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

Hi. It's Vincent Andrews, Morgan Stanley's chemicals analyst, and we are pleased to have Air Products with us today and have Simon Moore, who is the head of the company's sustainability efforts. With me as well is Victoria Irving from Morgan Stanley's ESG team. And before we get started, what I'm going to do is just read a quick disclosure and ask you to see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley salesperson. And with that, welcome, Simon. Welcome, Victoria. Thank you, everyone, for joining us. I think, Simon, maybe the best place to start is just -- we have a very diverse group of investors with us today, so if you can provide just a brief background on Air Products and an overview. So for -- there's some folks out there that are new to industrial gas and sort of where your broad-based positioning comes from, so maybe just get us rolling with that.

Great. Well, first of all, thank you very much, Vincent, Victoria and the rest of the Morgan Stanley team for giving us an opportunity to participate today. We'll get into a lot of exciting topics today, Vincent. You and I were just talking about the topic of today, we talked about 12 months ago when it wasn't the most interesting thing in the investment community. It's amazing how far things have come in a year, and we're incredibly excited about where things are going to go into the future. Again, appreciate everybody who's come in and is watching this. We look forward to meeting live with people at some point in the future, but for now, this is a great way to interface. So let me take you up on your offer, and let me step back and talk a little bit about Air Products. We're a leader in the global industrial gas business. We've been in business about 80 years, about $8 billion in sales. And we're a very global company, but it's very local manufacturing. We've got about 750 manufacturing facilities around the world. And in general, we're producing our products very close to where our customers consume them. We've got 17,000 employees who work hard every day to keep our customers supplied. And one of the unique things about Air Products is really the on-site business model. And just to quickly explain that, that's the business model where we build very large plants and we sign long-term agreements with our customers. And we don't take the volume or price risk and we don't take the cost risk on the inputs. So these can be things like traditional hydrogen plants for the refining industry, nitrogen plants for the semiconductor industry, oxygen for steel and chemical. And Air Products has more than 50% of our sales in the on-site business model. What does that mean? Why does that matter? Well, to be blunt, it's very, very stable. So we're in a difficult crisis around the world right now and have been for a while, and unfortunately, probably will be for some time to come, but the Air Products business, and particularly our onsite business, creates stability during this time of uncertainty. It creates stability in our cash flows. And one of the ways we manifest that stability in cash flows is our dividend. We've raised our dividend for every year for 38 straight years, and we share about $1 billion a year with our shareholders directly through our dividend program. So while we're very, very excited about our growth opportunities, we also are returning money to our shareholders through our dividend policy. Air Products has been on an incredible journey for particularly the last 6 years since we were honored to have Seifi Ghasemi join us as our Chairman and CEO. Vincent, you and the team have seen some wonderful changes we've made. We've improved our profitability, our EBITDA margin by about 1,500 basis points during this time. We have a very strong and robust base business, which we will continue to focus on and execute on. We have some tremendously exciting growth opportunities. And one thing that I'm not sure everybody recognizes is, as a result of some of that success and the excitement about the future, we're currently the largest U.S. chemical company by market cap. Probably something that would be hard to imagine 5 or 10 years ago. So with that, Vincent, let me turn it back to you.

Okay. Well, congratulations on that. I hadn't recognized that. Maybe let's now just go to sort of the high level ESG overview, and then we'll dig into more detail on it. And starting with the environment, why don't you talk about sort of the evolution of Air Products' impact on the environment, kind of the starting point of sort of what is your base mission in the core business? And then maybe talk about some of the long-term goals you just announced?

Sure. Well, great. And what's so exciting about this for us is, as I say to people, we didn't roll out a new sustainability strategy 2 weeks ago. What you heard from Seifi 2 weeks ago is how our business strategy is completely intertwined with the world's focus on ESG, sustainability and, to be blunt, cleaner energy. So our base business today, we talked about hydrogen for the refining industry, that's about 25% of Air Products business today. That is because the refiners need to clean up their crude oil and create cleaner transportation fuels. So you use hydrogen to desulfurize, take the sulfur out of the crude oil and have less sulfur coming out of the tail pipe to improve the environmental impact of transportation fuels. We provide oxygen for glass, for aluminum that helps clean up the environment for our customers. So we have a lot of applications. A lot of our business today is driven by the world's focus on energy and clean energy, so more than 50% of our offerings today are sustainable offerings. One of the most exciting things for us is we certainly do emit CO2. Chemistry is chemistry. And when you're producing hydrogen, you're going to produce some CO2. But for every ton of CO2 we emit, we -- our products help our customers save 2.5 tons of CO2 equivalent. So again, let me just say that again, Air Products does produce and emit CO2, but for every ton we emit, our customers can save 2.5 tons of CO2 equivalent, so very net positive impact on the environment. So sustainability has always been very, very important to Air Products. It's broadest sense in terms of social, governance, the way we want to work with our communities, the way we want to treat our people, very, very critical to Air Products has always been part of that. And it has created, in the past and on an ongoing basis, tremendous business opportunities. And again, the 3 growth pillars going forward, and I know we'll talk about these, gasification, carbon capture and hydrogen for mobility, those are sustainable offerings. Those are driven by the world's focus on sustainability. And so we're very, very excited about that.

