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

[Audio Gap] For the second day of the Jefferies Industrials Conference. I'm Laurence Alexander with the Jefferies Chemicals team. It's my pleasure to introduce Sidd Manjeshwar from Investor Relations at Air Products. And I guess we're just going to dive right in.

So Sidd, let's start with the hydrogen strategy. There's been a lot of debate around Air Products, given the appearance of vertically integrating into methanol ammonia jet fuel production. How do you think about those moves at Air Products? And how do you derisk the initiatives?

Sure Laurence. First off, it's great to be here. Thanks for this opportunity to you and the Jefferies team and it's always wonderful to be with our investors talking about our base business and all the exciting opportunities we see in the clean energy space. I appreciate you starting the dialogue about where we are today and headed strategically. I think the world's future truly depends on low carbon and zero carbon solutions. And we at Air Products Inc., our hydrogen strategy and our hydrogen is key to accelerating the energy transition. Look, today, when you -- the various use cases you brought up as well. I think today, what people don't fully appreciate is public policy today is derisking and driving the energy transition forward. And the specifics are how different countries, regions, states are doing it all different. You've got the U.S. IRA, which is a game changer. Europe has the entire alphabet soup including the Green Industrial Plan, H2Global. Japan is now putting JPY 15 trillion behind their hydrogen strategy. You've got Canada doing similar things. But I think there's an overwhelming consensus that, that's the fundamental direction we're headed in. And if nothing else, we see that only accelerating with the global signpost each day. Now for us, at Air Products, we are the largest producer of hydrogen today. We produce it, supply it safely over pipelines as a liquid, as a gas in trucking over trucks. We've got the largest pipeline infrastructure networks today in the U.S. Gulf Coast, in California, a couple in Canada, in Europe as well. So we're really excited about taking that 60 years of experience we've built. The know-how, the technological expertise, adding some technologies to that and being able to deploy the right solution for the right situation. And I think that's very critical. And what I mean by that is what's key for us is to press our first-mover advantage to not only help our customers along their decarbonization journeys, but continue to meet their demand and providing a myriad of solutions for specific situations. And staying on the mantra of the right situation and the right solution for it. So you mentioned 3 use cases, right? If you think of methanol case, let's use our most recent transaction, the classic decap we did in Uzbekistan. Now we look for the best adjusted returns when we invest globally. But that's a project where we're acquiring Haldor Topsoe's two largest ATRs in the world, where some lessons learned there will come to bear in our Edmonton project, which is also an ATR. But that's a classic decap where in our base business, where we are providing syngas, hydrogen, nitrogen, oxygen to their facility, which then takes that and goes downstream and provides high-end synthetic fuels, methanol and other use cases. But it's purely to help Uzbekistan for socioeconomic benefits and for the energy security and independence. We've all seen what's happened to Europe in the last 18 months with energy security. So that's a very critical project for the country and for us as well. And it's a great win for us. But that's another example where it's a long-term tolling arrangement. If you think about ammonia, let's pivot to our Louisiana project, that's another classic example where we were the first company to get 400 million tonnes of pore space from the Mineral Board of Louisiana, where we own the entire value chain. So the entire 45Q credit come -- accrues to our benefit. We're not paying people fees to pipe it or sequester it. We own the entire value chain, which makes our product a lot more cost competitive. On the ammonia side, look, we're not in the ammonia business. We have no interest in it, in its classic form. Ammonia is purely efficient carrier for hydrogen globally. Today, we move liquid hydrogen thousand miles from Canada to the U.S. and California, Texas to California. But when you moving it overseas, the efficiency of moving it as ammonia tends to be the most efficient way to do that. And now several other companies are following suite and announcing similar ventures. We've been on this journey for several years, which means, anecdotally, you've heard people talk about efficiency losses in the ammonia, disassociation to hydrogen of roughly 30%. We're now in a single-digit number there. And we're close to applying for patents on it. So I think that's another example where we're pressing our first-move advantage. The 45Q derisk that project over 12 years on an unescalated basis. The 45Q is an escalation mechanism but on a purely unescalated basis, we get $5.2 billion over 12 years from the U.S. Government, which basically, to your point, derisks the entire project, that's even before selling a single molecule to a customer. And then we've got many use cases, which are -- we've got a pipeline network that's connected to the world's largest pipeline network with dozens of customers. So we've got the option of putting blue hydrogen to our pipe or moving blue ammonia to the Far East, where they're now blending ammonia into coal assets in Chile, in Thailand, the Philippines, in Japan where, in that part of the world, coal is part of energy security for power generation needs. And then your jet fuel or the SAF example, that's another example where I think what you're seeing with this whole right situation and the right solution for it is, in some cases, we -- our classic model is the build, own and operate model, our sale of gas concept. In some cases, we buy the feedstock and we provide a end part that the customer uses like the decap. But in some other cases, like the SAF example, World Energy basically brings the feedstock, we just provide the technology and the asset for the hydrogenation of that. And then the end product, the SAF, the jet fuel, the [ Maxx Jet ], they can go sell in their market. So again, that's purely a tolling arrangement, again, a multi-decade contract. And if you look at our backlog slide, which is our mega-scale projects in our earnings deck. Of the 13 projects, I think 11 of them are all long-term contract pipeline deals. And today, in our industrial gas oligopoly, we have the highest percentage of on-sites. And I think as these projects come to fruition, that percentage just continues to creep up.

