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

Hi, good morning. My name is Jeff Zekauskas, and I analyze chemicals for JPMorgan. It's my pleasure this morning to introduce the management of Air Products. The CEO of Air Products is Seifi Ghasemi, and he became CEO in 2014, and I don't think Air Products has been the same since. The format we'll have this morning is fireside chat. And also Simon Moore, who's the Head of Investor Relations and Sustainability is here; Melissa Schaeffer, who is the CFO of Air Products is here. And I think we'll begin. Seifi, good morning.

Good morning.

I thought what we might do is we might start by discussing Air Products' 2 very large hydrogen projects. So in Louisiana, you have a $4.5 billion project to produce blue hydrogen through ammonia. And in order to execute that project, I think you need something called a Class 6 permit. Can you tell us a little bit about what a Class 6 permit is? And in general, how long does it take to get one of those?

Sure. First of all, Jeff, it's delighted to be here with you, as always. You know our company very well, and it's a pleasure talking to you. We -- the project that we have in Louisiana, the -- first of all, why are we in Louisiana? The main...

I'm going to pull disclosure here. There you go.

The main reason that we are in Louisiana is because, number one, the government of the state is very friendly toward energy transition and new projects. The second thing is that we think that Louisiana is one of the best places where you can actually sequester the CO2 once you put it into the ground because the geology is friendly. And then the third thing is, obviously, in the United States, you have the so-called 45Q program where the government gives you a tax break for any ton of CO2 that's sequestered. So you put all of that and the U.S. has a significant amount of natural gas. So you put all of that together, it becomes the right place to do a project where you produce blue hydrogen, which we think is going to be a transition going from gray to green, which is the ultimate solution. The challenges that we had was number one, we needed to convince the state to give us the permit to sequester. That means give us the acreage and the area and access to the underground reservoirs and so on to be able to [indiscernible]. Then now that we have secured that, then we are doing the geological studies. We have done a lot of that already. And now when people talk about class experiment, that is specifically for when you drill the well. The government has significant specifications in terms of how that well should be constructed so that when sequester or when you push the CO2 through that into the ground, it doesn't come out, and it doesn't create issues. So that is something that we obviously know how to design. The people that we are working with are experts on this thing. And in terms of amount of time, it probably will take 2, 3, 4 years to get that permit, and that is what we are working on. But the sequence is not that you are going to wait 4 years until we get the permit. We do the project. And in the meantime, we work on the permit because it's not as if you are not going to get the permit. It's an issue of making sure that you meet their specifications of what the government wants you to do.

So you can work on the project simultaneously. You can begin construction and at the same time, press to get the permit with the government?

Yes. That's what we're doing.

And the time to construct a facility -- and so the -- your scheduled date is 2026.

Right.

And so it's 2022 now. And so the permit takes 3 to 4 years. Construction, I imagine, is also the same period of time. So in practical terms, is this really a 2026 project or 2027 when you actually can operate at a full utilization rate?

Well, right now we are shooting for 2026 because we think that we usually build plants in the Texas Gulf Coast in 36 months. And when you look at the recent hydrogen projects that we have executed $400 million, $500 million that are public, we have announced those. We build those things in 36 months. So over here, we have given us a little bit more than 4 years because we have already started. So this is -- and now we have '22, '23, '24, '25 and '26. So we think we can meet that, but it all depends on obviously, supply chain, permit and all of that. But we think realistically, it's '26. It might be '27, but it's within that time frame.

Within that time frame. And the -- so when investors think about the returns of the project, what I think they do is they look at your capital per ton. And in rough terms, the capital per ammonia ton is about $1,300, and you receive a 45Q tax credit, which is $50 a ton for carbon dioxide, but there's more carbon dioxide that's produced than there is ammonia. So at $50 a ton, it's about $70 per ammonia ton. So the tax implications are large. In the Build Back Better bill, which didn't pass in the end, the numbers were much higher than $50 a ton. So from your point of view, would that have been very favorable for Air Products if it were passed? And could you talk a little bit about what that range of tax credit might be?

Sure. First of all, the $50 is a tax credit. So before tax, it's more than that because got actually this 20% since. We did the project and built the project and got the approval based on existing law. We did not start saying we are going to get something in the future. But if Build Back Better bill would have passed, the $50 would have gone to $85, if it had passed in the form that it was. So it would have been an additional benefit. But right now, we had done the project based on the $50. And so we are not -- that would have been kind of icing on the cake, but we're already here.

