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

Okay. Great. Welcome back, everyone. Next, we have Air Products with us, and we are delighted, not just to have Simon Moore, longtime Investor Relations Vice President, who -- this will be his last Morgan Stanley Chemicals Conference in Boston. Thank you, Simon, for everything over the years, we will miss you. And we also are delighted to have Sidd Manjeshwar, who is the incoming Investor Relations professional. And I think before we get started, I think a couple of things with the -- before we get to the Q&A, I want to read a disclaimer and then we'll have Sidd just say hello and introduce himself. So let me remind you for important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Sidd, welcome. Thank you for coming.

Yes. Thank you, Vincent, and team. It's great to be here with you. and our investors. And it's also humbling to be taking over the reins from one of the best in the business. Personally, I've been with the company for close to 2 years as a Corporate Treasurer leading global lender discussions and rating agency conversations and communicating our exciting growth strategy with them. I've also been helping out with a lot of our large project execution efforts globally, including Jazan project financing. Prior to Air Products, I spent the majority of my career and the broader energy and renewable space. So thank you for your time again.

Welcome. Well, Simon, look, I think, a great place to start is just with the inflation reduction acts. You guys are way out in front of it in terms of your strategy in the hydrogen arena in blue and green. And here it is on top of that. And I just would like to talk about the variety of impacts it's having past, present and in future on the projects you already have in flight, which you might consider on a go-forward basis. And what you're hearing from the broader customers of hydrogen from the community in terms of what's changed in terms of their desire as post IRA.

Great. Okay. Well, first of all, Vincent, thanks a lot for allowing us to be here. Thanks to the rest of the Morgan Stanley team. Thanks to the investors already here and the ones that are listening. Again, I appreciate the introduction. It's been a great chance to work together, and we'll see each other again before I retire in March. So thanks a lot. Let's talk about the IRA. And I'll get to the specific projects. But I think when we step back at this, we're going to really look at this as kind of a seminal moment where the U.S. committed, no kidding, energy transition is real. Hydrogen has a critical role to play in that. So again, I think, it supports our strategy that we've been talking about for a couple of years. But it really signals not only to the U.S., but it also signals to the rest of the world that the U.S. is very serious about this. And I think one of the things that is going to be interesting to watch is, what do other countries do in some ways, I don't want to say in response to the IRA, but kind of in response to the IRA. I think Canada had an announcement last week and talked about maybe some things that they want to do to be supportive. So I think in the long run, this is really, really going to be important. Let me go back and unpack our projects, but I wanted to kind of give that kind of headline perspective. Well, obviously, we've seen tremendous opportunities in hydrogen's role in the energy transition. We've got projects around the world. Specifically, we've got a very large project in Louisiana, a so-called blue hydrogen project that we are executing. And we have recently announced a project in New York. A green hydrogen project using hydropower. So we were already, as you said, full speed ahead on this strategy. But I absolutely believe IRA will open up additional investment opportunities in the United States. That doesn't mean to say there aren't opportunities around the rest of the world, but certainly, the U.S. is more attractive because one of the great things about the IRA is it doesn't pick technology solutions. It sets up incentives based on carbon intensity. And quite frankly, lets companies go figure out what the best way to do that is. So specifically on our Louisiana project, we're going to sequester about 5 million tons a year of CO2. The so-called 45Q tax credit is now $85, up from $50 a ton for sequestered CO2. So I think that's very supportive of the Louisiana project and is likely to create opportunities for us to invest in additional new capacity. Again, if I think about the New York project, a green hydrogen project happens to be based on hydropower. In that project, as most people know, it's a production tax credit of up to $3 a kilogram for hydrogen produced. So a slightly different flavor of how to do this, but kind of accomplishing the same thing. So those are the 2 projects we've announced so far. I think Seifi on our earnings call last week referenced a lot of other exciting projects we're taking a look at, which include new investments as well as now the opportunity to look at retrofitting our existing hydrogen fleet. So we have a lot of hydrogen plants in the U.S. Two of them have carbon capture on them today in Port Arthur, Texas. The rest do not, but with the enhanced 45Q tax credits, we can see the opportunity to retrofit some of our existing plants and reduce the carbon intensity, providing lower carbon intensity hydrogen, which is a value to our customers. So in sum, there's specific project opportunities, but we really think this is a major change for the U.S., and I think we'll see how the rest of the world follows.

Maybe we can just talk about the project pipeline a little bit and probably a couple of ways to unpack it. One, look, the New York project was announced shortly after IRA, but you obviously didn't just start working on after the IRA went through. So what's the lead time on those and without, obviously, going into complete details, how many other New York type projects are you generally sort of doing work on? And how much work do you do or how close do you get to FID or whatever the term you want to use about going forward? Like how far you go where you kill projects? Or what does your phasing look like?

