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

Good morning. This is Jeff Zekauskas, I'm the chemical analyst at JPMorgan. I'd like to welcome everyone to -- this morning to the JPMorgan Virtual 2021 Industrials Conference. The format of our conference is virtual in the interest of health and safety. And thank you very much for attending this morning. [Operator Instructions] This morning, it's my great pleasure to introduce Seifi Ghasemi, who is the CEO and Chairman of Air Products. Seifi has been an innovative leader of Air Products over the last few years. Also, Scott Crocco, the Chief Financial Officer, will be available to answer questions; as well Simon Moore, who is the Head of Investor Relations and Head of Sustainability; and Mun Sheih, who is also in the Investor Relations deportment. So Seifi, maybe I'll turn it over to you to -- if you have an opening statement. And then what we'll do is we'll begin our conversation. Please.

Well, first of all, Good morning, Jeff. It's always a pleasure to see you, and good morning to everyone who is watching. I always enjoy talking to you, Jeff. You ask very good questions. So I look forward to our interaction. In terms of any kind of an opening statement, I really don't have anything that significant to say, other than what we had already said at our results announcement in early February. So I'd rather save the time and rather than me making a speech to focus on answering your questions, Jeff.

Sure. So the -- people are getting vaccinated now in the United States. And different parts of the domestic economy are opening up. When you look at your business results in the United States, can you detect that yet? Or it's more difficult to see?

We cannot detect that yet, Jeff. The one good thing about our business that you know very well is that we do not have much of an inventory. So we almost got a good instantaneous indicator of what the economy is like. One of the reasons that maybe we don't see it yet is because of the freeze in the south, and that kind of created its own disruption. But as we are talking right now, we have not seen any kind of a significant economic recovery that is worth talking about in the United States yet. We obviously see that in China very well. China is back up. Industrial production is almost up 8%. So we are seeing the benefit of that. But in Europe and in the U.S., we have not seen anything yet.

We had that stretch of freeze in Texas. And what that did is it led to disruptions in petrochemical production and chlor-alkali production, in so many areas of the chemical industry. Is that something that touched you or affected your volume, Seifi?

Yes, of course, it did. It obviously affected our volumes because during that time, most of our plants, we were ordered to shut down. We couldn't deliver product to our customers because of the freezing roads and all of that. Our costs went up because we had to support overtime to deal with that and make sure our plants don't completely freeze up on all of that. So it had a negative effect on us. It is not material. And quite frankly, we are still figuring out what the effect is on our bottom line because of some of the intricacies of the reimbursements for natural gas and power during the shutdown. But overall, it did affect us and I think it will turn out to be in a negative way.

Yes. I forget that with your hydrogen business, there's a natural gas pass-through element. And the price of natural gas during that period was exceptionally sort of violently up upward. So are there complications in figuring out what the cost pass-through is under those conditions?

No. On that one, it's very straightforward and we have passed all of that cost to the -- it's very clear, there is no ambiguity about that. And unfortunately, the customers are going to bear that cost. That -- there is no complication on that. But then we have a merchant plant that is -- where we are producing product for ourselves or we have a hydrogen plant where -- it's emission hydrogen plan not an on-site hydrogen plant, but we make liquid hydrogen to sell to our customers, then it does affect our business. But the pass-throughs are very clear and no complications on that at all.

My [ initial ] impression is that miles driven is moving up and when I look at the crack spreads for some of the refiners, it looks to me that they're improving. Is that an element that you can perceive right now? Or are things so much covered over by the disruptions from weather that it's harder to tell about what's going on in refining?

Jeff, as you know, still some of the refineries are still down because of the disruption and all of that. But overall, I would not want to disagree with you that we are beginning to see some growth in demand in the Gulf Coast. That is happening, but it is not significant and material for us to notice that in a big way. But by the time we announce our results in the end of April or early May, we will have a better view in terms of what is actually going on.

So while we're in that subsector, you acquired PBF. And I was wondering whether that acquisition answered to your expectations? Or has it been more difficult to manage the acquisition during this difficult time of lower gasoline demand?

The acquisition of PBF is actually working out to be better than we thought. There is no issue with that. And I guess the next question would be that how come you don't see that in our results. It's because when we report our results in Americas, you are not seeing -- the positive effect of PBF is definitely there better than we expected, but you don't have all of the negative effects that we have suffered from the freeze and from the fact that the economy is not as strong as we are. And then the other thing is that I'm sure, when you compare our results to some of our competitors' results, our volumes are not as exciting as theirs because we don't have a big health care business in the U.S. or Latin America, where we report Americas, and they do. And if you are -- you have a health care business right now with COVID, you're going to do pretty well in volumes, both in the U.S. and especially in Latin America.

