Air Products and Chemicals, Inc. (NYSE:APD) Q1 2023 Earnings Call Transcript

Air Products and Chemicals, Inc. (NYSE:APD) Q1 2023 Earnings Call Transcript February 2, 2023

Operator: Good morning, and welcome to Air Products’ First 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 Mr. Sidd Manjeshwar. Please go ahead.

Sidd Manjeshwar: Thank you, Katie. Good morning, everyone. Welcome to Air Products’ first quarter 2023 earnings results teleconference. This is Sidd Manjeshwar, Vice President of Investor Relations and Corporate Treasurer. 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 Senior Vice President and Chief Financial Officer; Sean Major, our Executive Vice President, General Counsel and Secretary; and Simon Moore, our Vice President of Investor Relations, Corporate Relations and Sustainability. As previously announced, he will be retiring at the end of March. 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.

This discussion contains forward-looking statements. Please refer to the forward-looking statement disclosure that can be found in our earnings release and on Slide #2. In addition, throughout today’s discussion, we will refer to various financial measures. Unless we specifically state otherwise, when we refer to earnings per share, operating income, operating margin, EBITDA, EBITDA margin, the effective tax rate and ROCE both on a total company and segment basis, we are referring to our adjusted non-GAAP financial measures, adjusted earnings per share, adjusted operating income, adjusted operating margin, adjusted EBITDA, adjusted EBITDA margin, adjusted effective tax rate and adjusted return on capital employed. Reconciliations of these measures to our most directly comparable GAAP financial measures can be found on our Website in the relevant earnings release section.

Now, I am pleased to turn the call over to Seifi.

Seifi Ghasemi: Thank you, Sidd, and good day to everyone. Thank you for taking time from your very, very busy schedule to be on our call today. I am proud to say that the people at Air Products delivered great results this quarter despite the significant macroeconomic headwinds. I would like to thank each of our talented, dedicated and motivated employees for their hard work. Now please turn to Slide #3. Our safety performance, which is always our highest priority. As you can see, we have made significant progress since 2014. But we always work hard to do better. Our goal is to achieve zero incidents and zero accidents. Now please turn to Slide #4. For the first quarter of our fiscal year 2023, our earnings per share was $2.64, an improvement of 0.16 per share or 6% versus last year.

But our underlying performance versus last year was much better than that. The items that you need to consider to make a fair comparison versus last year are a $0.15 negative impact from currency, and a one-time gain of $0.20 in the first quarter of last year from the finalization of the Jazan ASU joint venture. I would like to point out also that our guidance for the first quarter was to deliver earnings per share of 2.60 to 2.80. Our actual EPS is $2.64, which is within our guidance but at the lower end. The principal reason is that the Chinese and European economies were weaker than our expectation in early November, (512) forecast. Now, please turn to Slide #5. We are committed to recording our shareholders, while pursuing our long-term growth strategy.

I am pleased to say that we have again raised our quarterly dividend this time by 8% to $1.75 per share per quarter, or $7 a share on an annual basis, extending our record of more than 14 consecutive years of dividend increase. We expect to pay out more than $1.5 billion to our shareholders in 2023, reflecting our commitment to return cash to our shareholders. Now, please go to Slide #6, which shows our EBITDA margin trend. While energy costs remain high, our margin improved this quarter. Our team has worked hard on increasing prices to offset the higher energy costs in our merchant business, and we continue to work on productivity. I would also like to point out that three quarters of the margin declined since the peak margin of around 42% is due to a higher energy cost pass-through in our upside business, which increases our sales but does not impact our profit.

