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

Okay. I will go ahead and get started. I appreciate everybody joining us today. Again, my name is Mike Leithead, head of the U.S. Chemicals and Packaging efforts. Here at Barclays, we're really appreciative to have the Air Products' CEO, Seifi Ghasemi; Melissa Schaeffer, CFO and representatives from the IR team. [indiscernible] months ago, so I appreciate him coming down. Munshi and then Sid Manjeshwar, who's the incoming IR [indiscernible] really smart guys [indiscernible]. Before we start off again, again [indiscernible]. First question, do you currently own this stock. One, overweight; two, market weight; three, underweight? [indiscernible], you don't have a quicker because you can't be hammer in the one book. Okay. So there's some opportunity [indiscernible]. Next question. What is your general bias towards the stock right now? Positive, negative, neutral? Almost positive. Next question, and that's good. In your opinion, through cycle EPS growth for Air Products will be above peers, in line with peers, below peers? Most say above peers. Next question. In your opinion, what should Air Products do with the excess cash? Bolt-on M&A, larger M&A, repurchases, dividends, debt pay down, internal investment? Hope there is not a lot of [indiscernible]. Okay. Most say internal investment, I think you guys would agree. Next question. In your opinion, what multiple of 2023 earnings EPS should Air Products trade at? Less than 10 [indiscernible]? Okay. Towards the higher end. Next question. The most significant share headwind [indiscernible] core growth, margin, capital deployment or execution? I think there's one more [indiscernible] question after this and then we can dive in. Okay. I think most say execution strategy. Last question. Does ESG play an active role in your investment decision relating to the company? One, it's a positive factor; two, yes, but it's a negative consideration; three, no, it does not play a current role in our assessment; four, no but we do [indiscernible] incorporate ESG in the near future? Yes, positive factors, overwhelming.

I like the...

Yes, yes. So great. Again, safety, Melissa, I really appreciate you guys being here. Maybe just to start off big picture for kind of level set for Air Products, [indiscernible] lot of end markets, [indiscernible] all regions. Maybe can you just look for around the world what you're seeing in terms of growth demand, and we'll kind of go from there.

Sure. First of all, it's a pleasure to be here. I know a lot of people in the audience. Always good to see you. And quite honestly, thank you very much for the feedback you just gave us [indiscernible]. With respect to your question, we obviously don't have a habit of giving an update on what is going on in the middle of the quarter. But frankly, sitting here in front of you after 2 months in the quarter, if I can say no comment because it sounds so critical because I have an idea of what the quarter looks like. So I'll give you some general comments, if you don't mind. Number one, if we start from the eastern part of the world. The [indiscernible] gravity of our business is obviously in China. In China, we did have a weak first quarter, both in volumes and pricing. But in China, the key thing to watch is how does the economy bounce after the Chinese [indiscernible] and that is positive. We are seeing the economy come back pretty well. The opening with the COVID has helped. So we are a little bit more optimistic about China now than we were 2 months ago. And we hope that the bounce back in economic activity will help with getting some pricing trend that we lagged in the first quarter. In Europe, volumes are not that exciting, as you would expect, considering what's going on. But the only -- as I said, [indiscernible] that the energy prices have started to go down. And if that trend continues, and we do a good job in holding on to pricing levels that we have achieved already, which were pretty robust in the first quarter, as I'm sure you saw, then we have a chance of recovering our margins in Europe in the second quarter, which would be a good positive development for us. And then in the Americas, nothing has really changed from the first quarter. We are having a strong pricing and the economy is just moving along [indiscernible]. You know that there is [indiscernible].

Great. And on China specifically, there's obviously been a lot of debate or focus around the country's COVID policy shift. I mean just kind of how do you kind of swift through the tea leaves there? Obviously, you've seen a fairly good recovery, it sounds like so far. How do you think about the progress or the potential for China over, say, the rest of this year?

Well, obviously, right now, what is going on in the world and the dynamics for this going on in terms of support or not support with Ukraine and so on, it's really difficult to predict the geopolitical thing, and we don't know enough about it to have any opinion about that. But the 1 thing that -- I mean barring any significant change, we do remain -- continues to remain optimistic about China potential [indiscernible] people. The [indiscernible] is getting stronger. And our company in China, we don't import anything into China, and we don't export anything from China. We are looked as a China's company, the political situation is not affecting our operations or our customer reaction to us that somebody said this is an American company. They don't want to do business with them. There's none of that. So we continue to remain optimistic about what China is doing and what it [indiscernible] conclusion.

Great. And then I think Air Products obviously just reported first quarter results. The base business remains, I'd say, fairly strong and steady overall, but there was a lot of investor questions on the call around [indiscernible] and then your update there. So maybe a kind of level set for folks what the change in [indiscernible] mean and how do you think people should interpret that?