Okay. All right. And then in NEOM, I think about the NEOM project, and the NEOM project is a $7 billion project, all in. And at least by my calculation, it's something like $5,800 per ton of ammonia. And your project in the United States is about $1,300 per ton of ammonia. So if you're going to have equivalent returns per ton of ammonia or per ton of hydrogen, I would think that the returns in NEOM have to be 3x as large as the returns in Louisiana. Is that roughly true?

Jeff, with the -- I don't want to say that you're comparing apples and oranges, but you are in the sense that it's different.

Maybe you can compare apples and oranges. It depends on what you do.

The difference is that in Louisiana to make the ammonia, you have the operating cost of natural gas and electricity. That is -- that investment is not part of the investment, you have to buy it. So those 2 together in Louisiana will be something like $500 million a year. In NEOM, those costs are 0 because we are producing the energy from wind and solar, which is free. So therefore, the profitability is you have to look at Louisiana is X dollars per ton, but with an operating cost per ton of close to $200 a ton. And in NEOM, it is $0 per ton because there is no energy requirement. So as a result, if you take a $200 per ton or $250 per ton that you need and put a real net present value on that, that by itself has become pace for a significant amount of the capital. So the energy cost in NEOM, we already pay for that through the investment. So as a result, you do not have to sell the product for 5x in order to pay for the difference, which would be a lot lower than that.

Well, I think you just agreed with me, that is the returns of the NEOM per ton are much, much higher than the returns of the Louisiana project per ton because the operating costs are very different, and so that merits the greater amount of capital put into...

Yes. I thought that you were going in the direction that you have to sell the product for a significantly higher.

No, that's skeptical.

You're absolutely right because the return -- the potential return per ton of product being sold in NEOM is -- could be higher than in Louisiana. That's correct. I did agree with you at the end of the day.

Okay. Sometimes when you speak about hydrogen publicly, you talk about green hydrogen as like diamonds and blue hydrogen, I think it's like gold and maybe gray hydrogen is silver. And when I think of those things, I think, well diamonds has one price and gold has another and silver house a third. But when I think about hydrogen, I always think that it's more of a gradient, that is that the value of gray or blue or green will be tied to the carbon emissions and that the way that they'll be valued will be relative to each other having to do with the net carbon emissions. Do you agree with me? Or do you think that the gray and the blue and the green are just qualitatively different and are not really comparable on a gradient?

No, you're absolutely right. The value will be based on the carbon content. And when you look at gray, if you take the total supply chain, the gray ammonia is almost 12, 13 kilograms of CO2 per kilogram of hydrogen. Blue ammonia has the potential to be like 2.5 or 3, depending on how you look at the supply chain. And green hydrogen will be 0.36 kilogram. So when you look at the value of the carbon thing, then that is what determines the value. That is why green will be significantly higher value. Think about it in terms of if there was a carbon tax. And then a kilogram of hydrogen, you would have to multiply 13 by $200 a ton. In blue, you have to multiply 3 by that. And in green, you almost have 0. So the value becomes significantly different. And that is you're absolutely right, people will look at it than that because that is how we create value by producing these unique products.

So when Air Products originally announced these projects, ammonia was maybe $350 a ton. And ammonia today, depending on what geography you're in, is somewhere between $1,100 and $1,400 a ton. That is the actual ammonia value is much, much higher. Does that change the calculation for Air Products -- I mean, of course, it's good for the projects? But does it change your way of thinking in terms of how you might sell your end product, whether your emphasis will remain in hydrogen or that you might have a more complex strategy?

Well, the value should -- we are not in the ammonia business. We are in the hydrogen business, and we use ammonia as a means of carrying the hydrogen and moving the hydrogen around. So the real value is what you just mentioned before in terms of the carbon intensity. And we don't want to compare our projects to commodity ammonia, which 1 day it is $1,100 and 1 day, it might be less than that. But the very fact that even gray ammonia is that high, is that if, for example, you are an operator of a ship. And you are thinking about the fact that one of the ways of solving my problem with CO2 emissions is that instead of loss sulfur fuel oil that I need to put in the ship to move around, I'll use ammonia. Then you would start thinking that, gee, even for gray ammonia, I have to pay that much. So in case I use blue ammonia or green ammonia, I get the carbon credit plus the fact that even the gray is this, so then it will be a benefit. So overall, the fact that the prices have gone up is good -- is very good for the project. But the real value that we create is the hydrogen value and the carbon intensity. And I will really be sensitive to that because I don't want to people to think that, well, now they are getting into the ammonia business. The product that we are making ammonia is a means of transporting this high-valued hydrogen, which has a very low carbon intensity.

