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

Good morning, and welcome to Air Products' Third Quarter Earnings Release Conference Call. Today's call is being recorded at the request of Air Products. Please note that this presentation and the comments made on behalf of Air Products are subject to copyright by Air Products and all rights are reserved. Beginning today's call is Megan Britt. You may begin.

Hello, and welcome to the Third Quarter Fiscal 2026 Earnings Conference Call for Air Products. Our prepared remarks today will be led by Eduardo Menezes, Chief Executive Officer; and Melissa Schaeffer, Chief Financial Officer. We have prepared presentation slides to supplement our remarks during the call, which are posted on the Investor Relations section of the Air Products website. During this call, we'll make forward-looking statements which are our expectations about the future. These statements are based on current expectations and assumptions that are subject to various risks and uncertainties. Our actual results could materially differ from these statements due to these risks and uncertainties, including, but not limited to, those discussed on this call and in the forward-looking statements and Risk Factors sections of our reports filed or furnished with the SEC. We do not undertake any duty to update any forward-looking statements. Please note in today's presentation, we will refer to various financial measures, including earnings per share, capital expenditures operating income, operating margin, the effective tax rate, ROC and net debt to EBITDA on a total company basis. Unless we specifically state otherwise, statements regarding these measures refer to our adjusted non-GAAP financial measures. Reconciliations of these measures to our most directly comparable GAAP financial measures can be found on our investor website in the relevant earnings release section. It's now my pleasure to turn the call over to Eduardo.

Thank you, Megan. Hello, and thank you for joining our call today. Now please turn to Slide 3. Earlier today, we reported results for the third quarter of fiscal 2026. In the quarter, we managed volatile marketing dynamics to deliver a 9% increase in operating income compared to the same period last year. Our operating margin of 25.6% was also up compared to the same period last year, largely from volume and price improvement, partially offset by higher costs. Earnings per share were $3.47, up 12% compared to the same period last year. This was above our guidance range, largely due to improved volume and higher contributions from our equity affiliates. Volume improvement was led by higher on-site results, new asset onstreams and [ helium ]. The [indiscernible] headwind in the quarter was 2%, which was better than expected, largely on electronics momentum in Asia. Return on capital of 11.7% was up relatively to prior year and improved sequentially. Moving to Slide 4. We remain focused on 3 key priorities for 2026. On earnings growth, EPS are up 14% year-to-date. With another quarter of strong performance, we are raising our full year earnings guidance which now implies an improvement of 11% to 12% for the full fiscal year. We continue to expect EPS growth to be achieved primarily through volume growth from new asset contributions, pricing actions and continued productivity. Next, we continue to make progress on optimizing our large project portfolio. On June 30, we announced our decision to exit the Louisiana project, the Casa Grande, Arizona project and other smaller scale clean energy distribution projects. As a result, we recorded a pretax charge of $2.9 billion this quarter. We are working on opportunities to redeploy the industrial gas assets and sell the ammonia production assets associated with the Louisiana project. On the green ammonia project in Saudi Arabia or NGHC, we have now finalized a marketing and distribution agreement with Yara. I will speak to this more in a moment. Finally, on our third priority, maintaining capital discipline, the cancellation of the Louisiana project will allow us to reduce our capital expenditures. While we expect to reduce capital expenditures overall, we will remain focused on investing in our backlog of traditional industrial gas projects, especially in the electronics end market. In addition to investing in our traditional industrial gas projects, we remain committed to continue our strong track record of returning cash to our shareholders. Year-to-date, we have returned $1.2 billion to shareholders in the form of dividends. Please turn to Slide 5. I'm pleased to share that Air Products in Yara have signed a marketing and distribution agreement for renewable ammonia from the NEOM green hydrogen project in Saudi Arabia. Under the agreement, Yara will transport and commercialize the renewable ammonia that will be acquired by Air Products from NGHC that is not used by Air Products to produce green hydrogen in Europe. This model creates the first fully integrated value chain for renewable ammonia by enabling product from the world's first large-scale green ammonia plant to be sold and delivered through Yara's existing global supply chain. As a final note, we do not expect this project to have a material financial impact in fiscal year '27. Please turn to Slide 6 for a summary of our current project backlog and an update of our capital expenditure forecast. Before I go into details, I want to provide some context on how to think about our backlog. To be included in the backlog, a project must have reached a final investment decision on FID following a robust review process to ensure we have adequate returns relatively to the risks of the project. Our backlog will include investments in projects with long-term contracts with a strong customer and in a few cases, production facility to grow our liquid bulk and packaged gases business. With this criteria, we currently have a traditional industrial gas backlog of approximately $3 billion in projects. A significant portion of the capital projected for the backlog will support electronic customers. This includes over $1.5 billion in project wins for Air Products in the last 6 months, translating our backlog into a view of capital expenditures. On the right-hand side of this slide, we are targeting to invest approximately $1.5 billion per year going forward in traditional industrial gas projects. These are air separation and hydrogen projects of varying sizes and there are new projects being added and completed projects being removed from the list. The CapEx figures for fiscal year '27 are preliminary and represent the committed spend for traditional industrial gas projects based on our current backlog. As we continue to build our backlog, our focus will be on opportunities that meet our risk-adjusted return threshold. As we previously disclosed, we are also moving forward with several underperforming projects, given our commercial obligations and product status. Although these projects are not expected to contribute materially to our future operating income, we continue to work to improve their results through commercial negotiations, operational improvement and productivity. After we bring these products onstream, we expect total CapEx expenditure of roughly $2 billion to $2.5 billion per year, which can sustain both our future growth and ongoing maintenance. Again, I want to thank the Air Products team for delivering the results this quarter. Now I will turn the call over to Melissa to discuss those results in greater depth and review our 2026 outlook. Melissa?

