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

Ladies and gentlemen, please standby. Good morning, and welcome to the Air Products and Chemicals Investor Conference Call. Today's call is being recorded at the request of Air Products. Please note that the presentation and the comments made on behalf of Air Products are subject to copyright by Air Products and all rights are reserved. Beginning today's call is Mr. Simon Moore. Please go ahead, sir.

Thank you, Jake. Good morning, everyone. This is Simon Moore, Vice President of Investor Relations, Corporate Relations and Sustainability. I am pleased to be joined today by Seifi Ghasemi, our Chairman, President and CEO; Dr. Samir Serhan, our Chief Operating Officer, who is actually joining us right now from Saudi Arabia; Melissa Schaeffer, our Chief Financial Officer; and Sean Major, our Executive Vice President, General Counsel and Secretary. Air Products issued a press release yesterday announcing the final closing of the $12 billion Jazan project. We look forward to discussing this project today, including the anticipated impact on Air Products' financial results. The press release and the slides for this call are available on our website at airproducts.com. This discussion contains forward-looking statements. Please refer to the forward-looking statement disclosure that can be found in our release and on Slide #2. We appreciate you joining us to discuss this very exciting opportunity. After our comments, we'll be happy to take your questions. We will be limiting our comments and only taking questions pertaining to this project. We look forward to discussing our quarterly results with you on November 4. Now I'm pleased to turn the call over to Seifi.

Thank you, Simon, and good morning to everyone. Thank you for taking time from your very busy schedule to join our call on short notice. All of us at Air Products are very excited to be on this moment to announce the completion of this very significant and a strategic $12 billion transaction. This award, Saudi Aramco, the world's largest company to clearly that demonstrates the value of our technology and operating our know-how. I have talked to you about this project many times in the last 2 years. So today, I want to have you hear from my colleagues who have done the really hard work behind the scenes. Therefore, I now would like to turn the call over to Dr. Samir Serhan, Air Product's Chief Operating Officer. Dr. Serhan?

Thanks, Seifi. Good day, everybody, from Saudi Arabia. Many thanks to our colleagues from Air Products. Air Products Qudra, Saudi Aramco and ACWA Power for closing this impressive $12 billion decaptivation project. Now please go to Slide 3. The Jazan joint venture will supply hydrogen, power, steam and other utilities to one customer. And that is the next door, branding new Saudi Aramco, 400,000 barrels per day refinery. Some of the power will go also to the Saudi power grid. In comparison to other coal gasification projects, this is a liquid gasification project using Air Product's proven Air Product's Shell gasification technology, we will be gasifying vacuum residue, which is a high sulfur bottom of the barrel product to produce syngas, a combination of hydrogen and carbon monoxide. To do this, we will use oxygen from the world-scale air separation units we have installed there. We clean the syngas and will produce hydrogen supply to the refinery but also after cleaning up some of the syngas, we add nitrogen to it from our air separation units to produce power. So those are syngas gas turbines to produce power. Now please go to Slide 4. I have to admit calling the Jazan $12 billion decaptivation project in the industrial gas industry as a mega project is an understatement. It is definitely worth the 4-year wait. Going beyond the dollar value, the Jazan project is a world-scale project by many measure. Let me put this in numbers. The Jazan project has 72,000 input/output points. This is like control, highly controlled facility. This is more than a wholly-owned Air Product's plants on the 100-kilometer pipeline we have in the U.S. Gulf Coast. We will be producing 2.5 billion standard cubic feet of syngas per day. This is equivalent to 16 large hydrogen plants. This is big, vaccum residue gasification 8x bigger than the largest operating capacity today. It took us 40 years to become the world leader in the production of hydrogen. Jazan's syngas production will increase the amount by 40%. We have a team of 800 people are ready to commission this facility. This is more than 30x what we need to commission [indiscernible] hydrogen plant. More than 300 million hours were used to build this facility. [indiscernible] will produce 7,000 metric tonnes of day oxygen/nitrogen. This is the world's largest single industrial gas complex for the production of oxygen and nitrogen. The site size is 3.3 meters -- million square, very impressive to go there and drive around it, that's equivalent to 460 soccer field. We basically process 1.5 million meter cube per hour of seawater cooling. This is equivalent to 200 Olympic-sized pool every hour. We produce around 4 gigawatts of power. This is equivalent to power that you need for the consumption in the country of Denmark. Please go to Slide 5. The Slide 5 shows the shareholders. Air Products own 46%. Our joint venture Air Products Qudra own 9%. Air Products Qudra's 51% owned by Air Products, 49% owned by Qudra Energy. Acwa Power own 25% and Saudi Aramco own 20%. We do have a joint venture over the [indiscernible] and maybe you hear it for the first time, it's called IGCC. This is Jazan Integrated Gasification and Power Company. Jazan Integrated Gasification and Power Company. Please go to Slide 6. The value again of the transaction is the $12 billion. The combined shareholding for Air Products is 50.6% because of the 46% plus our 51% and the 9% for Air Products Qudra. The funding is 40% equity and 60% nonrecourse project financing. Air Products equity share is around USD 2.4 billion. The joint venture, [ JPT ] will own and operate the facility for 25 years. The joint venture will receive a monthly fee from Saudi Aramco for supply of again, hydrogen, power, steam and other utilities. Now I'm happy to turn the call to Melissa to go over the financials. Melissa?