Sure. Well, that's a great question because not only does -- I think, every company in the world has announced a hydrogen project now, every location in the world wants a hydrogen project. So sorting out -- your question is a very good one because sorting out what's real and what's not real and putting your resources on projects that seem real. And we're not perfect at this. We get it wrong sometimes. We work on stuff, and it just never happens for whatever reason. But we've got a pretty vigorous process where a group of people get together on a very regular basis. In fact, it's each Monday morning, and we look at all the projects that we're working on, potential projects that we're working on and make decisions about, yes, is this something that we even want to pursue? The answer to that can be no, and so we spend no time on it. Okay, we're going to do a little bit of work on this because we need to support the opportunity. And then we're going to kind of have another checkpoint and see where it is. So we can spend years developing these projects. I think as we've noted to the 3 or 4 years, you can appreciate that's 3 or 4 years' worth of work with some very experienced commercial people, technical engineering people, financial people, there's a lot of investment in getting these projects to the right spot. Now most of these projects are not a bid that we're responding to. It's not like there's necessarily a customer who put out an RFQ who's asked us to bid on things. These are developed projects, generally speaking, you can see that we've now shown a footprint of new hydrogen projects where we have hydrogen pipelines. That's obviously one of the criteria that's very, very important to us. And so it's really about developing these projects, sometimes alone, sometimes with partners. And in terms of when we announce them, we really try for the investor base to be clear that when we announce a project, it's real, it's FIDed, and we're moving ahead. Occasionally, there'll be a set of circumstances where we need to talk about a project a little bit earlier in the public domain, maybe a partner wants to, maybe a country wants to, maybe we're going to apply for some public funding, and we want to get that out there. But we'll always try to be clear in those ones that, hey, look, this isn't the final project decision yet. So...

Okay. And so what was it that, was it IRA that really got New York over the line? Or was that going to happen anyway?

Well, I think that the IRA was very, very supportive of the New York project. And again, the way this works in this case, the New York Power Authority is the entity that has the right to essentially sell the power from the hydro power. And so we were very pleased to get 94 megawatts of hydropower allocated to us, which was supportive of the project. Okay. So...

And then look, the other thing beyond IRA has changed really in the last year or so, it's just sort of in the energy complex on a global basis. And looking just sort of at a molecule of hydrogen or ammonia or whatever you want to consider it, and the idea that the gray product would come from natural gas. That cost curve has changed materially, whereas with 45Q and so forth in certain areas, well, the economics of green and blue have improved. So how do you think about those interplays? And obviously, there's maybe some benefits to some of your in-flight projects in terms of sort of what the gray price floor is now. But is that changing sort of the opportunity set, both in terms of what you might want to do where? Is it also -- and maybe this ties us back to IRA as well. But you said -- but we're developing projects. We're not responding to RFQs. Are you -- is that changing? Is the phone ringing now more than you're making the outgoing to step up? What is going on with all that?

Yes, it's a good question. If I don't get all of it, please, I'll come back to it. Okay. Thanks. So a couple of things. Look, I think, it is a little bit dangerous to sort of do multi-decade type projects based on kind of today's natural gas price. And I know that wasn't your question. I don't know what the natural gas prices will be in the future, but it'll come back down at some point to some level. What I do think is important out of this, and obviously, the energy crisis in Europe. We all hope that Europe gets through this winter and continues to get through it. But even in the face of this energy crisis, it is absolutely crystal clear that Europe wants lower carbon energy going forward. And I don't actually think that's driven by the current economics, it's driven more by we want low carbon, and we want some alternative sources of this energy. So I actually think maybe what is a bigger situation that's going on is Europe's continued commitment to wanting low carbon energy and wanting it from some other places. So if that comes as hydrogen imported in the form of ammonia, I think that's very much aligned with Europe's strategy. And we have the potential -- we've announced 2 potential projects to put in basically terminals to receive the ammonia, crack the ammonia and build out the downstream infrastructure. So I think maybe more so than the current prices of energy, I think that's very exciting. I mean, certainly, if the prices of natural gas stay elevated, it makes green hydrogen more attractive. Your question about whether RFQs are coming or not, I would say it a little bit differently. Let's talk about the Canada project, as an example. We announced in September that IOL, Exxon's business in Canada, have signed up to take about half of the output of that plant. They value low-carbon hydrogen for their renewable diesel project. So that's a case where Exxon didn't -- or IOL didn't come to us and say, "Hey, I want you to build a plant." They came to us and said, "Look, we're doing a renewable diesel project, you guys have a pipeline network in the area, how can you help us lower the carbon intensity?" So we take that opportunity. We put that together with the idea that in that Alberta area, there's a lot of incentive and motivation to look at heavy trucks being driven as hydrogen fuel cells, okay? So now I got a market for some liquid hydrogen in the area. Let me make sure I've got the right gasification technology and then look at that, I can sequester the CO2 because I'm near the Alberta carbon trunk line. And then you know what, just to kind of finish it out, I'm going to use some of that hydrogen to make power to further reduce the carbon intensity. So that maybe an example of a bit of a hydrogen. We clearly had a customer we were talking to who had a need, but really, still, there was a lot of that project that we were kind of able to put together. And I think that's one of the most exciting things for Air Products. We've got a variety of technologies and experiences and we can bring them together to create the right solution for the right situation. It makes no sense to turn the hydrogen to ammonia in Canada because you're not moving it very far. Equally, it makes no sense to turn the hydrogen into the liquid hydrogen in Saudi Arabia because you are moving it a long way. So sometimes we'll distribute it via pipeline. Sometimes is a liquid, sometimes is ammonia. And again, we've got the capability to bring the right solution to the right answer.

