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

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 this 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, Jenny. Good morning, everyone. This is Simon Moore, Vice President of Investor Relations, Corporate Relations and Sustainability. I'm pleased to be joined today by Seifi Ghasemi, our Chairman, President and CEO; Dr. Samir Serhan, our Chief Operating Officer; Melissa Schaeffer, our Chief Financial Officer; Sean Major, our Executive Vice President, General Counsel and Secretary; and Sidd Manjeshwar, our Vice President, Treasury and Investor Relations. We issued a press release this morning announcing that Air Products and AES plan to invest approximately $4 billion to build the first mega-scale green hydrogen production facility located in Texas. 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. Thank you for joining us to discuss this very exciting opportunity. After our comments, we'll be happy to take your questions. Now, I'm pleased to turn the call over to Seifi.

Thank you, Simon, and good morning to everyone. Thank you very much for taking time from your busy schedule to join our call in short notice. We are obviously very excited, very excited about this project. It is at the heart of our business. It is in the United States of America. It is in Texas and it is by far the largest green hydrogen project that anybody is doing in the United States. We are obviously very optimistic about the future of hydrogen in terms of not only the gray hydrogen that we make today, but also blue hydrogen and green hydrogen. And with this project and then the project that we have announced in Louisiana, we are by far the leader in the production of both blue and green hydrogen. We are very excited about the fact that we have a very credible partner on this project with AES that will make this project realistic and appropriate competencies for the companies to execute this thing. At the project, as Simon mentioned, we'll be able to produce more than 200 metric tons per day of green hydrogen. I'd like you to move to Page 4 for a little bit more detail about how we have structured this. On the left-hand side in the box that you see, we will have a joint venture company, 50% owned by Air Products and 50% owned by AES, which will design, build, own and operate a facility that consists of windmills and solar panels to produce about 1,400 megawatts of electricity and the project will also include the electrolyzers in order to produce the green hydrogen with literally 0 carbon intensity. Then that entity will also get any of the IRA benefits in terms of the incentives that we have put in there for green hydrogen and for green electricity and all of that. And then that entity will sell the product on a long-term contract basis to Air Products. And then Air Products will be the sole off-taker and marketer of that hydrogen into the U.S. and international markets if that is required. So that is the fundamental structure, as I said, the entity on the left will be owned 50-50 and the entity on the right, which is our day-to-day business is obviously going to be owned 100% by Air Products. This project is absolutely a perfect fit for what we have been talking about in the last 6 or 7 as our strategy. It is absolutely in alignment with our higher purpose of doing something good for humanity and this project certainly does a lot to reduce -- to get other companies the capability of reducing their carbon emissions by using the 0 carbon green hydrogen. It creates significant value for our shareholders because we are going to be the first mover with this project in the U.S. We will have the product, we will have the benefit of the tax incentives. So it will create a very attractive, financially attractive investment. It solidifies Air Products position as the board leader in hydrogen because this project combined with what we are doing in Saudi Arabia will put us way ahead of everybody else in terms of having multiple sources of green hydrogen. And it has -- it creates a baseline for us, a base plant on which we can expand and gain experience and do more of these projects both in the United States and outside the United States. And then in terms of helping us meet our sustainability goals, it's obvious, but it does and also it will help other people make meet their sustainability goals. So I think just about everybody on the line is very familiar with hydrogen, green hydrogen, blue hydrogen, we have talked about it many times. And we have been working on this specific project with AES for now more than 3 years to develop the project. And I'm very happy that we have got into the position that we can now publicly announce this. As I said, everybody is very familiar, so I want to stop here and leave time for us to answer your questions. So please, operator, we are ready for questions.

Our first question is going to come from John McNulty, BMO Capital Markets.

So I guess maybe a couple of them. So on the joint venture itself and the capital that you're contributing into that venture, I guess, should we be thinking about between the offtake agreement which you're taking on, but just specifically on the joint venture part, is the capital that you're putting in there, should we make the assumption that the returns are comparable to what you normally look for, which is a minimum of 10%, whether it's just from the project sales and but also incorporating in the tax credits, I guess, how should we be thinking about that?

Well, first of all, good morning, Second thing, you should be thinking that every dollar that Air Products spends on any project, whether it's joint venture or 100% or so anything, we expect the minimum return of 10%. So the answer to your question is, yes, you should expect that the joint venture will have that kind of a return.

Okay. Fair enough. And then just on the downstream side, so just taking kind of a cursory look at the map, Wilbarger County kind of seems like it's a little bit in the middle of nowhere, which I guess is somewhat by design because you can't find necessarily the space for wind and solar. But I guess how do you move the product up from -- on the downstream side from this facility? I guess how should we be thinking about what maybe the end markets are that you're really targeting? And do you have any arrangements or any offtake agreements that you've been kind of working in kind of in the background on this that you can speak to where we've got some confidence or comfort that you've got a home for all this product?