Thank you, Dr. Serhan. We are very excited to have concluded this transaction and are looking forward to the joint venture providing critical products to support Saudi Aramco's Jazan refinery. Please turn to Slide #7. I would like to explain a few key points about the financials. First, as many of you know, Air Products will not consolidate the results of this joint venture. Although, we do own a slight majority of the joint venture, based on the accounting definition of control in various rights of Aramco, we won't consolidate. This means we will not report any sales or operating income from Jazan. Our portion of the joint venture results will be reflected in equity affiliate income on Air Products income statement. Of course, this has no impact on the EPS contribution. Second, I want to describe how the joint venture will account for this project. As a reminder, Saudi Aramco pays a joint venture a monthly fee for the supply of the products. Essentially, this is an on-site deal. However, because of the accounting view on key terms of the various agreements, the joint venture will account for the contractual on-site payments from Saudi Aramco as financing revenue. The implication of this is that the joint venture report profits will decline modestly over time, and therefore, so will Air Products reported EPS. And third, the project will close in 2 phases. We closed on the first phase this week. That is about 60% of the overall project. We expect to close on the second phase in 2023, which is the balance of the project or about 40%. The reason for the 2 phase close is the status of the asset. The 2 phases are aligned with mechanical completion of those assets. Now please turn to Slide #8 to review the details. Although this project has 2 phases, it's important to recognize that 100% of the $12 billion equity and debt financial commitments are fully completed. We closed on Phase 1 this week, about 60% of the equity and debt has been paid. So Air Products has contributed about $1.5 billion of equity. We will now begin reflecting an annual run rate of about $0.80 to $0.85 of EPS for Phase 1. We expect the joint venture to close on Phase 2 in 2023. At that time, Air Products will contribute the balance of our equity or about $900 million. From the time of Phase II closings through year 10, we expect the EPS to average about $1.35 per year. Years 11 through 15 are expected to average about $1.15 in EPS. So you can see the accounting treatment as a financing only has a modest impact on the EPS. Also, throughout the contract, we do expect some quarterly and annual variation primarily based on maintenance costs. Now I'm happy to turn the call back to Seifi to wrap up.

Thank you very much, Melissa. I appreciate that. I just would like to just make 2 follow-up statements. Number one as Melissa mentioned, please although this is 2-phase closing, we have secured all of the financing, the $7.2 billion of financing for the entire project. So we don't have to do a refinancing. And the second point that I want to make is that the monthly fee that we get from Saudi Aramco, that monthly fee is fixed for the whole 25 years, that monthly fee does not change. Actually, it has an element of escalation with labor costs. So the variations that the Melissa referred to has to do with how we treat this thing accounting-wise? But in terms of cash and the monthly fee, that is fixed for the entire 25 years. So before we get to your questions, I would like to say that Air Products is obviously very proud to have completed this complex transaction and believe me, it was very complex, and it took us to the time that we did. We are very proud to be partnering with Saudi Aramco and ACWA Power and Air Products Qudra. We, as Air Products, remain committed to continue investments in Saudi Arabia and supporting the Kingdom's Vision 2030 as you have seen in many of the other projects that we have done and we will do in the future. So with that, we are now ready to answer any of the questions that you might have.

