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

Hi, everyone. I'm Jean Ann Salisbury from Bernstein. I am the Natural Gas and Midstream analyst. And I am joined by Seifi Ghasemi, the CEO of Air Products. Thank you all for joining us, and I will let Seifi speak a bit about the company for kind of 5 to 10 minutes, give an overview, and then we'll move into Q&A. I should warn you that, as I said, I am the Midstream and Gas analyst and so many of my questions will be generalist in nature, which is good because it's a generalist conference, but I would like to alert you to the existence of Pigeonhole. If there are more specific questions that you want answered or just anything that you want answered, please use Pigeonhole to add questions and on questions, we can make it really interactive. And with that, I will turn it over to Seifi.

Thank you, Jean Ann, and it's a pleasure to be here. Good afternoon to everybody who is listening. Now that you have given me an opening statement to make, I'd like to start from the time I joined Air Products in 2014. At that time, one of the benefits that had was that I had 35 years experience in industrial gases one way or another because I started in this business in 1979. So the issue, like any other new CEO is what do you do? What is the strategy? The things that were related to cost-cutting and rightsizing the company and changing the organization and culture and all of that, I don't call that a strategy. Those are tactical things that you need to do. The fundamental is that strategically, what are you going to do for the long term? So knowing the industrial gas business, one thing that are new for sure is that our base business, the base industrial gases business, merchant business, on-site business, nitrogen generators, oxygen generators, that business, the best it can do is that it can grow with the GDP of the locations that you're operating. Then when you put it in aggregate, then you will have a company which is going to grow 2% or 3%, 3.5% a year. That was not the kind of company I wanted to run. We wanted to run a company where our EPS has the potential of growing at least 10% a year. So then -- so what is the strategy? What do you want to do? By the way, a lot of people tell me that, wait a minute, when I look at the history of industrial gases, a lot of companies have grown faster than that. Of course, they have. But that is because of mergers and buying each other, that is not because of the fundamentals of the economy. So by 2014, the industry was pretty much concentrated. So if you wanted to find the strategy of growing by mergers, there were really 2 things to do. One was to go and buy Airgas. We looked at that. We didn't want to do that because we thought the price was prohibitively expensive, and it's not that great a business. Our competitor -- one of our competitors did that and I think you can see the results of that. It hasn't done anything for them. So that was a good thing we didn't do that. The second thing was to sell ourselves to Linde, which is what, Praxair. But we didn't want to sell ourselves to anybody and there would have been synergies and all of that kind of stuff, but that is short term, that's short-lived, that is not a long-term strategy. So we have to sit back and say, what is our long-term strategy? So on that one, number one, you look at the company and say what is our core competencies. Our core competencies at their product is that, number one, we know the industrial gases very well. We know how to handle oxygen, nitrogen, hydrogen, helium and all of that, we know these gases intimately. The second competency is that we are good engineers and good innovators. The third thing is that we know how to build facilities. And the fourth thing was that Air Products had the potential of great financial strength if we focused on industrial gases because we were in a lot of other businesses. So what did we do? We sold the non-core businesses, and that gave us significant financial strength. And then I took that and then our core competencies, and I said, okay, now what are the growth businesses that with this core competency, they can get involved. And I believe very strongly, I did that. For the past 20 years, I believed in that, that there is going to be an energy transition. And therefore, the best place to grow is to be part of the energy transition. I did think that at my other company, then I promoted, then 20 years ago, we bought a lithium company. And that turned out to be the right thing to do because it was part of the energy transition. So therefore, with a thought in how do we play in the energy transition, we came up with 3 areas: one, gasification of low-value raw products, which is either coal or pet coke or refinery bottoms; then the second strategy was climate change, CO2 capture is going to be phenomenally important, so carbon capture; and then the third one was hydrogen. Air Products was the leader of gray hydrogen but we thought we should go the next step into blue hydrogen, which is where you capture the CO2 or to green hydrogen. So that is when we put the pillars of our growth to be focusing on those areas. That does not mean that we have forgotten about our base business. We are still participating in that, that base business is great, it makes us a lot of cash, and we are participating in every aspect. I mean, I noticed that a few weeks ago, one of our competitors were saying, "Oh, we have 124 small projects that we are working, that is better to do than big projects." But the 125 small projects we are working on. We haven't forgotten about them. But that is going to give you the 2% or 3% growth. For major growth, we are focused on the 3 areas of gasification, carbon capture and hydrogen. We see significant opportunities in these. And in each one of these areas, we have been very focused in innovation of technology, and also acquiring technology when we don't have it. That is why we bought the Shell and the GE Technology for gasification. On carbon capture, we have worked very hard on developing new technologies. And for green hydrogen and blue hydrogen, you see us doing projects and we will announce more projects as we go forward. So that is really our fundamental strategy moving forward, and we are focused on executing that. That's really all I wanted to say, Jean Ann.

