Linde plc

Q2 2021 Earnings Conference Call

7/30/2021

spk10: Good day, and thank you for standing by. Welcome to the second quarter 2021 Lindy's Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star and then one on your telephone. Please be advised that today's conference may be recorded. If you require any further assistance, please press star and then zero. I would now like to hand the conference over to your speaker today, Mr. Juan Perez, Head of Investor Relations. Please go ahead.
spk07: Crystal, thank you. Good morning, everyone, and thanks for attending our 2021 Second Quarter Earnings Call and Webcast. I am Humphrey Dyes, Head of Investor Relations, and I'm joined this morning by Matt White, Chief Financial Officer, and Sanjeev Lamba, Chief Operating Officer. Today's presentation materials are available on our website at lindy.com in the Investor section. Please read the forward-looking statement disclosure on page two of the slides and note that it applies to all statements made during this teleconference. The reconciliations of the adjusted numbers are in the appendix to this presentation. Sanjeev and Matt will now give an update on Lindy's business outlook and second quarter performance, and then we'll be available to answer questions. Let me turn the call over to Sanjeev.
spk16: Thanks, Juan, and good morning, everyone. Lindy employees once again produced stellar results in the second quarter, achieving multiple new records, including a 24.2% operating margin, a $2.7 earnings per share, and 15.7% return on capital. Volumes grew 15%, pricing increased 3%, along with global weighted inflation. And we continue to optimize the business through many productivity initiatives. I'm really proud of how the Lynda team delivered industry-leading performance despite the many challenges we constantly face. And I expect to continue this performance for many years to come. Last quarter, I presented to you the LIMDA strategy, which outlined the levers that we use to grow EPS, more than 10% per year. Given the results so far, I think it's safe to say we're well on our track. That said, I believe it's also important to have a clear path to future revenue expansions. which I'd like to discuss on the next slide. So on slide three, you'll see that when previously I had highlighted to you that Linde has a unique advantage of being able to offer its customers a sale of gas or a sale of plant option. Our engineering capabilities are a clear competitive advantage, allowing us to participate in almost every type of growth opportunity while maintaining our investment criteria. Going forward, we are therefore going to present the sale of gas and sale of plant backlog combined. This quarter, our total project backlog stands at approximately $7.5 billion, representing contractual growth with high-quality customers and secured cash flows. Now, in addition to this project backlog, in parallel, we also invest around $1 billion per year on base business growth opportunities. These are great opportunities to deliver high-quality, long-term growth, but they are either under $5 million in spend or don't contain contractual, fixed-free elements for secured, incremental growth. Base growth projects typically also have shorter execution times, are margin-creative, and support a network density strategy. Some examples include the clean energy projects we announced earlier this year, the hydrogen liquefier in the U.S. Gulf Coast that we recently started up, and of course, more than 25 small onsite projects that we have already run this year. We serve glass, bulk and paper, mining, and other growing end markets with these small onsites. In addition, the business continues to leverage a dense network with winning new merchant and packaged accounts, which further enhances the quality of our business. As stated, we currently have approximately $7.5 billion of contractually secured growth projects, which we'll execute over the next three to four years, plus $1 billion per year of incremental base growth capex. The revenue expansion from these investments exclude organic growth already being captured from our existing dense supply network across a diverse spectrum of end markets. Of course, we've well demonstrated how we leverage this through the current economic recovery that you're seeing. As I sit here today, we are currently reviewing a pipeline of hundreds of prospective projects not included in this backlog, which easily represent more than $10 billion of potential investment opportunities, including a significant number of electronics and clean energy projects and, of course, sale of plant projects. Both sale of gas and sale of plants are great ways for us to grow while maintaining our investment discipline. Given our strong execution capability, I remain bullish on Linda's outlook and growth prospects. Regardless of what happens with inflation or macroeconomic trends or the pace of secular growth drivers, we have a proven business model that can generate compound value growth for our shareholders today and decades into the future. Now, before I hand over to Matt, I want to make a comment on our ESG goals. I mentioned to you in last quarter's call that we are developing new ambitious ESG goals. which we expected to share in the near future. We've been diligently working with our business leaders around the world to determine these targets, and more importantly, to incorporate them in our operating rhythm. Based on that progress, I expect to disclose these new ESG goals before the end of the year. I'll hand over now to Matt, who will take you through the financial results and guidance. Matt. Thanks, Sanjeev.