[Operator Instructions] We will begin with John McNulty with BMO Capital Markets.

This is Bhavesh on for John. First of all, congrats on the deal. Now in terms of the returns, evidently, the returns for the project has come in higher than our initial expectations. Can you help us understand what drove the change in earnings power from around like $0.85 for the full project to now as high as $1.35? And what role did the lower interest rates play in this?

Well, that is a very interesting question. The key is that during the whole time, what we were telling you was that the return on the project is a minimum of $0.10 for every dollar that we invest. We never gave you the actual number. We said it is the minimum. So when you calculate the minimum income, you come up with $0.85. So this project was a very good project from where we've been. But in addition to that, it is true that when we started with this project the interest rates that we thought we would get that in the order of 5.5% to 6%. And obviously, right now, they are less than that. And as a result, that has helped us with the return. And if you recall, exactly last year at this time, we did a lot of damage to our stock by saying that, "Look, we have an issue with the negotiating the Saudi Aramco and it is related to the interest rates and how much we share." So it took us about to resolve that, but it was resolved in a day, which is a win-win situation for both parties, and it did improve the return. So it's a combination of the 2 factors that the project originally was higher than 10% anyway and lower interest rates helped it to get it to numbers that you have around 50%, Okay?

Got it. If I could add a quick follow-up. So there is a substantial debt at the JV level. Can you share what you assume in terms of repayments when you calculate the EPS terms?

Melissa, you want to handle that?

Absolutely, Seifi. Bhavesh, can you repeat your question? I'm not sure if I clearly understood what you're asking there.

Sure. So it's about the debt at the JV level. Can you share what you made your assumptions in terms of repayment of debt when you calculate your EPS returns for APD?

Bhavesh, maybe I could just try to -- what we've really focused on in this conversation with investors is to really focus on the return on the Air Products equity investment, the $2.4 billion. As Melissa pointed out, it's nonrecourse debt. And so really, again, I think the easiest thing to think about is this is a $2.4 billion Air Products investment. Obviously, the joint venture will be paying the debt consistent with the agreements on the debt.

On that one, if I may add, now that I fully understand your question. The financing that we have put in place for this project, it is obviously in different tranches some of it is 7 years, some of it is 15 years, some of it is 23 years. And each one of those has a repayment schedule. And obviously, the banks and so on, some of them are not very keen to disclose the details of that. But overall, I think we just wanted to tell you the impact on Air Products rather than the details of how the joint venture will account for this. Okay.

Next, we will hear a question from Jeff Zekauskas with JPMorgan.

When you think about the earnings per share contribution to Air Products, is the cash contribution to Air Products also $0.85 or if you think about the coming year, will you get $0.85 a share in cash, and say, over a 5-year period, what's the relationship between the EPS contribution and the cash contribution to Air Products? And then secondly, what's the -- and then what's the EBITDA of the project?

Okay. Let me handle that. Number one, the EPS calculation for Air Products is an accounting thing. The cash flow to us is a function of what Saudi Aramco pays us, and that number is constant. And as I said, it escalates a little bit with labor costs. So the cash contribution is going to be there for the whole 25 years, Jeff. Obviously, we do need to repay the loan, but you know how these things work out with the mortgage style and the retail of the loan and all that. So the important thing is that the cash coming into the joint venture, that doesn't change month to month at all, okay? So that was the first part of the question. And the Second part of your question, can you just clarify that again?

Yes. What is the EBITDA of whole project?