Now please turn to Slide #7. In addition to delivering strong results, we also achieved several significant project milestones during the quarter. In December 2022, we were very excited to announce our $4 billion green hydrogen project in the United States. This project will be located in Northern Texas, and is our latest mega-scale zero carbon, which means green hydrogen project since the announcement of our revolutionary NEOM green hydrogen project in 2020. And it will be by far the largest green hydrogen project in the United States. The information about this project and the recording of our December paid net cash is — for this project are available on our website. Now please turn to Slide #8. We were pleased to announce in January 19, the completion of the second phase of the $12 million Jazan gasification and power project, which is 51% maturity owned by Air Products, and it is 60% project financed.

During the first quarter, with the first phase of this project, which was completed in October of 2021, Air Products contributed around $0.5 billion for the purchase of $7.1 billion of assets from Saudi Aramco. In the second phase, which was just completed, Air Products contributed an additional $900 million for the purchase of $4.2 billion of additional assets. Our total cash contribution for this project is $2.5 billion. As expected, the first phase of the project at the end was $0.80 to $0.85 per share on an annual basis, which significantly contributed to our results in fiscal year 2022. With the completion of the second phase, we now expect about a total of $1.35 per share of earning contribution on an annual basis. This is fully in line the announced investors more than 3 years ago.

Now please turn to Slide #9, to provide you an update on our great NEOM green hydrogen project, which is appropriate to give you an update, since we are very close to completing a major milestone, which is signing the definitive project financing agreements for this project. And therefore, we wanted to give you an update, before you read about that in the next few weeks. We have been making excellent progress on this large-scale project to bringing green energy to the world. The engineering is now about 30% complete. All major subcontracts for the project have been awarded including the power plant . Land preparation is completed and construction has started. And the joint venture team is in place and executing the project. Now, please turn to Slide #10.

As you know, Air Products has a ownership position of the NEOM production joint ventures. But importantly, and this is very important. We remain the sole offtaker of 100% of the green hydrogen produced in the form of green ammonia produced at this facility and an exclusive 30-year contract. We continue to see significant opportunities to use this to bring green hydrogen to consumers around the world. And as I said we are the sole offtaker and distributor of this product. Then I want to emphasize that the offtake price for this green ammonia, it remains the same as when we negotiated the original project in the summer of 2020 when we announced the project. This is a very key point than the fact that now we are project financing this project, and as a result, we are absorbing all of the financing charges and so on that has not changed the offtake price.

Then, now please turn to Slide #11. Initially the three partners which are Air Products, NEOM, which is owned by PIF; and ACWA Power, we intended to use our own cash to fund the project, the total project. Over the past 2 years, we’ve seen significant interest from the global financial institutions who see tremendous value proposition on this project. Therefore, we got tendered and reconsidered and we decided that the best course of action to minimize our cash contribution and maximize the return on the cash is to do non-recourse project financing of this project. The partners will contribute 25% cash and the remaining 75% will be non-recourse project financing. And obviously, if you are doing non-recourse project financing, you want to maximize the amount of money that you can borrow.

Therefore, you put a lot of your ongoing cost and you bring it forward to the real present value and borrow against that. I would explain this a little bit more when we get to the detailed chart. This means that Air Products — this project financing means that now our cash contribution to this project will be $800 million, less than $800 million, which is significantly less than the $1.7 billion that we originally expected. That is what you would expect us to do, that is the ballpark point of project finance. Now please turn to Slide #12. I’m pleased to say that the non-recourse financing is well underway and we are more than 2x over-subscribed from what we want to borrow. We have received commitments from over 20 global financial institutions, demonstrating their confidence in this project.

Later this month, we expect to complete what we call the dry close, which is the signing of the definitive financing agreements, and we expect the full financial close to be completed a few months later. We will obviously let you know as we make progress on the project finance. Now please turn to Slide #13, so that I can provide you with an overview of the total project capital needs. First, the original $5 billion that we have mentioned before, for the capital required to build the facility. We have increased that — it has increased by about $0.5 billion due to inflationary pressure that everybody expects. Then in addition, we have further increased the investment by $1.2 billion to include service from other people, but now we want to provide those services ourselves in order to make the project totally self-contained and we wouldn’t be dependent on others.

