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

Hi, good morning. My name is Jeff Zekauskas. I analyze chemicals for JPMorgan. This morning, it's my pleasure to introduce the management of Air Products. Representing Air Products is Seifi Ghasemi, who is the CEO and Chairman. Seifi has been CEO since 2014. On Seifi's left is Sidd Manjeshwar, who is the Investor Relations Head at Air Products. In the audience is Simon Moore and Mun, who also are on the Air Products' team. The form we'll take this morning is a fireside chat. Seifi, would you like to begin with an opening remark?

Yes. The only opening remark I have is that it's a pleasure to be here with you, Jeff. You are the most knowledgeable analysts that I know of in the industrial gas sector, and so it's always a pleasure to participate in a conversation with you. And it's wonderful to see a lot of our investors or prospective investors in the audience. So I look forward to our talk, and I don't have any significant opening statement, Jeff.

Okay. When I look at Air Products, in, for example, it's Americas business, the volume growth in 2022, maybe was about 7.5% in the December quarter, maybe it was 6%, and these are more elevated than the volumes you've been experiencing in the past. What's happening in the Americas? Why is business more robust and so much faster than industrial production growth?

Well, I think in the U.S., the drivers are obviously post-COVID recovery, and we are growing faster than industrial production and GDP because we do have new projects coming on stream and we also have one of our sectors, which is helium, which is growing faster because we do have the products while others don't have the product. And as a result, that helps us in terms of our market share in that sector. I mean if other people are on allocation, and we have the products, so by default, we get additional market share.

Has Helium been affected by the conflict in Russia-Ukraine? Or are the production issues in helium separate from that?

No. I think helium is driven by the very fact that helium is very scarce. There is only very few places in the world where that product is produced. It is not something that you can manufacture synthetically. And we had the foresight about 7 years ago to go and secure a significant source of helium from Qatar, so-called Qatar 3 and as a result of that, we ended up now having the product that other people don't have.

One of the larger changes in the energy industry over the last 9 months have been changes in the price of natural gas. And Europe had natural gas prices that were $60 per MMBtu, midyear last year and then maybe they were $30 an MMBtu in the December quarter. And now maybe they are, I don't know, $14 or $15 per MMBtu. And the industrial gas companies do a good job of pricing up when they experience raw material inflation. In your European operations, how do you feel about your profit changes? Do you feel like you were over-earning at a point in time? Do you feel like prices are coming down and your margins will be squeezed? How do you assess European products profitability?

Well, on that one, if you look historically, Jeff, the first quarter of 2022, we didn't have very good results in Europe because prices of natural gas going up, which means power prices were going up, therefore, our costs were going up, and we had increased prices to catch up because it was a big surprise in terms of how fast the prices went up. But then in the subsequent quarters, as you have noticed, we did catch up. And now last quarter, we're a bit ahead of that. and I expect that to continue for a while. But -- with the prices coming down, but in time, it will balance itself. But we got hurts 1.5 years ago, and we will benefit from that in the coming 6 months or 7 months of whatever it lasts.

What about China? China has gone through so much. They've changed their COVID policies. They had Chinese New Year, they shrank a little bit. What's your general sense of the Chinese economy as it relates to industrial gas?

The Chinese economy has been a positive surprise for us because with China, it's always the issue of how does the economy come back after the Lunar New Year? And what we are seeing right now is that the Chinese economy has come back pretty well after the Lunar New Year. And therefore, we are positive about our volumes. We -- because when we went into the Lunar New Year, there was oversupply. Our pricing wasn't as good as I would have liked to see it. But I think we have a chance to catch up with that as we go forward. So overall, we are optimistic about the performance of our business in China. Obviously, there is geopolitical issues, and I can't predict that. But overall, as things stand right now, it looks okay.

So from your point of view, when you look at your fiscal 2023 earnings, it seems to be more or less consistent with what you've expected previously or do things in general seem better or worse?