So I'm very happy you're asking that question because quite frankly, I don't think we did a good job on our earnings call to explain the NEOM situation. I think you should have had a separate call and [indiscernible] to going through that part. We did it at our earnings call because at the time, we expected that 2 days later, you will have the [indiscernible] close with the banks and we said the news is going to come out [indiscernible] but obviously, the [indiscernible] hasn't happened yet. Hopefully, it will happen next week. But -- so I think the NEOM team deserves further discussion. [indiscernible] situation in NEOM is actually a lot better than what it was in the past. Obviously, the investors interpret [indiscernible]. The reason that I stated it better is that, let's please take a second and focus on [indiscernible]. In 2020, we said that we are going to build a plant that would cost $5 billion to produce green hydrogen. That's 1 piece. And that was going to be 1/3 Air Products, 1/3 ACWA Power because they got a power company and they need to build the wind and the solar piece, they can add value, and 1/3 basically the government of Saudi Arabia through their secure [indiscernible] because we need hundreds of acres of -- thousands of acres of land for building the wind and the solar and they need to be part of it. Otherwise, we don't have a project. So that was -- and each party was going to put in $1.7 billion to do that. That is 1 piece and that was going to have a certain return. The next piece is that the hydrogen that is produced is going to be in the form of ammonia that Air Products will be the 100% offtaker and market that product [indiscernible]. That is very important that we are the [indiscernible] at a certain pace that we negotiated in 2020. And then we had made some assumptions about that we're going to take that product, then exactly at different locations [indiscernible] sell it and make a return on that, which was most of the return on the wind power project. So today, what are we saying? The part we are saying that the price for the ammonium is the same price we negotiated in 2020. Therefore, that peaks had the profitability of the downstream has not changed at all. And actually, from our point of view, the situation is a lot better than 2020 because we see a lot more interest and demand for green hydrogen. So nothing [indiscernible] what we announced changes the profitability of that part of the equation. On the production side, you're saying that $5 billion has gone to $8.5 billion total cost because it now includes some inflation, additional scope because they don't want to buy the services from other people, we want to build it ourselves and the cost of project financing. Why are we project financing it? Because people are -- there's a lot of interest on green project. People are willing to give us -- we will announce the interest rate next week. You'll see why we want to do project financing. So as a result of this, on the production side, instead of Air Products investing $1.7 billion, now we are investing $700 million. So we are actually saving $1 billion of our money that we are going to put in other projects and get a good return like [indiscernible] they did last month. So that profitability hasn't changed. So the only thing that's changed is the return on the $700 million. The return on the production side now is less than it was expected to be [indiscernible] 2020. How much has it changed? It cannot be 0 because people are giving us $6 billion to finance this project. So it cannot be a nonprofitable project. These banks do their due diligence. So assume that instead of 10% on the $700 million, we are going to make 5%. So in total, we have -- in the worst case situation, that you can say in the entire thing, you have talking about $35 million of operating profit after tax divided by number of shares [indiscernible] were trading. So that can be a maximum hit if anybody wants to face the worse situation of $3, $4 a share, not $35 a share that we experienced, but that is the way it came out. I think people on the call when I was talking about the price of ammonia hasn't changed, they didn't fully appreciate that I'm talking about price of ammonia that [indiscernible] not the price of ammonia that we're going to sell and then they kind of said, well, they are losing the profitability on $1.7 billion without realizing that -- but we are not spending [indiscernible] $700,000. So as I said, I think it would have been better if you have a separate call, but I'm glad you're giving me an opportunity to explain that.

Thank you for that. It was a very detailed and articulate way to kind of lay that out. I guess the natural follow-on question I get from investors though is, again, there's $700 million there, and we can talk about what the rate is of return there. But you guys are also spending $15 billion plus on other projects. And I hear concerns from investors sometimes around what -- is there any movement on those returns or what have you. So can you speak to your confidence around your cost estimates, your potential for more project clients. And just as we think about the rest of the backlog that you have today?

Well, the backlog when you say, $15 billion, a lot of those projects [indiscernible] or almost they didn't. So it would be not credible for me to sit down and say there is no effect on [indiscernible] there will be an impact because there is inflation and your building facilities. But the intent, the biggest projects that we are doing, let's say, take the project in Louisiana [indiscernible] blue hydrogen facility. Over there, we have not yet to show the product. We do not have a long-term contract that we are saying -- you're saying that the revenue is fixed. If your cost goes up, your [indiscernible] so it tends out that the cost is more to build the brand and then the [indiscernible] to charge more with us or our project that we announced in Texas. We just announced that last month. We are fully aware of the inflation and we know what the costs are. So true, there will be some inflation, we have to deal with that. Our record is pretty good. We just [indiscernible] that we announced 2.5 years ago that we are going to build a $1 billion facility in the U.S. Gulf Coast, which is going to be hydrogen to supply hydrogen into ammonia [indiscernible]. That thing was an investment of about $1 billion. That plant is going to come on stream in the next 2 months. We have finished that project on the schedule [indiscernible] budget despite the fact that the [indiscernible] with inflation so you have additional record on that. We need to be aware of it [indiscernible] but that's part of our job.