These include power transmission lines and other infrastructure that was needed for the project. This increases the capital cost, but it decreases the operating cost and we decided that was a better trade-off. But the key point was to make sure that the project is not dependent on other people doing that people have control over the whole thing so that we have everything that we need for the project to be operated. Now the other item that I’m sure will be a subject of questions from people is the $1.8 billion for project financing costs. That is a big number, but it is really explaining why that is. Again, as I said, if you have project financing, you want to put and borrow as much money as you can. First of all, about $1 billion of that $1.8 billion is the interest during construction.

So we are spending money. We want to borrow that money. There is an interest to that borrowing. Therefore, that adds up for the of the project to about $1 billion. We want to finance that and borrow against them. Then we are using instead of leasing the land for 50 years, we decided to pay for the land upfront that reduces our ongoing cost, and we can finance that. That is a few hundred million dollars. Spares for the project. Usually you buy the spares as you go forward, we decided to buy all the sales upfront and finance it. So those are the kind of costs that comprise the $1.8 billion. It makes a lot of sense, and that is the beauty of finance that you can . You have the flexibility of bringing forward a lot of your costs that will save your operating costs in the future.

Photo by American Public Power Association on Unsplash

So all together, the total funding needed for the project is $8.5 billion. Now please turn to Slide 14, which is the overview of the funding. As I described before, the $8.5 billion is made up $6.2 billion of non-recourse debt, which we wanted to maximize and $2.3 billion of cash from the three partners. Therefore, obviously, the Air Products cash contributions , which is less than $800 billion and this is as compared to the $1.7 billion than we originally expected. So overall, we are very pleased with where we are. We are very pleased with the fact that our project financing , minimizing our cash flow, and we are very pleased that the prices that we are paying for the has stayed the same as it was in 2020. We are very optimistic about projects and the prospects for a good return for the total supply chain as we go forward.

Now please turn to Slide 15. I would like to summarize the discussion by sharing some thoughts about our strategy. As I have mentioned before, there are two pillars for growth strategy of Air Products and sustainability is the foundation for both of them. Through our core industrial gas business, the supply customers in dozens of industries with critical products and services that lower emissions and increase efficiency and productivity. Through our Blue and Green hydrogen project of the future, we will commit more than $15 billion by 2027 to deliver clean hydrogen at a scale helping to drive the energy transition and moving . These two pillars, which support Air Products for success put us in the heart of needs for — the Board’s needs for sustainable energy and environmental solutions.

I’m proud to say that the people of Air Products have continued to drive results in the near-term and make excellent progress in executing our growth project as we move forward. Slide #16 summarizes our management principles, which I reiterate every quarter. These principles are critical to Air Products’ success and will continue to guide us in the future. Now I’m pleased to turn the call over to Melissa, our Chief Financial Officer. Melissa?

Melissa Schaeffer: Thank you, Seifi. As Seifi mentioned earlier, we’ve delivered another set of incredible results in the quarter even with significant macroeconomic headwinds. Our commercial teams across the region continue to execute press actions and their efforts paid off. Price droves the 25% operating income improvement despite a significant negative currency impact, and operating margin was also 300 basis points higher compared to last year. I also would like to thank the team at Air Products for their continued outstanding efforts. Now please turn to Slide 17 for a review of our first quarter results. In comparison to last year, sales, volume and price were up nearly 10%. The 7% gain in price for the total company equaled a nearly 20% improvement in merchant price compared to last year, the fifth quarter in a row of double-digit increase.

Volumes were up 2% higher, driven by better onsite in merchants, but partially offset by lower sales equipment activities. Volumes were strong in America and Asia, but weaker in Europe. Currency translation from the strengthening U.S. dollar reduced sales by about 6% and lower operating income at 8%. Despite this headwind, operating income jumped 25% and operating margin was 300 basis points higher, primarily driven by strong pricing. Operating income was higher across the region and particularly strong in America and Europe. Improvements in EBITDA and EBITDA margins were not as significant as operating income and operating margins due to the prior year one-time items primarily related to the Jazan ASU joint venture finalization. ROCE has climbed steadily over the last 6 quarters, reaching 11.3%, which is 120 basis points higher than last year.