Great. Then we can move into the Q&A. I have some questions here kind of left into base business and then the 3 areas that you mentioned. And again, I highly recommend anyone that has questions to put them in on Pigeonhole, and I'll make sure to get them into the queue. So starting with your base business, there's obviously been puts and takes to the base business from COVID. I believe helium and hydrogen are down, but oxygen is up. Have these basically offset each other? And how do you see it coming out of COVID?

Well, our base business is a good business. During COVID, obviously, there was a balance. The general industrial activity went down, but oxygen requirements went up. So in areas where we have the medical -- the so-called medical oxygen business, like in South America or in China or in India or in Europe, that part of the business did well. In the United States, in North America, we do not have packaged business, and we do not have the medical business. I think in the long-term, that is not a good business to be in. But in the short-term, because of COVID, I'm sure people made a lot of money on that, and it is reflected on their results. So I'm not -- I don't think we missed anything. And as we come out of COVID, then we go back to when everything as it was. I'm very happy with our -- all of our businesses, we are positioned very well. We have restructured the company in terms of cost basis, and it is reflected in the margins that you see because we have improved our margins by more than 1,500 basis points, from 23%, 24% to close to 40% today.

Great. And just for any generalists that are less familiar with the story, can you talk a little bit about how you're able to get those margin improvements over the last few years?

The margin improvements come from 2 areas. Number one, it was significant reduction in the cost of how we run the business. And on that front, it wasn't that we went around and said, everybody costs 20%. We looked at how we are running the business. Before Air Products had a matrix structure, you had the local business. But then on top of that, there was this structure of global operations, global marketing and all of that, which added a lot of costs, but not a lot of benefit. So what we did was that we went to a decentralized organization where we have empowered our people in the regions. We have very strong business unit presidents in the different regions, they run their own business, and there is not a lot of interference from the center in terms of their day-to-day operation, and we were able to take all of those costs up. Those costs, and I talked about that, that is close to $400 million to $500 million of costs that we were able to take up. So that is one reason for the margin improvement. The second thing is that we have had a significant focus on pricing. And making sure that we get the right price for the products that we sell, and that has -- is very much reflected in the results that we announced publicly that you see that now it is about 15, 16 consecutive quarters that we are getting in price increases, which we fully deserve and we need that in order to maintain our level of activity and pay for the R&D and all of that. But those are the 2 basic reasons for the improvement of the margins. And the third one is we are benefiting from our growth strategy with the gasification and carbon capture and hydrogen in these areas, and they are contributing to our margin improvement.

Yes. That makes sense. And then just one more on the base business. How do you give investors confidence that it's kind of a GDP tracking business? And there's not risk of kind of rate erosion or margin erosion over time? Why do you feel that a lot of it is contracted, but structurally it feels like a pretty safe business? But if you could just give a little bit more color on that.

Well, the fundamental comfort that I give the investors is because it is not -- this is not a business that anybody and their cousin can go and open the garage and start a business because you require a significant amount of capital and a significant amount of know-how. A part of the business, which is exposed to that is the packaged gases business, and that is why we are not in the package gases business in North America because we think there are too many competitors. And therefore -- but the base business, the merchant business, the on-site business, it requires a lot of know-how and a lot of capital to get in -- for different people to get into that. The second thing is that we are dealing with fundamental basic molecules of oxygen, nitrogen, hydrogen, helium, these are molecules that people need to make their products. So it's not something that one morning somebody gets up and says, well, I don't need a new suit or I want to change my designer. I mean, this is fundamental essential stuff that people need to use. So there is a lot of stability in our base business.

Yes. That makes sense. So you kind of mentioned the 3 areas that you're moving into and how you chose them. Your competitors are not really going into these three. Can you just talk a little bit about whether you think that Air Products has something specifically that would make them more successful in these 3 areas? Or if it was more just a strategy choice?

Well, no. In gasification, we -- by buying GE and Shell technology, we have put ourselves in a position of being very unique. I don't think there are a few Chinese companies in gasification. But right now, if you are any part of the world and you want to gasify anything, whether it is coal, pet coke or refinery bottom, you're going to be picking up the phone and calling Air Products. So we are in a very unique position there. And as time goes by and people want to do these things, I think it will be proven that Air Products is really the only choice, is the prepared choice in terms of what we can do. I mean, people always have other choices, but we will be the preferred choice. So I feel very good about that. Then when it comes to carbon capture, we do have unique technologies in terms of how we can capture carbon from industrial plants. We are developing on new technologies on that. So we are -- I think we have a good competitive advantage on that one. And on that, I would like to stress that we are right now operating the largest real carbon capture facility in the world in Port Arthur, where we captured 1 million-ton a year of CO2, and we put it in the pipeline for enhanced recovery. So we actually have a real commercial plant operating. And then with respect to hydrogen, we are the largest producer of gray hydrogen. We know -- you know that. And then the transition is going to be to blue hydrogen, that blue hydrogen is related to CO2 capture. So if you can do the CO2 capture and you know hydrogen, then you can make blue hydrogen and the added advantage there. And then on green hydrogen, I think by what we are doing in NEOM in building a real commercial plant, which will produce clean hydrogen at a competitive cost is going to give us a competitive advantage of the first starter in that field. So I feel pretty good about the 3 areas being positioned very well.

