Air Products and Chemicals, Inc. — 2024 Q2

Thank you, Katie. Good morning, everyone. Welcome to Air Products' second quarter 2024 earnings results teleconference. This is Sidd Manjeshwar, Vice President of Investor Relations. I am pleased to be joined today by Seifi Ghasemi, our Chairman, President and CEO; Dr. Samir Serhan, our Chief Operating Officer; Melissa Schaeffer, our Chief Financial Officer; and Sean Major, our Executive Vice President, General Counsel and Secretary. After our comments, we will be pleased to take your questions. Our earnings release and the slides for this call are available on our website at airproducts.com.

Thank you, Sidd, and good day to everyone. Thank you for taking time from your busy schedule to be on our call today. As you know, I always start with safety, which is our top priority at Air Products. Slide #3 includes our employee lost time injury rate and recordable injury rates in the first half of fiscal year 2024. Both of these rates were at their lowest levels since 2014 and the best in the industry. This is great progress, but our ultimate goal will always be 0 accidents and 0 incidents.

Thank you, Seifi. Now please turn to Slide 10 for a review of our second quarter results. Compared to last year, on-site activities were robust driven by higher demand for hydrogen and contributions from new assets. The volume was down 2% primarily due to lower demand for merchant products. Price contributed 1%. The combined impact of pricing and lower power costs across most regions resulted in strong contribution margins. The declining natural gas prices in Europe and North America resulted in lower energy cost pass-through, which has no impact on profit but contributed to higher margins.

Thank you, Melissa. Please turn to Slide 12 for a review of our Americas segment results. Compared to last year, underlying sales were positive with price and volume together up 4%. Merchant pricing was 6% higher, which corresponded to a 3% overall price improvement for the region. Volumes grew 1% as a strong demand for hydrogen more than offset weaker merchant volume. EBITDA was up 15% driven by higher price, volume and equity affiliates' income. Of the 1,000 basis point improvement to the EBITDA margin, roughly half was attributable to lower energy cost pass-through. Sequentially, EBITDA was 5% higher, mainly due to higher price and equity affiliate income.

Thank you, Dr. Serhan. Now please turn to Slide #17, Air Products has a great business model and continues to operate from a position of financial strength. While we execute our bold growth strategy in this challenging and continuously changing macroeconomic and geopolitical environment, our organization must remain flexible and agile. On a daily basis, our employees are committed to taking action that improves our safety performance, simplifies work and reduces costs so that together we can deliver productivity to the bottom line and continue to earn the right to grow as we pursue our strategy.

So I think the first one is just on how you're thinking about the cadence of the earnings as it progresses through the year. Obviously, 2Q came in pretty solidly, 3Q, maybe a little bit below what we and the Street were looking for, which kind of makes for a really steep ramp in the fourth quarter. I guess, can you help us to think about what drives that ramp, whether it's some of the projects or the Corporate line coming off, I guess, can you help us to think about the cadence for the year?

John, excellent question. I would like to answer it in the following way. First of all, there is a question about the -- our guidance for the quarter. The guidance for the quarter is a little bit lower than what people expect. And that is because we have some major turnarounds that we have to do on our plants in Europe and in the United States that is driving our maintenance costs for the quarter, and that is why we have given a lower guidance than what we would have liked to do. So that is the -- for the third quarter.

Yes. No, that's hugely helpful. Yes, it definitely helps to bridge in a reasonable amount. And I guess, maybe to that, as the follow-up or my second question, you had alluded to in some of the prepared remarks cost reduction actions and things that were starting to help on the margin side. And then -- and actually just in your last answer, you gave maybe -- you intimated that there's there is some help there. I guess can you help us to think about some of the actions that you're taking and if it's any specific division or how we should be thinking about that.

We look at the company across the board. And by productivity we mean that we try to do things in a more efficient and more simplified way, which means that we don't have as many costs. That is the action that is normal for productivity. It just means that you are trying to do more with less -- with the same number of people you have or with less people. So those are the specific actions we have taken.

In the Louisiana project, you'll bring on 3.5 million tons of ammonia. Some consultants think that the Japanese market is only 3 million tons of ammonia by 2030. Your competitors have begun to have memorandum of understanding and procuring volume. When your plant comes on in 2027, is there 3.5 million tons of demand for blue ammonia? And where might it come from?

