Paul Rodden • Season: 2024 • Episode: 362
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Welcome to The Hydrogen Podcast!
Episode 362, In this episode, Paul dives into the Curonian Research report on Air Products, analyzing the risks and rewards of investing in their clean hydrogen projects. He discusses the execution challenges in scaling green hydrogen, including technological maturity, supply chain constraints, and regulatory factors, providing a comprehensive look at what investors should consider when evaluating Air Products as a potential low-risk hydrogen investment.
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Transcript:
Today, we take a deeper dive into evaluating Air Products from an investment perspective. Is Air Products really a low risk bet for clean hydrogen? I’ll go through the report and give my thoughts on today’s hydrogen podcast.
So the big questions in the energy industry today are, how is hydrogen the primary driving force behind the evolution of energy, where is capital being deployed for hydrogen projects globally, and where are the best investment opportunities for early adopters who recognize the importance of hydrogen? I will address the critical issues and give you the information you need to deploy capital. Those are the questions that will unlock the potential of hydrogen, and this podcast will give you the answers. My name is Paul Rodden, and welcome to the hydrogen podcast.
In a report from Curonian Research in Seeking Alpha Air Products, a low risk bet on clean hydrogen future. Air Products is a low-risk, cash-generating business that can grow considerably and generate attractive returns on capital invested.
Air Products is the largest hydrogen producer globally and is investing heavily to transition to clean hydrogen production processes as the overall industry demand soars.
This stock currently offers a 2.2% forward dividend yield and aims to grow per-share earnings by about 10% per annum.
Reforms suggested by activist investors could also help boost the per-share value of Air Products over the next few years.
Industrial gasses are essential ingredients in the manufacture of several core commodities such as steel, fertilisers and petrol. Demand for these does fluctuate, but Air Products is not exposed to market volatility as it signs long-term take or pay contracts with the customers. On top of this, energy costs and inflation are passed on.
Air Products is essentially as safe as a utility but generates considerably greater returns on invested capital than its regulated peers.
Air Products is currently trading at a 5% cash flow yield and is likely to grow considerably over the next two decades as the world is transitioning to clean hydrogen. Volume and pricing growth will likely unlock double-digit returns for long-term holders.
On top of this, Air Products stock has underperformed industrial gasses peers as they started investing in merchant hydrogen projects, even though it has a stronger core business.
The core business of Air Products derives the largest share of revenue from long-term contracts with customers, and it also generates the highest underlying margins.
The primary debate surrounding Air Products centers on its strategy for clean hydrogen capacity investments. Departing from its usual approach, the company is building merchant hydrogen capacity without long-term off-take agreements. By assuming development risk, Air Products aims to enhance its returns on investment. Air Products projects full-year earnings of $12.20 to $12.50 per share as the business continues to expand. The company is currently trading at approximately 25.5X its expected earnings for the year.
Air Products has consistently grown its adjusted EPS over the past decade, achieving an average annual growth rate of 11%. This growth pace appears sustainable and is likely to continue, due to the high level of new investment projects and relatively high return on capital investment achieved in the past.
Recently, top-line growth has been modest for Air Products, impacted by challenges in China and lower energy pass-through costs. However, the company still managed to increase earnings through a shift in business mix and productivity initiatives.
Overall group volumes remained flat due to weakness in Asia; however, pricing has gone up while the selling and administrative expenses declined by 1%, despite labour costs inflation. Air Products has delivered a strong performance, successfully enhancing productivity across the business.
Asia, Air Products’ second-largest market, has experienced softness that is slowing the entire group’s performance. While we don’t expect a recovery in Chinese operations next quarter, recent stimulus measures increase the likelihood of an eventual rebound in China. Air Products will report fourth-quarter earnings on 7th November, and we suspect that the EPS might land at the lower end of the $3.33 to $3.63 guidance due to ongoing weakness in China, but it appears that most analysts are anticipating this already.
Over the longer term, we expect Air Products to continue growing commodity volumes as well as to continue passing on gradual price increases. The management of the business is targeting a continuing annual EPS growth of 10%.
Air Products currently has a backlog of $19.5 billion in capital investment projects. Most of these clean hydrogen projects. Air Products is currently one of the largest producers of so-called grey hydrogen but will invest heavily to transition to carbon-neutral hydrogen production processes where possible.
Global demand for hydrogen is on the rise, driven by its expanding use in industries such as steel production and emerging applications like cement manufacturing. Additionally, hydrogen is playing a growing role in refining sustainable aviation fuel (SAF), supporting the transition to cleaner energy sources.
Long-term, green hydrogen holds potential as an energy storage solution and could be adopted in commercial transport sectors, including trucking and shipping. This versatility positions green hydrogen as a critical component in the future of sustainable energy and transportation.
Clean hydrogen demand growth is expected to offset grey hydrogen decline by quite a margin. The overall hydrogen demand is expected to increase markedly.