We do not want to disclose the exact EBITDA because of the sensitivity on the part of our partner Saudi Aramco because they don't want everything to be disclosed. But Jeff, between you and I, it is not that difficult to calculate that because if we are giving you on EPS of $1.35 or $1.40 for the project. Then we have 221 million shares. So you can come up with the earnings or 50% of earnings after tax. Our tax rate is 80%. You divide that by 0.8, you get around something like $475 million. Then you add to that the interest, you know how much the debt is $7.2 billion. The interest rate, we don't disclose the exact amount, but you can make an assumption of what it is. You know the numbers better than I do, and then you divide that by 2, you add that, that would be the interest charge. And then you take $12 billion and depreciate it over 25 years, now you pretty soon come up with an EBITDA. I said I don't want to quote an exact number, but you come up with number in the order of magnitude of $750 million, $800 million. But you need to calculate, we are not allowed to disclose the exact number. Because if we disclose the exact number, then we are disclosing the exact fees that Saudi Aramco is paying us, and they do not like us to disclose that. But it's not too difficult to come to an approximate number, Jeff. You know how to do that better I do.

If I could just clarify, Seifi, I think the number that you mentioned, is $750 million, that is not a 100%.

It's Air Products share. It's Air Products share. The total thing obviously will be twice of that.

And Jeff, just to be clear, from an accounting perspective, obviously, this is an equity affiliate income on our statements.

Right. So the equity affiliate...

Jeff, the bottom line is that if -- all of the EBITDA is not going to show in the EBITDA that we report. But you guys are very smart to figure that out. The EPS shows that -- all of the EBITDA will not show in our reported numbers, because we are not consolidating.

Right. So the meaning of all of this is that, in general, over in 2022, the -- your Air Products as an Air Products entity will receive, I don't know, $190 million in cash. Is that right?

And a lot more than that. The EBITDA there -- the fact of the money we get -- I mean, Jeff, please look at it this way. We get a monthly fee from Saudi Aramco and our cost is the cost of the maintenance of the facility. The better balance of it is the cash and then we use that cash, some of it we put it in our pocket and some of it we used to pay down the debt. And the amount that we get paid doesn't change. That's -- that is bad all the time. That doesn't change. It's the accounting of how they look at it changes.

We will now take a question from Kevin McCarthy with Vertical Research Partners.

Seifi, can you comment on the closing occurring in 2 phases. What is driving that? And with regard to the latter closing in 2023, what is governing that time line? And could it wind up being sooner or later? How do you see that playing out?

Kevin, thank you very much for asking the question. The reason for the 2 phase closing is that we are taking ownership of assets. We want to take ownership of assets, which are 100% mechanically complete. Not all of the assets at the refinery are totally mechanically complete. Therefore, we had a very good conversation with Saudi Aramco, and we said that, look, we want -- we obviously going to buy the whole thing. We have the financing for the whole thing and we are committing to buy the whole thing. But the actual physical transfer of assets has to happen after their mechanical completion because we didn't want to be dealing with their contractors who are there at the site mechanically completing some part of the facilities. Therefore, the first stage, the 60%, is for the parts which are fully mechanically complete. And then the balance can be, as you said, mechanically complete sooner. The trigger is mechanical completion. So if the other assets get mechanically complete before 2023, we have the financing, everything is in place, and we will take possession of that, and we will see the effect on our bottom line sooner. That is the trigger, and that was the logic, Kevin.

Understood. That's very helpful. And then as a second question, if I may, on Slide 8, you indicate that the annual EPS accretion to Air Products will step down by about $0.20 from $1.35 to $1.15. I gather from your prepared remarks that may have to do with accounting, but perhaps you or Melissa could talk through what the actual accounting treatment is that is triggering that step change a decade from now?

Well, I'll try to give you an answer and Melissa can expand on that. The fundamental accounting treatment is that from an accounting point of view, people look at this thing as a financing like a mortgage financing. That is what is driving the addition. That's fundamentally the answer for that.

Yes. So yes, the treatment is the Aramco payments are, just like what Seifi said, a mortgage-style financing. So the payment is split between a principal and interest with interest, obviously, being a profit and the same payment shifts from interest to principal over time. So the lower interest, the lower profits that we see, again, just as Seifi said, as mortgage-style.