Jeff, very good question as usual. Jeff, first of all, the number that you're saying, 3.5 million tons of ammonia, that assumes that we will take all of the hydrogen that we produce at that plant, all of the deep blue hydrogen that we produce will be turned into ammonia. That is not necessarily the case. As you know, we have a huge pipeline that goes all the way across the Gulf Coast of the United States. There is significant demand for blue hydrogen, for real blue hydrogen, not fake blue hydrogen. And therefore, we expect that a significant amount of the hydrogen we produce will be used as hydrogen through our pipeline to serve the customers that we have because they would be in need of that.

Okay. And then for my follow-up, the -- in the quarter, what seems surprising was the weakness in equity affiliates' income in Europe and in the Mid-East. And in the script, there was some talk of higher interest costs in the Mid-East. And it's difficult to know if that's a onetime event or if that's a sustainable event. Could you comment on that?

Okay. I will try to have Melissa answer the -- I got excited, I lost my voice, Jeff. But I'd like Melissa to answer the first question and Dr. Serhan to answer the second question. Melissa?

Yes. Thank you, Seifi. So Jeff, what you're seeing in equity affiliate income is a little bit of timing, but we did see a bit of a decline in our Jazan joint venture. This is really a onetime item from the previous year and some higher interest expense for this quarter. So again, it's primarily timing, not an underlying business issue and a prior year onetime issue.

And just following up on Jazan, I mean, again, Jazan is delivering $1.35 for earnings per share, and we expect really the project to continue to deliver this amount on an annual basis. I mean, there will be some seasonality depending on operating cost, maintenance.

Just curious about the business mix that was unfavorable in Asia. Was that primarily helium? And can you provide an update on how that business is going in Asia? Are you adjusting to the Russian source product coming in, in your outlook in the next couple of quarters?

Thank you for the question. We are adjusting -- I think that's a very good word. We are adjusting to the helium condition -- business conditions in China. And that situation has stabilized, and we expect a stable situation on that for the balance of the year.

And a question about the Alberta project. Are you still expecting that blue hydrogen project up there to start up sometime in late 2025? And just curious, how much of the volume of that plant would you say has now been committed? Can you provide any update on that?

The answer to your -- first part of your question is yes. And the second part is that I would like to say, that's just about all of it.

And you have contracts on that, Seifi?

We believe that we'll [ be all sold ] up. We do have it, okay? Thank you.

Seifi, on NEOM, have you signed any offtake agreements for any portion of the production from that project?

David, no, we have not signed any contracts that we are in a position to announce for that project yet.

Understood. And the same question for Louisiana. Has any portion of that contract been contracted for?

Not yet. And we have been very specific about this thing. That is not by accident. That is by design. We are not going to sign any contract for either 1 of these 2 projects until we get to the stage that we can get the price that we expect. We have taken the risk of being the first mover in this area of green and blue, and therefore, we deserve returns which are more than a plain vanilla, going and building an air separation unit. So we are going to wait until we can extract the right price.

First question, just on Europe. Could you take out the Uzbek impact and just let us know what volumes did in Europe excluding that? And then what was the split of that number between your turnarounds and the weak merchant business?

All right. Duffy, you know that that's a very detailed question and very sensitive competitively. But I'll turn it over to Dr. Serhan to see what he wants to disclose.

Yes. I would emphasize what you mentioned, Seifi. We would really not like to get into those details. I mean...

Thank you. That's the right answer. Absolutely. Sorry, Duffy. Another question...

But we've highlighted before that the Uzbekistan project is expected to really produce around $0.35 per year of earnings.

Okay. And then the difference between GAAP and non-GAAP, there's $0.20 of charges that are called out as business and asset actions. Can you detail what exactly those are and call out a few of the bigger items to that number?

Melissa, do you want to answer that?

Sure, Seifi, sure will. So thanks for the question. So as we mentioned, we continue to focus on our cost productivity and have taken discrete actions that are reflected in that business and asset action line item. For the vast majority of these, that is severance costs that we're recognizing in that $0.20. And just for your awareness, the full year run rate of that savings is about $75 million.