spk03: Please turn to slide four. for an overview of the second quarter results. Sales of $7.6 billion are up 19 percent from 2020 and 5 percent sequentially. Versus prior year, volumes increased 15 percent across all supply modes and end markets. Manufacturing, chemicals, and metals drove this increase. since Q2 2020 was the low point for cyclical markets. Sequentially, volumes increased 4%, which marks the fourth consecutive quarter of volume expansion, demonstrating our leverage to the economic recovery. Price increased 3% versus prior year and 1% sequentially as all geographic segments continue to manage inflation. This is also evident in the 2% energy cost pass-through related to onsite contracts. Operating profit of $1.8 billion increased 39% over prior year and 9% sequentially. Operating margin of 24.2% was 350 basis points over last year despite of 50 basis point headwind from cost pass-through. This represents the eighth quarter in a row we have increased operating margin more than 200 basis points from a combination of volume expansion, pricing actions, and productivity measures. EPS of $2.70 increased 42% from 2020 and 8 percent from the first quarter. We've also provided the Q2 2019 growth rate of 48 percent. As mentioned last quarter, I believe it's important to distinguish true growth, which this clearly demonstrates, from mere recovery. ROC, which is one of the most important metrics in this industry, rose to a record 15.7%. It has increased every quarter since 2018 from steady profit growth over a prudently managed capital base. In fact, Lindy has consistently proven the ability to deliver industry-leading, high-quality growth by following a disciplined capital allocation model. Slide five provides more color on that capital allocation model, including overall cash management. You can see the progression of operating cash flow on the table to the left, with the first half up 27% over last year. Note that we had $300 million of higher cash taxes this quarter when compared to Q2 last year. Since this is only timing related, I expect operating cash flow to improve year over year and sequentially in the third quarter. To the right, you can see how we allocated capital for the first half of this year. Stated simply, we want to grow the business, invest back into the business, and reward our shareholders with increasing dividends and share repurchases. I think the pie chart below confirms this approach. We invested $1.5 billion into the business and returned $3.2 billion back to shareholders. I'll wrap up with guidance, which you can find on slide six. This slide is similar to last quarter, including how we set the guidance ranges. Third quarter guidance is $2.60 to $2.70. This represents 21% to 26% growth over prior year and 34% to 39% growth over 2019. Compared to Q2, this assumes no sequential improvement in the underlying economy and a 1% foreign currency headwind. For full year 2021, we are raising prior guidance by 50 cents to a new range of $10.10 to $10.30. This 50 cent increase is from the Q2 outperformance and the higher Q3 guidance range. In other words, and consistent with last quarter, we have not updated the fourth quarter at this time. Rest assured, next call will provide an updated and more meaningful fourth quarter guidance. And if volume trends are stable or improve, we'll be at the upper end or above this range. Until that time, we remain highly confident in our ability to grow 2021 EPS at least 23% from last year and 38% from 2019. while positioning Lindy for industry-leading, long-term value creation. I'd now like to hand the call over to Q&A.
spk10: Thank you. And as a reminder, to ask a question, you will need to press star and then 1 on your telephone. To withdraw your question, you may press the pound key. One moment for our first question. And our first question comes from David Degleiter from Deutsche Bank. Your line is open.
spk02: Thank you. Good morning. Sanjeev and Matt, the 15% of volume growth in the quarter, what do you think that was versus the industry? Did you gain share, do you think, this quarter versus competitors?
spk16: David, thanks for that question. So as you saw, you know, seller growth, and we mentioned across all end markets as well, The reality is we saw that economic recovery come through. We've said as part of our strategy we'd leverage that economic recovery. That's what we're seeing happen around. I would say that in some markets we have seen some share gain, but that's kind of an ongoing business transactional element that we see all along.