Well, John, the thing is that we are obviously very bullish about the demand for hydrogen in general and green hydrogen, specifically. The way that the product coming out of the first box, out of the joint venture is gas as hydrogen, green hydrogen. We will have many ways of moving that product. We can move gas as hydrogen by pipeline to different locations. We can take gas as hydrogen, liquefy and distribute the hydrogen in liquid form or we can take the gas as hydrogen turning into ammonia and move the ammonia by rail anywhere you want or we can take the hydrogen, green hydrogen and turn it into another high-value green product that can be moved and used. At this stage, we do not want to disclose the details of exactly what we're going to do with that because it is proprietary. When we are ready, we will make an announcement in terms of how we are going to use the product. But as I said, we are very bullish about the demand for this kind of product. It is -- this is a mega project, it's a huge project, I agree. But at the end of the day, 200 metric ton a day of hydrogen, if you have 4,000 trucks converted to fuel cell engines, it consumes all of that product. So the project is huge, but in terms of the available market for it, the available market is significantly huge. So we are very bullish about that. And I don't want to give you a very specific answer about the end use because it is truly -- we are working on some neat applications that we will disclose at the right time.

Got it. Fair enough. And maybe if I can sneak one last one in. I think in the press release, you had highlighted you expected to get subsidies that would get as high as or pretty close to $3 per kilogram. I know in the IRA bill, look, it's a very long act and it's -- there's a lot of nuances to it. The obvious 45V credits are up to $3 per kilogram. Can you help us to bridge how you get from 3% to close to 5%? Can you kind of fill in some of the blanks there, because admittedly, we haven't seen all the nuances of it.

Well, John, the thing is that the nuances are nuances and I mean we have the IRA Act and that people need to know, turn it into rules and all that. But the $3 per kilogram for gas as hydrogen is pretty clear because the act is very clear about the $3 and the threshold is 0.45 kilograms of CO2 per kilogram of hydrogen, which we will easily, easily meet with this project. The part that is in addition to that is the kind of credits that you are going to get for the renewable power because this is an integrated facility that is what we're building an integrated facility. And therefore, you can stack the hydrogen benefit and the green hydrogen benefits to get -- the green electricity together. So there is a lot of different ways and different interpretations of how you can calculate the benefits of the green energy generation. And you can calculate that to be $2, $1.5, $2.50, I don't want to get into the details of that because we are not super expressed in that. I think our friends at AES can answer that better than we can. But it certainly is going to be more than $3, John, because you will have those kind of benefits. And besides that, there is another benefit that could come into play and that we are using the site of an old coal-fired power plant and there are some tax benefits in case that you are doing that. So it can get pretty complicated about that, but you can count on the fact that the benefits will be higher than the $3.

And our next question is going to come from Joshua Spector from UBS.

It's Chris Perrella on for Josh. I wanted to follow-up on that, that the tax credits, assuming with the project in Louisiana and this one, you potentially generate more credits than you would pay for U.S. taxes. Can you accrue these benefits? And will they expire?

No, the legislation, if you go through the details of the legislation, the legislation allows you to -- if you have tax credits that you cannot use, you can trade that with other people. And there is also provisions that if you run out of tax credits that you can get reimbursement cash for 5 years.

All right. And then...

We will be able to use the tax credits for sure, whether we have enough tax in the U.S. or not, we can give it to other people who are paying taxes.

All right. And then would this -- given the IRA tax benefits, is this project still accretive even without all the benefits? Or did that play a key role in the decision-making process here given you guys have been working on this for 2 years?

Well, you notice that we are announcing this thing right now, not too long after the IRA was enacted. The tax credits are doing what the U.S. government intended to do, which is to accelerate the implementation of these kind of projects in the United States rather than waiting another 10 years until cost go down or the market develops and therefore the prices will be appropriate. So I think the tax credit has given us the incentive to announce the project and move the project forward now because it makes it more economical to do it right now in the United States.

And then -- thank you, Seifi. And one more quick question, have you announced a partner on the electrolyzer? And are you guys going to use PEM or alkaline for that?

We have an agreement with thyssenkrupp about the use of the electrolyzers and they will probably be the most likely people who are going to provide the electrolyzers. We have a global agreement with thyssenkrupp, which is exclusive.

And our next question is going to come from Jeff Zekauskas from JPMorgan.

I know Seifi that you target a 10% internal rate of return on your projects. But given the tax benefits of this project, shouldn't it be at least 15%?