Specifically on China, it looks a little bit better than what we expected when we kind of planned for the year. I hope it continues, but as far as the rest of the world, things are developing the way we expected back in October when we gave you the forecast.

Okay. And one of the things that's happened over the past year is passage of the Inflation Reduction Act. Do you think that, that was a piece of legislation that will benefit the industrial economy in the United States over time?

Absolutely. Because I'd like to say that the IRA legislation is the most significant piece of legislation to help with the climate change that anybody has ever done. It is huge. It is longer term. So I think the people who wrote that and got it pass should be congratulated. It's -- and it will certainly help the -- not only with the climate change, but it will certainly help with attracting investments in the United States because a lot of people want a green product or blue -- I mean -- let's say, low-carbon products and the best thing is to just come and build your facility in the U.S. and take advantage of it rather than us, for example, making green hydrogen in the United States and then converting it to ammonia and sending the ammonia to Germany and then converting it back to hydrogen. Well, why not put your plant in the United States, and we can produce the product and save you all of the distribution cost. So I think the IRA is not only a great piece of legislation for the climate, but it is also a very clever way of attracting investment in the United States. And I'm sure by the reaction of a lot of people around the world, you have already seen there, that people are beginning to see that.

Was there a rationality in the setting of the tax credits in the bill? So there's a $3 credit per kilogram for green hydrogen, for example. Is that an arbitrary number? Or is there something of more general economic significance to that?

No. I mean people who wrote the legislation, they're very careful in terms of what does it take -- to be specific, what does it take, for example, a company like Air Products, to build a green hydrogen facility in the United States versus building a green hydrogen facility in Saudi Arabia? So in Saudi Arabia, for example, you have a lot of sun, you have a lot of wind and all of that and labor costs and all of that. So you create a situation in the U.S. that you become competitive. And that is approximately $3. Quite frankly, it's -- it takes about 60-kilowatt hours for making a kilogram of hydrogen in terms of the energy that you require. So if you take $0.05, that becomes a $3.

So it's a way of, over time, redirecting investment to the United States?

It's encouraging you to build the thing in the U.S. Absolutely.

And would there also be, I guess, knock-on effects? Because if you're going to use green hydrogen instead of shipping the hydrogen, I don't know, out, so a steel mill could use it or another manufacturing plant, you're now more incentivized to bring that building to the United States...

Absolutely, absolutely. As I said, instead of making the product cheaper in the United States and then having to go through all of the conversion and shipping it to Europe, why don't you bring the steel plant or the chemical plant to the U.S. and then shift your semi-finished product.

One of the things that comes up in the industrial gas area are the costs of building things in the NEOM project, the costs have risen and also interest rates have really gone up. Financing costs have gone up. When you think about your Louisiana project, I think you originally assessed it as maybe a $4.5 billion expenditure. Are those numbers still good? Or are they a little bit dated because interest rates have gone up or are there other inflationary sources?

There is a lot of factors that affects the cost of these mega projects. One is obviously inflation, the other one is interest costs and all of that. But then there is another factor is that just like in the case of NEOM is that as we become more optimistic about the opportunity, then we add things to the plant. If we are going to build the plant of a certain size, then we can upgrade things a little bit and that will add to the cost. This is the same thing that we did in NEOM. The fact that it went from 5 to 8.5 wasn't all inflation and interest rate, it was also the cost of financing, but it was also because we added to the scope. So whether we do that in the project in Louisiana and so on, it remains to be seen. But those are the factors that contribute to additional investment. But the thing is that when you started the project 4 years ago, we started the project in Louisiana. We publicly announced almost 2 years ago. The IRA wasn't there. So now IRA is there. And when you look at that, with that incentive, you say, "Well, maybe I can make more of this stuff or I can make a different product in order to maximize the economics."

So I think you're now financing maybe somewhere between 4.5% and 5%. Does that affect industrial gas returns in general? Or do those financing costs pretty much get passed on to customers or to companies that want to do on-site projects with you?

