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

Good morning, everyone. My name is Mike Sison. I work with Wells Fargo. I cover chemicals. I'd like to welcome you to our second day of our Industrial Materials Conference. With us today, we have the team of Air Products, Sid and Mun here. So I'll just get into it. If anybody has questions, feel free to chime in.

Sid, you guys have a really nice slide in your investor presentation, shows since '14, very consistent EPS growth around 11%. In fiscal '23, which is this year, your guidance is 10% to 12% growth, which, again, a very difficult year. And I guess the question, when you think about historically, high energy cost increases demand for industrial gases. That seems to be the case this decade so far. And then there's a lot of opportunity to energy transition going forward. So when you think about Air Products' growth algorithm going forward, should that 11% go up? And maybe just sort of talk about the opportunity in increasing that over the next decade.

Sure. Great question, Mike. First off, let me say thank you to you and the entire Wells Fargo team for the opportunity to be here. It's great to be here and talking to our investors about our base business and all the clean energy opportunities we see globally. Look, for us, if you think about since Seifi's arrival and under his leadership, the hard-working, diligent, committed people at Air Products have delivered an outstanding 11% EPS CAGR over the last 8 years. This on the back of pandemic, other economic, geopolitical uncertainties that we've navigated. So I think we're truly proud of that accomplishment. We've consistently delivered not only top line but earnings growth, right? And this year, we're bringing on $2 billion worth of new projects online. So I think it's an incredibly exciting time for us at Air Products because we're in this multiyear framework where we continue to invest and win projects in our base business. Last year, we brought 60 assets online. And then we're also investing significant sums of capital on our traditional projects in our core industrial gas business and accelerating the low and 0 carbon energy transition on the back of hydrogen projects globally as well. And if you look at all our -- the next 5 to 8 years, we've got projects coming online at a steady clip across the globe in the blue and the green hydrogen space as well. So I think for us, if you look at our backlog today, we've got roughly a $16 billion backlog, $11 billion of that is committed to energy transition, and we've committed overall $15 billion of capital to the energy transition overall. And then if you look at -- we've got a capital allocation scorecard in each of our earnings decks. We've got ample capacity to continue to deploy capital as well. And to the extent we can use tools like project financing to continue to increase the velocity of capital deployment, while defraying some of our capital needs to project finance banks, we look to do that. So I think for us, overall, to your point, these projects, as we keep bringing them on, they truly drive long-term earnings growth for us, well in excess of the 11% that we've demonstrated over the last 8 years.

Great. Let's dig a little bit deeper on the IRA bill in the U.S., and you sort of touched on clean energy and maybe how that bill helps boost demand and project growth for you.

Sure. Very topical as well, great question, Mike. So we've been on this energy transition for the last several years. And the U.S. IRA; the Green Industrial Plan in Europe; Japan now announcing JPY 15 trillion that they're going to put behind their hydrogen strategy; the Canadians doing similar things, having given us $500 million in grants already for our Edmonton project, these truly have driven a seismic shift forward for our energy transition strategy. Thankfully, we've been on this for the last several years, but it's truly a game changer. And I think we'd like to congratulate the folks that sort of put together the whole IRA bill, because carbon tax in the U.S. is a very political sensitive topic. So I think the way the IRA has been designed, it truly gets to the heart of addressing the energy -- clean energy or the climate change needs of the world, right, by decarbonizing heavy industry. And hydrogen plays a critical role in that. Now the IRA, what it does for us is, it truly incentivizes and reduces the cost of producing clean energy. It makes it easier for us to produce clean energy. And candidly, that's driven a lot more conversations -- exciting conversations with customers because now for them, blue and green hydrogen is a lot more affordable. And then the other thing what the IRA has done is, it's -- the U.S. -- Europe was kind of surprised when we came up in the U.S. with that form of policy legislation. Now what it's done also is, on the back of the energy crisis in Europe, a lot of industrial companies are considering where am I going to deploy my capital? And the U.S. is heavily skewed to producers, but ultimately, those benefits accrue to the consumers as well. So today, a steel manufacturer can easily consider putting an asset in Texas close to our assets or our pipeline versus now thinking about doing that in Germany and dealing with energy costs there and the energy crisis, they continue to go through with their natural gas issues. So I think it's transformed. The energy transition in the U.S. is driving a lot more investment dollars and companies are looking to come up the adoption curve much sooner as well.