And so one question that came up. So I'll just sort of tuck it in here. Is Air Products -- given you had a pretty solid quarter, the share price reaction. To what extent do you think that was related to the Nutrien announcement?

Yes. I think post the results, we were all scratching our heads around the reaction as well. Look, I think the Air Products team continues to deliver at a remarkably high level. We not only beat our guidance and our consensus. We also increased our guidance for the full year. And if you think about our track record over the last 9 years, on our base business alone, we've delivered 11% EPS CAGR alongside a 10% dividend growth CAGR as well, very compelling for our shareholders, and we're very proud of that track record. And that, again, is purely based on our base business before we started on this mega-scale project, capital deployment cycle for low-carbon projects, accelerating the energy transition. Look, Nutrien's a world-class organization, and it's not my place to speculate on their strategic positioning, but at least from all the reports you guys have put out on the sell side, what I've gathered is they've just hit a few speed bumps. I think they've had a myriad of issues, operational, asset curtailments, phosphate pricing environment, contract repricings in Asia. And as a result, the combination of that has caused them to, I think, guide down a couple of billion on the mid-cycle EBITDA guidance. So it seems like it's an organization in capital preservation mode. And if you think of their closest peer, it's still continuing on their journey of developing their clean ammonia project as well. I think what this demonstrates and people -- you and the investors are way smarter than us. When you see 600-plus, 1,000-plus announcements where companies are leaving their strategic bailiwicks and entering [ assembling ], I think what it tells you is the value opportunity here for low-carbon hydrogen globally is incredibly compelling. But when some people hit execution challenges, it tests their conviction of executing these projects. But what it also brings to bear is, there is a learning curve here, and people getting up the learning curve have hard lessons to learn. We've been in this business for 60 years, and you heard Seifi and Dr. Serhan mentioned, when we build the NEOM, the lessons learned there can be brought to bear on our Texas AES JV that we're doing, which is a mini NEOM as well. So when we do projects, we extract synergies on our FEED, pre-FEED, our engineering work that we do. And just on the execution side of things and there's benefits on the procurement side as well. And hydrogen is something that people take lightly. I mean there is -- you need to have a solid safety track record to operate that molecule as well. And I think some of the secret sauce with us is we've got distribution networks globally, which is why today, the space is an oligopoly, right, with 3 large players. And I think the other thing with -- on the Nutrien announcement is people may not fully appreciate is -- our Louisiana project where we can capture in excess of 95% of the CO2, the CI of our molecule is materially different from what some of these other guys do. So we go to very different markets. We go to power generation industrial markets where the subsidy mechanisms are very different from what you get if you just went to a traditional ag or fertilizer market. And the Louisiana project is a classic example. When you own the entire value chain, including the pore space, the entire $85 a tonne 45Q benefit accrues to Air Products, whereas for other players when they play in different parts of the value chain, they're sharing margins with others as well. So the cost competitiveness of the product tends to be materially different from what we are able to deliver.

And so sticking with the mega projects, can you speak to the risk of cost overruns? When would we, on the outside, know if a project has -- had an overrun? Is it only when the project is finished? And how much of that CapEx risk gets transferred to your customers? Will you get a return on the overrun if there is an overrun?