Thank you, Eduardo. Please move to Slide 7 for a high-level summary of our third quarter financial results. Sales were up 5%, while operating income grew 9% on volume, currency and price, overcoming higher costs from fixed cost inflation. Volume growth was led by our on-site business, driven by contributions from new assets coming onstream in Asia and Americas as well as higher production from U.S. refinery assets. Pricing was up, primarily in Europe and the Americas. With this underlying business performance, operating margin of 25.6%, improved over 100 basis points compared to the prior year. Earnings per share of $3.47 increased 12% from the prior year due to the base business growth as well as strong [indiscernible] contributions. Return on capital of 11.7% was up 60 basis points on strong base business performance and large project optimization. Please turn to Slide 8. Our third quarter earnings per share of $3.47 increased $0.38 or 12% from the prior year. We saw a 2% headwind from helium this quarter, which was better than our guidance of 3%, driven by improved volume and pricing in Asia, supporting our electronic customers, partially offset by lower space volume in the Americas. Currency was favorable 2% and in line with our third quarter guidance. The base business improvement was driven by on-site volume, including new assets and pricing. We also saw strong contributions from equity affiliates in Mexico and Saudi Arabia. Despite higher costs in the quarter, driven by fixed cost inflation, we remain on track with our head count reduction plan for the year. having recognized approximately $75 million in the savings year-to-date. Moving now to Slide 9. I will provide an overview of our results by segment. You can find additional details of the quarterly segment results in the appendix. In the Americas, operating income improved 6%, primarily driven by on-site volume, including contributions from our HyCO existing facilities and a new asset in our Gulf Coast hydrogen pipeline. The volume improvement along with pricing was partially offset by higher costs, including fixed cost inflation, distribution and dislocation costs. Asia operating income grew 18%, primarily due to benefits from the gasification assets held for sale, new assets onstream and helium. In Europe, operating income increased 2%, primarily driven by pricing actions, which more than offset higher power costs. This benefit, along with a currency tailwind of 2%, more than offset higher costs, including fixed cost inflation. In our Middle East and India segment, operating income was relatively flat, while equity affiliates income increased from our joint ventures in Saudi Arabia. Lastly, the Corporate and other segment benefited from productivity as we continue to reduce our corporate SG&A. This improvement was partially offset by lower sale of equipment activity. Please turn to Slide 10. Year-to-date, we are free cash flow positive as strong operating cash flow exceeded the capital that we spent on maintenance and executing the backlog. We have also returned $1.2 billion in cash to our shareholders in the form of dividends in fiscal 2026. As it relates to our leverage, our net debt-to-EBITDA ratio is 2.1x, which considers our proportionate ownership of the NGHC joint venture assets under construction. We remain committed to bringing the company back to an A/A2 rating over the long term. Moving now to Slide 11. We expect our fourth quarter earnings per share will be in the range of $3.55 to $3.65, up 5% to 8% from the prior year. We expect to achieve this growth through continued benefits from new asset contributions, pricing actions and progress on our productivity initiatives. However, we remain cautious given our macroeconomic uncertainties. We expect helium to continue to be a headwind due to lower price despite some volume and price improvement in Asia. With this, our fiscal full year guidance is now in the range of $13.39 and to $13.49, which correlates to an 11% to 12% growth from prior year. For capital expenditures, we now expect to spend approximately $3.5 billion this fiscal year. We have reduced the capital outlook to reflect payment timing adjustments, lower expected maintenance and cancelled projects. We will now open the call up for questions. Operator?