spk02: Very good. And Matt, thinking about share buybacks, how should we think about buybacks in the back half of the year?
spk03: Yeah, so David, as you know from our capital allocation policy, we'll continue to sweep excess cash towards buybacks. So year to date, you know, we've been over $2 billion. We're on a good pace. And as I mentioned, I expect Q3 cash to be higher. So I see no reason why, you know, we need to deviate from kind of our current pattern. But obviously our priority continues to be to invest in growth, which we're going to do. And as Sanjeev mentioned, we have a lot of opportunities there. But we're purchasing shares pretty much every day in the market.
spk02: Thank you.
spk10: Thank you. Our next question comes from Tony Jones from Redburn. Your line is open.
spk13: Oh, thank you. Thanks for letting me ask questions. Good morning. Yeah, I've got two, actually. One was on volumes. So if I look at, say, Q2 2019 and then sort of adjust for the price and cost passed through this quarter, as just reported, that sort of implies volumes are up about three, four percent versus that Q2 in 2019, but slightly down in Asia. Firstly, I guess, is that right? Does it maybe imply some further optionality in Asia Pacific? And can we use that sort of underlying 3% to 4% volume growth versus 2019 for the next couple of quarters? And then a second question, sorry, if I'm asking quite a few things here. CapEx in the cash flow and also as a percentage of sales looks like it's been trending down for a while, but the project backlog looks really solid. How should we think about that? Or is it just the post-pandemic timing effect of investments? Thank you.
spk16: Tony, thanks. Why don't I jump into the CapEx piece, and then I'll ask Matt to just talk through the volumes and reconcile them. Just on CapEx, I think one of the reasons we're providing that pipeline view today was to give you a sense of how we see that opportunity. I've said in the past I've seen some improvement in proposal activity across, you know, both sale of gas and sale of plants. And, you know, on the sale of gas side, that proposal activity, particularly coming from electronics as an example, and of course a suite of clean energy projects, and the more traditional markets as well, including chemicals, and others. So I do expect to see that CapEx reflecting the pipeline opportunity that we just defined. So I don't see, I mean, the changes are marginal anyway, but notwithstanding that, I see absolutely no concerns around how I expect that pipeline to flow into backlog. Thank you.
spk03: Thanks. And Tony, yeah, just to answer the volume question, your calculation is close, but it's about 5% globally is what we would have seen Q2 volumes versus 2019 from this quarter. And Asia-Pac actually is leading. It's more around 8%. So I'm not sure if maybe in the deconsolidation or how you calculated that, but the volumes in APAC were about 8% above Q2 2021 versus Q2 2019. And we're pretty much off mid-single digits across the board for all the regions. So I would say we're seeing the right patterns and the right traction, and obviously price, you know, 3% to 4% as well when you look at that metric versus 2019. Thank you. That's great. Good detail.
spk10: Thank you. Our next question comes from Bob Cort from Goldman Sachs. Your line is open.
spk08: Thank you very much. Good morning. Guys, I wanted to ask about the Strong Island project. That was going to start up in 23. How is that progressing? I think it's your biggest ever investment. And what have you learned of anything about building those gasifiers? Thanks.
spk16: Thanks, Bob. So, you know, one of the larger investments, as you rightly point out, that's progressing well. Obviously, there has been some COVID impact, you know, on our schedule as well as of our That's still on track to getting largely mechanically complete by the dates that we'd originally set out, plus or minus a few weeks. And to be honest, Bob, we've been running gasifiers at that Singapore site for decades. So really, none of this is new for us. From an engineering point of view, we've been building gasifiers since So, you know, there's a lot of that organizational learning that we've been able to put into that project, so it's coming along quite nicely.
spk08: And as a follow-up, if I might, you guys have an interesting seat in the whole gas or hydrogen economy that's developing. I wonder if you can give us your latest thoughts on which way that's going. Is it going to be globally distributed hydrogen? from, you know, single complexes in the best electricity areas? Is it going to be locally produced hydrogen? Is it going to be ammonia? Any updated thoughts on how you see that ecosystem evolving? Sure, sure.
