some regions, they're at 50%. But overall, in China was about 55%, 58%. Our utilization in Europe before COVID was about 76%, 77% and the same in the U.S. but now obviously, those numbers need to be adjusted for the fact that the demand is significantly lower.

And Seifi, by end market, could you characterize demand trends? Any earnings impact from lower refinery utilization rates here?

We do not see any significant lower demand on the refinery side because most of the -- our business with the refineries is on-site business. And on on-site, we have contracts which are not dependent on volumes. So we have not seen an effect on our business. Although the volumes at the refineries have gone up and down, we haven't seen any impact on our revenue from those because those revenues are fixed in the refining sector -- refining and chemicals sector.

Right. And I know about 2/3 of your business is on-site, and you -- is that fairly stable as we sit here in fiscal Q3?

Yes. 52% of our business is on-site, and that has held pretty steady during the crisis.

Got it. And I know merchant price is always a very sensitive topic. You've had good success for almost 2 years now. If you look backwards, what's driven this better success in pricing in the merchant business?

I obviously cannot comment about the pricing for the industry. I can only talk about pricing for Air Products and for pricing for Air Products, I cannot comment about the future, but I comment about the past. What has driven the increased prices for us in the past is that in February of 2017, almost 3 years ago, we made a very public announcement that the prices for our merchant gases has not increased for almost 9 years. Our costs have increased, whether it's labor costs, maintenance costs and all of that. And therefore, we are going to increase the prices in order to compensate for all the additional costs and the R&D cost and all of that, that we put into the business. And therefore, we increase the prices with the full knowledge that we might do some market share. So that has been the driver, and that has been our basic philosophy in that. So on that front, we kind of went beyond supply/demand kind of a thing. They just needed a higher price to sustain our business. And that has been driving the price increases for Air Products.

And my last question on pricing. I know comps getting tougher and without forecasting the future, should we at least hope and expect positive pricing going forward, even with tougher comps ahead of us?

I cannot predict that. I don't know, David. We have to wait and see.

I had to try. On this recession, how would you characterize -- I think you gave some -- quantified some of your exposure to a recession or economic downturn on a quarterly basis. Can you just walk through that math and how you got there? And that's the first question.

Well, on that front, we said that, look, if you take where we are today, where China is almost back to normal, then with the on-site business and our business chain in Asia, basically China and Korea and Taiwan, then about 70% of our business is kind of back to normal. So what is left is about 30%, which is about $3 billion a year, which is our merchant business in Europe and in U.S. So we said on the average, if the volumes on the average for those regions is down 20%, that means $600 million on an annual basis. That means $150 million per quarter. And since the margin for that business is about 50%, that means for every quarter, we will lose about $75 million of operating income, which is about $0.25 to $0.30 effect on our bottom line. So we said that, that is approximately what the recession is costing us per quarter. That's how we did that math on a very rough basis.

Understood. Now was the headwind -- has it downturned or the recession created some opportunities for Air Products?

Well, the only thing that it might create opportunities is if asset prices go down, and therefore, there might be opportunities for some acquisitions, but we haven't seen too many of that. But that is only kind of silver lining in the cloud, but we don't like the recession. I hope that the world gets back to normal tomorrow, and we will do a lot better, we like that environment a lot better than a recession environment, obviously.

Understood. But have you taken some cost actions and cash and spending reductions to deal with this current downturn?

Well, there's 2 aspects to that. Obviously, in a situation like that, we are very mindful of cost and spending and travel costs and all of that. But the one thing that we have not done, and we are not planning to do is that we are not planning to have any kind of a massive layoff of our people or any kind of a reduction in their salaries. I think the times are tough, people are under a lot of stress because of what is going on. The last thing we want to do is get our people nervous about their jobs or their pay. We value our people for the long term. We want them to be productive during these times. And therefore, we have made a commitment to them that we are not going to lay anybody off or cut anybody's salaries during these difficult times, to give them some peace of mind. And we are seeing the benefit of that because people are as productive as before. We have 750 plants around the world. Our people have kept them running during the entire time or we are closing our books, we are reporting our results. We are doing this and all of that. So we are not missing a beat, and I think that's because of the positive attitude of our people. And at the end of the day, what is Air Products? Air Products is a collection of our people. And I want those people to be in a very positive state of mind, especially during these times.