Right. And then digging a little bit into the opportunities in clean energy, Air Products is the biggest hydrogen player in the world, green, blue. In Cleveland, it might be orange, I don't know, who knows. But I think the blue hydrogen is the one area that is a pretty big opportunity off the bat. Can you maybe talk about Air Products' blue hydrogen strategy and where the opportunities are for you here in the U.S.?

Sure. So for us at Air Products, within our walls, it's not an or strategy. We can do blue and green. And I'd liken it to -- today, if you go to a gas station, you can get basic, you can get supreme and you can get ultra, right? And that's your green, blue and gray. I think moving forward, the world will see applications for all 3. Now it's just a case of you can't flip a switch and go to green right away, right? The availability of land, natural resources in terms of wind, water and sun are not as compelling in different parts of the world. So I think blue is going to play a very critical role in the transition -- in the energy transition to gravitate towards low carbon overall. What I'd encourage investors, customers and regulators to truly focus on is while the colors are interesting, even the IRA, it doesn't incentivize the color. What it incentivizes is low-carbon intensity. And it lets companies go figure out what's the cheapest and the lowest or the most innovative way of you producing these products. So I think similarly for us and for our blue strategy, we want to own the entire value chain. We've got exciting projects, which is a net 0 blue project, where we're selling to Exxon of Canada under a multi-decade contract in Edmonton. We've got our Louisiana blue hydrogen/blue ammonia project. So in Louisiana as well, what we've done is we were the first company to get pore space on the Mineral Board of Louisiana, which we were incredibly proud of. So there we own the entire value chain, and then the 45Q benefit that the U.S. IRA gives us. When we announced Louisiana, it was at $50 a ton. Today, it's at $85 a ton. So those are really compelling economics where we get $425 million for Louisiana because we can sequester 5 million tons of CO2, and that's inflation adjusted for 12 years. So we're getting $5.2 billion of capital for that project to invest in a large scale blue project. And then, we would also own the pore space, so we'll go manage, sequestering that carbon as well. So I think those are some of our truly competitive advantages. And in the Gulf Coast, we've got over 1,000 kilometer pipeline network in the world with over 2 dozen assets. That is the largest in the world. We now have the opportunity to also retrofit several of our existing assets as well. Some may be end of life, but that also makes customer conversations a lot more interesting today as they come -- look to come up the initiated the energy adoption curve. I think for us, what's key is we want to be side-by-side by our customers to sort of service their demand growth needs. But also as they go along their decarbonization journeys, to be there to provide the right solution for the right situation that they need.

The customers in your pipeline now, is there any reason they shouldn't consider coming to you and asking to help convert those pipelines to blue for them?

We are having conversations with customers. We announced a couple of projects on the carbon monoxide side, which are, again, long-term contracts last quarter. Those were on the back of the IRA and some of the mechanisms -- incentive mechanisms the IRA provides. So we are having those conversations with customers. Like us, all our customers have net 0 targets, interim targets. So everyone's coming looking to get up the energy adoption curve and the IRA for all of us has truly been a game changer, because the IRA provides you 45V, 45Z credits, 45Q credits, so we get benefits either directly or indirectly because the markets that we service, like our SAF project, gets benefits under the 45Z. But indirectly, we're selling 4 to 5x more hydrogen to a renewable diesel or a SAF project than what we would sell to a traditional refiner. So overall, I think it's a game changer for the entire ecosystem.

Great. And then you mentioned Louisiana. I thought maybe we get a little bit of an update, how is that project going? I have 2 kids going to Tulane. I love New Orleans. So just curious to how that one is -- how that one is unfolding?