spk16: Happy to provide that, Bob, and that's a great question. So, you know, it is, as you rightly point out, a very fast-developing dynamic space, and we start to talk more and more about clean energy more broadly, but just talking about the specifics of what you've asked. So our view is, when we think about our strategy, we believe local execution and locally driven strategies are where we see the most value creation in terms of our business model and in terms of how we kind of attempt to take that strategy to execution. We are demonstrating that with South Korea in a local market where we are putting a liquefier and building a whole ecosystem around liquid fueling for heavy duty vehicles. So that's kind of broadly our strategy. Now, I must add to that that with all of that, obviously, we also recognize there's a portfolio approach that we would be taking to this, and we do expect to see that there will be some larger installations that would feed markets which may not be entirely local, which might have some export content to it. but we do see the distributed model as being certainly both more effective and creating greater value, but supplemented in cases by some larger production facilities where you have some obvious competitive advantages. I mean, you know, we've talked previously about, you know, how you could get in Northern Africa, as an example, very low-cost electricity that allows you to put a large complex green hydrogen production facility. And the best way to get that hydrogen to market, as an example, would be to then take it from that large complex and pipe it across to Europe if you could. And again, you'd have to repurpose some of the existing pipelines and make sure that cost effectively gets to Europe for it to have some traction there. So that's one example where we think you would see you know, changes like that happen. You know, Chile with the, you know, the desert has a similar advantage of, you know, very high quality solar ability to take that, put it into renewable power, generate green hydrogen, and then move it to markets close to it. Does that give the color you were looking for, Bob?
spk08: Yes, perfect. Thanks so much.
spk10: Thank you. Our next question comes from Nicola Tang from Exchange BNP Paribas. Your line is open.
spk11: Hi, everyone. Thanks so much for the interesting sort of color around the project backlog. I wanted to ask a little bit around that. You know, while the backlog itself is pretty solid at the $7.5 billion, the size of the backlog itself hasn't really been growing. If anything, I think it was more like $9 or $10 billion a couple of years ago. So you talked about those, you know, hundreds of projects worth, you know, potentially 10 billion. Can you talk about the potential timing of adding those into the backlog? You know, as existing projects come online and then, you know, therefore drop out the backlog, do you expect to see growth in the backlog or actually it will be more stable at current levels on a sort of net-net basis? And then the second question, similarly around the backlog, was I was curious, Sanjeev, you mentioned that you're seeing project activity or potential project activity in traditional sort of industrial areas. I was curious to understand, you know, what areas you're seeing that pick up in activity. Yeah, and then I've got a next bit, but I'll pause there.
spk16: Thanks, Nicola. So let me start over the backlog, and then we come back to the project activity pickup that I referenced. So, you know, as you said, the backlog is $7.5 billion. It gets impacted by startups that we have. So we are going to have some startups later this year, and we'll see that impact flow through. You've actually got some press releases that we had recently around some of those as well. Now, in terms of timing of the projects coming into the backlog, as you know, we don't often control that timing. More often than not, Juan controls the timing because he kind of doesn't let us announce many of these wins. But notwithstanding that, you will see in the second half an improvement in that backlog come through because we are very close. on a couple of projects which we think will be formally closed out, which is contracts signed before we can bring them on. Again, Nicola, you know this, but I'll just recap it. Our conditions for putting something as a backlog are very stringent. They have to be secured by a contract. It must be more than $5 million. Obviously, for the larger projects, that doesn't matter. And it needs to have a guaranteed cash flow profile which ensures that that backlog then has guaranteed incremental growth. So those conditions have to be met, and we see a number of projects that will flow into the backlog later this year, and then some obviously in the early part of next year as well. So I feel reasonably confident on the developments that we're going to see in that backlog, both on the sale of gas and the sale of plant side. Now, I'll move on to the proposal activities. I'm going to talk about one area in particular where we see a significant amount of activity, and you've heard me reference this before, Nicholas, so it won't come as a surprise, which is electronics. And, you know, really, you've been hearing in the press, obviously, a lot about chip shortages, but the reality is, you know, that industry has been looking at ramping up its production capabilities for about 12 months now, and there are you know, a host of projects that are all in various stages of development by TSMC, by Samsung, by Intel, by global foundries. There's a long list of people who are going to be investing in that space. And therefore, a large part of our time at the moment in that proposal activity is being spent around the electronics, you know, area in particular, Nicola. Now, in addition to that, we're also seeing some chemicals projects. We're also seeing even, you know, and it might surprise some, but even in the seal area, we're seeing some projects. The one other area, Nicola, which kind of is really linked to clean energy, but, you know, where we're seeing refining, chemical, even steel companies engage actively with us is around reduction in their emissions, or in the case of refining, what can we do around carbon capture and reducing their emissions? How can we help them create technical solutions? I've said this before in the last call that, you know, we have a full suite of technologies around us. We have the ability, working with partners, to provide a holistic solution to many of our customers in that space. And, again, we're seeing a lot of activity pick up on that and move forward.