I'm not skeptical. I was just curious, but I appreciate it.

No, that's fine.

I appreciate that answer. Can you talk about your South American business a little bit because it's a little bit meaningful. And the COVID has struck South America a little bit differently than it has in the United States. What are the volume trends like when you go into South America for you?

If you want to focus specifically on South America, we don't report the results separately, but what I can say in general, Jeff, is that we do have a health care business in South America. In Colombia and in Chile, we do have health care business. So actually, our business in Latin America compared to last year is doing better unfortunately because of the COVID thing and the oxygen demand. Our business in Mexico, where we have a joint venture, is actually doing very well because -- mainly because of the COVID and the demand for oxygen.

Is it still the case that you're -- that your helium business in the United States is -- hasn't recovered the way that you would want to because the medical sector has not recovered as much?

Well, that is exactly right. Our volumes on -- for helium are significantly down because of the fact that most of the helium demand for MRI machines is related to elective surgeries and diagnosis and all of that. And obviously, people haven't been doing that. We expect those to come back once that situation becomes normal because we don't think there is a lot of demand destruction. But currently, our volumes are lower than normal.

So even though the industrial gas environment in the Americas is subdued, is the general trend that prices are still moving upward?

Well, Jeff, you know that I don't comment on the forward-looking comments about prices, so...

No, backward. No, you don't have to talk about this...

Up to the end of the -- when we announced our results for the first quarter, yes, the pricing momentum was positive, yes.

When you think about industrial gas prices over, I don't know, a 10-year period, Seifi, in oxygen and nitrogen in the United States, are they very different? Or have they moved faster than inflation or slower than inflation? I realize it's complicated because of the way raw materials may affect things. But in general, do you think your customers are really squeezed or they've been happy with the overall price progression over time?

Well, Jeff, the products that we sell to our customers are absolutely essential for them to make their products, they are significant value added and they are not a significant part of their cost. We felt that we needed to increase prices to cover our cost and to cover all of the money that we spend on R&D in order to create better products for our customers. So when you look at the Americas, for example, in the last 12 quarters, we have had 12 consecutive quarters of about 6% price increase. So overall, prices have increased in the last 2 or 3 years. There is one product line that has -- prices have gone up higher than the other ones, and that is helium. So that is helping the overall equation. But overall, I still don't think the prices are where they should be because they need to increase prices because of power prices, gas prices, inflation, people's cost and return on our capital that we spend. So I think we still have room to increase prices to cover our costs and all of that, but that obviously depends on market conditions.

If you take the step back Seifi to, say, I don't know, 2018 or '19 and you think about the overall growth of the industrial gas business and you think about its future prospects, and then you look at its future prospects from today, do you think that the industrial gas industry is likely to grow at a faster rate or the same rate or at a slower rate? There seem to be better pricing conditions. There seem to be hydrogen opportunities. Exclusive of gasification opportunities, how would you frame the growth rate of the industry going forward?

Well, Jeff, that is an excellent question. And one needs to answer that segment-by-segment because when you say industrial gases, it covers a lot of things.

It covers a lot, yes.

So if you take our traditional industrial gas business, the traditional industrial gas business, which is the merchant business and the packaged gases business by themselves, that business, you can check it for the past 40 years that I have been in business, you can only grow as fast as GDP. There is no other way. You cannot accelerate grow faster than industrial production or GDP. That is why all of the industrial gas companies are trying to get into areas of growth. A significant part of the growth of the industrial Gases business, when you look at the past for the different companies, has been because people have gotten together and mergers and acquisitions. A fundamental merchant business does not grow and has been growing at around 2%, 3%, 3.5%. Except for if you are in China, sure, your merchant gases business grows by 6%. So this is why we -- very clear 6 years ago as a strategy for Air Products that, look, we have our base business, we love our base business, we will support it, but we realized that the growth rate on that business is going to be 2%, 3%, 3.5%. We want to grow Air Products at 10%. Therefore, we need to come up with new ideas about growth. And that is why we started focusing on gasification, focusing on carbon capture and focusing on hydrogen. So if you take gasification, carbon capture and hydrogen, those areas have potential for significant growth, but it depends if you are a player on that and all of that. That's kind of the way I look at that, Jeff.