Does the -- do these projects, because of the value of what they produce, in some way, change the industrial gas business model? That is, historically, industrial gas was on-site and merchant-packaged. And some were done under very long-term contracts, some were done on shorter-term contracts. But we're going to go into a world that seems where there's volatility around the value of the core molecules. So from your point of view, do you think that these are very good projects, but they may look different than the terms under which you sell industrial gases today?

I think in time, Jeff, they will become a little bit similar in the sense that let's say that, again, you are a significant user of either green or blue hydrogen. That means that you have transformed 10,000 trucks or you are an operator of planes or trains or where your requirement for green hydrogen or blue hydrogen is significant. Then you would want to come to Air Products and say, why don't we sign a 20-year contract, so that I have the assurance of supply. Right now, those discussions are not happening because the demand is not...

Is there not yet?

That's significant, and it is not right in front of the people, but we are ahead of the care. And what we believe is that by the time our projects come on stream and so on, people will get to those stages. So I can see in 2030, I was talking about the fact that we are building a new in NEOM and the product is being sold to the government of Germany or the government of U.K. It will become that kind of a thing eventually. But right now, it doesn't look like that, but eventually because people, if take -- I mean, if you have a huge fleet of cars, I mean, of heavy trucks or trains and you want to convert, then you can't rely on the merchant market than supply/demand, then you just signed a long-term agreement. A little bit like -- it becomes a source of energy that people need to contract for to have the security of supply. So it might become like that. But the way the -- when you say industrial gases business, what we are doing is really we are creating an energy company. It's not so much industrial gas, it's creating a source of low-carbon energy for the world. So like when people went from burning wood to burning oil, it was a new source of energy, creating a new source of energy for the world.

Okay. So I'm going to move to a different subject.

Sure.

So the price of natural gas in Europe is very high, maybe today, it's $35 MMBtu. And historically, Europe has tended to buy its gas from Russia rather than emphasize use of LNG from all over the world as it might. Do you think that, that will change? And is that something that can benefit your products, given that you have an LNG heat exchanger business?

I completely agree with you. Yes. I think the movement started about 4 or 5 years ago. Actually, the authorities in Germany started approaching other countries about the fact that we want to diversify our sources. That is why some of the very big projects were announced in the U.S., huge projects like the Golden Pass thing and all of that, Sabine Pass on all that in order for Germany to be able to significantly import LNG. And that is why, as you have seen, you know this better than I do, a lot of the terminals, which were built for importing LNG in the U.S. have been transformed into exporting LNG to Europe. We have benefited from these projects because we do make the cold-heat exchanges for these. And we are seeing a pickup in projects, and therefore, it is a reasonable thing to assume that our LNG business will benefit from these new projects, yes.

So when you think about Air Products over a very long period of time, there was a period of time when a lot was disclosed about the LNG business. And now I think it's in your Corporate segment, you have to make some calculations. And so like when I make my calculations, I think, well, maybe the EBITDA of LNG today is about $60 million. And maybe the peak EBITDA of LNG years ago was $140 million. And so maybe it can go from $60 million to $140 million over some period of time again. Is that the way you think about it? Are those rough numbers, right? Are they wrong? Or maybe I have to ask Melissa, I don't know.

Well, the peak EBITDA for our LNG business was in 2015 and it was about $200 million.

$200 million.

What it is today, your order of magnitude, right. Can it become a $200 million or more? Yes, it's possible. When it is going to happen and so, it certainly has the potential. And we have the -- if you look at what we have actually done in the past 8 years that I've been at Air Products, we have significantly increased our capacity. We have built a new plant in Florida where we could -- we had a constraint when the stuff was made in Pennsylvania in terms of what size we could ship. We have a port manages in Florida. We have significantly expanded our manufacturing capacity. We have a lot of capacity. And as a result, we have the potential if the demand is there to significantly ramp up.

So with the way that LNG -- the building of LNG works, is it more likely that it can take a few years for projects to be permitted since everything has happened so quickly? Or do you think that this is a business that really should nicely build over the next several years? That is, might it be flat for 2 or 3 years and then it will really jump? Or does it grow linearly? Do you have some insight into how your backlog might change?

Well, one of the interesting things about our LNG business is because the sale of equipment, once you get an order, it's not like building a plant that you decide to build the plant, then you have to wait 4 years before it comes on stream to start recognizing some profits. If we get an order and we put it in the shop, we recognize profit based on the percentage of completion. So if we get a big order, a quarter later, you're going to see the effect of that in our results, like when we got the big order for -- that have 4 and all of that kind. So the ramp-up in the profitability can be gradual and can be, as I said, the potential is that we will see some benefits there. Yes.