Well, Jeff, good morning. You're asking a very good question. The thing is that we are hoping that the tax benefits of the project will result in a lower hydrogen products that we can buy from the joint venture and still have the joint venture as the appropriate returns.

And our next question will come from Marc Bianchi from Cowen.

I was curious, I recognize there are a lot of different scenarios for the downstream portion. But is there any dollar number that we should be thinking about in terms of investment required from Air Products to develop that?

Well, it depends on what we do with it. If we take it and liquefy it, then there will be investment required for the liquifiers, which is not that huge. If we decide to put it in a pipeline and send this somewhere, then obviously, we have to invest in the pipeline. And then if we decide to turn it into something another product and so on, then we have to look at the economics of that product. So the downstream capital, a lot of that is already in place. So this is the thing about Air Products being involved in these projects because we are a real hydrogen company. And as a real hydrogen company, we have the infrastructure to produce hydrogen, use it and get it to the end customers. We have a 700-mile pipeline. I mean that is the difference between us and a lot of other people who aspire to be a hydrogen company, we already have the infrastructure. So we do not have to rebuild it. So the downstream investment, as I said, depends on what we do with it, but it is not going to be anything which is right billions of dollars. Obviously, depending on what we want to do with, yes.

And is the pipeline option most likely connecting to your Gulf Coast pipeline? Or what is the range of scenarios with pipeline? Because I don't believe there's any hydrogen pipeline that's in close proximity?

But now you're getting me to get into a little bit more detail than I wanted to, but just not to avoid the question, you can put it in a pipeline and send it to an industry that is going to be developed in that area that would need green hydrogen. They don't have to send it all the way down 250 miles to our existing pipeline. There is a lot of different options.

And our next question will come from Kevin McCarthy from Vertical Research Partners.

Seifi, you've been moving very aggressively and been very active to advance and extend your first-mover advantage in clean hydrogen as you mentioned. So my question will be, if we think about the next 2 to 4 years, what would limit or govern the pace at which you can proceed and continue to execute on all these projects? Is it capital? Is it the identification of attractive specific projects? Is it internal bandwidth to evaluate and execute? How would you frame that?

Good morning, Kevin. That's an excellent question. I would have to say that the biggest determining factor is going to be capital and access to capital. We do not plan to issue additional equity at Air Products. We have always said, we are not buying stock and we are not going to issue additional equity to dilute our shareholders. Therefore, what we spend will be subject to 1 metric, which is what is the net debt over EBITDA for Air Products. And that number, we want to keep it in such a way that we keep our A rate. So at the end of the day, that is the limit in terms of how many projects we will do. Now there are innovative structures that we can use in terms of project financing, as you have seen that we are doing and all of that. But at the end of the day, the limitation is the capital. In terms of internally, I feel very good about Air Products' capabilities. And if you have more projects should they add additional capabilities, they have a very group -- a very competent group of people within the company. Dr. Serhan and his team are well capable of handling lot of projects. And as they are already, they are already executing more than $20 billion of projects. So I don't -- the limit is the fact that we do not want to lever Air Products more than 3x or 3.5x because we want to maintain our A rate. So if we ever get to that, that would be the limit. But we do, as you know, Kevin, every quarter have a truck which shows you how much capacity we have before we get to that limit. And you'll see that we still have a lot of running room, which is the great thing about Air Products balance sheet. So we can do many of these projects before we get to that and hopefully by the time we get to that, some of these projects have come on stream and generate the EBITDA, but that would be the constraint at the end of the day.

That makes sense, very helpful. If I may, I wanted to also ask you about the relationship with AES. It sounds like you've been working with them over 3 years. Can you talk a little bit about how that partnership came about? Is it exclusive? It looks like they've been adding wind and solar capacity very aggressively over the last 6 years. And so I'm wondering if perhaps they have excess capacity in certain areas that you may be able to take advantage of?

Well, Kevin, that's a very good question. First of all, AES is a great company. They have a great CEO whom I have a lot of respect for. The relationship came about actually about -- originally about doing a project in Chile because of the -- lot of the mining equipment there and the fact that they want to convert to hydrogen and all of that. So we started getting to know them as a result of that. But then we started talking about the U.S. and what happens in the U.S. and what they have in the U.S. and we ended up with this project. We worked very well with them, they are very confident company, as I said, I'll get along very well with Andres, their CEO. And now we have developed this project with them. The relationship is not exclusive. They have their capability to work with other people and we have the capability to work with other people, at least it's not exclusive at this stage. So each one of us has the freedom to do that. But they have come together over here because not only the culture of the 2 companies fits, but also the core competencies of the 2 companies is a perfect fit for doing this kind of a project. But I do want to add, we are not a big fan of having somebody produce power 1,000 miles away and then they put it into the grid and they take it off the grid and produce hydrogen because there I think it becomes a question of can you really claim that, that is clean and all that. We are a big fan of integrated projects like this one, where the power plant is directly connected to the hydrogen plant.