Great, terrific question on incredibly topical today. Look, inflation is something that affects each of us in our daily lives and companies as we execute mega-scale projects. It's probably one of the single most things we're entirely focused on as an organization. Thankfully, inflation is trending in the right direction. It's come down quite a bit since what we saw on the tail end of the peak of COVID as well. But I think what I'll bring to some visibility to investors is the way we execute projects is an EPC organization. Two classic examples are, we just brought our Jiutai asset online a couple of months ago. And that was executed in the throes of COVID, where that asset was locked down for 62 days where literally, except for a food truck coming in and out of the site, nothing else could move, right? And then there were other disruptions as a result of COVID. This was executed in inner Mongolia in a remote area, and that project was done on time, under budget, right, which speaks to our capabilities of our world-class EPC organization led by Dr. Serhan. Now the other ways we bring some benefits to bear here is we've got engineering centers, 8 to 10 procurement engineering centers across the globe, all the way from China to the U.S. So as the sun moves, we've got engineering teams at work 24/7 on these projects. And like my prior example, when we develop assets, there's a lot of synergies we extract on engineering work, et cetera. The other thing is we do all our EPC work on our own. So feasibility, pre-FEED, FEED, everything is done by us, including execution. So unlike some other companies where you may have -- where they're bringing in a technique or a floor or [ bechtel ], we do everything on our own. So there's less bureaucracy, things tend to be a little bit more streamlined, efficient and we are more hands on. And that has a lot of time and cost benefits that come to bear. Similarly with our procurement strategies, when we're developing multiple projects, we tend to make we extract value there as well. And then we've got a multitude of commercial frameworks where we back-to-back our risk with our subcontractors through lump-sum turnkey arrangements. When we made the NEOM announcement, we'd mentioned all the contracts or procurement were handed out. So now that's already done, we've derisked ourselves from that perspective. And then finally, what I'd say is, on certain projects like a Louisiana project, once we bring price visibility for long-term contracts to investors, whatever the final number on that project tends to be, we'll make sure we earn the right risk-adjusted returns on our projects. And you've heard Seifi say this multiple times, we aren't a cost-plus mentality. I think he's also brought this mentality where, what are the markets willing to bear and we can extract a scarcity premium, that's the right approach for us.

So quite a few projects in the mega project pipeline were negotiated before the subsidies in Canada, U.S., Europe and Asia had been finalized. So why shouldn't that pipeline in aggregate have returns closer to the mid-teens?

Sure. Look, I think what you've seen with the public policy being announced globally is, it's helping everyone, us as producers as well as our customers come along the adoption of the energy transition curve, right? Because the whole point is for it to be easier for us to produce the molecules and some of those benefits that we socialized across the value chain. I think the biggest thing there is the derisking piece of things, right? My Louisiana example where the entire capital for the project or a large portion of it is entirely derisked through these subsidies even before selling a molecule at a premium to the customers that see tremendous value for this. I think that's key. I think the other thing what you'll see is, I mean, we always guide our investors the minimum 10% EBIT return for consistency. But you generally get a lot of questions today as well with central banks that have hiked at least in the U.S., rates by, what, 550, 600 basis points in the last 14, 15 months. When we look at project returns, we look at unlevered returns globally. So when you layer on a project, a capital structure on top of that, the returns naturally get enhanced. We tend to be pretty good at using every tool in our toolkit in terms of tapping capital markets, project financings. Even when we did the NEOM project recently, we've gotten multi-decade pieces of paper at less than 5%, right, which is incredibly compelling in today's interest rate environment. Similarly, when we did the $1.4 billion of green bonds where we were the first company to come up with a green finance framework for blue and green hydrogen, we were able to extract again as a first mover, a negative new issue premium to price those bonds inside our secondaries, another win for Air Products. But I think returns wise, I mean let's look at our Jazan example, that's our single largest investment that we made as a company in the last several decades. That project is well north of the 10% that we typically promise investors, right? And again, that's another example of extracting or delivering the right-adjusted return globally to our shareholders as well.

So I want to come back to one of your earlier comments that your core business has been delivering sort of 10%, 11% earnings CAGR. But you now have this investment cycle? And do you view that the investment cycle basically cannibalizes some of the core business? It distracts attention, distracts capital flows, you're not investing in the industrial gas -- the core industrial gas, the merchant capacity and so on? Or do you see it as additive? To put it another way, if you take your current backlog which, on your rules of thumb, look like it's going to add a couple of dollars to earnings in the near term, $4, $5 in the medium term. Shouldn't you be on track to north of $20 of earnings by '26?