Great. So let's start moving into the 3 areas. So we have a question on hydrogen from the Pigeonhole. So thoughts on current hydrogen projects, future of hydrogen as a revenue driver over 1 to 3 years, and where management sees hydrogen fitting into the company 2030 and beyond?

Okay. First of all, I mean, if I understood the question correctly, hydrogen will be obviously a significant revenue generator for us once we implement some of the projects that we are talking about. And in terms of how much it is and how big it is going to be, there is all kinds of different kinds of forecast. But I think if we are talking 2030, 2035, it can be -- our hydrogen business can probably be bigger than our entire business today. So the potential is there. I think the world is moving towards -- the energy transition is actually accelerating. There is a significant amount of push from, especially the younger generation that is pushing the governments to take action now. This will translate, I think, in time into some meaningful carbon tax in different countries, and that will significantly drive their need for blue hydrogen, for green hydrogen and gray hydrogen, all 3 of them will be there. And that is why we, at Air Products, want to be in a position that we can go to any customer anywhere in the world and say, what do you need? What fits your requirements? Do you want gray hydrogen, you want blue hydrogen or do you green hydrogen, we can do all 3 of them for you, so that we can cover all of the Board and all of their customers.

Makes sense. So kind of building on that, do you think we need more specific action or subsidy or carbon tax from the Biden administration for hydrogen to get momentum in the U.S. the way that it has in Europe? Or do you think what we -- what's happening now will be enough to get momentum?

I think what is happening in the U.S. right now with the things that are in place, I think it is -- I mean, I want to be careful. It is enough to make a commercial project. And you are going to see us announcing projects along those ones. But obviously, if the government does more, if the 45Q is made into -- rather than a tax deduction, it would be made into a direct payment, the incentive will be higher. If the value of the 45Q is increased from $45, $50 to $80, $90, it becomes even better. If other states adopt the LCFS program that California has, which they have, like in Oregon, Washington, if that becomes a nationwide strategy and laws, that would significantly help. But I think even under the current circumstances, it is possible to do projects and we will do projects for blue hydrogen. And obviously, green hydrogen is more difficult because with green hydrogen, you need green electricity at a reasonable price, and that is very difficult to combine in the U.S. right now. But I think in time, maybe that will have. But there is plenty of opportunity around the world for them.

Great. Hydrogen globally seems to be a land grab now. Where do you see Air Products as having a head start? And where do you see the largest barriers to entry for people to get into hydrogen?

Well, I think on that one, obviously, everybody is using gray hydrogen all over the world. In terms of blue hydrogen, which will be most probably in form of blue ammonia or even blue hydrogen by itself, if you can capture the CO2, I see that there will be significant amount of opportunity and demand for that, number one in Japan in form of blue ammonia, because they plan to take that blue ammonia and inject it into their gas -- their coal-fired power plants in order to reduce the carbon emissions. I think in the United States, if -- and Canada, there are opportunities for capturing CO2 and producing blue hydrogen. And those are some of the things that we are obviously working on. And then for a green hydrogen, I think the first and biggest opportunity at the beginning will be in Europe because the European Union is adopting policies, which is more related towards the fact that, look, I just want green hydrogen. I don't want you to use hydrocarbons and then give me blue hydrogen, they are more focused on green, real green hydrogen. So I think that will probably be the biggest market at the beginning.

Okay. I have a few NEOM specific questions here, if I could ask you to just give kind of a 30-second quick overview of the project for anyone on the line that's not totally aware of it?

This is about NEOM?

Yes.