Very good. Switching to more interesting things in the portfolio. You've had 2 big announcements recently, a new project in Indonesia in alliance with Haldor Topsoe. First on Haldor Topsoe. Why is this announcement so important to Air Products? And I know it's going to focus on the development of ammonia methanol and DME projects going forward.

Because our business model, the way we are kind of presenting a business model, which is actually very successful is that we are telling people that, look, if you are building a plant that is producing methanol, in the old times, you came and bought the oxygen from us that you needed, then we said, we can supply you syngas. And now we say that, look, we can supply you the methanol. That -- it gives us a capability to provide the bigger package to the customer. So right now, in Indonesia, when we are -- people are giving us coal and we are giving them methanol. We have the technology for oxygen. We have the technology for gasification of coal. And now we have technology for the production of methanol. So that is very essential that we can go to the customer and say that we can be one-stop shop. We have the capabilities to engineer it. We have the capabilities to provide the technology. We have the capability to build it, and we have the capability to finance it, and we have the capability to run it. So make your life easy, you give me the call, and I give you the methanol and you focus on where you are good, which is selling the methanol. So that is a very positive, very interesting business model. And as a result of that, I think we will be able to expand our business in that area. And that's why the alliance with Haldor Topsoe to provide those technologies that which we didn't have for the production of ammonia, for the production of DME, for the production of methanol, for the production of urea, that's very important and very relevant.

And what was the rationale for Haldor Topsoe to enter into this alliance of their products? What do they get from this relationship?

Well, I mean, they get not only -- the more projects we do, it creates opportunities for them to get a technology license. But I think if I may say so, get to watch with the best industrial gas company in the world, who is actually doing something and expanding on these areas rather than shying away from them by saying that burning coal is a bad thing. We think burning coal to produce chemicals is actually a very good thing.

Understood. And last point on this. As you move into methanol and ammonia production, is there any additional risk as you step out from maybe your core air separation and gasification expertise?

But there isn't because we are not taking an additional customer risk because the customer is still the same customer, right? Whether we supplied them oxygen or syngas or methanol is the same customer. And then the second thing is that with adding access to the technologies, there is no technological risk. So I don't think you are adding to the risk at all if we are just doing a bigger project.

Understood. Switching now to decaps. Back in April, you acquired 5 hydrogen plants from PBF Energy. You signed a long-term contract with them for hydrogen. Can you talk about why these decaps were attractive and whether you might be seeing more of these going forward?

Well, that is the basis of our on-site business, David. If you look at it, why do we have an on-site business? Our on-site business is building plans for other people. So PBF, we had a very interesting situation because in most -- in all of those refineries, they had their own hydrogen plant, but at the same time, we had hydrogen plants that we were supplying hydrogen to them. So it was a very logical discussion to go and say, look, you have 2 hydrogen plants from us and 2 hydrogen platform yourself in the same refinery. If we own all the 4 hydrogen plants, it will be more efficient, and we can share on the synergies. So that is the reason that these things make sense. And quite honestly, I mean, that's the fundamental of our business, we go and make -- build plants for other people that they could otherwise build themselves. So I think that a lot of these people who own industrial gas assets are gradually going to come to the conclusion as some of them have already come to the conclusion that it is -- that's a noncore business. It's better to buy the oxygen or buy the hydrogen from somebody else rather than build your own plant and try to operate it yourself.

How large is this market opportunity on the decap side? And would you do decaps on ammonia and methanol plants as well?