So we are full speed ahead on the execution of that project. It's a large complicated project, but there are several aspects to it. One is building the hydrogen, the ammonia assets, and then there's also getting your Class VI permits for sequestering the carbon. All that's being done in parallel. So we're full speed ahead. It's a long, complicated project, so a lot to do. And we look to bring it online in, I believe, it's '26, '27 that we've got on our backlog. So as things stand today, we're on schedule and excited about the progress we're making.

Great. And then your other big hydrogen projects in Canada, Alberta. Any update on how that's progressing?

So that's another project. That was probably the first feather in our cap where we announced a net 0 blue project. So I think that's progressing really well as well. And I think I'm preaching to the choir here and investors appreciate this, but that's another great example of how a bespoke strategy or a bespoke solution goes and addresses multiple needs. At this point, that asset is fully committed. The majority of the product is sold to Exxon, which is IOL in Canada, through a multi-decade contract. And this is on the back of their multi-decade investment in their renewable diesel asset, which they look to bring to the shores of California or British Columbia to take the benefits -- to enjoy the benefits of the LCFS mechanisms, et cetera. Now there -- we use our gasification technology where we're going to lean on the Alberta Carbon Trunk Line to sequester the carbon, but we're also servicing a burgeoning hydrogen for mobility market for the trucking industry in Alberta. And by investing in that project, and it's on our pipeline network, so we've got a network of customers we're selling that product too. And we look to do probably more of projects like Edmonton there. But what it truly does is we took a couple of different tools in our toolkit, put it all together, helped IOL, helped Canada. We're making Edmonton, basically, the hub of Western Canada's hydrogen economy. And on the back of that, the Canadian provincial and federal governments, both collectively gave us CAD 475 million to accelerate the energy transition. So that project is also progressing. We're looking to bring that on late next year, I believe, is 2024. So excited about the progress we're making there and the conversations we're having for other projects in that region.

Great. And then if you're -- if blue hydrogen is as big of an opportunity as you say, how much should you see come up in your backlog over a year? Is it -- if you're successful, will you be announcing $1 billion, $2 billion? There's sort of a size and number that you should get annually.

Sure. If you think about blue hydrogen, I think if you think of the 2 aspects to it. One is capturing the carbon, which is fairly easy. We've been doing it for the last decade-plus at 2 of our SMRs in Port Arthur, Texas, where we capture over 1 million tons. And that's using our patented, proprietary VSA technology that we use, right, which we can then use for retrofitting our other assets as well. There are very many solutions as well, which we can tap into. But I think what I'm trying to bring the conversation to is retrofitting our blue assets, our hydrogen assets in California, I'm not as sanguine about that because where are we going to put that carbon, right? Capturing is the easy part. We could do that in Edmonton, which we are, and we've got other assets there, which we could potentially retrofit. We've got pipeline networks in Rotterdam, which we could do that on. The Dutch government has announced projects like Porthos where they're looking to sequester carbon. So once some of those come to fruition, we should have other announcements we can make to our investor community. But we're looking at new projects or other Louisianas, other Edmontons as well as retrofitting our existing assets as well. So I think having access to that pore space is critical. We've got a 25-year lease where we can sequester close to 400 million tons of carbon. So it could handle not only our existing Louisiana, our overall gray footprint and more as well. So we're excited about the future. I wouldn't want to venture a dollar number, but you can see the pace of which we've been making announcements in developing these projects. And we've been on this journey for a couple of years. These projects take a long time to put together. Every time we make an announcement, you hear Seifi says, we've been working on this for a couple of years, getting permits, putting commercial frameworks together. But I think some of the big building blocks are in place now, which we can then build off.

Right. Great. Shifting gears. Why don't we talk a little bit about green hydrogen and where -- how you think that market will unfold over the next decade. It is more expensive -- quite a bit more expensive than blue or gray, even with the IRA Bill. So -- and -- so why don't we just start there, and you're one of the few companies who actually have projects in the backlog for green hydrogen.