And our next question will come from Vincent Andrews from Morgan Stanley.

This is actually Steve Haynes on for Vincent. Thanks for taking my question. I was wondering if you could just give us a bit more color on the composition of the $4 billion investment maybe between power generation assets and the electrolyzer? And then just any degree of confidence in that the $4 billion being conservative and you also kind of mentioned there might be opportunity to upsize the investments. So just any thoughts on that would be appreciated.

Well, that's a great question, but I'm a little bit hesitant to give you the details of the breakdown of the capital cost. But order of magnitude, we are saying that this project is 900 megawatts of wind and 500 megawatt of solar. I think it's order of magnitude that half of the project will be the wind and solar product and half of the project will be the hydrogen and the infrastructure for order of magnitude.

And our next question comes from John Roberts from Credit Suisse.

Congrats on the project. Air Products, your sole responsibility for the hydrogen, does AES bear any sole responsibility for any parts of the project? Or if the wind doesn't blow or the sun doesn't shine, do they have any sole or is the JV responsible for anything other than the hydrogen marketing?

Well, on that point -- first of all, good morning, John. The JV is 50-50 and we are building the plant together, investing together and the plant produces a certain amount of hydrogen that will be sold to Air Products. Now if the wind doesn't blow and the sun doesn't shine then the JV will not be able to produce the amount of hydrogen that was envisioned and therefore they'll be selling less to Air Products. Therefore, its returns will go down. But it is not going to be that they are going to -- the JV is not, they are going to say, hey, we have built this plant, we are going to make hydrogen and here is the hydrogen available if it. Whenever we make it, you take it and in a certain price, if they can't make it, then they will have a lower return. But it is not as AES is going to guarantee to wind and sun or for that matter Air Products because we are a JV in the production.

And then secondly, I know you don't want to talk about the -- go ahead.

Go ahead, no ask simply, John. Go ahead.

You don't want to talk about the uses of the hydrogen, but you expect a baseload customer somebody that might consume a third or half of the output or you expect it to be very diversified or distributed uses of hydrogen?

It depends what we do. The base load for the thing is all of the trucks running in the United States and we think in time, they will be turned most of them into fuel cell vehicle. So that is a huge customer base that we can serve. But then in addition to that, we are looking at other options to taking the green hydrogen and converting it to other products, which are much more value added. So there is -- we see a significant amount, as I said during my opening comments, we are obviously very bullish with respect to the future of hydrogen. I know not that everybody shares that view, which is a good thing, I hope everybody continues to think that there is not a huge market so that we keep building these plants and when the market develops, we'll be the only one who has the product, which would be a good position with...

Our next question comes from Stephen Byrne from Bank of America.

I'm curious to know kind of the size of the electrolyzer capacity you're going to install. There seems to be a bit of a disconnect between 1.4 gigawatts of renewable power and 200 tons per day unless the load factor here is fairly low. So just curious to know what is the load factor in electrolyzer capacity and whether it would be cost effective to install battery storage to increase that 200 tons per day potentially double it?

You are asking excellent question. The answer to the first part of your question is that, obviously, the utilization of the power is low, that is why you need incentives to make these things economical at this stage because the intensity of the wind and the sun in Texas is not as good as what you have in Saudi Arabia, for example, where the ratio becomes bad. So that is -- the overall utilization is -- I don't want to give you an exact number, but you can calculate it, it's obviously around 35% to 40%. So the installation of a battery to enhance the productivity is something that we always consider and look at the cost of that and all of that. And that is, as you correctly say, a potential in the future to do that. And actually, AES is one of the largest and leading producers of battery storage. So that is another way of doing that in order to put the battery in there and therefore with the same electrolyzers make a lot more product. You are very right about that.

Our next question comes from Sebastian Bray from Berenberg.

I have 3 please. The first is, why would the U.S. government include a cap of 75% on the 45V tax credits relative to taxable income, if it's effectively rendered meaningless by the ability of the companies benefit to trade tax credit. So I'm wondering, is there something specifically in the text of the inflation reduction act that says this does not apply if the companies can trade tax credits? Or is it more of a case that this has been left of a discretion of the IRA and you think that the IRA would take this view. My second question is just simply on the accounting of the JV. Does 50-50 just mean 50-50 consolidation of sales and operating profit? And my third one is on pricing. Is there across the mega hydrogen projects that Air Products has put in place, is there any visibility yet on the willingness of customers to pay a fixed price? Or does it look like there will be indexation to a market price involved?