spk11: That links quite nicely to my last question on sort of the decarbonization point. I was wondering if you had any initial thoughts on the EU's Fit for 55 proposal and the potentially what it means for Linder or the wider gases industry, I suppose, and whether there's any sort of progress on a CO2 framework on the U.S. side, and similarly, what could that mean for you?
spk16: So, Nicola, you've heard me say this before, but for decarbonization more broadly and the hydrogen economy particularly to pick up, we need a couple, three things to happen. Obviously, regulation with teeth. We've seen that happen very much in Europe. I think your point is absolutely valid that we see Europe provide the kind of penalties and incentives, the carrot and sticks, which are allowing momentum to build in that space quite actively and aggressively. So that's good to see. We are participating in that, whether it's IPSE funding, whether it's other incentives, whether it's the broader coalition that is looking at contract for differences to make sure that we are leveraging facilities elsewhere to support European economies. I've also said, and of course, just to make the point, in the U.S., we are encouraged to to see progress happen in that area as well. Now, you know that the U.S. currently offers a 45Q. Our view is that that is inadequate for any substantial momentum to build up in the space, but I'm encouraged by conversations going on in the House and hopefully in the Senate that will move some of the incentives and proposals forward in that space. So I'm looking forward to seeing developments there quite closely. So I guess the other couple of things that need to happen, which I think create the momentum that we need, and I am at the risk of repeating myself from the last call, we do need to see that the technology roadmaps ensure that the technology for either green and blue, which is currently available and scalable, you know, creates the cost curve that is necessary for large-scale adoption to happen. That remains, you know, I won't say that's a challenge that is actively being worked on, but, you know, there is a timing challenge to that and it'll take years before we get to a point where green in particular, you know, has the ability to have a cost-effective solution available at scale. Good solutions are available today. We provide many of those ourselves, but I recognize that there is still a scale-up that is currently lacking in the green hydrogen space. And finally, I think we need to be working very closely with making sure that the endpoint consumption, so in this case, if we are talking about heavy-duty vehicles, buses, or trucks, or indeed trains and ferries, that technology development in that space is happening actively and Hence, the number of partnerships that we do to make sure that we're right in the middle of those developments and we are encouraging and promoting them as much as possible. So I know I've provided a more broader answer than you were looking for, but I think this was worth recapping because these are the things that are ensuring that the momentum that we see today sustains and you actually see investment and development in that space.
spk11: That's great.
spk10: Thank you so much. Thank you. Our next question comes from Jeff Zakowskis from JP Morgan. Your line is open.
spk05: Thanks very much. Your returns on capital have moved up, which is natural given your cost reduction programs and the growing economy. Have your returns on capital, though, in your on-site projects really changed over the past couple of years? That is, are the returns on capital in on-site going up or staying the same?
spk03: Jeff, this is Matt. How are you? So our investment criteria is the same. So we've maintained that throughout. And therefore, how we look at the projects and the expectations we have remain the same. But to your exact point, given the density model that we have, we're getting significant growth on this business on a non-capital intensive basis. And then we continue to deliver on our projects, start up our projects, and execute those projects, which deliver on the expected returns that we entered into them on, and the combination of the two is giving us a significant acceleration in return on capital. And at this point, we continue to see this happen, and as long as these trends continue, it should bode well for that metric going forward.