Maybe that's a good opportunity for an update on NEOM. And in a couple of things, just sort of where are you in terms of the project progress versus the announcement? Obviously, it's a long lead time project so that maybe there's not a whole lot to say at this point. But there's also -- I get a lot of questions about trying to differentiate between the Air Products Project NEOM and the NEOM city of the future. So maybe you can help us understand what's similar, if anything, or what's different in the lot about those 2 things. And -- yes, maybe we can just do that.

Sure. Well, very simply, the project is absolutely full speed ahead. We are executing the project. As you pointed out, it's a very big project. It's being built in that part of the world where there's really no infrastructure. So you've got to start by building the infrastructure to be able to build the facility, but we're full speed ahead. I think we announced maybe about 10 or 11 months ago that we have an agreement now with thyssenkrupp for the electrolyzers, just as an example. So we are full speed ahead of the project. I appreciate you asking about. Obviously, it's a 3-way joint venture. And really, NEOM is one of our joint venture partners, but we have nothing to do with the city of NEOM. Our project is fully self-contained, fully independent, is executing everything we need. So obviously, the city of NEOM has some very exciting ambitions of what they're going to do, but how much they get done and how fast that happens, doesn't have anything to do with our project. So I appreciate you asking, we're fully independent, we're full speed ahead.

Okay. And you kind of talked about a little bit this earlier when you're talking about Alberta, but just in terms of how you're thinking about marketing all of these products out of whether it's out of Louisiana, whether it's out of Alberta, out of NEOW, what's the what's the right mix? Should we just be thinking about, hey, overall, Air Products is about 50% on site and I don't know what, 40% merchant, something like that? So should we be thinking about you're going to probably be plus or minus that type of that type of mix? Or is it just going to be project and site-dependent?

Yes. I think it's going to just depend on the specifics, I mean, to be honest with you. So again, if we're on a pipeline network, some of that hydrogen is going to go down the pipeline network and almost certainly, that gets sold under long-term take-or-pay on-site type agreements because that's the business model that the pipeline networks have grown up with. The fact it's a lower carbon type of hydrogen doesn't change the fundamental nature. I mean, again, IOLs investing money to build a renewable diesel facility and they want to run that for the next 20, 30 years. They need a long-term, stable, reliable priced hydrogen and so that's exactly what we're looking for. So I think to the extent it's going to get delivered down the pipeline network, that is kind of by definition, our on-site business because it goes to a customer who needs this product for a very, very long time. I think when we turn to look at the liquid hydrogen business and whether that's liquid hydrogen from Canada or liquid hydrogen from the New York project, we have a liquid hydrogen network today. We have 4 or 5 plants in North America, and we haul liquid hydrogen throughout North America today. So to some degree, yes, it's a lower carbon, but it's really just additional assets in that system. Maybe some of today's liquid hydrogen customers will be looking for lower carbon hydrogen. We also see opportunities for the mobility market as we've talked, for the heavy bus and the heavy truck market. So I think it's not even so much does that look like our merchant business. We have a liquid hydrogen merchant business today. Here's a couple of more assets that are likely to be done under similar business model. Again, when we turn to ammonia, again, just a different way of transporting that hydrogen, our belief is that the large opportunity is the heavy truck, bus market. And we think as people are adopting hydrogen fuel cell buses, they're going to want some stability of supply, particularly maybe in the early years of adoption. And so I don't know that we're going to get 20-year take-or-pay agreements, but I think if you're the study bus fleet manager and you've bought a bunch of hydrogen buses, you've got to make sure you've got a good reliable supply of hydrogen. So I think both parties are going to want kind of a longer-term agreement. So I don't think we want to overpromise the contract structure there, but I do think that both us and the customers are going to be interested in a fairly long duration contract. And we'll see how that develops.