So the rise in natural gas values in Europe is it's a mixed plus. That is -- it helps the LNG business, but it places strain on providers of industrial gas in Europe. And in your last quarter, energy costs were a larger factor in pulling down financial returns. And it's hard for me to tell whether the prices are now running ahead of raw materials or raw materials are running ahead of prices. Can you discuss the -- your -- can you discuss Air Products' experience with the rise in energy prices in Europe and how you're trying to manage that?

Fundamentally, Jeff, as you know, I've been in this business since 1979, I'm here in the last 42 years. Increase in energy prices over time is a benefit for industrial gas because when the energy prices are going up, you get the license to increase prices. It might take you a quarter or 2 to catch up. But then on the other hand, when energy prices do go down, which they eventually will because -- then you don't reduce prices right away, and therefore, you get a benefit on the tail. So right now, last quarter, the reason we fell behind is the energy prices that are going up faster than anybody could predict. And we cannot go to the customer and increase prices until energy prices have gone up. So we have fallen behind. But eventually, we will catch up. And then once we have caught up, if there is any kind of a relief, that means that oil prices go -- or LNG prices go down back to what they used to be, which is $10, $15. And cost of electricity for us, the important thing is cost of electricity, then we will become ahead of the curve. So over time, over the course of the next 1 or 2 years, this thing will actually help our results rather than hurt. But on a quarter-by-quarter basis -- now we said last time that -- look, we were talking publicly in January, and we said that, look, we are catching up. But who knew that Russia is going to go into Ukraine? So by them doing that now the prices have even gone -- so now we have even a harder job to try to catch up, but we will catch and the good thing is that we -- it is part of our business. People understand that we spend power to produce the product. And if you want to keep our margins, it's not as if you're trying to be unreasonable, we need to increase prices. So -- and because then the customers who buy this stuff from us, then they increase their prices, right, and that's how you get inflation.

So the thing about European gas prices is some days they're $35 MMBtu. And some days, they're $60. In some days, they're $100 and some days they're $20.

Right.

So does that mean that the profitability of the business in Europe really fluctuates quite a lot because the daily prices have moved so much and then what you have to do is go to your customer and explain some of these consequences. And what you also have to do is try to source your power a little bit differently in order to economize your costs. Is that a fair description?

Jeff, I'll go through the details of exactly what they do. Different parts of the world, we do differently. But fundamentally, we know that power is a huge part of our cost. So in different places, we have different strategies depending on what our energy people think. So some places, we go and buy the power ahead of the time. That means we fixed prices with the power company for the next year. Then energy prices can go anywhere, but then we have maybe deal. And they basically like hedging. Some places, we do it for the quarter. Some places, people don't want to do it for anything because they say that it's too volatile for me to commit. So in Europe, we usually buy a quarter ahead or sometimes 2 quarters ahead. So right now -- so it is not as if our power cost changes daily. But it -- over the course of a quarter or 2 quarters, obviously, it changes based on how we have done forward and all of that. That is when we can end up having a different result than people might expect if you compare us to our competitors because maybe our competitors were smarter than us, and they hedge their power cost better than we did. And as a result, when energy prices went up and we got hit last quarter, they didn't get hit as much because the people have done a better job forecast. So that's a little bit a matter of what your energy people are doing and how they see things. But that's -- but these are all -- over time, over the course of a year or 2, they just level off. It doesn't make any difference.

Okay. That's clear. Some people think that the fastest category of industrial gas growth is electronics, both in gas -- maybe mostly nitrogen for the electronics industry. Do you agree with that? And do you feel that Air Products is winning its share of the electronic business that comes up for bid?

Excellent question, Jeff. I think the fastest growing industrial gas molecule is going to be hydrogen in the future.

Yes.

Right now, the second one is definitely electronics. And the high-purity nitrogen, which is what these people do because everybody is building a fair. Air Products is getting more than its fair share of the new projects. The issue is that when we win a project with most customers, most customers don't mind us announcing that we have signed a 20-year contract to supply, I don't know, Exxon or BP with the project in refinery. Electronic customers are very, very peculiar and very careful because they don't want to show their hand because when they come and sign a 20-year contract for the supply of nitrogen, it is for a fab that they are going to build, not for something which is operational. Therefore, they don't want to tell their competitors, even which country they are building. So we are not at free -- we don't have the freedom to announce every project that we do. Some other people might have a little bit more freedom with some of the customers that are there. So I can assure you that Air Products is getting its fair share because we are very focused in that sector. We have as good, if not better technology in high-purity nitrogen, and our product line is very competitive. So we have gotten our fair share. And I think over time, we are actually talking to some of these customers that we're doing very often with them that, look, people think you are not winning anything in this sector. Help us out. I mean, you don't want us to say that we have won a project in a specific project, fine. How about if you're saying in the United States. You don't even want to say that, say, in Northern Hemisphere. Let us say something. And hopefully, we will have some success so that we can demonstrate to the investment community that we are winning large projects, which we are.