Well, the thing is that it depends how we -- it's 1 thing that we finance a project non-recourse financing like in NEOM. Nonrecourse financing means that it is nonrecourse. It is not on our balance sheet and all of that kind of stuff. We have another way of raising money, which we usually do is that we don't do nonrecourse financing, we go and raise bonds. The bonds are obviously cheaper than the nonrecourse financing cost. So it's a combination of those things. And if you are doing the $200 million project, we don't do a nonrecourse finance. But if you do an $8 billion project, we do that. So you have to take all of those into consideration. But in general, if interest rates are up, then that means the cost of everything goes up. And therefore, the prices should go up. That's one of the reasons that we are increasing price.

Yes. In the -- when I look in the United States at companies that are selling blue ammonia or plan to sell blue ammonia in the future, my impression is that the financial terms at which they're selling them today are more or less a cost plus basis. They look -- and what I mean by cost plus is they look at the price of natural gas and natural gas will move up or down, and you need whatever it is, 35 MMBtus of gas to make a ton of ammonia. And then what they'll do is they'll make arrangements with Japanese utilities and they'll make a margin above the gas price. Is that the way you see the selling of blue ammonia -- because you're going to make blue ammonia at your Louisiana facility. Is that the trend in the industry to do these cost-plus deals or is it more complicated than that?

Jeff, I'd like to make 2 comments. Number one, when people tell you they have blue ammonia, it's very easy to say that. But you have to look at the real carbon index. I mean what is the carbon index of the hydrogen that goes into making the ammonia? And how have you made that hydrogen? People are not going to consider ammonia being blue if you have taken existing SMR and captured half of the CO2 and then say, "No, I have blue ammonia" because you don't. If you have to capture more than 95% of the CO2 in order to be blue. So that is 1 issue of definition of the blue. But then the second thing is that when you make blue ammonia, your raw material is not wind and sun, your raw material is natural gas. If your raw material is natural gas, you do not want to take the risk of the natural gas price for the next 20 years when you sign a contract. So every contract that we have today for selling hydrogen that goes into making ordinary ammonia and in the future, we go to making blue ammonia, all of our contracts has the price of natural gas as a complete pass-through. We take zero risk on that. So if you're going to sell blue ammonia, we will do the same thing. That's not cost-plus. That is saying to the customer that, look, I have no idea what the geopolitical situation is going to be 15 years from now. Natural gas could be $2.70 or it could be $10. So you need to bear that cost. So that is -- yes, that is how we would -- I wouldn't call it cost-plus, but it is just not taking the risk of the raw material because that is totally -- I mean we do that with not only natural gas but also with power. Those 2 things are passed through to customers. That has been our practice for the last 30 years, and that would be the practice for selling the blue ammonia.

Sure. So in the Louisiana project, when it was originally announced my memory is that you said that you might produce up to 3.5 million tons of ammonia. Have you defined that in a clearer way? That is, do you have a range of what you might produce? Do you need to begin to prepare to size your plant? Where does the ammonia output stand possible future ammonia output?

Well, I'd like you to just give you more details is in a sense that we have announced publicly that the plant that we are building in Louisiana has the capacity of producing 750 million standard cubic feet per day of hydrogen. So now one option is to take all of that hydrogen, which is very low carbon index hydrogen, all of that and convert it to ammonia. If you do that, you can make 3.5 million tons a year of ammonia. But we happen to have that plan next to our pipeline, which is a 700 mile -- more than 700-mile pipeline, which carries hydrogen. It can carry any kind of hydrogen. So we have the possibility of taking some of that 750 million, putting it in our pipeline and selling it as blue hydrogen to a lot of chemical companies and all that. So the final decision about how much ammonia we make depends on how many customers on the pipeline would want to have blue ammonia and at what price we can sell it to them? So it will become an economical decision. So -- it is a maximum of 3.5 million, if we sell zero hydrogen. Obviously, we are going to sell some blue hydrogen, so the capacity will be less than that. I don't want to give -- predict right now exactly what we will do because it depends on the market because the plant is coming on stream 4 years from now, 3.5 years from now. So we will make that decision. But the thing that we like is that we have the flexibility. We are not bound by a certain thing. If the other one looks more economical and some of the chemical companies say that, look, I can take the very low carbon-intensity hydrogen and use it to make renewable diesel and as a result, get a significant premium then I ship it to California, then they were willing to pay us a high price for the hydrogen and then we sell them the hydrogen rather than converting it to ammonia.