Okay. Thinking about just the CapEx and sort of the amount of projects, I guess, a couple of things. One, I think, we've talked in the past about how you've been investing in people and capabilities, obviously, in order to be able to ramp up and do this much stuff. So where are you just in terms of the amount of stuff you can be doing? Are you anywhere close to a ceiling where you'd have to say, you know what, we're kind of maxed out, sorry, customer, you got to get in line. Now there's a backlog. You got to get a slot, we can't execute for you anytime soon. So is there -- or anywhere close to that limitation?

We can do more projects, Vincent. I'll expand on that a little bit more, but we can absolutely do more projects. So there's a lot of dimensions of that capacity, right? And to be honest with you, the balance sheet is probably one of the easiest ones to kind of put numbers around. We do that for folks. It's pretty conservative, but we've got well in excess of another $10 billion to deploy over the next few years. And I think, again, as you've heard us say, that's pretty conservative the way we do the math. So I think there's a balance sheet capacity. Probably what's a little bit harder to put your finger on is business management skill leadership capacity. And we've been, as you noticed and said, we've been investing in resources. And it's a lot of different type of resources. I think that's what's important to recognize -- so the people that are working on the project for the 2 years before we win it, it's business and legal and accounting and definitely some engineering, but then we win the project and we start executing it, and quite frankly, it's a different group of people. So one of the things that is happening is we've got a lot of big projects coming on stream next year. So guess what? The amount of engineers working on those projects, they're not working on those projects anymore at the end of the year. They're ready to start working on something else, the same thing. The business development folks that we're putting together the New York project, guess what? That project is now put together, there's still some work to do. But they can now move on and kind of work on other things. So I think we're going to continue to invest in the team's capabilities to be successful, but I think we had kind of a ramp-up period. Now you're starting to see the benefit of some of the work that was done 5 or 6 years ago. And so I could see us continuing to increase, but probably not at the rate that we have been over the last few years.

Okay. And maybe switching gears to the current environment. The business has performed quite well this year. We've done a great job of managing through, obviously, a very volatile energy environment in Europe. You've gotten price in excess of power and electricity costs in the merchant business. There's still some a lot of concern out there about sort of the health f your customer base and what their economics look like after they paid for your services and what choices they may make. But then we looked at the most recent quarterly results, and I think you said on an underlying basis, maybe your volume was down slightly in Europe, excess sort of onetime issue. What are you thinking about on a go-forward basis for the next fiscal year? What are you assuming happens?

Yes. It's a great question. And I think, unfortunately, it's got a start and an end with, is there a concern around Europe? Of course, there is, right? We all have some concern around Europe. But if we think about our business and unpack that a little bit, about 1/3 of our business in Europe is the on-site business. About 1/3 of that 1/3 or about 10% of our business in Europe is the hydrogen business. Almost all that hydrogen business goes to the refining industry. And to be honest with you, the refineries are running pretty hard. And I think even in an energy crisis, you still have to run the refinery because you need to turn the oil into, of course, usable products. So we actually had pretty strong hydrogen volumes. And so we are backed by the quality of our on-site contracts, but more fundamentally, the refineries are running hard. I think we really haven't seen a problem in our on-site business. Again, we haven't really seen a problem with our customers, but we also have the stability of the contracts. I think 2/3 of our business in Europe is the merchant business, and that's a little bit different, right? We have a lot of smaller, medium-sized customers there. And I don't think, in general, our price increases are creating a real financial hardship for them. But if they're buying power, they're buying power that is costing 5x what it did a year or 2 years ago. And so I think we're generally pretty pleased with how the volumes have held up. But I think it is fair to say that the underlying manufacturing business in Europe is probably under some stress, and we're going to have to see how that goes. And I think that's a place where we might see some impact in our merchant volumes going forward. Again, our guidance for next year, as we said, is predicated on, quite frankly, things not getting a lot better anywhere in the world, but also things not getting a lot worse, and we'll see.

And then how do we think about -- we talked about pricing, and obviously, the automatic pass-through on site, but in merchant, you've taken an extraordinary amount of pricing this year, maybe we'll see power and electricity peaked in August and now it's come off. So clearly, on the automatic pass-through that gets passed back. But how do we think about it in the merchant business, presumably, you're going to have to for some period of time, give some of it back, but then maybe you have to go back out again, like what's the cadence of this going to look like?