Next, we have John Roberts with UBS.

Congratulations here. Seifi, Air Products has been in and out of mega-scale utility power plant projects over the decades. I think Jazan is an exception with Air Products having such a large power utility operation. Is that a fair characterization? Or do you expect to operate more mega-scale power plants in the future?

Well John, you are very well informed and you know the nature of these projects. some of these mega-scale projects, you generate your own power because of excess steam and the excess heat that you have. So by default, you end up operating power plants, even with some of the SMRs, we have steam turbines and we generate our own power. So it's the nature of these mega-scale projects that we will end up operating big power plants like the one in -- the project we are doing in Indonesia as a big power plant associated because we have a lot of excess heat. But on this project, it was unique because these really, our expertise and all of that was in the production of the syngas. And the syngas, as you know, goes to here to drive a discrete number of gas turbines. That is why we partnered with ACWA Power, because ACWA Power are experts in power. So they and their operating know-how will help us do that. I do not expect that we would be doing a lot of projects with this scale power plant, I mean, this is a 4,000 megawatt power plant. It's a huge power plant. I don't expect us to be doing that. But a lot of other projects that we are doing still have 300, 400, 500, 700 megawatts of power generated because that is a part of the process.

That's helpful. And maybe could you just put in perspective your overall Saudi Arabia strategy. I know we've got Jazan and NEOM are the 2 really large ones, but what else do you have going on there in Saudi Arabia.

Well, I can only disclose to you what we have announced publicly, John. On publicly, we are involved in 3 big projects. One is this one. The other one is NEOM. And then the other one is the Jubail network, where we are trying to replicate our hydrogen pipeline on the Gulf Coast of the United States in the Jubail area with all of the refineries. Other than that, Saudi Arabia is on the move. There are a lot of ambitious plans there. Saudi Aramco is involved in a many, many things. Every day, they make announcements about what they want to do about blue hydrogen, about green hydrogen and all of that. And we look forward to continue to work with them. We feel very comfortable operating there. They have given us these big projects. Obviously, we are significantly committed. We think that the Saudi Arabia is moving forward very fast with the Vision 2030 and all of that, and we want to be part of that. But I cannot disclose anything other than what we have disclosed publicly, John, I guess.

Now we'll move to a question from PJ Juvekar with Citi.

Yes. So my question is on the CO2 emissions from the Jazan project. Can you just talk about that? And are there any future carbon capture sequestration plans as the Kingdom is planning to go to net zero by 2060?

Well, the CO2 emissions from the plant obviously belongs to Saudi Aramco because they are giving us the feedstock then [indiscernible] generated as a result of the feedstock, and that's our agreement with them. So they are accounted and responsible for that. In terms of having plans to capture the CO2 in the future, as you know better than I do, PJ, the great thing about gasifier is that the CO2 is capture ready. So would they want us to do that, take a look at that in the future. I don't want to speculate, but that is -- if they want to, the CO2 is captured very easily.

Great. And then you mentioned monthly fee is fixed, but it has some escalators built into it. Can you just talk about these escalators based on some kind of inflation major?

Yes. It is very much like our standard contracts there. We take the fixed fee and we say so much is for the return on capital, and then the rest of it is related to labor costs. And then the labor costs is related to labor escalation indexes in Saudi Arabia and since some of the people will be from the other parts of the world with escalation in the U.S. and so on. It's a standard kind of escalation formula for this part of the cost that can vary.

Next in the queue, we have Laurent Favre with Exane BNP.

I've got one question left, please, and it's regarding decaptivation more generally. I was wondering if you could talk about the pipeline for more decaptivation. Is this something that is still pretty high on your agenda?

Well, thank you for the question. I mean this project and what we have announced is the ultimate example of the decaptivation. I mean here is half of the refinery that Saudi Aramco is basically divesting. So the opportunities are there. As I have always said, it is sometimes with some companies, it is very difficult to execute because the operating people don't want to give up their own assets. But there are plenty of opportunities around the world where people are operating industrial gas assets especially hydrogen plants. But quite frankly, should we divest that because we think we can operate those things more efficiently. And we continuously look for that, but these things don't happen very often, but we are very happy that this one has happened.