Great. First question for Seifi. I think this morning, the European Commission announced the first winning bids for their green hydrogen subsidy auction. I think most of the winning bids were under $0.50 per kilo of hydrogen. I guess, does that outcome surprise you at all? Would you have expected higher subsidy bids? Or just -- is that roughly consistent with the bidding activity you would have expected?

I have no idea what you're talking about in terms of $0.50. It is impossible to have $0.50 hydrogen. To make hydrogen, you make -- you must have the unit -- to make hydrogen, you need about at least 50 to 60-kilowatt hours of power, and even the cost of power at $0.05, that's $3 a kilogram for hydrogen, excluding your capital costs and excluding your running costs. So I'm not familiar with that number. I don't know what you are referring to.

Apologies. I was referring to the European Union's European Hydrogen Bank auction results this morning, referring to kind of the bid prices that were awarded to 7 different projects under $0.50 per kilogram of what they were awarded in terms of subsidy. But again...

I'm sorry, I'm sorry. Now I understood your question. Yes. They are -- those are not that they are buying hydrogen at that price, sorry, about that. They are giving subsidies for people to use hydrogen. Some countries are giving $0.50 a kilogram. Some countries are giving as high as $8 a kilogram. It depends on the country, and it depends on which tranche and all of that. But whatever subsidies they give, it's welcomed because that encourages use. My apologies at the beginning, I thought that they were buying hydrogen at $0.50. No, no, those are subsidies in terms of -- yes.

No worries. Then again, it came out this morning. So I know it's a quick...

Yes.

And then second question related to Jazan, maybe for Melissa. Can you just remind us, again, you've talked about the EPS impact. But can you just remind us on the cash portion, are you receiving cash commensurate with your earnings per share? Or how should we think about the cash from the joint venture relative to the EPS impact?

Melissa, you want to go ahead and answer that?

Yes, I sure will, Seifi. So yes, we do get regular dividends from the joint venture in commensurate with the earnings. Sometimes in our cash flow statements, you will see a little bit of timing of when those distributions do occur. But yes, absolutely, we are getting the dividends as expected.

On the earlier discussion around Louisiana, Seifi, you mentioned that there'll be a market for your blue hydrogen into the pipeline network. Investors have asked if that could cannibalize some of your existing gray hydrogen volumes. Can you talk about how we should think about that dynamic?

Well, it will eventually cannibalize that because I think, eventually, everybody will be using blue hydrogen. I mean, 10 years from now, I don't think anybody will be using gray hydrogen. So -- but the thing is that we expect volumes to grow. The volumes, as you saw even this quarter on our pipeline system is, we are totally sold out. And if we had any more hydrogen today, we could sell it. So we expect that there will be significant growth in addition to what is in the pipeline. And in the long term, we are going to make only blue hydrogen. I mean, 15 years from now, we will not have any SMRs running.

Okay. And Dr. Serhan made a comment in your prepared remarks about the electronics market outlook. It sounded like maybe looking a little bit better. I was hoping you could expand on that and maybe help us understand how much your earnings are being held back by that. So once the electronics market recovers what sort of uplift in EPS should we expect?

Dr. Serhan, you want to comment on that?

Yes. We do see signs of the electronic businesses picking up, but really, we're not counting on any of that upside in our outlook for the second half of the year. So we're being conservative in this regard. But we do -- especially in Asia, I mean, with our major customers, their volumes are picking up across nitrogen, argon, helium, especially helium.

And I apologize. I fell off the call before. So if this has been asked, please move on. Seifi, I wanted to ask you, you did better in the second quarter. You were above the high end of your guidance. It seems to me that maybe that was a function of costs coming in on the power, and maybe nat gas side, a little bit lower than maybe what you thought 3 months ago. So one, is that the case?

Vincent, the thing is that your comment about our second quarter coming out better than we expected is because obviously we have taken -- we are seeing better volumes in U.S. and Europe. U.S. and Europe were very strong for us in the quarter, which was not what we expected. So that was the good news. The addition is that we are taking cost actions.

cost, pricing. Those are the things that affects our short-term results and obviously executing our projects.