And maybe just level set us in terms of -- as you go after these things, I think your CEO, Seifi Ghasemi, has been very clear about the return targets he expects to achieve as he puts capital to work against these initiatives. So just maybe remind us of what those are and how that plays into your strategy from an ESG perspective?

Yes. Great question. And one of the reasons why that's such a great question is you don't have to ask Air Products, are you choosing sustainability or are you choosing profitability? Our business strategy and the position that we put ourselves in means our projects that are profitable and business-driven are very consistent with our sustainability focus and the world's focus on ESG and sustainability. So we don't have to make a choice between the 2. And so what Seifi has committed to the outside world is that the projects that we're going to invest in are going to return a minimum of a 10% IRR. And quite frankly, that's true across all of our opportunities. That's true across our gasification opportunities, our base business, the carbon capture projects we're looking forward to develop and do in the future and certainly the hydrogen for mobility projects. So with those -- the growth of the on-site part of the business -- as I mentioned, the on-site is in our base business today, and we're taking that on-site business model and taking it in some new areas. Nobody had ever done gasification as an on-site business. Plenty of customers have done gasification, but it was the creative application of the on-site business model to gasification. We're looking to do the same thing for carbon capture and the same thing for the carbon-free hydrogen production. So for Air Products, I think from an investor standpoint, you see the very stable cash flows driven by the on-site business model. You see the same firm commitment to good return projects done with the right customers in the right places in the world. And there's nothing that's changed about that, it's just, again, the world's focus on sustainability creates some great opportunities for us going forward.

Okay. And before we dig deep into the hydrogen opportunity, maybe you just want to touch a little bit on the social and governance initiatives that you have in place at the company.

Sure. Great. And I'm really glad you asked about that because, again, when Seifi rolled this out 2 weeks ago, he spent a lot of time talking about this. And he talks about a higher purpose for Air Products. Now let's face it. In the wrong hands, a statement about a higher purpose can sound a little bit corporate doublespeak, right? We've all heard that before. But I got to tell you, from the -- from Seifi's commitment to this and the way he demonstrates this to the team every day, this is real. And it's not only something he believes, but it's something the rest of us believe that really what inspires our team is the excitement and the opportunity to work together, people around the world, to solve some of the most pressing challenges of the world from an energy and environmental standpoint. And absolutely, we intend to and we'll make money doing that. But to be honest with you, to inspire your team because you're going to make money, that's not that exciting. So the higher purpose is really what I think inspires our teams. And so that gets into some of the social and governance. As I mentioned, very, very important to us to have good relationships in the local communities that we are lucky enough to have our plants in. So we work very closely with those communities and some of the local first responders and those sorts of things. From a governance standpoint, I think it's very important, of course, what I would call the traditional or formal sense of governance. Do you have the right board structure committees? Do you have the right shareholder rights? Absolutely. But in the day-to-day aspect of governance, let me give you an example. One of the things when Seifi came in, he empowered the regional teams to run the business. So what he meant by that is you, as a business leader, are going to get an EBITDA target and you're empowered and obligated and expected to drive your business to deliver that EBITDA profit. So that's an empowered model. However, from a capital deployment standpoint, Seifi said in every presentation that capital deployment is the most important job of the CEO. So from a capital deployment standpoint, he sort of brought that back in and said any capital investment above $3 million, I'll say that again, any capital investment above $3 million, he has to approve. So there is a great example. Okay, so that doesn't show up in a governance report, but how are you managing the business? How are you keeping your leaders focused on the right things? And in the case of capital deployment, the governance is to roll that in a little bit more tightly and yet in terms of running the day-to-day business is to push that out and empower that. So I just thought that, that was one example of how we think of governance in the real day-to-day of running the business.