Well, then let me try the question -- let me try it a different way. When you look at the growth in your electronics gases, are the growth rates comparable in the different geographies, that is which geographies are growing faster and which ones are growing more slowly?

But recently, obviously, there has been a lot of talk about growth in the U.S. and the Intel and all that. But if you take in general, the fastest growth is in China.

And that's been true of your business?

Well, in China, we usually don't lose a lot of business. If there is something new, we serve.

Okay. In the United States, in the hydrogen business of Air Products, at least by -- in the classical gray hydrogen business, at least by my calculations, what I believe is that Air Products has been growing more slowly than some of your competitors. And it probably has to do with consolidation factors in the refinery industry in the United States. If that is correct, do you view that as the business of Air Products has paused until it manages the effects of the consolidation that is taking place and then you grow with the industry or you grow faster than the industry? Or has your business been impaired by some of the closures that have occurred?

If you look at if we are supplying a specific customer, whether it is Exxon or Valero or any -- those places, our volumes for hydrogen has actually increased because the demand has gone up. When you look at our overall hydrogen pipeline business, it doesn't show that it shows that we are about 6% below because we have had some specific customers who have decided to shut down their refinery. So as a result -- I mean, it's public knowledge, Shell decided to shut down their plant in Louisiana. Meriton started to shut down their plant in Martinez and all that. So those have pulled the total down. But on a comparable basis, our business is growing. And we are not at a competitive disadvantage. We actually have an advantage because we have the best pipeline that anybody has in the Gulf Coast, and we have the pipeline in Los Angeles, we have the pipeline in Canada. So I'm not worried about our hydrogen business at all. On the gray hydrogen, we get our fair share and all of that. But fundamentally, that -- the growth in that business is very much related to existing growth because people are not building new refineries and all of that.

I want to turn a moment to China. China has issues today with the management of its energy, with its COVID policies. When you look at the -- at your business in China and its prospects, do you think that it's weaker than you had imagined? Or do you think that your growth in China is what you thought? How do you assess the economic progress of China as it touches Air Products over the next year or 2?

Up to now, it has been in accordance with our expectations. The key question going forward is, how are they going to deal with COVID. One policy is that they would follow what they have been doing, which is trying to say 0 COVID. I don't think that's going to work. If they adopt the policy that we basically adopted in the U.S., that means that we have sat back and said, we are going to go back to our normal life. And if that means that 1,000, 2,000 people die every day, they die. I mean that's what we have done, right? We basically have said we are tired of this thing, took the mask off and we can take the risk. But the risk is that we have 1,000, 2,000, 3,000 people dying. China, they want to have 0. I honestly don't think they will succeed. And as a result of that, then how do they respond to that in the sense that they shut down everything, like some of the things that. If they continue doing that, then the economic activity will slow down, not only in China, but the whole supply chain. If they decide to adopt the U.S. policy, I don't think -- so we are in a wait-and-see mode. But the nature of our business in China is that -- I hate to put it like this. But if the COVID thing spreads, obviously, the need for oxygen goes up significantly, and we are very well positioned to supply that. But I just hope everything will work out for the best.

So maybe as a final question. In the old days, you used to say, I don't really like to repurchase shares. But if my share price fell a lot, then I might rethink that. Now whatever has happened to Air Products has not happened in 1 day, but the price used to be $300 and now it's $220. So is that enough? Or that's not enough?

First of all, let me make a distinction when I say buying shares, one is personally and the other one is for the company.

For the company.

Yes. Personally, I keep buying shares. For the company, when I look at the opportunities that we have of where to invest our money and the kind of returns that we get that is significantly better for the investors, and I'll be happy to go through the math with you, then buying the shares. Because buying the shares, all it does is that it helps you in the short term that you show a higher EPS. Sure. But then what you do 5 years later? So right now, even at $220, it doesn't make sense for us to buy shares because if you look at the returns, it makes shares -- sense for us to buy shares at $112, and hopefully, that's not where the stock is going. But as I said, personally, obviously, it's a different thing. I'm not in the market buying shares today because I can't because I always have information that the public doesn't have. But fundamentally, and that is how we look at share buyback. So we are not at a point that I would go to our board and say, "Look, if we are better off buying shares than building Louisiana or building the next NEOM.

Okay. I think we've run over time. And thank you for your attendance, Seifi. It's always a pleasure to have you. I hope you'll come back.

Thank you very much. Absolutely. Thank you.