Well, the decap side just for the industrial gas facilities, this can be as big as $30 billion. We are not going to do a decap of a methanol plant on itself -- by itself. But if that is a part of an integrated facility that includes ASU gasification and an internal plan, yes, we will take a look at that. But we are not going to just go and buy a methanol plant. Because there, it doesn't go with our integrated strategy.

Got it. Switching out to your overall capital deployment target, Seifi. You initially targeted $18 billion over this current 5-year period. I think with Indonesia, you've now spent, I think, about $14 billion. You've also mentioned that given the iterative nature of this model, you could spend as much as $30 billion over the next 5 years. So given all this, how should we think about capital deployment as well as the balance sheet you need or have to support this deployment?

Look, we have a very strong balance sheet. And on that front, the way you look at the numbers is that we can lever the company. We want to have an A rating and right now, order of magnitude, obviously, the rating agencies will make the final decision. But order of magnitude, we can lever the company 3x and still maintain our A rate. So with the EBITDA that we have, 3x that, that's almost $11 billion. And we have a net debt right now of only about $1.5 billion. So we have almost $10 billion of filing power. We have a very strong balance sheet. And therefore, we can finance all of these growth projects that we are looking at, and we are very optimistic that we will be able to do that. We are very optimistic about the future of Air Products, very optimistic. And quite frankly, that's why I wanted to stay another 5 years, at least to make sure that we see all of these things come to fruition. So I am very optimistic about the future of Air Products. Right now, we obviously have the COVID-19 and the recession that we have and everybody is not in a very good mood. But for the long term, we remain very, very optimistic, very excited actually about Air Products.

And that's good to hear. Just on this initial $14 billion you've spent and committed. How is it relative to your targeted 10% IRR hurdle? Where does that -- where do these projects come in? Is it -- I assume it's above that hurdle rate?

And if you take them on the aggregate, they are better than the 10%.

Got it. Next up, Jazan -- the Jazan project. Do you have an update there? Are we still on track for October start-up? And how should we think about earnings contribution in '21 as this project ramps? How quickly can it ramp to full utilization?

Well, my advice to the investors is, don't count on the chickens until they are hatched. So we are working on this project, and we say, October, but we have to wait and see. So I don't really have an update. I just like to say that we are working on it. It's a big project. There is a lot of ups and downs with the project and timing. And I mean, that's a $12 billion acquisition. So I don't really have an update. Just -- we keep working on it, and we try to be -- we obviously would like to get it done as soon as possible, but we are not the only people who are party to this. There are 3 people involved and thousands of lawyers and accountants and all of that. So -- and we obviously cannot get together and talk, you have to do everything by video conference. And so it's actually not a very ideal situation, but we keep working at it.

Understood. There's also the YK project in China. I know you've been trying to get over there to get an update or to work on that project. But where does that project stand in terms of its potential?

We have made a commitment to the investors that we will have a final definitive answer about that project by the time we announce our results in October. That is that we will tell the investors whether that is a project which is go or not a go. If it is not a go, we could take it off of our backlog. I think we have about $1.6 billion allocated for that in our backlog. So then our backlog will be reduced by about $1.6 million, if you say that, that is not happening. I don't want to make that statement right now because we keep working on it, but you know what the issues are. It's the issue of coal and coal allocation. But we will have a definitive answer by end of October when we announce our results.

Understood. Also, a while ago, you announced that your JV in Saudi Arabia with your JV company to build industrial gases hub in Jubail. Talk about the potential of this project and the time line for this to come to fruition.

Well, the potential for that is significant because we are trying to build the pipeline system and the hydrogen facility to connect a lot of the refineries and chemical facilities there to create a mini version of the Texas Gulf Coast pipeline system that they have. That project, we announced that we intend to do that. We had a groundbreaking ceremony. And therefore, we are working on that. Trying to put specific numbers on it, I think, is premature, but it can be a big thing.

Sounds good. Overall, how would you characterize the pipeline for new projects?

Very good, very positive for the long term. A lot of the projects that we are working on, people are looking beyond COVID-19 and so the projects for the next 10 years and 15 years. So we feel pretty good about the pipeline of projects that we are working on.