Okay, that's excellent. So let's dig into hydrogen now. You spoke a little bit earlier about your sort of core hydrogen business in terms of the work you do with your refinery customers. But -- so maybe that's a good jumping off point to talk about the evolution from gray hydrogen to blue into green and how you intend to play in all 3, and probably the ultimate place we're going to get to is hydrogen mobility. So why don't you walk us through that?

Yes, sounds great. And to be honest with you, we want to be a leader in all of those areas. So let's just -- a little definition, right? So today, almost all of the hydrogen in the world is made from hydrocarbons, and there's very little carbon capture. Now we happen to have the largest carbon capture project on a hydrogen plant in Port Arthur, Texas that captures 1 million tons a year of CO2. So we've got experience and credibility in all of these areas. We're the world's largest producer of hydrogen, so if you want to call that gray -- hydrogen, and hydrogen is produced from hydrocarbons where the carbon is not captured, we do see growth opportunities in that area. And again, whether that is driven by steam methane reforming of natural gas or whether that's driven by gasification of coal or bottom of the barrel, we see that there will be growth opportunities there, and I think we've positioned ourselves very, very well. When we also think about our hydrogen expertise today, it's not just the production. It's the distribution. And whether that is us owning and operating the world's largest hydrogen pipeline network in the U.S. Gulf Coast where we can -- we have over 600 miles of pipeline moving hydrogen to the key refineries. We also operate liquid hydrogen facilities around the world where we take the gaseous hydrogen, we liquefy it and then we deliver it as a liquid to our customer. We also, of course, take gaseous hydrogen and deliver that via truck around the world every day. And in some cases, we are supplying that to the hydrogen for mobility market. So I know we're going to talk about that in a second, but I kind of want to make the point that we're doing that everyday today. There's probably, today, every day, 4,000 fills of hydrogen into the transportation market that Air Products is providing. So 4,000 fills a day of a vehicle that Air Products is supporting. So again, it's small in revenue standpoint, but we've got a lot of experiences to that. So that's if I draw the box around the gray hydrogen. We think that will continue to grow. Really, all blue hydrogen means is producing the hydrogen or the syngas from a hydrocarbon but capturing the carbon. And again, as I mentioned, we've got -- the great thing is we've got operating experience. We built a carbon capture project and retrofitted it into an existing operating hydrogen plant in Port Arthur, Texas. We did this 6 or 7 years ago. It's captured 1 million tons a year of CO2. We know how to do this. We've proven that we know how to do this. So the excitement that we have there, quite frankly, is we have these hydrogen plants and gasifiers. They emit CO2. It's a very clean and relatively capture-ready form of CO2. It's a more concentrated stream of CO2. So it's more economic to capture it. And we're excited about -- we have the technology, we have the experience, places around the world that are focused on reducing the CO2 footprint, we'll be in a position to capture that carbon. And I think we'll talk in a little bit about what you might do with it, but I just want to make one key point on this. Air Products does not have the financial risk of that CO2. So if we're emitting the CO2 in our contracts with our customer, we've passed that risk along to that. So if we wake up tomorrow and there is a x dollar a ton or x Euro a ton carbon tax somewhere in the world and we have to go and pay that because we emit the CO2 off our hydrogen plant, that gets passed along to the customer. So quite frankly, we don't have downside risk associated with carbon taxes or carbon regulation. We have upside business opportunities, and we're excited by that. And then finally, of course, the carbon-free or the green hydrogen. And I'm sure we're going to talk about the NEOM project. It's something we're very excited about, investors are very excited about. But I'll just introduce that by saying there's a lot of people -- there's a lot of excitement and there's a lot of people talking a lot about green hydrogen. We have stepped up and committed to a game-changing project. We have -- our Board has approved this project. It's a total of $7 billion capital investment with our partners. We're moving ahead, and that project is going to be on stream and delivering carbon-free hydrogen in 2025. And so I think it's great that there's a lot of excitement in the area, but I think it's also important for people to distinguish those who are doing a lot of talking and a little bit of action, and maybe we didn't talk as much, but we've stepped up with a game-changing project to the world. So with that, let me see where you'd like to go from there, Vincent.

Yes. Let's bridge that to NEOM. And I think the way to do that, you kind of alluded to it, but I think your CEO, Seifi Ghasemi, has also been very clear that he thinks having a first-mover advantage is going to be critical here. So maybe just sort of bring us the strategic thinking that got us to NEOM and then help us understand the mega project. What is it? Where is it? How is it going to operate? What's the time line? And then we can bridge further from there.