Very, very good question. In terms of the tax fees, I'm obviously not a tax expert, but I think that in general, I would like to say that the legislation -- IRA legislation specifically allows for this. I would like to open the floor to some of my colleagues on the call if they have any specific point of view. Melissa do you or Sidd have any specific view on this taxing? I think the IRA is very much specifically allows for this tax trading. But I'm not sure of that, I'm pretty sure of that, but do you have any comments on...

Yes -- no, thank you, Seifi and thank you for the question. Specific to the tax credits, so from the IRA perspective, obviously, we get the opportunity to have direct pay for a period of time. So the direct pay will allow us to be able to allow that cash in from -- after that period, we will be able to take advantage of tax equity associated to these payments. So there are different options that we are looking to be able to take advantage of the IRA tax credit.

Okay. Then in terms of the accounting, in terms of how are we going to account for the details of the accounting of the joint venture, we are working on that. There are several ways of doing that. We can both take it as equity income as kind of equity income from the joint ventures. But Melissa, do you want to make any general comments about that?

Yes. No, thank you, again, Seifi. Yes, so from an accounting perspective, we obviously will wait to see until the finalization of the joint venture agreement. With that being said, we do think this will mirror our other joint ventures that we have a production joint venture and then are the full offtake similar to our joint ventures in Saudi Arabia. So again, we'll look to see when the agreements are finalized and look to be able to attribute their proper accounting then, but it will likely be similar to our NEOM joint venture in Saudi Arabia.

Yes, which means that we will treat it as equity-affiliated income rather than consolidating the joint venture. Okay? And then your third question about the pricing, we have obviously talked to different people. And one of the things that people like about green products, especially green hydrogen is the fact that since your input cost, input raw material is wind and sun and they are for free. Therefore, one can have a very long-term contract with almost a fixed price, the only variable being small operating cost, labor cost of producing the product. Therefore, customers can get comfort that green hydrogen is going to be a lot more stable in pricing than even blue hydrogen because price of natural gas, obviously determines the price of blue hydrogen and that can go up significantly. But with green hydrogen, basically, what we need is a return on our capital and a recovery of the labor cost and the labor cost is very low on these projects. The main determinant of the price is the return of capital that you want. So as a result, some customers are very attracted to the fact that they can get a 30-year contract with almost a very well-defined energy cost for them for the long term and that is very attractive to people as compared to being subject to the price, basically, the oil price going up and down and the geopolitical risks that, that has. I hope I did answer your questions?

Yes, indeed.

[Operator Instructions] And our next question comes from Christopher Parkinson from Mizuho.

This is Kieran on for Chris. I just -- most of my questions have been asked, but just a quick one. It seems like the passing the IRA helped move this project forward. I'm just curious whether it's projects you've been in conversations with or new projects for being thought out, how that -- how those discussions have maybe changed and the opportunities that you're seeing have evolved over the last few months and since the passing of the IRA.

Well, that's a very good question. I think what has happened since the passage of the IRA, the fundamental nature of the market hasn't changed. What it has changed is that it makes it more attractive now to build and invest in the United States in green hydrogen and blue hydrogen honestly, because the IRA gives you the $85 of tax credit for sequestration of CO2, which is a main ingredient of making blue hydrogen. So the overall discussion about the board demand for hydrogen hasn't changed if the supply secure a debt, fundamental movement toward the energy transition hasn't changed. But what has changed is now instead of us announcing a project in another country where there is a lot of wind and sun, now we do a project in Texas where it is -- from physically, it's a little bit less efficient in terms of the availability of the wind and so on. But the tax incentive makes it more interesting. And that was the intent of the IRA is to make the U.S. an attractive place to invest. And once people invest, I get the experience, then they will invest the second plant and the third plant and the market will mature and therefore the U.S. will be maintaining its leadership position. So that, that I think was a very positive thing that the U.S. Congress did and the administration there is to make it attractive for people to invest in the United States. So the IRA is not only a climate bill, but it's also really an investment encouragement bill and we are obviously taking advantage of it and this project is the best example of that.

It appears there's no further questions at this time. I'll turn the conference back over to you for any additional or closing remarks.

Thank you very much. I'd just like to thank everybody once again for joining our call. We appreciate your very good and excellent questions and we look forward to talking to you soon when we either announce another project or we get to our quarterly results. And in the meantime, I wish everybody a very happy holiday season. Thank you.

And this concludes today's call. Thank you for your participation. You may now disconnect.