Yes. Maybe let's start with our flagship project, NEOM. When we announced NEOM in July of 2020, at the time and even today, I think we are the only big mega-scale green hydrogen project that comes online in 2026. That asset would produce between -- up to 650 tons of green hydrogen per day. We actually financially closed on NEOM in the last 2 weeks with close to 23 of our global financial lending institutions. So we are excited that those financiers came up and have given us multi-decade financing terms where they basically validated our strategy of taking this to the shores of Europe, the U.S. and other parts of the world. Since then, we've announced 3 large green energy import terminals in Hamburg and Rotterdam, where we have an existing pipeline infrastructure, as well as in the U.K. And if you think about NEOM, maybe just talk about 2 aspects. One is the price visibility as well as the second is the volume visibility for customers. For us to fully load NEOM, if it entirely went for a mobility application, it's 13,000 trucks. In Germany, in the H2Global program that was announced late last year, they're looking to convert 650,000 trucks that plan their roads today to hydrogen. So we need 13,000, which is 2% of an energy adoption to aqua and that's Germany alone. So for us, these volumes are a drop in the ocean. We're trying to figure out how many more NEOMs do we need to develop to truly address this burgeoning market. Similarly, if you think of other applications, right, if you think of the 3 big broad use cases, hydrogen can serve as a fuel for mobility applications that could be for trucking, trains, shipping. It could go -- green ammonia could be put into ships or a derivative as a green methanol, right? And then planes are now thinking about liquid hydrogen as well or a derivative, which is SAF, which is our world energy project. The second is hydrogen as a feedstock where it goes into chemicals, pet chem, refining today, right? Steel companies converting the DRI. So given the carbon EU ETS scheme and the allowances and the targets that EU is set for steel companies of net 0 by 2050 and a 30% by 2030, it's going to be -- it's going to get very expensive for people to do nothing. And it's much cheaper to transform the DRI with hydrogen and the H2Global program, the renew EU program, the climate protection contracts or the hydrogen bank contract for difference contracts where you can get up to 4 kgs of a subsidy, basically truly help people come up the adoption curve and make things a lot more affordable for our customers. And then on the mobility side, you've got these mechanisms called RF NBO. It's a renewable fuel of a nonbiological origin. Those are roughly EUR 9 a kg in Germany today. So these are really incredible policy levers that are going to help Europe come up the energy adoption curve for us. And that's where we primarily look to bring NEOM molecules apart from other places in the world where we see needs today.

For NEOM, a lot of investors tend to ask me what are the risks on the project. What do you -- and how do you manage those risks? What do you think those are? And what are the measures that you're taking to minimize those?

Yes. Look, all our projects that we execute globally, we are the EPC. So we are incredibly hands-on. We're not delegating this to somebody else. So there are fewer cooks in the kitchen when we execute projects. So bureaucracy isn't something that you can sort of say Air Products is burdened or laden with, right? We wear a 4S pin on our lapels. Speed and simplicity are 2 of them, right? So we tend to do a really good job of managing our projects, being efficient with our decision-making. We are the EPC. So we're fully focused on every aspect of the project. We hire very reputable, large-scale subcontractors that help us with construction as well. And then we've got engineering centers across the globe. We've got -- including in Allentown and in Houston in the U.S., in London and in Rotterdam. As you move East, you've got them in India and China. So what that means is as the sun rises in the East, where our engineers are working 24 hours a day across our platforms and all the projects that we are executing. That's one. Given that we've got a footprint globally, that tends to help manage our engineering costs across the world. And then we tend to do things where we've got a 360-degree learning. So once we develop NEOM, NEOM 2.0 is likely going to be cheaper than NEOM 1, right? Because the lessons learned are being put to use there. And then within our assets as well, if we've got ammonia loop across 3 asset bases, we're not redesigning the wheel each time. There's a lot of synergistic savings that we can get not only on the engineering, but the procurement, the construction, et cetera. So I think we're very keenly focused on managing our schedules on our projects, our capital increase because I know with inflation rampant, that's something that investors are very focused on and managing safety as well. If you recollect, when we won the Jazan transaction, the $12.3 billion large integrated gas -- power plant project in Saudi Arabia, on the -- the precursor to that was a $2 billion fixed train ASU transaction that we did for Aramco. That was done under budget, on time with an outstanding safety track record. I think part of that, along with the technological advantage that we only had that gasification technology and the relationship, earned us the Jazan transaction. So I think that is another place where we see huge opportunity for us globally. But it's something we take very seriously and are very focused on.