We expect ROCE to further improve as we bring new projects on stream and continue to put our cash on the balance sheet to work. Adjusting for cash, our ROCE would have been 13.3% this quarter. Sequentially, volume was weaker following a strong prior quarter, which also benefited from soft sales and a favorable contract . Price continues to gain strength across the region. Merchant price improved 3% versus last quarter. EBITDA was down 5%, primarily due to weaker volumes, while EBITDA margin was up 200 basis points as positive price cost pass-through more than offset the lower volume. Now please turn to Slide 18 for a discussion of our earnings per share results. Our first quarter adjusted EPS was $2.64 per share this year, up $0.60 or 6% compared to last year.

Strong price drove the improved results. Price, net of variable costs contributed over $0.70 this quarter as our price actions more than offset the higher variable cost increases. Cost was $0.11 unfavorable primarily due to inflation and higher maintenance. Price, volume and cost together added $0.63 or a 25% increase compared to last year. However, the negative $0.15 from currency and a roughly $0.20 of prior year one-time benefit associated with the finalization of the Jazan ASU joint venture moderates a strong underlying results. The Jazan item accounted for much of the $0.14 decline in equity affiliates’ income and an unfavorable $0.10 in non-controlling interest. The effective tax rate of 19.1% was 210 basis points unfavorable due to less tax benefit this year.

We expect an effective tax rate of 19% to 20% in FY 2023. For the quarter, a non-service component of our defined benefit plans were favorable $0.04 last year and unfavorable $0.07 this year. As I shared with you last quarter, we now exclude the component from our adjusted results. Now please turn to Slide 19. Our distributable cash flow continued to climb, driven by improving EBITDA. While cash expenses included interest, cash tax and maintenance CapEx remains relatively stable over the last 3 years. Over the last 12 months, we generated close to $3.1 billion of distributable cash flow or almost $14 per share. From our distributable cash flow, we paid over 45% or over $1.4 billion as dividends to our shareholders while still had an almost $1.7 billion to invest for growth.

Our ability to grow distributable cash flow, especially in challenging conditions, demonstrates the strength and stability of our business. It enabled us to continue to create shareholder value by increasing dividend and deploying capital for high return projects. Slide 20 provides an update of our capital deployment. As you can see, we have over $36 billion of capital deployment potential through fiscal 2027. The $36 billion includes over $8 billion of cash, additional debt capacity available today, about $17 billion, we expect to be available by 2027 and almost $12 billion already spent. We still believe this capacity is conservative given the potential for additional EBITDA growth, which would generate additional cash flow and additional borrowing capacity.

As always, we continue to focus on managing our debt balance to maintain our current targeted AA2 rating. So you can see our backlog of nearly $20 billion will provide a substantial amount of growth in the future. However, please note this figure still includes the second phase of Jazan project that was completed in January as well as the capital required for NEOM at its original higher value as we work through the finalization of project financing. Moreover, we will include the $4 billion Texas green hydrogen project when the project reaches final investment decision. We have already spent over 30% and committed 74% of the updated capacity we show on this slide. We have made great progress and still have substantial investment capacity remaining to invest in high return projects.

We believe that investing in these high return projects is the best way to create shareholder value for the long run. We continue to evaluate our capital deployment options and determine the best way to use available cash and trusted to us by our shareholders. Now to begin the review of our business segment results, I’ll turn the call back over to Seifi.