So investors are sometimes quite risk-averse. And so they look at some of the deals that are -- that seem to be being put together, where Japanese utilities are buying or plan to buy blue ammonia. And they're comforted by that because they say, "Oh, okay, the ammonia is going to come on in the future and there's a market for it." If you're going to make 2 million or 3 million tons of blue ammonia in 2026 or '27 whenever it is, are you comfortable that there's a market for it? Or do you think that it may have to go into the fertilizer markets in all places?

We obviously see that there is a market for it. But the best thing to do is to wait until '27, you see what happens.

Where do you think the largest market for blue ammonia is in 2026 or '27? Who are the natural buyers of that blue ammonia?

Okay, Jeff. We think that one of the biggest markets is to take the blue ammonia and use it to blow directly into a coal-fired power plant to reduce your carbon intensity. And that is a really elegant way of replacing basically LNG because right now, people are making LNG and shipping that to Japan. That means that you are giving the burden of the carbon reduction for somebody to do something in Japan because then they burn it, the CO2 goes in. If you shipped in blue ammonia, you have already captured the CO2. Therefore, you're shipping them clean product and they would love that. So we think that would be one of the biggest markets for that. But it could also be that a steel company in Japan decides that they need to decarbonize. Well, if they want to decarbonize the only way to decarbonize is to use hydrogen instead of coal. Therefore, they might be interested in taking blue ammonia, dissociating it and using the hydrogen for making steel. So that can be a huge market for it, whether it is considering that Japan and Korea and some of the other people make a significant amount of steel. Because fundamentally, when you're talking about decarbonization, the real opportunity in decarbonization is in heavy industry and the volumes are gigantic. It's very easy to calculate that if you seriously -- if the government of Korea or government of Japan is focused on carbon reduction, they are going to look at the largest polluters and go after them. The largest polluter is not the guy who is driving the truck, the largest polluter is the one -- the person who is making steel. They go after those people and those volumes can be huge and the only option, this is the thing -- the only option is hydrogen. You cannot decarbonize the steel plant using electricity, no matter how much green electricity you have. You have to use hydrogen. So that is why we are very optimistic about the demand. So somebody -- right now, Europe is saying that if I want to decarbonize by steel companies, I'm going to tell them to use green. Great news for us in terms of what we are doing in Saudi Arabia. Somebody in Korea might decide that green, I'm happy with blue ammonia -- blue hydrogen because if it is really blue and that means if the carbon index is really low, then I solve the CO2 problem. I still am using hydrocarbons, but I'm solving the CO2 problem. Therefore, why don't I take blue hydrogen -- blue ammonia dissociated and have my steel companies decarbonize that effect then the demand for blue ammonia is not just blowing it directly into the coal-fired power plants, but it can become huge for making the steel or for making chemicals.

So investors are always thinking about the risks of your various projects and in Louisiana, it was originally thought of as a $4.5 billion investment and I think the tax credits are maybe $4.2 billion. So for me, even if you made no money on selling however much blue ammonia is being made, you're going to get very close to your 10% return on investment. But normally industrial gas companies, in my opinion, maybe they make $300 a ton on average when they sell hydrogen. So the investment returns at least for the Louisiana plant really should be pretty high and above your normal 10% threshold because of the tax credits. Is that fair?

