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

Good morning, and welcome. My name is David Begleiter of Deutsche Bank's U.S. Chemicals Equity Research team, and welcome to Day 2 of Deutsche Bank's Virtual Global Basic Materials Conference. Leading off today is a team from Air Products. Very pleased to have with us today Seifi Ghasemi, Chairman and President and CEO of the company; and Scott Crocco, CFO of the company as well.

We can go right into the fireside portion of the presentation. If you do want to ask a question, you can go to the chat box, low left-hand portion of the screen. So with that, Seifi, good morning. How are you?

Good morning, David, and I'm very fine. Thank you very much.

Excellent. You had a major announcement yesterday, a $1.3 billion net zero hydrogen energy project in Alberta, where you're basically taking hydrocarbons and converting them into something as good as green hydrogen. It appears to check a lot of boxes that investors are looking for, for your next project in terms of country risk, technology risk and scalability. Can you provide a brief overview of this project and tell us what you think makes this project unique?

Thank you very much, David, for asking that question. We are obviously very proud of the project that we announced yesterday. Number one, it is in a country which is leading the effort with the energy transition. It is north of our border, and we are familiar with the country. And we have a significant operation there with the pipeline and all of that. So that is the good thing. The second thing is that the project is very innovative. In the way that we have put it together, we are making it possible to use hydrocarbons and make, as you said, hydrogen, which is as good as almost green hydrogen. The project consists of taking the natural gas and breaking it down in an auto-thermal reformer. By doing that versus a steam methane reformer, which is the usual means of cracking natural gas to make hydrogen, with the ATR, which is almost like a gasifier, we can capture 95% of the CO2 that is produced in the process of breaking down natural gas to hydrogen. So that 95% of the CO2, we are going to capture that. We know how to do that. We have the know-how to do that. We'll capture that, compress it, and then we will put it in an existing CO2 pipeline that the Canadian government has built and sequestered. So that is almost ideal. Then what we are going to do is that we are going to generate all of our own power that the facility needs. But in addition to that, we are going to utilize a gas turbine, which will be operated on 100% hydration and this clean hydrogen that would generate power to export to the grid in addition to meeting our own requirement. It exports to the grid, and that export to the grid compensates the carbon that we are putting, that 5% CO2 that we put in there. So in total, the facility is net 0. We think there is significant value in the products that we make. We are going to have a hydrogen liquefier to produce liquid hydrogen for mobility in Alberta, where there is going to be the demand by the time we come on stream in 2024. And then the rest of the hydrogen will be used by all of the primers in that part of the world, which are looking for and going to net zero and, therefore, they have a requirement for clean hydrogen. So the whole combination is very exciting. We will replicate this in other parts of the world. But there was no better place to start than in Canada, where we have an existing infrastructure also.

Since the capacity is significant, more than [ 50 % ], can you discuss the product in that region that can support that type of a capacity increase?

Well, if you're referring to the capacity of the unit, the unit will have a capacity of around 400 ton a day of hydrogen. And then we have laid out the property about the land and so on to duplicate this many more units, that's why we call this a multibillion-dollar project over time.

So you're talking about the growth in the region to support the capacity that you're adding in terms of hydrogen capacity. Is there enough demand growth?

Yes. The liquid hydrogen that we are adding in the region, it will be the first liquid hydrogen plant in the region, and it will have a capacity of about 30 ton per day.

Got it. Returns on this project cost and the earnings impact to Air Products?

Well, David, we have always said that we are looking for a return of -- 10% return on equity, about 10% IRR on these projects, which really translates to every dollar that we spend, we expect about $0.10 of operating income. And this project is in line with that. And depending on what is the final price of this green hydrogen or this blue hydrogen that we sell, that would determine the return. But I feel very good about the project and the returns that we expect.

Very good. There's a lot talk about perhaps being a premium for this net zero or blue hydrogen. Are you expecting a premium price for this hydrogen going forward?

Of course, David. We are producing a product that nobody has, and it obviously will have a premium value.

Excellent. As mentioned, it seems that the technology risk is pretty low using existing technologies. Anything unique about this project that gives you pause in terms of technology and construction and ramping up?

Well, the technology -- the thing about the project is, again, a little bit like NEOM, is the way we have put it together and the components. But the ATR is something that has been tried. That is a known technology. And the innovative thing is obviously the 100% hydrogen turbine, but that is something that -- Baker Hughes has those units, so we are not taking any technology risk.