Understood. Now there has been some pushback in terms of the risk profile of these projects, given the concentration in China, Saudi Arabia, Indonesia. How do you address those concerns or assess the risk of these projects?

Well, the thing is that, first of all, these projects, they are becoming a little bit more derisked because we are doing the acquisition in the U.S., we are doing projects in Saudi Arabia, we are doing projects in China, we are doing projects in Indonesia, we are talking about projects in other parts of the world. So it's not as if everything is coal gasification in China that some people like to characterize it that way, which it is not. So I don't think that we are putting all of our eggs in one basket. The risk on these projects is basically execution on our part, and that is why we have strengthened our organization and our focus and trying to make sure that we execute these projects properly.

Sounds good. Switching to gasification safety. Is a structurally low oil price a negative to -- for future gasification projects?

I think the project in Indonesia, I answered that because the project in Indonesia, we announced at the time when oil prices were $15, right? People are looking to go beyond that. These projects are done for national security reasons. People are not looking at this project for the next 20 years. They are not looking at the price of oil at a specific moment of time. So I don't think that is going to have an effect in the longer-term desire of countries like Indonesia, China or India to do gasification of coal. Those people will do the gasification of coal, and there will be plenty of projects in that. But gasification is not only about coal, gasification is about gasification of pet coke, which there's plenty of us hidden around, and people are not going to be able to have a way of disposing that. All of the refineries in the world will have that problem. And gasification is about gasifying the bottom of the barrel, the pitch from the bottom of the refinery, which is 6% sulfur. And that -- the only -- in IMO 2020, you cannot put it in ships, the solution is gasification. So gasification is about a lot more than just gasification of coke.

And last question, gasification. You own 2 of the primary technologies, the Shell and GE technologies. How important is it to own these technologies and how strong of a competitive advantage do you have now in gasification?

Well, those are the 2 premier technologies. And right now, when you look at the different projects around the world, there's a project in India. It's using the Shell technology. The project in Indonesia is Shell technology, the project in Saudi Arabia is the Shell technology, most of the projects in China are either Shell or GE technology. So obviously, we are very proud to have those technologies. There are other technologies, too. Those are not the only technologies, but we think those are the 2 premier technologies. And that is why before we started getting big on gasification, we wanted to have those technologies because that is where it gives you a competitive advantage. And actually, some of our competitors will have gotten into gasification, like the project that they are doing in Singapore, that is our technology. They bought that technology from us.

Understood. Switching to hydrogen. You've talked about this being perhaps Air Products' biggest opportunity going forward. Why is this? And how is Air Products positioned for this opportunity?

Hydrogen is going to be the energy source of the future. I'm not talking about the next 3 years or 5 years, but in the next 10, 15 years. 20 years from now, hydrogen will be the primary source for driving cars, automobiles, trains, even hitting your home and producing power. We are very optimistic about the future of hydrogen, and we are positioning ourselves to be a significant player. We already are a significant player in all aspects of hydrogen. We actually produce more hydrogen than anybody else in the world. And we are very focused on hydrogen. But as I have always said, the investor shouldn't expect anything on their bottom line for the next 5 or 6 years because of hydrogen, but we are positioning ourselves for the future.

Do you think the U.S. government should play a bigger role to foster the development of the hydrogen [ time ] in the U.S. versus what's happening maybe in Europe, China and Japan, what they are doing?

I think U.S. has a history of taking the lead in the development of new technologies. I think if you go back, the auto industry in the United States took off because you had the President Eisenhower, who believed in building the interstate highway system. Without that, we wouldn't have had a big auto industry or for that matter, an oil industry. U.S. has been a leader in space, a leader in internet, a leader in everything else. So obviously, I think that it would be very positive. If rather than just having the State of California having an energy policy and promoting green energy and all of that, it would be very helpful if the federal government had a coordinated strategy. But I'm not running the federal government and I don't know what the federal government in the U.S. will do. But unfortunately, I think that some other nations might take the lead in here. As you saw in the recent paper from the European Union, if you read about what they want to do is all about hydrogen. I think that's a public document that everybody has access to, and they're talking about not billions of dollars but trillions of dollars to advance hydrogen economy.