Seifi, congratulations for the results that you outlined over the last decade, and it's nice to see the 10% earnings growth goal moving forward. Unfortunately, one thing that has changed over the last 15 months or so is Air Products' trading multiple of EBITDA. And so I'm wondering, to the extent that the company's hydrogen projects and investor anxiety around that issue may be weighing on the multiple, might Air Products be interested in establishing a market value for its hydrogen business through an IPO and/or a spin-off, for example? Is that something you would consider, if not today, then perhaps in 2025 or '26 when we move closer to sustaining cash flows from the various project startups?

Kevin, Air Products is right now involved in not only trying to deliver short-term results that meet the expectations of our investors and our own goal of 10% per year increase and, at the same time, executing $20 billion of projects. I don't think this is the time to try to do any kind of a financial engineering and all that because that would be significantly distracting to the management and to our people. We should continue doing what we are doing. And when the investor anxiety has disappeared once we have signed 20-year, 30-year contracts for the 2 big projects that we have underway. And once our hydrogen business, blue and green hydrogen business becomes reality and produces EBITDA and producers returns and all of that, that is at the time that one can talk about those kind of things. This is not the time.

And I appreciate the feedback regarding timing, hence my reference to future years. But perhaps to follow-up on the logic, if I may. It sounds as though the game plan is to enter into multi-decade long-term contracts and with greater clarity on counterparties and terms, perhaps the pressure on the multiple will be alleviated, as I understand what you're saying.

Well, Kevin, this is a very fluid situation. It can be any time. It depends on -- as I said, our criteria is not to run and announce something so that the stock would go up $50. Our criteria is how do we extract the real value that we deserve for these projects for the next 30 years? That is our criteria.

You cited major turnarounds in Europe and Americas potentially dragging on 3Q. Can you give us a sense of the volume and margin impact and what are those turnarounds there?

Dr. Serhan, you want to take that?

Can you please repeat the question again, if you don't mind...

Yes, on the major turnarounds in Americas and Europe.

You're talking about the third quarter? Yes. I mean, we have 3 major turnarounds basically in the Americas in the third quarter. And that's why really our maintenance expense for the quarter is pretty significant. And they're also finishing a major turnaround in Europe, that's also going to contribute to basically significant increase in our maintenance costs for the third quarter. And these are mainly for like hydrogen plants...

Got it. And then do you have an update on permitting and preliminary engineering for the North Texas project? And when do you anticipate FID there?

I'd like to take that. We have done a significant amount of engineering on the North Texas project. But we are not going to make a commitment on FID on that project until the rules for the implementation of IRA are finalized. There is a significant impact. And as you know, there is significant amount of controversy about how those rules should be interpreted.

Great. Can you just quickly take us for a trip around the world in terms of the merchant operating rates and what you're seeing? I think those on the Street are hearing a few varying kind of takes on what's happening with the global economy. So we'd love to hear yours.

Thank you very much, Chris. If I may just -- in general terms, China has been weak for us in the first half. Right now, there is stock. We haven't seen any evidence yet. But there is stock and some actions taken that might indicate that China's economy will improve in the second half. We are waiting to see that, and we have not included any improvement on that in our forecast.

Sure. And just a quick follow-up, just given all the puts and takes, I'm sure you've seen, but in various public appearances, a lot of your competitors and peers, whether it's been Exxon or Shell or Aramco or Total, they've had, let's just characterize it as a very mixed commentary on a lot of the initiatives that you've been saying -- in terms of your potential offtakers over the next 3, 4, 5 years, do you think their comments during present day affects your positioning in terms of being a potential partner of choice on many of these projects? Or how should we interpret that industry rhetoric versus your own?

Chris, the products that we are going to make, the potential users for green hydrogen are steelmaking, refineries, shipping, using green ammonia as fuel for ships to meet the very stringent requirements in Europe and hydrogen for mobility. Those are the 4 areas that will eventually -- the offtakers for the product. And we are obviously talking to people in all of those 4 sectors. We don't have anything to announce. And if we are talking to anybody, we are under NDA, therefore, we cannot announce anything or give any details. But those are the sectors that we will be using green hydrogen.

Just a couple of quick follow-ups. Just to follow up on the turnaround and maintenance side of it, are you able to size the EPS impact that you think -- in 3Q since you called that out as a bridging item for second half? And would you characterize this year as a heavier maintenance year versus normal? I mean, obviously, there's turnarounds going on all the time but we're maybe not talking about them typically as much as we are today.

Serhan, do you want to take that?