Very good. As mentioned, I was struck by the number and quantity of government ministers in your press release. It appears Alberta is a very good place to do business, very low risk, maybe even better than the U.S. Would you agree with that assessment? And how would you characterize country risk, if any, in Canada?

Well, country risk is extremely low. I mean Canada is our northern border. It's a democratic society, and I don't expect any significant upheavals up there. But the part that we like is that, and it was demonstrated yesterday with what you saw in the press conference, is that the politicians and the government are really committed to the energy transition. And therefore, you saw not only the mayor of Edmonton, not only the premier of Alberta, but you had the Minister -- 2 federal Ministers, Minister of National Resources and Minister of Technology and Development, both of them being there, which was the only other thing that we needed was the Prime Minister himself. But fundamentally, it was a total demonstration of the commitment that the government has to energy transition. I'm very optimistic about that, and that will create opportunities for us to do other things in Canada.

Very good. You mentioned the project could be expanded. I assume that would be lower cost. And so how are you thinking about the next expansion project, the size, the cost and timing?

Well, we hope, as I said, there are about enough land that we can duplicate this project for the next phase. And then after that, we can triplicate it. So -- and obviously, if we build the next phase, it will be a lower cost because we already have the infrastructure. So we are very reasonably optimistic. We are in Alberta. Alberta has a lot of, obviously, natural resources in forms of natural gas and oil sands and all of that. They want to continue to use that. And in this Board, where there is going to be so much focus on carbon, a project like this where you can produce net zero product from hydrocarbon is greatly valued.

I would, without a doubt, looking at the project, it looks very replicable. Your green hydrogen makes sense. Obviously, there's a lot of gas in the U.S. There's a lot of gas in other regions of the world as well that's trended perhaps.

Well, in the U.S., we have a lot of natural gas, but the issue is the sequestration is not as ready as in Canada. I mean in Canada, they have built this specific pipeline. They call the Alberta CO2 Trunkline, and it makes it very easy for sequestration. We need to come up with something like that in the U.S. in order to make it more practical. And, quite frankly, I mean, we obviously are looking at doing these kind of projects in the U.S., too.

So taking a step back on the green hydrogen in South Arabia. You have net zero hydrogen project in Canada. How is the pipeline traditional green or net zero hydrogen projects looking right now?

David, as we go forward in time, we are beginning to see more and more interest and demand at different levels in different countries for blue and green hydrogen. And that is why I think that if yesterday that we thought demand is x today, the demand is x plus something. Therefore, we think that we are on -- we have the right strategy. We are focused on the right area. The energy transition is real, and we want to play a significant part in it, and more than a significant part. We are the largest producer of gray hydrogen in the world. We are determined to be the largest producer of green hydrogen in the world and the largest producer of blue hydrogen in the world. And we have projects to make that happen.

Had a question from the portal, Seifi, question being why is this a good use of capital considering it seems different from industrial gas model where capital is usually deployed with the customer?

Well, the thing is that this is a very good use of capital. That's what we do all the time. We just build facilities and supply it. I mean this is no difference than building an SMR to supply Exxon in the Gulf Coast. That's usually what we do. So this project is we are producing net zero hydrogen. Now if people are saying, tell me who the customers are, well, we have agreements with customers that we shouldn't do that, and we are not going to do that yet.

Very good. A couple of -- no, that's good enough for now. Seifi, just maybe on Jazan and Lu'An, any project updates there? First, in Jazan, are you still expecting financial close by September 30 of this year?

Well, yes, we do. But I'd like to qualify it in the sense that we are not in control of all the events in the world, political events and local events and all of that. So I don't want to give the impression that it is 110%, but we are making good progress. It is very public that we are in the market for the financing. We are making good progress on that. So everything is going in the direction that we expect this transaction to be closed before the end of the fiscal year, which is before the end of September, barring any unforeseen events.

Very good. It's really [indiscernible] Once close occurs, you will be able to -- earnings will ramp up immediately. Is that fair?

Once -- financially, we are closed, then we will start getting our fees, which will be reflected in our results. Yes.