[Operator Instructions] We'll now take your first question coming from the line of Duffy Fischer with Goldman Sachs.

Just a couple of questions around your asset at Jazan, given the attack that happened there. So one, I think when you brought that online, it was supposed to contribute about $1.35 of EPS per year. Is that still a good number to, in your Q4 guide, how much is kind of taken out, I guess, for what's happening there? Or does it take a while for that to flow through? And then just the third one, do you have any third-party insurance for that if that conflict escalates and it becomes somewhat impaired.

Yes, as you know, we've seen the news. And of course, we have information from the site, but I hope you understand for contractual reasons with Aramco, we cannot give you a lot of comments on the project. I can tell you only that the numbers that you have in terms of contribution are in the ballpark, probably a little lower than that, but the numbers are in the ballpark. And we do not expect any financial impact for Air Products in the -- coming from these events. But as you'll know, Saudi ramp is not commenting on the fact yet. So we need to wait to -- until they do that to provide more information. But again, the most important thing for us, there are no injuries to our employees or to the JV employees and we do not expect the financial impact.

Yes. And if I could just incrementally add one thing, Duffy, if you remember, the contributions for Jazan are a financing receivable. So they do decrease over the life of the agreement. But again, as Eduardo said, you are in the ballpark of contributions for '26.

Next question will come from the line of John McNulty with BMO Capital Markets.

Congratulations on some solid results. So I wanted to just understand, I guess, one of your comments on NEOM and then just get your kind of high-level view there. So I think you said with the Yara contract, there's no impact on 2027. Does that mean you don't foresee any drag on your fiscal earnings from NEOM or benefit for that matter? And then again, I guess, stepping back, can you speak to your level of confidence at this point as to whether or not Yara and yourself, you're going to be able to find a buyer for that volume in calendar '27 that at least clears your offtake agreement. If you can give us any color on that, that would be great.

Thank you, John. Yes, I can confirm that our expectation is to have no gain or loss in 2027. I cannot go much beyond that, again because of the Ts and Cs of the agreements we have with the joint venture and the confidential obligations that we have. But we do not expect any impact in '27 and what we expect going forward is before the beginning of each year, we can give you some more clear picture of what the expectations are. But as you know, this is an agreement for product that we're going to into market in the -- globally now with Yara. And here, we will evolve with time depending on the market conditions. But for 2027, we are confirming no impact for Air Products.

Your next question will come from the line of Jeff Zekauskas with JPMorgan.

You talked about how the penalty from helium this year is lower than you originally expected? Maybe it's a little bit more than $100 million retax rather than $150 million. If you had to distribute the -- I don't know, the $105 million or $110 million penalty through your business segments, how would you allocate it geographically?

Well, Jeff, we look at this on a global basis. I would say that what we are doing in the heating business is really remarkable. I know when we talk about externally that the impact is 2% or 3%. It's difficult for you -- for everyone to understand what is behind that. But just to give you a picture, 40% of all the volume we sold during this quarter came from our cavern in Texas. So it gives you an idea of -- in June was even more than that percentage, but give us an idea of how much we are exercising our system to keep our customers supplied and to make sure that we keep our position as a reliable supplier that can sign long-term agreements in this business. So our impact is mostly in price and didn't come from this quarter coming from a year of negotiations that were more than negotiations that we have. from a moment where the market was very short. So I would say that today, that impact is migrating more to Europe and North America because of the type of customers that we have mostly in the health care space and the MRI sector. But we're very optimistic about the future in the helium side and we have been really gaining a lot of new commitments for volumes in the long term, especially in the electronics area and especially in Asia.