Great. Well, let me go back in history a little bit. And I know this sounds terrible, right? We're just going to slow things down. All right. We're going to go back in history a little bit. Talk about the traditional hydrogen business. As you know, Vincent and others, 30 years ago, the industrial gas business did not do hydrogen. The refiners did their own hydrogen. Air Products got the first hydrogen on-site deal in California, the first time a refiner had outsourced their hydrogen production. And at that point, there were people who thought it was crazy. Why would a refiner outsource hydrogen? Hydrogen is nonindustrial gases. My point is that we got the first deal. And once you get the first deal, it's easier to get the second deal. And of course, it's easier to get the third deal. And today, 25 years later, while all of the industrial gas companies, at least the majors can do hydrogen, we still have the leading position. And so that first-mover advantage has already proven its value in the hydrogen business, the traditional hydrogen business. Now we turn to this market, which is very different. And I would say the first-mover advantage is not just sort of Air Products versus competition, but fundamentally giving confidence to the world that, no kidding, this can be done. So if you're a government, if you're a regulator and you're thinking about putting in some policies to support carbon-free hydrogen, 3 months ago, 4 months ago, you could have done that. And people were doing that, of course, and we're excited about that, but I'm not sure there was confidence that really was going to be that carbon-free hydrogen. It's much easier for a regulatory body to commit to a target or a framework for carbon-free hydrogen when they know that somebody is stepping up to build this game-changing project. If you're the manager of the city bus fleet of a certain city and you've got your hydrocarbon-driven buses today, and you're thinking about, do I go electric? Do I go a hydrogen? Well, 3 months ago, you might have thought about hydrogen, but how did you know there was actually going to be hydrogen there? I mean if I go out and order a whole bunch of hydrogen-powered fuel cell buses, but there's no carbon-free hydrogen, I haven't accomplished anything. So I really believe that our project has driven confidence in this whole concept for people and it's been a real step change in motivation. So we are in the middle of every one of those conversations. I'll be clear as well, as Seifi says, it's, look, we're never going to argue that we're going to do this alone. We're never going to suggest that Air Products can do all of this. This market is too big and will be, in our opinion, so robust. There will be other people who will provide carbon-free hydrogen. But we've moved the first in a big way. We think that will give us specific experiences around this project that will help us do the next one. But quite frankly, if you want right now to think about carbon-free hydrogen, there's only one company you're going to call, and that's us. And that's what I think, really in the long run, is our first-mover advantage here.

Okay. So now let's talk about what you've actually announced and who you're doing it with and where you're doing it?

Yes. Great. Okay. So really think of this as 2 parts of the project. So the first part is the production of carbon-free hydrogen. This is going to take place in a city called NEOM in the Northwestern portion of Saudi Arabia. Why is it there? And I know this sounds almost too simplistic, but the sun shines and the wind blows and there's seawater. And I know that seems so incredibly simplistic, but the bottom line is that's fundamentally why it makes sense to produce this carbon-free hydrogen there. What the project is going to do is take seawater, desalinate it for water. We're going to build a solar field and wind farms to create truly carbon-free electricity. We're going to take that carbon-free electricity in a world scale, a new world scale, a game-changer scale electrolyzer to produce carbon-free hydrogen. It's going to take some of that renewable power in an air separation plant and produce carbon-free nitrogen. So then we'll take that hydrogen and nitrogen and combine that into ammonia, and we'll have carbon-free ammonia. So I'll stop there because that's the production project. That's about $5 billion of total investments. It would be on stream in 2025. We're a 1/3 partner in that project. Our other partners are the city of NEOM, which is really the Saudi government, and a company called ACWA, which is our partner in a number of these projects, a very, very experienced power developer. So that project essentially is self-contained, going to produce -- what it's going to ship out is carbon-free ammonia. Now I'm going to flip over to the second part of the project, which is 100% Air Products on our own. We're going to take all of the carbon-free ammonia from that project and we're going to transport that ammonia around the world to places where people want the carbon-free hydrogen. So again, you'll transport the ammonia and you'll take that to a place, likely a city, let's say, a city bus fleet, and you'll dissociate that ammonia back into hydrogen, compress and store the hydrogen and deliver that hydrogen through a safe dispensing station into the hydrogen fuel cell vehicles. That -- we estimate that downstream capital is about $2 billion. So we're investing roughly 1/3 of the $5 billion plus $2 billion downstream, so that's the $3.7 billion investment. Seifi has committed that this project has the returns that we talked about earlier and, quite frankly, has the potential to have much higher return. Let me just maybe for a second talk about why ammonia, right? Because at the end of the day, this is not an ammonia project. We are using ammonia as the transport mechanism for hydrogen. What you want to do is you want to produce the carbon-free hydrogen in a place in the world where it's so economical to do that. And again, it's that unique combination of the sun and the wind there that allows you to leverage the solar field and the wind farms. So we have a very low production cost there. But as I think a few folks earlier in your presentation today acknowledged, hydrogen is a relatively expensive molecule to transport. We know that because, as I mentioned earlier, we transport hydrogen via pipeline, via liquid and via gas in trucks every single day. So if you try to move hydrogen around the world as a gas, very expensive. You could liquefy the hydrogen, but that takes a lot of energy. Hydrogen has to be very, very cold to be a liquid. So what we're doing is we turn the hydrogen to ammonia, that can be transported a lot more easily than liquid hydrogen, a lot more cost-effectively, and then we dissociate that. And I know you know this, Vincent, but I think it's a really important point because this is not an ammonia project. I mean this is a project that's going to produce carbon-free hydrogen. It happens to have ammonia as a step along the way, but this really is not an ammonia project. It's a carbon-free hydrogen project. So as we said, we're very, very excited about it.