That said, significant uncertainty remains around the widespread adoption of clean hydrogen, as many use cases are not yet economically viable. However, clean hydrogen initiatives are being supported by legislation and government incentives, which could accelerate its adoption.
This is concerning, as Air Products has launched most of its clean hydrogen projects without partners or capacity off-take agreements, opting to assume the full risk independently. Given the wide range of demand outlook scenarios, this risk could prove substantial.
Air Products has attracted criticism from DE Shaw & Co, a large institutional investor, for taking these unnecessary risks. They want Air Products to seek partners, just as Linde (LIN) or L’Air Liquide (OTCPK:AIQUF) did, and leverage these capital spending projects after de-risking them.
The strategy suggested by DE Shaw would reduce the capital spending budget of Air Products considerably and enable higher capital returns to shareholders.
In the latest results call, the company announced that it sold 70,000 tons of green hydrogen capacity to Total Energy to be delivered by 2030. This is just a drop in the bucket but could indicate that the business is finally lowering its ambitions.
The outcome of the activist involvement is not yet certain, however, we believe that the business is likely to continue growing either way.
It is not certain that all of the announced capacity addition projects will be implemented; however, the company has full control over the timing of final investment decisions and final startup dates.
Clean hydrogen demand is growing rapidly, and therefore we do expect most of these projects to find partners and sign some off-take agreements.
It would be hard to estimate the hydrogen production capacity growth for the next five to 10 years, though the growth potential seems considerable.
As long as there is a strong demand for clean hydrogen, the market participants will figure out the most efficient ways to deliver it.
Importantly, Air Products maintains a strong core industrial gases business that generates stable cash flows, enabling the company to take strategic risks in other areas. Regardless of the outcomes of its clean hydrogen projects, the earnings from its core business are likely to remain robust.
Air Products is currently trading in line with longer-term earnings multiples. There is no margin of safety in valuation at this point, but the growth prospects remain solid.
If Air Products can deliver its clean hydrogen projects profitably, it stands to achieve rapid earnings growth for many years, making its current 20x+ earnings valuation multiple appear reasonable.
On top of this, the business has already started investing in clean hydrogen projects, but no profit is being generated from these investments as plants are not producing yet. Once they do start, earnings and share value could jump up.
The Alberta project will come on stream in 2025, NEOM by the end of 2026 and the Louisiana project is expected to start in 2028.
Recovery in China could also give a profitability boost to the business.
We are therefore bullish on Air Products. Okay, so a great deeper dive into Air Products hydrogen project risk. And so now let’s take a look at the execution risk for these large scale, high capital intensive hydrogen projects. And what are the factors influencing that risk? Well, the first is technological maturity. Hydrogen production technologies, particularly green, as this article talks about, in the future, they’re still evolving and novel. Electrolyzer and fuel cell technologies may not scale efficiently or cost effectively. Now that’s going to introduce risk during the project ramp up. The second is supply chain constraints. Hydrogen supply chain is still under developed, but it is continuing to develop, especially in Europe and with limited suppliers for key components like electrolyzers and fuel storage systems, this dependency can cause delays and cost overruns. The third thing to think about is capital intensity and financing. Hydrogen projects are capital intensive, requiring substantial upfront investment. Securing financing can be challenging due to uncertain returns, which is also influenced by volatile energy prices, regulatory changes and the high cost of renewable energy input for those green hydrogen projects, the.
Fourth is policy and regulatory risks. Now, while government incentives support clean hydrogen, policies can shift with changing political priorities, affecting project viability, regulatory uncertainties around hydrogen handling, transport and storage infrastructure can impact timelines and costs. The fifth factor is market demand and competition. The clean hydrogen market is still developing, with demand growth tied to sectors like heavy industry, aviation and shipping. An emerging market without stable demand can create revenue volatility, especially if demand doesn’t grow as anticipated. The sixth is operational challenges. Hydrogen projects often face operational risks related to high pressure, storage and transportation, which require specialized infrastructure and safety protocols, both increase the complexity and the cost and the last one to consider is environmental and social impacts. Large projects, particularly for blue hydrogen, face scrutiny for environmental impact and community concerns which can delay or complicate development. Now, mitigating these risks often involves detailed planning, securing diversified partnerships, engaging in policy advocacy and investing in adaptive, scalable technology solutions.
All right, that’s it for me, everyone. If you have a second, I would really appreciate it. If you could leave a good review on whatever platform it is that you listen to Apple podcasts, Spotify, Google, YouTube, whatever it is, that would be a tremendous help to the show. And as always, if you ever have any feedback, you’re welcome to email me directly at info@thehydrogenpodcast.com. So until next time, keep your eyes up and honor one another. Hey, this is Paul. I hope you liked this podcast. If you did and want to hear more. I’d appreciate it if you would either subscribe to this channel on YouTube, or connect with your favorite platform through my website at www.thehydrogenpodcast.com. Thanks for listening. I very much appreciate it. Have a great day.