spk05: Okay. Thank you for that. And in the hydrogen area, when you contemplate various projects, are any of the projects that you contemplate involved with ammonia being made in some jurisdiction, whether it's the Mideast or Australia or somewhere else. That is, are you working with any possible builders of those projects, or you're not doing that?
spk16: Right, Jeff. So I'll headline that by saying, yes, we are. And I want to kind of give you a slightly broader picture as well. just to give you a sense of where we stand on the hydrogen piece. So as you know, I mentioned this before on a previous call, that we run our Linda Hydrogen Council. We meet every month. We review all the projects. The last review we had a couple of weeks ago saw 240 projects across that whole range of opportunities in that space, adding up to what we call probability-weighted capex of value of about 4.1 billion. So again, some of these are larger projects. Obviously, we see a large number of mobility projects which tend to be somewhat smaller. But to your point, one of the areas where we're seeing both the increase in the number of projects as well as large size projects is the space of carbon capture and Beyond that, we then look at hydrogen and ammonia as being two elements which kind of get added on downstream to that. So the answer is yes, we're working with a number of different customers and players who are looking at the ammonia loop. Jeff, you may also be aware that Lynda has its own ammonia loop. technology out of Linde Engineering. So, you know, we've done a number of these ammonia loops elsewhere, including in the Middle East and in Eastern Europe and in the U.S. So we have that unique advantage of being able to tie both or all of those technologies in and provide those solutions, which makes it very attractive to many of our customers.
spk05: Thanks very much.
spk10: Thank you. Our next question comes from P.J. Juvakar from Citi. Your line is open.
spk12: Yes, good morning, Sanjeev and Matt. Sanjeev, does your deal with ITM give you any advantage in winning green hydrogen projects since you have the PEM technology through the joint venture? And can you sort of give any examples of that?
spk16: Yes. PJ, hi. So, yes, of course. So the deal with ITM is unique in many ways, PJ. The first, that we are an equity investor in ITM. That means we have skin in the game with them. But more importantly, we have a joint venture with ITM. There is a Lindy Engineering ITM joint venture called ILE, which is where all the scale-up on larger projects above a particular size happens. And that is what gives us the unique competitive advantage of having access to great technology and being able to support ITM in scaling that up for large, large projects that we are looking at and pursuing. And, again, you know, we are seeing good developments in that space. A lot of proposal activity, PJ, as I referenced earlier on. We are very close in a number of cases in those discussions with some select customers. So, you know, really pleased to see that ITM linkage and find ourselves leveraging that quite actively, you know, as we develop these projects.
spk12: Great, great. And sticking to green hydrogen. You also had a deal with Plug Power to use their fuel cells to convert some of your Class 6 and Class 8 trucks over to hydrogen. Can you give us an update on that? Thank you.
spk16: So, Peter, we're working with Plug Power, and, you know, we work with Plug Power in many different ways. We supply most of the hydrogen requirements today, as an example. You know, while they don't have their own facilities up, we are also looking at, a collaborative development in a number of other spaces, which hasn't been announced yet. But, you know, we are kind of progressing on different fronts over there. One of the things that we have agreed with Plug Power, and I must admit here with a few other players as well, is that we will be trialing on our trucks, you know, fuel cells, and we'll be moving our trucks to hydrogen. So we already have a plan in place for the U.S., for Europe and South Korea to be progressing with those trials and seeing how they move forward. So again, a lot of activity happening in that space. We are really waiting with bated breath, PJ, to get these trucks on the road.
spk12: Great. Great. Thank you.
spk10: Thank you. Our next question comes from Peter Clark from StockGen. Your line is open.
spk15: Yes, good morning, everyone. Thank you. The first question is around, it's actually following on from the first question you had about the market share, particularly looking at the US packaged gas business, because I know there's differences in mix. I know the biggest competitor out there has a lot of hard goods, a lot of construction, but you've been seeing double-digit growth now in that business in the first quarter. You've probably accelerated on what you saw in the first quarter in the second quarter, and they're still actually down. particularly dragged back by the hard goods. So I'm just wondering, are you taking some share or is it all about mix and maybe regional? And then the second question is around the investments. Obviously, you're very excited with all the organic investment you have and the potential for that. I'm just wondering on the potential acquisition line, are you just not seeing many potential targets that fit the criteria on return given what you can do internally with your money? Thank you.