Seifi Ghasemi: Thank you, Melissa. Now please turn to Slide #21 for our Asia first quarter results. Our businesses were able to deliver positive volume and price despite the negative COVID impact in certain parts of China. Volume improved7% supported by new assets. This quarter, we benefited from more than 25 new small to mid-sized traditional industrial gas plants which came on stream across the region over the last years. Price was up 1% in total, which is 3% — which translates to 3% in our merchant business. Although underlying sales grew 8% versus last year and energy pass-through was a positive 2%, overall offset by a 10% weaker currency, which is obviously translation. Negative currency also reduced operating income and EBITDA each by about 10%.

Operating income and EBITDA both improved versus prior year as better volume and price more than offset the negative COVID impact. Higher price and volume also drove margin improvement. Although China’s government has relaxed its rules related to COVID, the subsequent high infection rates have impacted business activity. We expect economic recovery in China to take time. We anticipate power across the region to continue to rise, and we are taking action, which I mean pricing action, to mitigate the impact. Sequentially results compared unfavorably to last quarter, which benefited from some specific spot sales. At this point, I would like to turn the call over to Sidd to discuss our European results. Sidd?

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Q&A Session

Sidd Manjeshwar: Thank you, Seifi. Now please turn to Slide 22. As the chart shows, power costs for Europe moderated sequentially this quarter, but are still at a historically elevated level. Our commercial team has executed significant price actions to compensate to these costs in our merchant business and their hard work has paid off. Although we have fully recovered the higher power costs for the quarter, we are keeping a close eye on the dynamic power market in this region. As a reminder, power costs in our merchant business is the primary focus when managing the escalating energy costs in Europe. Our on-site business has contractual pass-through, which enables us to pass energy cost to our customers and almost all our national gas usage is for on-site hydrogen production.

Now please turn to Slide 23 for a review of our Europe results. Successful price actions, we have worked hard to implement the last few quarters, drove the significant improvement in Europe’s results. Compared to prior year, price increased 14% for the regions corresponding to a 24% improvement in merchant pricing. Volume declined6%, reflecting challenging conditions in the region. Demand for our hydrogen was weaker as customers continued to optimize their own hydrogen operations. Our merchant business was lower, partly due to the divestment of our business in Russia. Energy cost pass-through was up 9% due to higher natural gas costs although it had no impact in profit. Operating income jumped nearly 50%, while EBITDA was up almost 30%, primarily due to strong price.

Although unfavorable currencies reduced operating income and EBITDA, each by more than 10%. Price primarily drove the more than 400 basis point EBITDA margin increase. This was net of the higher energy cost pass-through, which lowered the margin by about 200 basis points. Compared to the prior quarter, volume was unfavorable due to vehicle merchant this quarter and a favorable contract amendment in the prior quarter. Now I would like to turn the call over to Dr. Serhan, for a discussion of our other segments.

Dr. Samir Serhan: Thank you, Sidd. Now please turn to Slide 24 for a review of our Americas results. Underlying sales increased15% despite the adverse effect of severe weather in December. Price improved for the region by 9%. This is equivalent to a 26% increase in the merchant business. Our team in the Americas has successfully raised the prices to cover the higher energy cost. Volume grew 6% primarily due to better merchant and on-site, volume also benefited from a new short-term agreement, which will benefit Americas results for the next few quarters. Operating income was up to almost 30% over last year. And operating margin improved 300 basis points, driven primarily by the strong price. Volume also contributed to profits, but costs were unfavorable.

EBITDA improved less than operating income because of our lower equity affiliate income due to unfavorable one-time items and lower medical oxygen volume in Mexico as the COVID impact subsided. Sequentially, the price continued to gain strength. Merchant price was up 7%, but volume was down 3%, following a strong previous quarter. EBITDA margin improved by around 400 basis points, primarily due to lower energy cost pass-through which accounted for three quarters . We expect our planned maintenance activity to increase next quarter and parallel with our customers’ plan turnaround. Please now turn to Slide 26 for our Corporate segment. This segment includes our — I’m sorry.

Seifi Ghasemi: Samir you need to.