Okay. Now let's maybe talk about the time line and how you're going to market the product. What areas of the world you think are particularly attractive for this? And how you're going to go about sort of working with customers, what type of contract length or just sort of how the marketing process is going to work?

Right. Great. And so what we're -- again, what we're doing is we're building off the position we have today in a lot of these areas. So we are providing hydrogen and fueling stations to people around the world today already. So what we will be doing -- as I said, the production will be on stream in 2025. We think the target market for this is really buses and trucks. And again, I know a couple of folks have talked about this, but let me just address that for a second. There's obviously the potential for passenger vehicles to utilize -- to be hydrogen fuel cell vehicles, but our guess is that the heavier the vehicle, the longer the haul makes it better for hydrogen. And what that really means is that the weight of the batteries become significant as you look at buses and trucks. So we're really not focused on the passenger car market. We can think about maybe in the long, long term whether passenger cars turn to hydrogen fuel cells, but in this time frame, we see more likely that passenger vehicles will be battery-powered electric and buses and trucks will be hydrogen-powered electric or hydrogen fuel cell electric vehicles. So again, we expect the project on stream in 2025. We would anticipate that, again, if we envision a typical scenario, it won't all be this way, but most of the buses in the world, especially the city buses, are managed by some sort of government or sort of quasi-government authority or agency, and they make the decisions about what they're going to do. And we are -- had already been and are and we'll continue to talk to those folks about as they've either been mandated specifically to use hydrogen, mandated to cut their carbon emission in their bus fleet or they're just interested in using hydrogen. The interest level, as you can imagine, has only has really exploded in this sense. People are very, very interested in the opportunity for hydrogen. So we're going to go to them, and we're going to say, look, I'll tell you all the stuff we're doing, but at the end of the day, we're going to make carbon-free hydrogen show up at the end of the dispenser that you can put into the vehicles. And we will build the plants. We will own and operate that. We will take care of everything. We want you to sign a long-term agreement for hydrogen supply for carbon-free hydrogen. We anticipate that will be actually well received by the entity who's buying because, again, if you're the city bus manager right now and you're going to go out and buy a bunch of hydrogen vehicles, you've got to make sure you've got a long-term reliable supply of hydrogen. So we actually believe that we're going to be interested in long-term contracts. We think the other side is going to be interested in long-term contracts.

And maybe just scale it for us in terms of how big is this project and how many buses do you need to partner with you just so people have a sense of sort of where we are versus the TAM.

Yes. Great. And to be honest with you, that's one of the most exciting parts of this. I mean this is a -- as I've said it a number of times, right, this changes the game for hydrogen for transportation fuel. It's orders of magnitude bigger than anything anybody has done. Yet, it supplies enough hydrogen for roughly 20,000 city buses, 15,000 to 20,000. There are something like 3 million city buses in the world today. So let me just say that again, right? So this project, as big as it is, as exciting it is, as it's game-changing, it can supply about 20,000 city buses. There's 3 million city buses in the world today. That's before we started talking about the truck fleet and some of those other opportunities. So that's one of the reasons why we are so excited about this. We will -- we absolutely see, believe that we will -- are planning to build more of these projects to support the market. But I get a lot of questions about, well, how big this park could be in 10 or 20 years? And I mean the reality is really, really, really big. And honestly, whether your forecast is $50 billion or $100 billion or $150 billion, it doesn't really matter. All you need to do is think about the amount of capital, the amount of opportunity to support some conversion rate of the buses and trucks out there, and that's why we're so excited about it.