And as I recall, you take green hydrogen, you put in ammonia, you ship it and you reconvert it back to green hydrogen. Is there any pricing risk in that equation down the road?

No, I think just generally across our projects, either blue or green, we like to own the entire value chain, right? And today, we do that. We produce over 9,000 tons of hydrogen today globally over across 110 assets globally. We move it in our pipes. We move it as a liquid on a truck, as a gas on our truck as well. So we've got a very good sense of what distribution costs are globally for this. We've also got a company called Gardner, where we have the lion's share of the ISO market for moving helium and hydrogen, liquid hydrogen. So we've got a very good sense of the technology, the distribution cost, what it takes to put all this together. I think ammonia truly is the most efficient way of moving hydrogen. So today, we've got a network of 4, 5 assets in the U.S. and Canada. We move liquid hydrogen from Canada to the U.S., from New Orleans to -- or Texas to California. So when you move it within country or within a region, you can move it up to 1,000-plus miles as a liquid. But when you move it across oceans, ammonia tends to be the most effective, seamless way of doing it. And there's an existing ammonia shipping infrastructure network today, which you can tap into. So it's not like you're again reinventing something. And what's a game changer for us is we've been on this journey of developing ammonia dissociation technology for the last several years. And anecdotally, you hear about people talking about a 30% loss. Our numbers are a fraction of that, which we're incredibly proud of. And that's what we can bring to bear for our customers as well. And a simple example, if you brought NEOM to Rotterdam, we've got a pipeline network there. So we can easily dissociate and put into our pipes that our existing customers, own mobility, names like -- we announced a long-term contract with Aers Energy in Belgium. So we're going to build a multi-fuel large hydrogen refueling station in the port of Zeebrugge. So every single fuel cell truck that goes in and out of the port has access to our hydrogen now. So I think those are sorts of the projects that we're now piecing together and sort of connecting the dots for our investor base as well.

Right. Shifting gears a little bit. A lot of investors ask me about your strategy in gasification. Jazan seems to be running really well right now, a little bit delayed. You got out of Indonesia, had some issues with Lu'An. So a lot of folks just wonder, is that still a good place to put your capital, put in the backlog? You just did a new one in Uzbekistan, right? So maybe just talk about the gasification strategy, what the growth opportunity is and why those projects make a lot of sense for investors.

Absolutely. And when we announced Lu'An and others, the IRA and other blue and green opportunities hadn't developed the way they have. The energy transition landscape has changed for the better dramatically in the last couple of years. And that sort of helped us inform our capital deployment choices globally. I think on our last earnings call, you heard Seifi mention 80% of our deployments are likely to be towards blue and green projects. Gasification is still a very effective technology in our toolkit. Look, our Louisiana project is a gasifier. Our Edmonton project is a gasifier, which is gasifying natural gas. And what that allows us to do is it allows Edmonton to be a net 0 project because you can capture in excess of 95% of the carbon there, right? Similarly, on Louisiana. So the Indonesia project, that was a situation where the country of Indonesia needed us to come and provide certain energy solutions to beef up their energy security and independence needs. And the pace of progress on that project and the line of sight to getting certain things done wasn't as we had hoped. So we decided it was time to redeploy that capital elsewhere. On the back of what we've done, I've heard anecdotally, several other oil majors have pulled out on similar projects there in that country. Now for us, to your point, the reason we won Jazan was the shell and GE gasification technology that we only have access to was truly a game changer here, right? And I think that's something that we look to delever, sort of bring to bear elsewhere. In the last several years, you've seen us do the PBF acquisition, the Jazan transaction, the Uzbekistan. These are classic traditional gas which is our core competency, the cap deals, right? And part of it is this technology advantage, knowing how to run these assets, bringing our efficiency and reliability to bear. Uzbekistan is another example. I think there was some concern when we pulled out of Indonesia around customer relationships and credibility. That's another perfect example of another nation, which is top 10 in the world for gold, copper and natural gas exports, looking to bring our solutions to bear again for their energy security needs. Today, they import a lot of these high synthetic fuel products. So by now generating it internally, they're saving foreign currency reserves. Incredibly progressive nation. Looking to attract a lot of foreign direct investments. And we're one of the few that's done this. There's been other big oil majors that have entered that recently. So it's a progressive regime. We're happy about what we are doing there, and it's an acquisition, so there's no capital risk. It comes online next year and will be immediately accretive to our earnings as well.