Great. And an important part of the NEOM update and you talked about just now, is the fact you're so enthusiastic about the downstream ammonia and hydrogen offtake in opportunities. So can you maybe just talk a bit about what you're seeing in terms of customer engagement and constant opportunities to ultimately market a lot of this ammonia?

Well, let me just put it into following context. If you want to look at the parameter of what is going to drive our profitability on all of these green energy projects that [indiscernible] everything else? What is the transition you're talking about? 150 years ago, when there was several energy transitions that we've had from wood to coal, from coal to oil. They were all driven by economics. It was cheaper to go to coal than wood and more efficiently [indiscernible] go to oil. Therefore, economics was driving that. And therefore, if you had a case that I have a source of energy, which is cheaper, you would win. The energy transition that we are going through right now has nothing to do with economics. Nobody can sit down and claim that they are going to make green hydrogen or blue hydrogen that will be cheaper than using hydro products. That is not a -- it's not economics. It is policy. So if you want to track whether we are on the right track or not, look at what is the policy that are being implemented in the different parts of the world to promote basically climate change. So sitting here -- we got into this journey 7 years ago. Sitting here, with the IRA, that is the best thing that could have ever happened in terms of -- in the biggest economy in the world, the biggest country in the world, the strongest country, making that kind of a commitment long term, it's a $450 million commitment. That is [indiscernible] Europe. So the reason we are optimistic is because we see a trend toward push for the energy transition becoming more and more and more at the highest results of all of these governments. And quite honestly, on a personal basis, I think we're overcommitted in the sense that some of these things that by 2030 this is going to happen, the amount of green energy [indiscernible] is just not going to be there, which is good for us because then the product has been at great demand, but that is what you should follow. And that is the basis that we are very optimistic. It's not that we have found a way to beat as [indiscernible] anything.

That's great. And then I think this also brings us to a good question about Air Products' view, I would say, participating in the whole value chain for blue or green hydrogen. Obviously, 1 of your main competitors has publicly taken the approach, only focusing on the ASU or the ATR and outsourcing some of the carbon sequestration or some of the ammonia sale. Again, without talking about them, can you just talk about Air Products and why you see great value in owning, I would say, the entire value chain and that stuff?

So first of all, I don't understand the argument that somebody is saying that, look, I don't think blue hydrogen is going to be -- has a future, but I am protected because I'm going to sell the hydrogen to somebody who's making blue ammonia. Well, how does that make sense? Because if the guy that you are selling hydrogen to is not going to make money on blue ammonia, he doesn't have money to pay you. So to make the argument that, that is how I'm derisking my project is kind of [indiscernible] the entire chain needs to work. Otherwise, you are selling to somebody who's going to go bankrupt. So that doesn't make sense. What we think is that by controlling the total chain, it will be more profitable. But that doesn't mean that we are going to sell to other people. The best example of it is that we are way ahead of what these people are saying, as I said, a plant is going to come on stream 2 months from now, where we are making the hydrogen, which is -- we are going to make it blue and selling it to somebody who's going to make ammonia 1 million tonne of it in the U.S. Gulf Coast to sell to the outside world. So wherever we can, we want to go all the way because we think we will make -- end up making more money because somebody is going to make the margin. Why wouldn't it be us especially if it is green because there, we think we have the know-how for the hydrogen refueling stations, and therefore, we can take this thing [indiscernible]. But fundamentally, the [indiscernible], fine, we do that. But I take significant issue with anybody saying, by doing what I'm doing on taking less risk at Air Products. It is, at the end of the day, is the product that has to be sold. If the product cannot be sold, then everybody is at risk.

Got it. Okay. And then it does bring us to a good point because we've talked a lot about green hydrogen, but there's a lot of opportunities for you as well in blue hydrogen. So can you maybe just update us on the offtake opportunities from installing carbon capture and what you're seeing right now in your pipeline?