Very good. And just on Lu'An, where do we stand on the restart of the facility? You had mentioned at the earnings release, 1 of the 4 gasifiers was running. How many are wearing today. And how do you think about the earnings contribution of the project over the next few quarters here?

As of this morning, 3 of the gasifiers are running, and we had some equipment issues with the fourth gasifier, but that is being rectified. And so we expect all of the gasifiers will be onstream in a month or so. And life will go on in accordance with what we have explained to the investors about our arrangements with the customer and all of that.

And once all 4 are running, are we at pre-shutdown rates? Or are we still -- do we have to run at full rates to achieve that?

No. We have explained to people that we have decided to give a kind of a reduction on our fee for 2 years starting October of 2020 for the project for a lot of reasons that has to do with our long-term relationship with Lu'An. So once all of the 4 gasifiers are on stream, we are not going to see the same level of contribution as we had in 2018 or 2019. It will be less than that. But then after 2022, it will go back to where it was.

Very good. I just had 1 last question from the portal about the Alberta project. In terms of the ATR allowing greater CO2 capture than the SMR, any disadvantages of the ATR versus the SMR?

No real disadvantages. It might cost a little bit more to build it, but there is no significant disadvantage.

Very good. Maybe switching to near-term trends, Seifi, how's business by region, by end market, as we sit here today?

Okay. That's a very good question. And David, if I may start from the eastern part of the world, our business in China is doing well. China's economic growth is holding up. And not only China's but also Korea and Taiwan and the whole Asia is doing okay. We are doing okay. Our results for Asia when we announced the results, people say, "well, where is the growth?" Well, those results are affected by Lu'An. But otherwise, underlying growth is there, and we are very optimistic about what we are doing. We are very well positioned and all that. Then our joint venture in India is actually doing very well, unfortunately, because of COVID. We are the largest producer of oxygen there, so we will get some benefit from that. But that's a small business. We don't consolidate it, so people don't see that in our results. Then we come to Europe. In Europe, our business is actually doing okay. That's not because the volumes have gone up significantly, but it is mainly because our people have done a very good job in terms of controlling our cost and running that place very efficiently. But at the same time, I have to say that economic activity hasn't gone down, but we are not seeing a significant pickup like in China. Then they come to the U.S. In the U.S., we are yet to see the growth that everybody is talking about. I keep saying that everybody doesn't like to hear it because everybody says, well, GDP is going up because people are traveling and all of that, but the fact that people are getting into the air, flying on the planes doesn't add a lot of use for industrial gas. The only thing that is a factor in our results in the U.S. is that we do not have a packaged gas business, and we do not have a medical business. So if you had a medical business in the U.S., with COVID, you would have better results. But then when you go to Latin America, our Latin America business has picked up not because economic has picked up but because we are doing 2 things in terms of productivity and all that. But the second thing is that, unfortunately, we are benefiting from COVID because, right now, the demand for oxygen in Brazil, Argentina, Colombia, Chile is significant. And we have a presence that we are benefiting, but if you are like one of our competitors where you have a significant presence in that part of the world, you will significantly benefit from the misery of the people where they need a lot of oxygen. But that's not going to last forever. So that's kind of the way we are seeing it right now. So overall, the sky is not falling, and we are doing fine. But specifically in the U.S., where everybody is very focused on, we are not seeing as much industrial activity as people would like to believe.

Interesting. Just merchant operating rates, how are they looking by region? How should we think about incremental margins in the merchant gas business as it recovers?

Well, the operating rates in China, depending on where you are, is about 75% to 80%, some areas, even more than 80%. In Europe, we are still at around 75%, 77%. And in the U.S., you are at around 76%, 77% utilization. In terms of pricing, I can only talk about pricing on a historical basis because I don't want to comment any about pricing moving forward. But on a historical basis, you see that we continue to get price increases. Right now, I think last time, we announced our result, it was the 15th consecutive quarter where we are seeing price increases. So we are very committed to that. As a result of being committed to that and making sure that we get -- we keep our margins and get paid for what we deserve, sometimes we lose market share. And we have been losing some market share, especially in the helium area where other people are more aggressive, but that doesn't change our strategy. We have a strategy that we are following. And besides that, we constantly spend money on developing technologies and new product for our customers, and we need to have appropriate pricing to pay for that.

Seifi, I [indiscernible] on pricing, but this is a pretty unique pricing cycle. How have other pricing cycles ended that were strong like this? Any commonality here that you can point to historically?