Well, that's a fair statement. We made the decision before the IRA. The IRA is obviously going to help. And we are also counting on another thing that might enhance the returns is that we are making a product that nobody is making today. Nobody in the world is going to be making -- or is making a blue hydrogen with the carbon intensity that we are going to be able to achieve in Louisiana. So in that case, what is the price for it? Forget about return -- I mean, it's -- if it becomes 2027 and somebody needs the product and Air Products is the only company that is making really blue ammonia that isn't fake blue ammonia, then there is a lot of room for pricing, right? This is why we are not in a hurry to go and sell the product right now. So it also depends on supply-demand. It's just like helium. I mean if everybody is on allocation, people need helium, we have it, nobody else has it, then we are not going to sell it for the same price we sold it 3 years ago. So there is a lot of dynamics that can significantly help us. And obviously, our job is trying to maximize these things. I kind of say this very seriously, people are paying me $15 million a year, not to sit down and run the obvious, but try to come up with something that makes people more money and that's my job.

So from your point of view, there's no rush to commit to the terms of selling blue ammonia in 2026 or '27 because as a base case, there's sufficient demand and you don't exactly know how the markets will evolve and even if one sold it as ammonia, ammonia is very, very profitable when you make it from U.S. natural gas?

Well, we are in the business of selling hydrogen. And the blue ammonia that we sell is really ammonia is a means of transporting hydrogen because there is no pipeline from here to Japan. If there was, we would put the hydrogen in the pipeline. So ammonia is a carrier for the hydrogen, and that's our business.

So one of the ways that Air Products seems to be different than other producers of blue ammonia or green ammonia is Air Products has a business model where it wants to dissociate the hydrogen from the ammonia. When I look at the other ammonia producers, there's not that to mention. And I think the reason for that is they fear that in converting the ammonia to hydrogen or disassociating the hydrogen, there's too much ammonia, which is lost. Does Air Products have proprietary technology that allows you to have a greater hydrogen capture or is this something that anybody could do?

Well, Jeff, you're asking an excellent question. And if you -- I'd just like to go a little bit more into the details. If people want to get into the business of making blue hydrogen, right, and transport it to different parts of the world, they need to make the hydrogen and convert it to ammonia because that's the only practical way of moving hydrogen. If you want to make that, fundamental requirement is not the ability to build an ammonia plant. Everybody can build an ammonia plant. It is not to build an ATR, everybody can build an ATR. The fundamental question is what do you do with the CO2 once you capture it? You have to have a place to put it and sequester it. If you don't have a place to sequester it, your in trouble. Therefore, that is what we were focused on 7 years ago when we came up with this strategy that 1 key thing is porous space. you have to have a place to put this stuff. And that is why we focused. We identified Louisiana as being the best place. And we have gotten the porous space, the best porous space in Louisiana that nobody else has. So if people are looking at us as a competitive advantage, it is not the fact that we can build an ammonia plant or ATR or anybody can do that. And everybody is running around saying, "I can do that," fine. But then the question is, what are you going to do with the CO2 once you capture it? That's number one. The second thing is that, okay, if you're going to make green or blue hydrogen and transport it to other places, and they want to use it as hydrogen, then you have to take the ammonia and convert it back to hydrogen. So that technology is key technology. That is where we think we have the best technology in the world. We have been working on that for many years. And therefore, we have a technology that can do that conversion economically versus what is available in the market where you lose 25%, 30% of the hydrogen. Those are the real competitive advantage of Air Products, not the fact that -- anybody can go and put the wind farm and some solar panels and make green electricity. Great. Then you can put an electrolyzer. Super. Now you have made hydrogen. Then what you're going to do with the hydrogen? Convert it to ammonia because you have to sell it somewhere around the world. So once you are making it into ammonia, now you have to be able to dissociate it. If you can't associate it, you're not in business. So that is where -- those -- the ability to sequester the CO2 by having a place for it and the ability to dissociate the ammonia, those are the 2 key advantages. And people are gradually going to get to that stage and realize that 99.9% of these projects that have been announced are useless because they don't have a place to do or they don't have the dissociation.