Thank you for that. What I would -- I would have echoed your remarks, Seifi. Though I would have said that the pricing dynamic in industrial gas for me is more positive than I would have imagined 3 years ago. And the overall profitability of the industry is better. And so I look at the industry in a little bit of a different way. Seifi, can you talk about industrial gas conditions in Europe? That's been an area where your volumes more recently have grown nicely. What are the dynamics there are these days?

In Europe, the -- from my point of view, it has been a positive surprise because I thought we will do a lot worse in Europe. I thought that with the situation with Brexit and COVID and all of that, that there will be more of a meltdown there. It has not happened. Europe is not growing very much. But the good news is that it is not -- the economic activity hasn't collapsed. And the other thing is that I have to give credit to our people in Europe who have done a magnificent job in controlling their costs and all of that. Therefore, as a result, in aggregate, we are doing fine in Europe. So it has been actually a surprise to me. I expected worse in Europe.

And what about conditions in China these days? What's the intrinsic rate of volume growth that you are experiencing roughly?

China is very positive for us. The industrial production in China was growing at around 8%, 8.3%. Our business, merchant business, microbulk business, is growing more than 7% or 8%. So we are very happy not only with China, but also with Korea and Taiwan. In general, Asia is very positive for us. And that is why we are very blessed that we increased our business in that part of the world in the last few years. And now we are seeing the benefit of that, and it makes up for the shortfall in the other parts of the world.

I know that you're probably constrained in what you can say about Lu'An and so I won't press you. But I would like to ask you about gasification overall in China in that when I think through some of your projects, you have Jiutai, which is coming up. But your projects now are more global. They are the Indonesian projects. There are some ones in the United States. In general, has the coal gasification opportunity in China changed over time for environmental reasons or energy reasons? And do you see it differently than you saw it before?

No, Jeff. We are very positive about gasification in China and in other parts of the world, not only just gasification of coal, but gasification of pet coke and bottom of the refinery. And with respect to Lu'An, I think that, that is a particular situation with a particular customer. And if we put more color on it when we announce our results. But I would not take the situation that we have there and kind of make general conclusions about gasification in China. We have 4 other gasification entities in China that are bigger than Lu'An. They are all running and they are all running very successfully. So overall, we are as positive as we have ever been about gasification. And I think we are at a very unique position now with the technologies we have. And therefore, as a result of that, we will benefit from that and we will do more gasification projects, not only in China, but in other parts of the world, where people are trying to create added value from their low-value coal that they have in the ground.

You said that you had 4 other gasification projects. Are these projects where you run the gasifier? Or are they projects where you provide the oxygen to someone else who runs gasification?

We provide oxygen to the people who are running the gasifiers. But the fact of the matter is that, supposed we owned it, the fact is that those plants are running. The gasifiers are running. They are making product. They are economical and all of that. So that is my point. And they are paying us. So that -- the whole thing whether we own it or not, the whole gasification process is working well, it is economical and it's something that we'll expand in China as we go forward.

Is Jiutai on schedule? Isn't that supposed to come on in 2022?

2022, yes. It is on schedule, yes.

So one of the things, Seifi, and as I've watched you as an investor, you really focus on on-site projects. And I had always thought that the higher returns on capital came from the merchant business and from the packaged gas business. So -- and I'm sure there are all kinds of complications. So why is it that you have such a concentration on the on-site business, which may not be the best return on capital when you think about gas [ as a whole ]?

Well, Jeff, with all due respect, I disagree with you because I think that the return on capital on some of their on-site businesses are better than the merchant business. That's number one. The second thing is that with the on-site business and the on-site business model that we have, you are not subject to economic cycles in terms of ups and downs of the economy. And the second thing is that if you are doing the right on-site projects, where you have something unique to offer, the returns can be very attractive, because we think that our on-site businesses, Jeff, that the return on capital employed is better than 15%.

I see. And that's true for the new projects as well?

Absolutely. Absolutely.

So Seifi, if I can ask you a couple of questions about Jazan. I've watched some interviews with you and one of the things that you'll say is that the agreement is 4,000 pages. Maybe it's 5,000 -- 4,000 or 5,000. And I was wondering why the agreement had so many pages in that it's a gasifier, it's oxygen, there are complications. But why is this so unusually complicated versus the many projects that you have?