Well, I think there is one thing unique about this cycle, David. Usually, in the past, when there has been a pricing cycle, it was related to inflation. This pricing cycle is not related to inflation. Now how it will end depends on what is going to happen. Right now you are seeing that all of the commodities and everything is getting into an inflation. So how does this end, I don't know. I really -- I think we are in a unique situation, and I do not want to speculate on that.

You have a lot of experience, Seifi, and I'm curious on your views on this inflation debate. I think we just had a very big print for inflation in this country. Are you concerned about inflation? And how is wage inflation at Air Products right now?

Well, we are seeing that. I think, inflation, why are people surprised? Everybody -- any economist will tell you that when you have a significant amount of government expenditure, which we have had now for almost 12 years since 2008, you end up with inflation. I mean so the fact that we have inflation shouldn't be a surprise to people. So I fully expect it. I think it will happen. And then the other comment that I want to make is that based on my 42 years of being in the industrial gases business one way or another, industrial gases usually does well during inflationary period because you do have an excuse to go increase prices, but the price of your raw material doesn't change because it's air.

Very good. So clearly, a net positive inflation for Air Products. You mentioned helium, just curious about how that business is recovering? And how you see the market from both a supply and demand perspective over the next couple of years? I believe there is new supply in the market or coming into the market as we speak.

Well, the helium business is an interesting business. There are very few sources of helium, so the supply is -- it's very obvious where the supply is. And right now, I think you will get into a shortage of helium for a while. But the big elephant in the room, as I say, is that Russia has announced this gigantic project in the eastern part of Russia, where they are going to supply natural gas to China, which they are already doing. And they are saying that they are going to bring on a stream, in time, almost 2 billion cubic feet of helium. Well, if they do that, the total helium demand in the world is around 7 billion, so that would be a significant addition and, therefore, it will have an effect on the prices. But the $64 million question is that when is that product going to come to the market or if it's going to come to the market. But if it does, then we will go through the same kind of cycle that we went in 2011, 2012, then a tad had their significant LNG project come on stream, and they have started putting 2.5 billion, 3 billion cubic feet of helium into the market. The market is growing. It will absorb it on time, but it will create a cycle. So when is that going to happen is very difficult to predict.

Got it. Got it. Just briefly on LNG, how is this business progressing? And what is the earnings potential of the LNG business over the next couple of years?

Well, right now, we feel pretty good about the LNG business. David, you know very well, that business is cyclical. We had the peak of that business for us around 2015. And then it started going down, and we were not making any money on that business basically in 2018 and 2019 and even in '20. But the business is beginning to come back, so we are in the up cycle. And hopefully, that will last for a few years. We like that business very much. We are the technology leader in that business, so we will live through the cycles. That's not a business that we want to divest or anything.

I had a few questions. Actually, I asked a lot of them in the beginning. But first, on the NEOM project, what's the SaaS of the project? Where are we on the key milestones ahead for this project? And what are the key risk factors you're tracking right now for this project given its 2025 target start-up?

The NEOM project is moving forward. Partners are committed to the project. We have started -- or the engineering is underway. We have started even ordering some of the key equipment, which has a long-time delivery time. So the project is moving forward. We are very excited about the project. It's a huge project, so it has its own challenges, but nothing that cannot be resolved. We are very optimistic about the project in general and excited about it going forward.

I know we went down from marketing, but when we get some insight to the end market distribution, the pricing, the hopeful premium for the product, what's the time frame for those actions?

I don't think we will give you anybody any information on that. That would have to come basically as people -- other people might want to announce it. This is a very proprietary product that we are going to make, and we will sell it based on what the market price is rather than say, we don't do things fast for last year. This is very unique. Nobody is going to have this so-called green project produced from wind and solar at this massive scale. And in terms of where the markets are and so on, we are working on that. But we don't really want to talk about it a lot publicly because that's our, if you want to call it, our secret sauce.

Got it. Seifi, between Lu'An and the net zero project, I think you've committed about $5 billion to these blue and green hydrogen projects. If I look at, it could be on a decade, where is it going to be? Could it be $10 billion, $15 billion, $20 billion for blue and green hydrogen commitments, do you think?