Okay. And in the Mid East equity income was up over $100 million. And I think in the second fiscal quarter, it was closer to [ $80 million ]. So is the -- are the joint ventures operating at a new level of profitability? Or this was just an unusual jump that had to do with transitory items?

Yes, Jeff, I'll take that one. So in the Middle East, yes, thank you. In the Middle East, we are seeing improvements in our equity affiliate income. The improvement in equity affiliate income though globally was amongst multiple joint ventures. One thing I do want to note, we did have an especially strong quarter this quarter in our Middle East joint venture, but that was largely contractually structural and it's driven on a preferred dividend to our joint venture partners, and that's just the timing. So we will see the normal run rate reconfigured in Q4 this year.

Your next question will come from the line of Chris Parkinson with Wolfe Research.

You've had a nice little bump up in your backlog from various electronics projects one official with Samsung and then 2 others, so I think we can all presume who the partners are. Can you just offer a little bit of color on, first of all, how long those projects were being assessed in terms of you becoming CEO or those kind of long-standing being assessed for multiple years. Were they relatively new? And then whether or not that you'd further expect some of those -- even some of the smaller projects to continuously trickle in over the next, let's say, 12 or 18 months or so?

Chris. Yes, I would say that on this backlog, we have one very large project that started in 2022, I believe, that is a product in Taiwan that was multiple phases that we're building more than 5 large aspiration plants. We have now 3 done, and we still have 2 to go. Other than that, all these projects, they are basically coming in the last 12 months. I would like to create credit for that or my presence here, but the reality is the market is going through a super cycle, and we have been working very hard to get our fair share of that. So we announced 2 very large projects, as you know, one in Korea, one in Taiwan. We have other projects that we are going to announce this quarter that we are talking to the counterparts about issuing the final announcement. And when we look at our list of opportunities, I would say that the lease is long today and it's skewed to the electronics side. So probably close to 2/3 of our opportunities or more than that in the electronics space. So that's not by -- that's where the market is today. I would say that the traditional market in chemicals and steel. There is a lot of capacity in the world, and not to say that there are no opportunities, but they are mostly coming from replacement of old assets and one project here or there. But the electronics is really where the growth is. And I think we're very fortunate that we kept that capability in the company that we have been executing projects in Asia for a long time and that fits well with where the market is now.

Got it. And just as a quick follow-up, NGHC has indicated there are over 90% complete on the facility, the primary facility and then about 95% plus complete on the solar farm and wind garden plus or minus. I think that update was actually from a few months ago. As that relates to Slide 18, just getting away from the actual agreement with Yara, as the ramp of those facilities begins, can you reconcile the exact timing and how we should think about how that affects Slide 18 in terms of the net debt adjustments? And then also in your 10-K, the debt was listed, I believe, and forgive me if I missed something, but around $4.7 billion in this slide, you have roughly [ 2 5. ] I was wondering what that extra $0.5 billion represents or if I'm just missing something.

Yes, Chris, thanks for the question. So as mentioned before, the consolidation of NEOM is, in fact, because of the EPC arrangement during construction, right? And so deconsolidation will happen once that plant is up and onstream. So after commissioning, we will deconsolidate. That is on Slide 18, what you're seeing here is the deconsolidation and back down to a net debt of around $11 billion, $11.5 billion. The difference between the $5.2 billion debt here, there is no difference. That is our carrying value of the NGHC net debt. The proportion may be just our proportion of that 33%. So there is no difference between what we've reported and what we have here. This is just the deconsolidation of the joint venture after the construction is completed and we've commissioned.

Yes. And just as one point, when Melissa talks about commissioning, you mean being at full production capacity and this is first-of-a-kind plant with a lot of new technologies. So we're expecting a long commissioning process. And that's one of the reasons why we cannot precise exactly when the this change in that consolidation can happen and also our full obligation to buy the product.