Right. Great. Shifting gears a little bit. You guys have a nice perspective around the world. You sell to everybody. Maybe can you give us just your thoughts on how China is recovering, anything on Europe and how the U.S. industrial land is taken off?

Sure. Usually, we're not supposed to be commenting intra-quarter on trends. But what I'd guide you to is when we announced our earnings last quarter as well, is we were pleased with the recovery we were seeing in China post going to 0 COVID and Lunar New Year recovery. I think we're cautiously optimistic. We're in a wait and see mode. You hear different stories from specialty commodity camps and other industries. But we're still in a wait and see and we continue to see improvement. Now the question is at what pace does that occur? But we continue to invest in China. Last quarter, we brought 30-plus assets online. So we continue to see price and volume growth through those mechanisms as well. In Europe, they've seen staggering energy prices for the last 18-plus months, right? That does take a toll on the industrial and manufacturing sectors. With pricing coming down -- Europe has primarily been a price story, right? I think us and our peers, the pricing discipline everyone has demonstrated to sort of help protect margins has been truly incredible to see. But as you see energy prices come down, some of those surcharges are likely to roll off. But again, we'd encourage investors to focus on pricing at variable costs in terms of how we protect margins there. In the Americas and just globally, our HyCO franchise and our own sites have done tremendously well overall. And Americas still continues to perform as well as expected. You hear it's the recession waiting for Godot kind of thing that every day you turn the news on, people are talking about it. We haven't seen it as yet.

Yes. Right. And then maybe talk about pricing a little bit. It's been a -- all -- the industrial gas industry has done a really nice job pricing. You're seeing deflation, does that affect the way you price your product going forward? And what do you think the pricing power is over the next decade for the industrial gas industry?

I think the pricing discipline and capital discipline on all our project executions will continue. I think we focus on price. We're not a cost-plus mentality. You heard Seifi mention that all the time. So I think we'll continue to -- we're not in the market of trying to steal volume based on price, right? I think we hold the price discipline. Let's see how the energy prices globally plays out. That has a lot to do with that. If you even look at our margin, the EBITDA margin slide that we put on our earnings, 75% of that movement in that margin has been on the back of these energy pass-throughs, right? So that has a large piece of how things play out. But we'll continue to stay disciplined and focused.

Great. I guess last question, given time, can you maybe just talk about the opportunities in traditional industrial gas backlog? So oxygen, argon, maybe some of the end markets, electronics is a good growth area for the industry. Any thoughts there?

Sure. We continue to focus on our base business and execute on that and win projects. We deploy between $600 million and $800 million of capital in that business on an ongoing basis year-over-year. Last year, we brought 60 assets online. This past quarter, it was 30 assets. These are all our traditional base industrial gas products across electronics, semiconductors, glass, fiberglass, chemicals. So we stay focused and continue to win projects. We've announced some large wins in the semiconductor space in Asia. We also have a flourishing LNG business. We announced a large contract in Qatar recently, but we've had several wins globally, and we have a lion's share of that market. That's another place where truly each of us in our oligopoly, our world-class organizations, but that's another place where our technological prowess and know-how truly differentiates us against our competitors. So we keep deploying capital and winning projects there as well.

Great. Well, great. Thanks, Sid. I appreciate your time. Thanks, Mun, and we'll look forward to hearing you down the road.

Sounds good. Thanks, Mike. Great discussion. Thanks for your time.