Yes. Sure, Seifi. I mean, definitely, our hydrogen -- our portfolio of hydrogen plant is really getting more and more which basically again, you need to maintain these units like every for 4 years -- around 4 years, you have to do a major turnaround. This year, without really mentioning a specific number, it is at a record high especially in the U.S. with our U.S. Gulf Coast, our assets in California, our assets in Canada. Basically, we have a significant amount of expense when it comes to maintaining our facilities. So -- and also coincided this year, we also -- we have our 4-year turnaround for our major facilities in Rotterdam in Europe. So...

Okay. All right. And if I could just ask then on Asia with helium specifically, you commented earlier that it stabilized. But I think from the last call you were talking about lowering pricing and regaining margins -- or regaining volume, sorry. Has that played out? Has it stabilized lower? Or have you regained any volumes? Where is that?

We have lowered prices in order to stabilize the situation.

Just two very quick ones. Just on the pricing -- merchant pricing in North America, is there any quirkiness in the end market mix where you're seeing pricing? Or is this 6% across the board? And then secondly, how much capital do you have invested in gray hydrogen currently?

I would like to have Dr. Serhan answer the first question. And the second question, I'm not sure we want to disclose that in detail.

I mean, when it comes to the merchant, it's really across the board. It's -- I mean, it's nitrogen, oxygen, argon, helium. It's really across the board that we really have pricing discipline there in this inflationary environment. So -- and I just also want to highlight in the Americas, I mean, we've mentioned it before in the prepared comments that again on-site -- hydrogen on-site has been really doing very well. I mean -- and that's helping the volume for the year. And we continue to see this going for some extended amount of time because of the refining activities.

Nice quarter. In terms of the fourth quarter, what volume growth do you need to hit the range that you have? I know you gave us a lot of -- 3 or 4 different reasons why it's going to be a lot stronger than the prior quarters. But any thoughts on what type of volume growth you need?

We have really not -- volume growth, not on the base business. But we will have volume growth based on new plants coming onstream. But most of it -- yes, sir.

Got it. And then just a -- yes, sorry. But yes, just a quick follow-up on your NEOM and Louisiana. I know you can't really or want to tell us what price, but what is the return premium that you're looking for to sign the offtake? Is there a certain way for us to look at it at -- from that standpoint?

As high as we can get. Because if we have a product that nobody else has, then why should we be satisfied with a specific return? And I, obviously, do not want to disclose that, but -- any kind of a return. We are -- we have a product that is going to come onstream that people are going to need. Nobody makes that product today. So what is the price for that? The price for that is not calculated on the basis that this is my capital, this is the return, and therefore, we do that. When you have somebody that people need, you extract the maximum price.

And if you allow me, Seifi, I just wanted to highlight, today, we already have 3 major on-site blue hydrogen contracts for 15-plus years with a premium for the blue product.

Right. Obviously, we haven't disclosed some of that yet. But we know what is going on in the marketplace, and our goal is to get the maximum return for our investors, not to sit down. And if it was just a matter of saying, "This is my investment and this is a 10% return and this is the [ price ]." Then you don't need to pay somebody $15 million to be CEO of Air Products. Then anybody can do that.

Seifi, did you say 15 years from now, Air Products will not have any SMRs running? Did you mean not running without carbon capture? Or -- can you talk about the average useful life left on the SMRs?

Yes. I very much appreciate you bringing up the point. I should have mentioned that we will not have any SMRs running without carbon capture. That is correct. I'm glad you clarified that.

On the lower natural gas feedstock cost for hydrogen, besides the pass-through impact on margin, I think you also get to key the benefit of efficiency improvements. And those efficiency improvements, I guess, are worth a lot less when gas is low. Is that a meaningful headwind? Or is that immaterial right now?

Well, I wouldn't want to say it's meaningful, but it is a hit, and I really appreciate you picking up on that. That is exactly right. When natural gas price is at $12 a 1,000 cubic feet, those bonuses are significant. Now the natural gas is $3, $2.5, the bonus has become a lot smaller.

Well, thank you very much. I would like to again thank everyone for joining our call today. We appreciate your interest in Air Products, and we look forward to discussing our results with you again next quarter. Please stay safe and healthy, and all the best. And thank you for your very good questions today, everybody. We really appreciate that.