spk16: Thanks, Peter. Great question. So, you know, I have to admit, Peter, I am thrilled with the U.S. packaged gas business and the way, you know, that team is really moving forward at the moment with that. We see double-digit growth both on gas and hard goods. We see strong sequential growth on both of those elements as well. So I know I've read, you know, some of our competitors talking about that space, but the reality is we are certainly – growing very strongly in that space, and I see us kind of moving forward. Anecdotally, obviously, people will tell you that we're taking share, but I don't particularly want to comment on that. That is anecdotal, but you can look at the numbers, and I think the comparison will kind of tell its own, get you to the right conclusion. So, again, very, very strong performance over there on both hard goods and gases. If I move on to investments and talk a little bit about the acquisitions piece. So one of the challenges, Peter, as you'll appreciate, given where we stand in our size and having lived through three years of of regulatory approvals on the merger, we are very sensitized to how large acquisitions can happen. So we are left with a much smaller pool of opportunities there. We will do tuck-in acquisitions in most of our markets any day. A good, high-quality tuck-in acquisition, we will go after and we will do that as soon as we find them. And, of course, they have to live up to our investment criteria requirements, as you know well. The larger ones become a little more challenging, particularly as we've got to kind of understand the requirements from local regulatory environments or antitrust, et cetera. And that's where typically something larger trips up. So do I expect to see us doing acquisitions moving forward? Yes. Will you see a large number of tuck-ins happen? Most likely where we find those opportunities come through, we will certainly pursue them all day long if we could.
spk15: Got it. Thank you.
spk10: Thank you. Our next question comes from Jeff Hare from UBS. Your line is open.
spk14: Good morning. Just have two very quick questions. First of all, in the margin improvement that you report, can I just check, does that include any benefit from rising energy costs? And if it does, could you possibly break that out? And then just looking at the operating cash flow, which is obviously flatten Q2 year-on-year and down sequentially. You've mentioned higher cash taxes. Are there any other movements within the cash flow in the quarter that have a negative impact?
spk03: Okay. Hi, Jeff. It's Matt. I can answer that. So I think your first question, just to make sure I got it right, you were asking about margin related to energy. Can you repeat that one again? I kind of lost it. Yeah.
spk14: So obviously you've got big margin improvement that you've been reporting, you know, for almost every quarter since you've come forward. you've merged, what I'm just trying to understand is within that margin improvement, you've obviously had rising energy costs. Does that give you a benefit to the margin as well? And so I'm trying to look at what the margin improvement would be net of rising energy costs.
spk03: Yeah, so on that one, the actual rising energy costs will dilute your margins, and that's what we call cost pass-through. So we isolate cost pass-through And obviously what that is, it's a simple grossing up. So you'll see the sales and cost of goods rise equal dollar amounts. So therefore, it has no effect on our variable contribution or gross contribution dollars, but it will have a negative effect on your margin because you're simply doing a gross up effect. So we isolate that out as cost factor. That is primarily natural gas and electricity, energy. So those components tend to drive that. Obviously, as inflation you're seeing in those type commodities rises, we will pass them through, but they will dilute our margins. So for example, year over year, I mentioned while we're up to 350 bps on our margin, that includes a 50 basis point headwind related to this cost path through. So excluding that, we would have been up 400 basis points year over year. So we are passing it through as our contract's enable, but it will be dilutive. As far as operating cash flow, yeah, to your point, the $300 million that was incremental year over year, it's about $250 million sequentially with the impact of taxes, and that is purely timing, just when payments were made. In addition, working capital probably was about $100 or so million unfavorable Part of that is growth, and we are growing, so we're consuming a bit of working capital. But when I look at our cash conversion cycles, our DSOs, they're quite good across the board. Another piece is simply engineering timing. As you saw, engineering was consuming a bit of their backlog. What that is on a cash cycle, you tend to have more of a negative downside. But as Sanjeev mentioned, we have a high degree of confidence of our entire backlog, including sale of plants. So we feel that's something looking forward we'll turn around. And I feel pretty good about where our Q3 cash flow will be and making some of this timing back up both on working capital as well as cash taxes. Thanks.