Great question, Laurence, and I don't want to get baited into guidance conversations. But what I'd say is, I think you're spot on. Look, we're on a multiyear investment cycle. And to your initial remarks, over the last 9 years under Seifi's leadership, just our base business alone has delivered 11% EPS CAGR. This is even before any of these mega-scale projects were announced or what have you. So when you layer on the mega-scale projects and our continued investment in our base business and the wins we get there, we can see our returns well north of the 11% we've delivered. You and the investors are way smarter than us and you can easily do the math, but you're directionally headed in the right space. If you think about our business, we continue to extract value through productivity actions, margin expansion initiatives. We announced some productivity actions this past quarter as well. And today, we've got an industry-leading EBITDA margin of 40%, well north of our peers, right? And that demonstrates some of the themes you're trying to tease out. On our base business, we continue to invest $600 million to $800 million each year. Last year, we brought 60 assets online. This past quarter versus the prior year quarter, we had another 30 assets. And in places where some others have seen some weakness in the chemical space, electronic, semiconductors, glass, fiber glass, EV battery manufacturers, et cetera. So I think we continue to stay focused on the base business, extract value there and these mega-scale projects will deliver a lot of value. This year alone, Jazan, we invested $1 billion in Jazan. We've got GCA that's come online. We've got Jiutai. Next year, we'll have the Uzbekistan acquisition adding value. We'll have Debang and our base business as well. So we're tremendously excited about the step function change we're going to see in our growth rates moving forward.

So can you talk a little bit -- speaking of your core business, can you talk a little bit about what you're seeing in industrial markets? We're hearing at the margin, softer commentary, particularly in Asia, apart from automotive. Can you talk a little bit about what you're seeing? And because your business is usually a pretty good coincident indicator for activity like real activity.

Sure. A very topical question. Maybe starting East and going across the globe in terms of the state of the union. What I'd say in Asia, the recovery is probably going to be a multi-quarter recovery in China, especially post emerging from zero COVID. I think most folks had anticipated a rapid snapback that hasn't materialized in the property sector and all the adjacencies coming through that continue to be soft. But I think one other thing I'd highlight for investors is compared to our industrial peer group, we have the highest percentage of on-sites, particularly in Asia, 60% of our business is the on-sites. And then most of these new asset wins that we've actually had added have been in Asia as well. And we're cautiously optimistic, but it will be a multi-quarter recovery in Asia. Moving to Europe. Look, Europe had the mildest winter in the last 30, 40 years. And things didn't pan out as people had feared, which is great. But the manufacturing sector, other anecdotal company announcements, there is a risk of deindustrialization in Europe and the alphabet soup of subsidies that they're bringing to bear is to keep the industrial base there but that stays under duress. Their energy prices over the last, what, 12 to 18 months have been 5 to 7x what they were traditionally accustomed to. On the back of that, we pushed a lot of pricing as well in terms of energy surcharges. But let's see how the winter and energy prices play out in Europe. I think that's the key thing there. Again, in Europe, our on-sites have been performing incredibly well, and we've performed much better. I think over the last couple of quarters, we've demonstrated unlike some others, not only top line, but bottom line growth as well, which we're very excited about. And coming to the Americas, I mean our assets are performing great. And in the Americas, everything is full steam ahead. We don't see any softness in the Americas yet.

Can you unpack one comment you made? If there was a -- if there is a surge in energy prices in Europe because there is a colder winter, is their products better positioned this year to manage the volatility?

I think just the entire industrial gas space has demonstrated incredible pricing discipline and a lot of these price increases that people have witnessed over the last 7, 8 quarters have been on the back of a lot of these energy surcharges. And you've seen our EBITDA margins move around quite a bit as well as a result of that. Roughly 75% of our EBITDA margin moves have been driven by some of these energy pass-throughs, right? I think the key is what does winter look like and what their gas storage injection levels and track heading into the winter. I think that will be the sort of x factor that drives all that. But I think in terms of our behavior, we'll continue to demonstrate pricing discipline. And I think most people -- we tend to be a very small portion of our customers' cost stack and customers appreciate when everyone is facing these inflationary pressures, these pricing actions reflect that.

And I guess just to close, I mean, on pricing, when Seifi came in, I think there was a big part of the surge in real pricing at Air Products felt like a cleanup of actions over the prior 15 years. Are you at a point now where you've hit sort of a good equilibrium price relative to your end markets and real prices going forward should be 1%, 2% kind of trend? Or do you think there is more room to go for just pushing your price towards 3% to 5% a year for several years?

Look, one thing everyone knows that Seifi with his incredible vision, his ability to see around the corner and his track record is he continues to promise that he'll deliver a certain amount of value to shareholders each year demonstrated by our 9-year or 11% EPS CAGR. So we don't have a cost-plus mentality in our space. And the pricing discipline, our peers have demonstrated, I think that's comforting as well. But I think his view is as a first mover as we press our first-mover advantage and help our customers along their demand growth journeys through decarbonization is always price a product at what the market is willing to bear. And I think that philosophy will continue at Air Products.

Okay. Thank you very much.

Great. Thanks for your time.