No. The NEOM project we have started literally 5 years ago, but where is it that you can possibly produce green hydrogen? So for green hydrogen, you need green electricity. The very first thing that comes to mind is, well, this is easy. Why don't we go and buy electricity from somebody who is operating hydroelectric dam. And then that is green because the water is falling over the waterfall. And that -- but when you look at that, there are not that many -- that much power available around the world. And if it is, the cost is too high. And besides that, if you build a new dam, environmental people have an issue with the fact that you are not really doing anything for the environment because the new dam damages the environment. So that is when we started focusing on, okay, the next thing is wind and solar. So solar, the issue, you can find a lot of places where there is a lot of sun. But the issue is, obviously, the sun doesn't shine 24 hours a day. And even in the most sunniest place in the world, you really get effective 6 hours of intense sunlight. So you cannot operate a plant on an intermittent basis. You cannot operate the electrolyzer on an intermittent basis. So that wasn't practical. You had to be in a place where you had sun during the day and wind during the night, so that the 2 of them complement each other. And therefore, you can have continuous flow of power for 60%, 70% of the time and then the other 30% of the time you can store the power. So when we looked around the world, there weren't that many places that had those qualifications. Then in addition to that, you -- if you find this combination of the sun and the wind in the middle of the desert in North Africa, then the question is, okay, now you can produce the hydrogen. But then how do you transport the hydrogen to Munich in Germany to put it in a truck that became the transportation of the hydrogen. And even if you take the hydrogen and convert it to ammonia in the middle of the desert, if you are 2000 miles from a port, then that becomes an economy. Therefore, you need to have wind, sun, be close to a port, have a government who is willing to give you hundreds of thousands of acres to put out these -- So it narrows down your choices quite a bit. So that is how we ended up focusing on an area that is on the Gulf of Aqaba and in northern part of Saudi Arabia. Well, that area, we got lucky because not only it has all of those qualifications, but it is also in the region that Saudi Arabia is calling NEOM, and they want to build a new city there. And therefore, there was a lot of interest on the part of the local government, of the government of Saudi Arabia to get involved in green hydrogen because the whole concept of the NEOM city, the vision there is green. So everything came together and that is why we ended up with the NEOM project that, that is the best location. So once we put the project together, we obviously chose that the only way to transport the hydrogen even from NEOM to the market is to convert it into ammonia because then you can transport the ammonia and then dissociate it and put it in trucks and hydrogen refueling stations anywhere in the world. Once we put the project together and we went to the government and said, okay, this is what we think we want to do, then they got actually very interested in themselves. And they said that, well, this sounds very good. If you want to build it here, we want to be part of it. So the arrangement that we have is that we are going -- we have a joint consortium of 3 entities, it is Air Products; it is the government of Saudi Arabia through PIF, their private investment front; and it is Aqua Power, which is our partner in Saudi Arabia. And they are one of the largest developers of sun and wind power in the world. So it makes sense that because we need a huge 3,800, 3900 megawatt power plant, sun and wind, so they bring that expertise. So the whole thing made a lot of sense. But then we wanted to be the sole distributor of this product in the world, and they got that. So the project is going to be built by the 3 partners. And then once the green hydrogen is produced in the form of green ammonia, then Air Products will take that as the sole supplier, and then we will build the infrastructure to transport the ammonia and load it, crack it and put it in people's buses and trucks around the world. That's kind of an overview of the project, and I'd be happy to answer any other questions.

Great. Yes. So it's $7 billion, I believe, of gross CapEx. So it's a big deal. And as you said, Air Products is kind of on the hook for distributing the green hydrogen, what gives you confidence that there's going to be enough green hydrogen demand at the price that you need for it to work?

Well, obviously, on that one, people say we are taking a risk. We are obviously taking a risk. But in life, if you don't take your risk, you -- there is no reward, right? Because if you were afraid of doing anything, then you'll never do anything. But the way we are looking at it is that the production of the plant is about 650,000 kilograms per day of equivalent hydrogen. That's obviously a lot of hydrogen. We are focused on buses and trucks, buses and trucks that are powered by fuel cell engines that uses hydrogen, they would use anywhere between 30 to 50 kilograms of hydrogen per day. So if you do the math, if by the time we are ready for the plant to distribute the product, if there is 15,000 to 20,000 buses and trucks in the world converted to green hydrogen, that is the production out of the NEOM. Then considering the number of buses and trucks in the world and all of that, we gave ourselves reasonable assurance that we think we can find those 15,000, 20,000 buses and trucks around the world. So it's a calculated risk, and that is how we look at it. But in addition to buses and trucks there are other applications that would require green hydrogen.

That's a great way to think about it. What do you see is driving the cost of green hydrogen down from here? And is it -- are you moving too early? Why not wait until the cost has come down a bit to do such a big project?

Well, the cost -- people talk about costs coming down, the costs are not coming down. I mean, if you are building solar field or a wind field, yes, the cost of the equipment might go down a little bit. But that is not a big driver. And the location that where we are, we are able to produce electricity at less than $0.02, including capital returns. So very few locations can do that. So I'm not worried about the cost thing. I think that we are in a very good position. And besides that, if you wait too long, then everybody will get into the business. You need to have the advantage of being the first mover, right?

Yes, that makes sense. Another one from the Pigeonhole, where else in the world could you see doing a NEOM like project? It sounds like you scanned the world before you settled?

Well, I would like to say that, that is a little bit our secret, when the time comes, we'll announce it. There are other places in the world. We are working on it, but we will announce it when the time comes.