I think that hydrogen is going to be the growth area for us. Between blue hydrogen and green hydrogen, we have the potential of doubling or tripling the size of Air Products by 2030 or 2035. Therefore, a significant part of our investments are going to go into -- these are all together. In order to make blue hydrogen, you have to make an investment in CO2 capture, right? So blue hydrogen, CO2 capture and gasification, they're all part of the same story. That is where our capital is going to go. And we have made a commitment that in the next few months, we will make a kind of give the investors an insight into, okay, we told you we will spend about $15 billion between 2018 and 2023. They are almost there in the middle. And now we will give you another glimpse about what we think we will spend between 2018 and 2028.

Very clear. And that kind of segues into carbon capture, which you answered a little bit here. But how should we think about the economics of carbon capture projects?

Well, the economics are there if the customers require -- I mean we are not going to make blue hydrogen or green hydrogen if the customers are not willing to pay for that because we need to get our return. But I think the demand is there. And some of the customers, whether they like it or not, they're going to be faced with the carbon tax, which would make it very economical for them to pay us in order to capture the carbon and have the green product.

Understood. Yes, as you talk about these very clean and sustainable projects, gasification is still a core part of your business. Is gasification still an attractive area of investment for Air Products?

Yes. Because with gasification, you can also capture -- with gasification, it's carbon capture ready. So in certain parts of the world, we can do gasification, capture the carbon and end up with a blue hydrogen product out of a gasifier, which would be really the ultimate thing. And those are the kind of things that we are looking at.

And where do we stand on -- what's the status of the Indonesia coal to methanol project?

We have announced 1 project. We announced it last year, the Bangalore project, that's about a $2.5 billion investment for us. And that project is moving forward.

Very good. Just on decaps, I know they're hard to do. But first, on PBF, how is that working out? Timing may not have been optimal, but how is that working out overall?

In the decap of in general or you're talking about a specific project then?

Well, first, the PBF decap. How's that working out and your returns on marketing?

PBF working out very well. We did the right thing. We bought the stuff at the right time. And we have converted that, it is -- we are operating that. The customer is very satisfied. You can ask them. And I think it was a win-win deal for both sides. So we are very happy with that.

Very good. And how is the pipeline traditional decaps right now?

Well, these things -- I mean, right now, we are doing the biggest decap of all, which is Jazan. Jazan is a decap if you're buying the assets from Saudi Aramco. So we have a huge project on our hand that to do. But the other ones will come on stream. There are opportunities, but I don't want to start creating an expectation that there is a lot more to be done. If it happens, we announce it and all of that. There are opportunities, but I think there are a lot of difficulties to get anything done. Look at Jazan. It has taken us really now 4 years that we have been talking about this thing, and it becomes a long cumbersome process to actually make it happen.

Very good. Seifi, lastly on ESG, you've done a very good job positioning our products as an ESG-focused company. Sustainability is at the core of what you do. How will this drive the entirety of the company and its growth and to review Air product as an ESG player going forward?

We are an ESG player, because what is ESG? It's environmental, social and governance. On environmental, everything that we are doing, everything that you have been asking me about in the last half an hour, David, is related to the environment. It's all about carbon capture, hydrogen and how you make gasifiers more efficient. So that is our company. That is our growth platform. We have our base business. We support our base business like anybody else, and we are not losing any ground on our base business. But in terms of growth, it's all about the environment. So the E element of ESG, we are way ahead of everybody, and I think you can find very few companies who are as focused on the environment as they are with real projects. We are not talking. We are actually doing things. The second thing is social. We are very well known in all of the communities about being a good corporate citizen. We have demonstrated that, and we demonstrated that in the ultimate during the COVID thing in terms of how we helped everybody and helped our own people by not laying anybody off, by not cutting anybody's salaries so that people and the communities can continue to survive. And in terms of governance, we had a great Board of Directors with a diversity of experience in terms of what they do. We strictly have the rules about the committees, the independence, the independence of the directors and all of that. So when you put the whole thing together, I don't think investors can find a better ESG player than us.

Excellent way to end the conversation, Seifi. Congrats on the net zero hydrogen announcement yesterday. Thank you for attending as always, and we'll talk soon. So thank you.

Thank you very much, David. It's a pleasure to be with you, and thanks for the audience who is listening. I appreciate that, and we look forward to talking to you again. Thank you.

Take care. Thank you.