Okay. You see, there are 2 parts to Jazan. One is the part that makes oxygen. That is a straightforward contract and that contract is probably 150, 200 pages, including -- but the other part, which is very complicated, is when you're talking about the gasifiers and the power plant. Because there, you are talking about $8 billion -- about $10 billion of investment, and at total integration with the refiner. So there are literally hundreds of streams of input and hundreds of streams of products, output into the refinery. And to try to define the responsibilities and how you calculate this and how you calculate that and so on, that is the complicated part. The oxygen supply part is not that complicated. It is the rest of the gasifiers and the power plant. Please don't forget, we are talking about a 4,000 megawatt power plant and 16 gasifiers and all of the streams of oxygen and byproduct and all of that, which goes back and forth. So that is what makes it very complicated.

So Aramco is a very, very sophisticated company. They run refineries. And I would imagine that they could run gasifiers too if they chose to. And so what is it that Aramco is really asking for from your products in that -- do they want a special expertise that they don't have? Is it more that there's a particular asset that they don't want to own and they would rather pay over time? I'm not asking you to psychoanalyze them were to give away any secret, but why would a company that's as sophisticated in its operations as Aramco want to do a project like Jazan?

Well, Jeff, it is no different than why would Exxon want us to build the hydrogen plant for them in an on-site business. Exxon is as sophisticated as anybody, and they do have their own hydrogen plants. The reason they have us do that is that it's not that they can't do it, it's because they think we can do a better job and we can guarantee on-site -- on-time delivery and all of that. So Saudi Aramco, they have -- Saudi Aramco has never run any gasifiers. They don't own the technology. I'm sure they can do it if they wanted to, but are they going to be as efficient as running it with somebody like us who owns the technology and who is running gasifiers. So that is the difference. So what we are getting paid for is providing an expertise that they do not have in-house and they figure out it's better to pay somebody like us to do this rather than recreating that expertise in-house. Because we expect to do 10 more gasifiers, but Saudi Aramco doesn't expect to do 10 more Jazans. So that's the main reason. We are being paid for an expertise that we have developed. I mean the only reason that Saudi Aramco started talking to us about this thing was when we finally were able to acquire the Shell technology. If we didn't own the Shell technology, I don't think they would have given us the job.

Thank you for that. In the negotiation or in the way that Jazan may or may not be completed over time. Does the deal get agreed to and then what you do is seek financing? Or at the same time, do you seek financing and try to close the deal at the same time?

We are doing both at the same time, Jeff. We actually went out to the market for financing Jazan in July of last year. So we have been talking to the bank. Saudi Aramco has been talking to the banks and we have been talking to the banks, while they were negotiating the contracts. So the 2 things are going in parallel.

So interest rates have lifted a little bit. And some of the Aramco facilities have been attacked. Are these events that perhaps might slow down the progress of your negotiation and the completion of the project? Or are they not relevant?

No, they are not material. I don't think that is having an effect. The biggest effect that is delaying we're seeing is the inability of all of our teams to get together in one room and try to agree to everything at the same time and then to interact with the banks and all of that. So the COVID-19 has been a significant factor in delaying this thing. Those kind of -- those other things, I don't think has had any effect on the progress of our deal. And obviously at some point in time, as I had reported before, we did have a significant difference in the opinion about the sharing of the interest savings and all of that, but we have resolved that.

And so from -- no, I don't mean to pin you down to a particular moment in time. But maybe the deal will get done this fiscal year, is that the case?

Well, you know that we are working hard to try to get the deal done as soon as possible. And hopefully, by -- when we announce our results at the end of April, we'll have a -- we'll be able to share more clarity about it.

Sure. I want to ask you a couple of questions about the NEOM project. When you think of it, Seifi, do you think of this -- I know it's got different sections, that is you've got to build the green ammonia plant and you're going to take the ammonia and you're going to purchase it and you're going to separate the hydrogen. Do you think of it as, in general, an on-site project? Or do you think of it as falling into some other category? How would you categorize the way you contemplate the returns?

Our goal is to have it like an on-site. That means that our goal is to sign long-term take-or-pay agreements from -- for the product. That is our goal. Now it's going to be 1.25 million ton a year of green ammonia. Are we going to have all of that on long-term agreements or would there -- some of it be there like merchanting that we will sell on a spot basis? Some people argue that it is a good idea because you never know what the prices are and so on. But our goal is to have a significant portion of that committed to long term 5-, 10-year take-or-pay agreements.

So hydrogen or the price of hydrogen is, I think, controversial and that the green hydrogen industry really hasn't, I guess, fully bloomed. And so hydrogen as it seems to me is very different than oxygen or nitrogen in the way that it might be priced. And so can you talk about how you think of approaching your customer? You build your plant, you go to the customer and you say, okay, I want to sign a long-term hydrogen contract. And he or she is thinking, well, this is very different from oxygen or nitrogen. I expect the prices to be much more volatile over time. How can I really commit to a fixed-price contract over a longer period of time?