And Seifi, just on hydrogen mobility, why is hydrogen a better solution than pure electric vehicles or hybrid solutions?

Well, it's because with an electric vehicle, at some point in time, somebody says, electric vehicle doesn't have any emission. But where did the electricity come from? If you are burning coal to generate electricity, you are not doing anything for the environment. That is why I think green hydrogen is going to be the answer for the future. That is the difference. Green hydrogen is going to be the future energy source for the world if we want to decarbonize the world. And we believe in that very strongly, and we think that is going to be a phenomenal opportunity as we go forward.

And that's a great segue to carbon capture. Maybe you can talk a little bit about the opportunity in carbon capture and how our products are positioned to succeed here as well.

About the carbon capture, I mean, what do you mean by carbon capture? You either capture the carbon in order to use it for enhanced order recovery. On that front, we are very well positioned. We have a commercial plant operating in Port Arthur where we do that. You can capture carbon by transporting and then sequestering it in wells underground. We know how to capture the carbon, and we are working with people who know how to put it into the ground. So that's another way of doing it. And then the third way is to capture the carbon and recycle the so-called dry reforming, and we are developing technologies related to that. So I think carbon capture is going to be a big thing because the board cannot go 100% with green hydrogen because the volumes become astronomical. Therefore, there will be a lot of room for, what I call, blue hydrogen, which is that you make the hydrogen in a steam methane reformer or an ATR and then capture the CO2 and either sequester it or use it for enhanced order recovery or recycle it. So we think there is a significant room for that, and we want to be a player in actually all 3 aspects of hydrogen: production of gray hydrogen, production of blue hydrogen and production of green hydrogen.

And that's a good segue to my last question. ESG. Is the focus on ESG investing, is that a positive or a negative for Air Products? Some view you as a large carbon producer, but obviously, you also have a big effort in the other end of the spectrum.

Yes. Well, the thing is that we have a business strategy and our business strategy is focusing on things that are good for the environment. It's all about oxygen, it's all about hydrogen. It's about green hydrogen, blue hydrogen. All of those things are things which are good for the environment. So as a result as we implement those things, we should have a very good, very favorable ESG rating, which obviously, environmental is one part of that and we think we have good governance and all of -- and social aspects to our company. But in terms of the environmental part, I mean, we are not sitting down and saying that, well, we need to change our business strategy to be an ESG company. We have our core competency is doing things which are the right thing for the environment. So as a result, I think we will get a very good score in that respect. And if that is what investors are focused, then it will be an advantage for us.

Very good. And just my -- really, my last question. There's been some announcements on the management side. You've extended your term as Chairman and CEO through 2025. Also, the Board's appointed Dr. Serhan as COO. Do these announcements portend any change happening in the future at Air Products?

No. We have a strategy, and I drove people that I'm -- as long as I'm vertical, I'm going to be Chairman of Air Products, and I mean that. But we do have succession plan in case people can get hit by a bus or a lot of things can happen naturally, not everybody lives forever. But we do have short-term succession plan, medium-term succession plan, long-term succession plan. But in terms of me personally, I'm going to stay as long as I can. And I hope that will be for a long time. And then we promoted Dr. Serhan to be the Chief Operating Officer in order to recognize a lot of the good work he has done in the last 4 years. And also to emphasize that execution of these big projects that we are announcing right and left is a very important thing for Air Products. And therefore, we wanted somebody with the proper authority and title within the company in order to promote the execution of those projects. And we are very happy we have him, and we are very happy to promote him with that title.

Very good. With that, our time is up. Seifi, thank you very much for your time, and thank you all for dialing in. Have a great day.

Thank you, David, and thank you all the investors for listening. I appreciate that. Thank you.