So I think conventionally, people think that maybe you lose somewhere between 15% and 25% of the ammonia when you disassociate the hydrogen. Is that fair? Are your numbers like closer to 15%?

Ours is significantly lower, and I don't want to disclose the amount. But we are going to be able to convert ammonia back to hydrogen in a very economical way without losing a lot. I don't want to disclose the exact percentage because that's obviously our proprietary technology.

And you're now building infrastructure in Europe to take the green ammonia from NEOM. I think you have a relationship with a port in [ Hamburg ] in the U.K., in Germany, maybe in Rotterdam. So the ammonia will land and then what will happen to it?

But right now, we have plans to build at least 4 terminals, at least. Obviously, we build more if there is the demand for it and all of that. But right now, Hamburg, we have publicly announced, we are going to take the ammonia over there, crack it, and once we have cracked the ammonia into hydrogen, we have 2 options. One is, take the hydrogen, put it in a pipeline and sell it to a customer which is close by that you can ship it by pipeline. That would be the most efficient way. The second thing is to liquefy it and ship the liquid hydrogen into hydrogen fueling stations and have the trucks go in there and use hydrogen. So that is the -- by having the terminal in Hamburg will give us the ability to sell out of Germany. Then we are going to build the terminal in Rotterdam. We will -- we have told people we are going to do that. The exact location and so on, we will announce in the next few months. We have already made those arrangements. And with Rotterdam, we can again -- in Rotterdam we do have a hydrogen pipeline that we can put the hydrogen in our pipeline or we can liquefy it and serve the mobility market in Northern Europe. We are going to build another one in Immingham in the U.K. And there, it is very easy. We can supply all of the U.K. And then our ambition is to build 1 in California, where we can supply the State of California. Why? Because California has the LCFS program, which means that it is -- people get a lot of incentive if they use green hydrogen. So those are the 4 that we have planned right now, but we are talking to people in Japan, in Korea, in China, about other terminals if the demand is there.

So I think when people conceptualize ammonia coming to Europe and hydrogen being dissociated the way they thought about it principally was that it would go to the mobility market, that is it would go to fuel hydrogen fuel trucks, but it sounds like the market is changing, where it sounds like there is more of an industrial optionality where the hydrogen will go and supply industrial users. Is that fair? Is that the market that probably will be larger first?

Well, when we built to make the commitment to NEOM, we obviously thought that the heavy industry will be one of the most important targets. These things, Jeff, as I've always said, the energy transition to clean energy is not an economical decision. It is a policy-driven decision. And the landscape in terms of what is required in Europe has obviously changed significantly in favor of green because Europe is taking a position that #1, they want green; #2, they're going to go after the heavy industry. When you talk to their government officials, they are very public to saying that, "Look, I'm not focused on converting the trucks, I'm focused on converting my steelmaking and my chemicals, go sell to those people." So that has changed. They have put the incentives in order to incentivize those people to do the conversion. And therefore, the landscape in terms of the usage has changed. And they have put significant incentive for some of these people that, look, I understand that if you want to convert the steel plant from use -- the blast furnace to using direct reduction, you need some investment upfront, maybe we can help you. You need additional cost in terms of operating costs, we are going to help you. So as I said, the decision is driven by policy. Now Europe is going with the policy of, you have to do this otherwise, I'm going to tax you. In the U.S., the IRA is saying, "You don't have to use it, but I'm giving an incentive to the producer so that he can produce the product cheaper, therefore, please use it." That's a different approach.

Thank you very much for assisting us in understanding how the hydrogen market evolves in Europe and the United States and how the economics change. Thanks very much. I hope to see you next time.

Thank you very much, and thank you for your very good questions and very relevant questions. I really appreciate that. Thank you. Thanks everyone.

Thank you very much.