We will now move to a question from Marc Bianchi with Cowen.

I understand this probably relates to the accounting treatment, but maybe you could help us understand why the EPS contribution stops after 15 years and the project is a 25-year project?

No, no. It doesn't stop. We just are not giving you the exact numbers after year 15. And the reason we're not doing that is because as I said, between now and year 15, we are looking at a lot of other options with just the financing. We have financing in place, but not all of the financing goes 25 years. Secondly, that we might issue bonds for this thing. We might do a lot of things in the financial structure that could affect the accounting treatment and the EPS. So we thought that it would not be appropriate for us to start giving 25 years of EPS, when we don't know exactly what it will happen, but we thought we can give you a feel for it, what it will be for the first 15 years.

Yes, make sense.

[ 8 years for ] that to continue. Okay, sure.

And then, Seifi, the follow-up, back to Jeff's question about the cash contribution. I think he was just multiplying the $0.80 to $0.85 times the share count, which would seem like the logical way to do it, but you were suggesting the cash contribution to APD would be higher. Could you just review that for us?

Yes, because we are getting a certain amount of cash from Saudi Aramco. That is the revenue for us, right? Then from that, you have to deduct maintenance costs, you have to deduct interest, you have to deduct depreciation. And then you get to earning before tax, then you multiply by 0.8 to get to earning after tax and you take that earning after tax and divide it by [ $2.23] to come up with the $1.31 for when everything is on stream. So there is a lot of things that is below the line in terms of the cash. And what I was pointing out is that the actual cash that we get is significantly higher than the amount of EBITDA that we would recognize because, as Melissa said, this is equity affiliate income and we take the equity affiliates we only take the EPS, the earnings after tax and report that as EBITDA. We don't report the actual EBITDA. This is the same thing with all of our joint ventures in Mexico, in Italy and in India. That is why when people calculate Air Products enterprise value, if they just go by the EBITDA that we are reporting they will be undervaluing the company. That's the point that we keep making, and most of the analysts understand that. And they say, okay, this is reported after tax, then they build it up themselves. On this situation, we are in a situation, where I cannot tell you exactly what the fee is. We never do that for any project, but you can build that thing up yourself. That's what I was trying to say.

We'll now hear from Chris Parkinson with Mizuho Securities.

Just a very quick question for me. You made a lot of comments about Saudi Arabia's development through 2030. Even in the last couple of weeks, there have been some fairly large announcements regarding blue hydrogen and a few years off. But let me phrase it this way, has the composition of your potential backlog with Saudi Arabia significantly evolved even over the last, let's say, a year or 2 versus the 3 projects which you have that exists in your backlog?

Chris, are you saying that would that grow or you're saying, may I just have a little bit of clarification on the price increase?

Just versus NEOM, Jazan and Jubail, so very -- they focusing a lot of attention on blue hydrogen capabilities, specifically in some of their largest fields. Is it safe to say that if and when those opportunities evolve with CCUS that you would be an active participant?

Of course, we will be. The thing is that, that is an area of focus for growth for us. And our vision is something that we just announced a huge project in Louisiana, as you know. And if there are opportunities for blue hydrogen in the Kingdom, and there is an appropriate arrangement in terms of financially and all of that. Obviously, we will be interested. Yes, sure. And we are very well positioned for that by the way.

Yes. That is my indication.

And at this time, there is no additional questions in the queue. So I'll turn the call back over to your host for any additional or closing remarks.

Yes. I would just like to thank everybody again for getting on our call on very short notice. We very much appreciate you were not only attending, but you also appreciate the very, very good and detailed questions that you asked us, which helps us explain the project. Thank you very much for that. And we look forward to seeing most of you next week at our results announcement on November 4. Have a wonderful day. Thank you again.

And with that, ladies and gentlemen, this does conclude your conference for today. We do thank you for your participation, and you may now disconnect.