Well, on that one, why blue hydrogen because the amount of energy that you need in order to do the -- address climate change. If you want to go all green, it will be just so gigantic that it is almost next to impossible in the short term, but in the short term, you can do a lot of good for the environment if you can capture the CO2. So it makes sense to use the hydrocarbons, make hydrogen, still hydrogen but capture the CO2 and so-called make blue hydrogen. We want to participate in that. It's just no different than to me, you go to a gas station, you buy either leaded gasoline which is grey hydrogen and leaded blue hydrogen or super, which is green. So we want to be in a position to supply all of that. And so blue hydrogen does have a future -- significant future. And that will be in the application to take the blue hydrogen, compare it with ammonia and then use the ammonia as it is to blow into a power plant so that you don't have to crack it again. Because if you want to crack it again, if it is not green, you're not going to get them [indiscernible].

Got it. Right. We'll pause here to see if there's any questions in the audience. I could be up here and ask you questions for hours. We already had dinner for 2 hours last time. I still have a long list of questions to pick your brain. But is there anybody in the room who has any questions? Any good question? If anybody has any questions, feel free to raise your hand at some point because I can keep going forever. Europe, can you just talk about -- obviously, we have the IRA here in the U.S., but it seems like Europe is obviously [indiscernible] a lot more progress on the regulatory front. How do you think that hydrogen economy kind of ultimately shakes out? Do you see it as an incremental opportunity? And to that point, what progress has Air Products specifically made to help advance that in Europe?

Okay. In Europe it's actually a very interesting dilemma here now because, first of all, they thought they will be the first and then the U.S. ended up to be the first. So now they are faced with absolute prospect that a significant number of people are going to move their operations in the U.S., not just hydrogen production, but also [indiscernible] because let's say, you're a chemical company, and you need hydrogen to feed your next plant or you're a steel company that need hydrogen to produce decarbonized steel. Well, if it is going to be very economical to produce green hydrogen in the U.S., which is [indiscernible] then why wouldn't you just move your [indiscernible] U.S. also and put it next to the hydrogen, then you don't have to transport the hydrogen to put it in there and then you transport [indiscernible]. So they are really worried about it. If they put in incentives the same as IRA, not going to give them a lot of good because they don't have any sun and they don't have any wind or [indiscernible] so what I've been telling them is they need to do an equivalent of IRA but focus on the customer, not focus on producers, incentivize the truck drivers, incentivize fleet company to use [indiscernible] and then import [indiscernible]. And then like that, you make people stay in your and that is, I think, what they have to do. They are very focused on that. But they are very concerned as they should be because otherwise, a lot of people will just move their entire manufacturing facility to the U.S. so that they are next to a source of, I mean, you have a credit pipeline, you're going to make green hydrogen [indiscernible] very economically. So why not put a chemical plant right there [indiscernible] use it. You don't have to transport it anyway.

And then maybe switching back to the base business. We've probably spent 25 to 30 minutes talking about the project backlog. But when I look at the base business, I mean the industrial gas market is still very healthy. This has done a very good job in driving merchant pricing. So can you just talk about broadly how the merchant business is trending today and then recognizing you can always prepare products or just how sustainable do you think this pricing discipline is to offset some of the cost inflation [indiscernible]?

Sure. I have been associated with the industrial gases business now for 44 years. I've always said that industrial gas business, whether it is Air Products or whether it is other people, it is a golden business. It's a great business. Why? Because fundamentally, you are leading with basic molecules that people need on a day-to-day basis making oxygen, nitrogen, argon, hydrogen, helium. These are molecules that are not replicable. It is very difficult to make them. It requires massive amount of capital, not everybody and their cousin can get [indiscernible] and get into their business. And therefore, it is a great business for everybody as long as you manage properly on a day-to-day basis. That is the basis -- the base business of Air Products. That is the strength of Air Products. And when you look at the charts and graphs that we shared with you, in the last 8 years, we have increased the earnings per share of Air Products, 10% every year, cumulative average growth rate based on our base business. None of the green projects that you're talking about is on stream. So all of that is being delivered by the base business. It's a great business. So you need to be focused on productivity, focused on pricing and get away from this really negative thinking of cost pricing. Well, we are making molecules that people need, you have to price [indiscernible] market rather than, okay, [indiscernible] 10%, that's what I'm going to sell it. So -- and then you have pricing power as has been demonstrated in the last and the business is stable because when the economy hangs, the industrial gas business doesn't hang because people still need the basic products. So fundamentally, our base business is a great business. We're very focused on it. We have a lot of our people very focused on running the day-to-day business most efficient [indiscernible] the investment. We are not losing the market share for the gas business to go on [indiscernible] or anything else. So the other projects are on top of it. They are not distracted by that. And as I said on the earnings call, I mean, we are bringing in 22 industrial gas day-to-day plan [indiscernible] operation in Asia last year. We are doing what we need to do there, and that will continue to be a great business for us.

Great. Well, Seifi, Melissa, I really appreciate you and the Air Products team being here. And thank you, everybody, in the audience for your attendance and listening. Thank you very much. Thanks everybody.