Your next question will come from the line of Vincent Andrews with Morgan Stanley.

First, I just want to clarify on NEOM. The comments on no material financial impact for fiscal 2027. Does that -- is that for both the income statement and the cash flow statement? And then also, I think in order, I heard you just say that as it relates to the consolidation that you said something about when there'll be a trigger in terms of when you're obligated to buy the product, is it potentially the case that you don't have to buy product in fiscal 2027? So if you could clarify that, I'd appreciate it. And then my follow-up would be on the CapEx reduction for the target year. I think you brought it down by about $500 million. If you could just talk about what's driving that and what you think the alternative use of that capital might wind up being.

Yes. Thank you, Vincent. Yes. On NEOM, we cannot discuss the details of our agreements, but as I said, the process for commission will take some time for the facility to get to full production and we're going to need to keep you informed during this period, but we are absolutely confirming no impact on the income statement. And on the cash flow statement, I don't know exactly how to qualify that with Melissa.

Sure. Absolutely. So since we aren't commissioning, the large portion of the spend and any distributions that we put into the joint venture are largely complete. If you remember, this is 73% project financed. And our contributions to the joint venture, again, are largely behind us. So again, no financial impact both to the P&L and no large impact to the cash flow statement. From a CapEx perspective, we did reduce our CapEx forecast for this year by about $500 million. That's largely just timing associated to the execution and the payments of all of our backlog under execution. So nothing material there. continue to be able to invest in our underlying industrial gas projects and the distribution to those will be against what we've already talked about, really the electronics wins that we're executing right now and projects that we continue to bring on our backlog in outside the electronics space as well.

Next question will come from the line of James Hooper with Bernstein.

Can I start on the Louisiana project and Darrow? Can you go through a little bit more detail what happens to the kit and the main, how you're thinking about it? And any discussions that you've had there, please?

Yes, but what happened to, I didn't get it...

Yes, there are no worries. The Darrow, what we're going to be doing is part of the attribution.

Yes. The -- this is a product we started probably 6, 7 years ago. So the project was in a 7 stage that we have a lot of the equipment already purchased in hand in warehouses and mostly in the U.S., but some in Europe and China. So it is a little -- a very different situation from what we had last year when we canceled the [ wind ] energy project. These are high, let's say, world-class assets. The air separtion plants, the hydrogen purification, the ammonia loop, and we see a lot of value for these assets in the market. As you can see in the transactions that were announced recently when people buying ammonia plants and so forth. So we are in a process of taking all the data and making sure that we maximize the value we can to cover from these projects by basically using part of this equipment in our own operations like the separation and some other equipment related to industrial gases. And on the case of the ammonia loop, which is a very important asset, making sure that we can commercialize that as a full unit. And in some cases, it's possible to generate projects for Air Products. I think we became public that one of the products that we executed with a similar ammonia plant that we did in Texas in terms of capacity. It was 3,600 tons per day. those 2 assets that we have from there they are 4,000 tons per day using the same technology. So they are desirable assets and the market is showing that they have significant value, and we can attach, if possible, possibility of supplying hydrogen and nitrogen to these assets. So this is the objective. We are going to work on that in the next few months. We have a team here in our products in engineering, business development, working dedicated to this task. And our objective is to recover as much one as we can and generate new business for the [indiscernible]. Sorry. Go ahead.

And just as a follow-up on that, Eduardo. If you do see a bit of a windfall with leverage starting to get below 2x, how are you thinking about capital allocation and projects or potentially starting a buyback.

Yes. It's -- if we get any money would be a non-GAAP income on top of what we initially forecast. And we're only going to go through our pool, and it will be allocated as we do with the rest of the cash uses and sources that we have. And Melissa can give more color on that.

Yes, absolutely. So as we've talked about cash flow neutrality focused on that this year and moving forward. we do have share buybacks in our capital allocation waterfall. We have a line of sight of being able to start that program towards the end of '27, beginning of '28. But that obviously depends on the projects that we have coming down the pipeline. So will want to invest in high-return projects first and foremost, continue to increase our dividend and share buybacks will become part of that program as we move forward.