Air Products & Chemicals, Inc. annual report, FY2020

Air Products & Chemicals, Inc. — Fiscal 2020 Form 10-K

Reporting period: Fiscal year ended 30 September 2020; the filing is an annual report rather than a standalone fourth-quarter filing. The company supplies atmospheric, process, specialty and industrial gases, related equipment, LNG technology and large-scale gasification, hydrogen and carbon-capture solutions through five reporting segments. More than 60% of sales were generated outside the United States.

Financial performance and liquidity

Metric	FY2020	FY2019	Change
Sales	$8,856.3 million	$8,918.9 million	Down 1%
Operating income	$2,237.6 million	$2,144.4 million	Up 4%
Operating margin	25.3%	24.0%	Up 130 bp
Net income	$1,931.1 million	$1,809.4 million	Up 7%
Net income margin	21.8%	20.3%	Up 150 bp
Diluted EPS from continuing operations	$8.55	$7.94	Up $0.61
Adjusted diluted EPS	$8.38	$8.21	Up 2%
Adjusted EBITDA	$3,619.8 million	$3,468.0 million	Up 4%
Adjusted EBITDA margin	40.9%	38.9%	Up 200 bp
Cash flow from operations	$3,264.7 million	$2,969.9 million	Up $294.8 million

Sales pressure reflected lower energy and natural-gas cost pass-through, unfavorable currency and the India contract modification. Pricing increased 3% and volumes increased 2%.
Management estimated that COVID-19 reduced full-year sales by approximately 4% and diluted EPS by approximately $0.60–$0.65, primarily through lower merchant-gas volumes.
Cash used in investing activities was $3,560.0 million, including $2,509.0 million of plant and equipment additions. Defined capital expenditures were $2,716.7 million, up from $2,128.6 million.
Cash and cash items were $5,253.0 million and short-term investments were $1,104.9 million at year-end, compared with $2,248.7 million and $166.0 million, respectively, in 2019.
Total debt increased to $7,907.8 million from $3,326.0 million, principally because of approximately $5 billion of U.S. dollar- and euro-denominated fixed-rate notes issued in the third quarter. Debt represented 38.9% of total capitalization versus 22.6% in 2019.
The $2,300.0 million revolving credit facility had no borrowings outstanding, and the company reported compliance with debt covenants. The only stated financial covenant limits total debt to total capitalization at 70%.
Quarterly dividends increased from $1.16 to $1.34 per share, producing $5.18 of declared dividends for fiscal 2020. This was the 38th consecutive year of dividend increases. No shares were repurchased; $485.3 million remained under the authorization.

Material changes versus the prior comparable period

Margin expansion and earnings growth occurred despite lower sales, driven primarily by pricing, lower energy and natural-gas pass-through costs, improved equity-affiliate results and the absence of 2019 facility-closure and cost-reduction charges.
A $33.8 million pre-tax gain from the sale of the former headquarters property benefited 2020 results. Fiscal 2019 included a $29.0 million facility-closure charge, $25.5 million of cost-reduction charges and a $29.1 million gain on exchanging equity-affiliate investments.
Equity-affiliate income increased 23% to $264.8 million, including a $33.8 million benefit from India’s Finance Act. The benefit was partly offset by a $20.3 million increase in income-tax expense, for a net $13.5 million benefit to net income.
The effective tax rate declined to 19.7% from 21.0%, while the adjusted effective tax rate declined to 19.1% from 19.4%.
The company acquired five hydrogen production plants from PBF Energy for approximately $580 million and completed three business combinations for approximately $185.4 million net of cash acquired. The largest was an Israeli industrial-gas business.
Equipment backlog increased to approximately $1.6 billion from $0.9 billion. Management estimated that approximately 50% of the 30 September 2020 backlog would be recognized as revenue in fiscal 2021, subject to project execution schedules.
On-site revenue remained the largest supply mode at $4,322.3 million, or 49% of sales, while merchant revenue was $3,951.2 million, or 45%, and equipment revenue was $582.8 million, or 6%.

Outlook, commentary, risks and unusual items

Management expected COVID-19-related volume weakness to continue into fiscal 2021, with recovery dependent on the duration of the pandemic and government and business mitigation measures. No fiscal 2021 capital-expenditure guidance was provided because of the uncertainty.
Management expected the on-site business, approximately half of the company’s business, to continue generating stable cash flow and planned to maintain pricing discipline, execute the backlog, grow the dividend and invest in high-return industrial-gas projects.
A long-term Asian customer delayed restarting a plant after planned maintenance. The company expected a restart in fiscal 2021 but was negotiating contract terms that could affect Industrial Gases–Asia sales.
The remaining performance obligation balance was approximately $22 billion at year-end; approximately half was expected to be recognized over the following five years, excluding certain new plants and variable or pass-through consideration.
Major risks include the duration and economic effects of COVID-19, project execution and cost overruns, customer delays or defaults, international political and currency exposure, energy and raw-material costs, cybersecurity, climate regulation, environmental liabilities, tax changes, litigation and impairment risk.
Environmental liabilities were accrued at $84.7 million, with reasonably possible exposure estimated at $84 million to $98 million. The company was involved at 31 environmental sites. A Brazilian antitrust fine of approximately $32 million remained pending on appeal; management considered an adverse final judgment possible but not probable and recorded no provision.
Unconditional purchase obligations totaled $9,556 million, including approximately $7.9 billion related to helium and rare gases. Contractual obligations totaled $20,662 million, including debt, interest, leases, pensions, taxes and purchase commitments.
The Jazan gasification and power joint venture could require a future investment associated with an approximately $12 billion project; the future investment was not included in contractual obligations because definitive agreements had not been signed.
The company reported no material impairment from its fiscal 2020 testing, but the Latin America reporting unit had only a 10% excess of estimated fair value over carrying value, making it sensitive to lower revenue growth or margins.
Management and Deloitte & Touche LLP concluded that internal control over financial reporting was effective. The critical audit matter involved judgment in recognizing revenue from complex on-site industrial-gas contracts.

Facts investors should verify

Whether merchant-gas volumes recover as COVID-19 effects moderate and whether the company’s pricing offsets volume and currency pressure.
The timing, cost, margins and customer commitments associated with the $1.6 billion equipment backlog and major projects, including Jazan.
Debt-service requirements following the 2020 issuance, including the $470.0 million of 2021 current maturities and the maturity of the $2,300.0 million revolving credit facility in March 2022.
The restart and renegotiated terms of the delayed Asian customer plant.
Cash conversion after capital expenditures, acquisitions, dividends and required equity contributions.
Potential changes in environmental, tax and legal liabilities, including the Pace remediation, the Brazilian antitrust matter and $237.0 million of unrecognized tax benefits.
The sensitivity of the Latin America goodwill reporting unit and other long-lived assets to weaker economic conditions, currency movements or lower margins.