Yes. Well, I think, certainly, credit goes to the team, quite frankly, not just in Europe, I mean, the amount of pricing the team has gotten in the Americas, and they're not quite as volatile as Europe, but still a very volatile pricing cost dynamic really, really impressive effort by the team, well done. And I think that our team really -- there's no new magic that we're doing here, but the team is ready to do everything more quickly, more crisply and has learned how to respond very, very quickly as costs change. So we continue to recognize that we're bringing a lot of value to our customers with our products. In general, our customers are really, really -- I'm sorry, our products are very important to our customers' operation. They generally can't operate without us but it's also generally a pretty small part of their cost stack. So we're going to continue to try to make sure we're bringing that value to the customer. But look, if we have significant power cost increases, we're going to have to bring that to those customers. And we'll see what happens going forward in the merchant business. I mean, obviously, for a lot of reasons, we hope there is some moderation in the power cost. That would be good for Europe. And then our teams will be, again, focused very hard on bringing value to the customers.

And then maybe as we think about '23, a couple of things. One, could you talk about the guidance? And what sort of -- how much of that is sort of new project start-ups is within your control? It's not really that macro dependent. And likewise, in the CapEx, there's a lot of focus on all these mega projects and everything we talk about. But presumably, in that $5 billion number, there's a fair amount of base business growth as well. So how do we think about '23 in terms of the earnings you're going to get from big project start-ups as well as just sort of the normal blocking and tackling of general growth CapEx? And -- yes, let's do that.

Sure. Well, again, it's an interesting time to be in October, one fiscal year company or one of the first companies that get to put out guidance for next year. So look, there's a lot of uncertainty. But again, as you acknowledge, Vincent, we're seeing the manifestation of the major project strategy that we embarked on a few years ago. The way we're seeing that is we expect Jazan Phase 2 to close in our second quarter. We have another projects. We have 2 other major projects we expect to come on stream during the year. And those projects are near the end of their execution cycle. They're not dependent on the macro, as you said, and they're going to drive a significant amount of EPS going forward. I think kind of in addition to that, just to build out what you said, we always have small and medium-sized projects that we win on an ongoing basis. They come on stream. They may not individually be large, but when you put them all together, they can have a meaningful impact on the business. Last quarter in Asia, we had very nice volume growth versus prior year. And some of that -- a lot of that was driven by some of these small and medium-sized projects. So it does vary over time. But I think order of magnitude, we see continuing to invest something like $0.5 billion a year of growth capital in these small and medium-sized projects. You might call them the more traditional industrial gas projects because the major projects are honestly a lot of fun to talk about, but I think it's important to recognize that we remain focused on our base existing business -- we're investing in that business. We're growing that business. We're winning projects. We're building plants, and we're doing what we need to do to continue to drive that business. So we have a couple of other things probably worth mentioning as we look at next year, we anticipate a pretty significant currency headwind, about $0.50 of currency headwind just based on where currencies are now. So again, credit to the team for being able to -- well, it's a plan at this point, but put together a real plan that allows us to more than overcome that. So I think perhaps stepping away from next year's guidance is, again, we've been talking about these major projects for a few years. In FY '22, we had Jazan Phase 1 that drove a significant amount of our EPS growth. Now we've got Jazan Phase 2 and 2 more projects. And then the year after, we got a couple of projects. So we are kind of on the beginning of a multiyear framework here, where you're going to see these major projects coming on stream. And I think the latest on stream of a project we've announced is 2026, 2027, I would not conclude that the game is over at that point. I think there's many other projects that we're working on now. We just talked about this. So I think you are at the beginning of a long cycle of major projects coming on stream. Again, we were excited about this opportunity. When we announced NEOM 2 years ago. We're even more excited today based on some of the things we've talked about. For example, we've talked about the IRA. We just, quite frankly, announced yesterday, we were very excited to confirm some support for the Canadian government for our Canada project. The nature of that is different than the tax incentives in the U.S., but the fundamental point is the same thing. The federal government of Canada and the provincial government of Alberta are excited about how hydrogen can play a role in their economies going forward, and they're happy to support companies who are doing innovative first-mover projects. There's various types of incentive programs in place and coming in place in Europe. And so again, the specifics of the program is a little bit different, but this backdrop of the major projects opportunity the hydrogen on the energy transition, combined with the focus on our base business, so they make an exciting time.

Okay. Are there any questions here in the audience? It's been a quiet day. So it's nothing to take personally. Thank you, guys.

All right. Vincent, thank you very much. Thanks to everybody who joined us today.

Thank you.