Well, Jeff, first of all, when we talk about hydrogen, one has to be careful about what kind of hydrogen you're talking about.

Sure.

Because there is the gray hydrogen, there is blue hydrogen and there is green hydrogen. Those are 3 distinct products. Gray hydrogen, right, is what we make right now. We are the largest producer of that. The price of -- the cost of producing that is very low. With natural gas at $3, you produce that and we sell 8,000 tons of that a day every day on a -- based on long-term contracts. But then when you say the customer, it depends what kind of a customer you are. If you are in the market for green hydrogen, why would you be in the market for green hydrogen? Because you are concerned about the fact that at some point in time, there will be a carbon tax and you have to end up paying a lot of money for the carbon tax. And therefore, you want to become green. That is why you want to talk about green or you are mandated that, look, you have to use this thing, like in California. So then the question becomes what price you put on that? And on that one, it depends on the supply/demand. I mean, Jeff, you are very familiar with this thing. I mean, what is the price of oil? Some days -- I mean we all know that it costs $3.5 a barrel to take the oil out of the ground. But Saudi Arabia doesn't sell it based on cost, right? It's supply/demand. So we are going to make green hydrogen. I think by the time we make it, nobody else is going to have it in the kind of quantities that we make it. So we are going to price it in accordance with supply/demand. So it could be any given price.

So when you say that, Seifi, and you think about the risk that you're taking, do you regard this as an above-average risk project or below average or average with any other industrial gas that you would sell?

No. The project in NEOM is a high-risk project. I don't think we need to pretend otherwise. It is a high-risk project. But unless you take risk, there is no reward. I mean what we are doing with NEOM is not very different than what people did with electric cars. I remember in 2010 and everybody was saying, this guy, Elon Musk, is a lunatic, what is in an electric car and electric motor and 4 wheels. If we can do it, General Motors will do it a lot better than he can. So he'll never make it. But you see where everything is. There is a significant amount of value on being the first mover. And we believe we are on the right track on being the first mover on this thing on a real project rather than all of these Mickey Mouse projects of 10-ton and 20-ton a year in different locations.

I've tried to model the NEOM project, and I don't know if I'm so proud of the modeling that I've done. But maybe what would be helpful is do you believe that the price that you're paying for the green ammonia will be very different than the price that other people pay for gray ammonia? That is, is the contract structured in such a way that there's a premium to the ammonia for you?

No, the prices are structured. It's a fixed price. It has nothing to do with -- there is no comparison to gray ammonia. I mean this is a totally different product. Please, at NEOM, we are not making ammonia, we are making hydrogen. Ammonia is a means of transporting it. So we are not in the ammonia business. We are in the hydrogen business. Ammonia just happens to be a way of transporting the hydrogen. NEOM is a hydrogen project.

But you have to buy the ammonia. Sorry.

Sorry?

You have to buy the ammonia in order to separate the hydrogen out. So in that step, when you purchase...

Yes. Yes. But it is something that we -- yes, don't forget, we are also the producer, right? We have to put a price on the ammonia so that we have a return on the manufacturing side. And then we take that -- we look -- what I'm saying is that we look at NEOM and what we are buying is we are not getting into the ammonia business, we are in the hydrogen business and the ammonia is a means of transferring that value-added hydrogen that we are going to sell.

Maybe as a last question, Seifi, do you think that the major players in hydrogen will be the industrial gas companies? Or do you think that there will be other significant players as well? And if you do, who might those be?

Jeff, I think that the players will be different. It will be very interesting how it will develop. But quite frankly, naturally, it would be probably either some of the energy companies or some of the power companies that might decide that this is the right thing to get into. We are not worried about that because the demand is going to be so much that there is room for another 15 NEOMs or maybe 100 NEOMs. So we are not concerned about that. The main thing that we want to do is we wanted to be the first, we want to be the innovator, we want to be the first and develop a brand.

Okay. Well, I wish you luck in your enterprise. And I'm sure that your products will be equal to its challenges. Thank you for attending our conference. And I hope to see you next year at our conference.

Thank you.

Okay. Take good care.

Certainly look forward to that, Jeff, and thank you very much for conducting such a productive interview. I really enjoyed talking to you, as you know. Thank you, again, and thanks for everybody who is listening. Thank you.

Thank you. Take good care.