spk10: Thank you. Our next question comes from Marcus Meyer from Badr Bank. Your line is open.
spk01: Good morning, gentlemen. Two questions from my side. First one on your nitrogen business. Given the recovery of the oil price, was there really a positive effect on your nitrogen for enhanced oil recovery business? And if not, what kind of oil prices you think you need or your business need to see a recovery there to come be back to 13, 14 levels? And the second question would be on the effect of startups you expect this year and also next year. that we can basically strip out the underlying business together with new business.
spk16: Thanks, Marcus. So your question on nitrogen enhanced recovery using nitrogen, as you know, we've got a couple of large customers who do that. That's been fairly stable through this period, so we haven't really seen significant volatility in that. It's been stable and works right through. The geology is, Marcus, that as you are using nitrogen for enhanced recovery, you are then in that process linked to that. You can't really step out or provide a lot of volatility. It isn't great for the field. So you see that at fairly stable levels. In terms of startups, yes, we do have a number of startups happening. As you know, from time to time, we kind of release, you know, provide a press release that covers some of those. I don't want to name them, but we do have a few happening towards the end of this year. And, yes, beginning of next year as well, there will be a few more startups that will happen.
spk01: But the kind of magnitude of growth, can you give us some kind of indication? Sure.
spk16: So one way to think about that, Marcus, is I'll bring you back to something that we've said in the past and just gives you a correlation, which is when I think about our EPS growth, I'd say, you know, our backlog and therefore that really, that backlog getting converted into startups provides us roughly a two percentage point over a three to four year period. You know, that's what we're likely to see from the backlog that we currently have. And that's one way to think about how the startup impact comes through down to the EPS level.
spk01: Okay. Thank you.
spk10: Thank you. And our next question comes from John McNulty from BMO Capital Markets. Your line is open.
spk06: Yeah, good morning. Thanks for taking my question. So I guess two of them tied to the same topic, which would be inflation. So obviously we're in a really kind of almost hyperinflationary market. Can you remind us, in terms of the backlog that you've got and the projects that are in that backlog, How much of the equipment, the materials, et cetera, have already been locked up so that you don't have to worry about inflation? And what percent is maybe not necessarily locked in at this point that we have to kind of think about?
spk16: Sure. John, so when we get into a point of securing a project, whether it's on the sale of gas or the sale of plant side, by then we get into a fairly detailed costing mechanism and we lock in our costs at that stage with all the OEMs in particular, but other sub-vendors as well. So when we are in a backlog stage, most of our costs are already locked in pretty much. So that should give you a sense of how we stand. As we're seeing inflationary trends now, we're already factoring those in into the proposals that we're developing and providing to customers. So, again, we have good mechanisms in place, a lot of experience of having managers jump to make sure that that coverage is very strong and a very diligent process or rigorous process around it in our engineering teams.
spk06: Got it. No, that's helpful. And then I guess just kind of tied into that, given this inflationary environment, it does look like, you know, your European business, your Asian business, we saw some price acceleration. Is that something, you know, given the inflation levels that we're seeing that we could see further acceleration from, you know, from the pricing that you're putting through? I know it's pretty lofty already, but can we see even more of that, you know, just given the environment? How should we think about that?
spk16: So, John, that's a great question. And, you know, as we've kind of shown, 3% overall pricing comes through. You know that a large part of the pricing comes through the merchant and package business. And very little of that really comes through the on-site line. So, therefore, you can do the math and you'll get to a number that says mid-single digit on average on pricing across those different segments, particularly from merchant and package. Now... Our team has done a fabulous job of making sure that we remain ahead of the curve as far as inflation is concerned. We've been telling you this for about two quarters now, and I expect that team to continue to do that as we move forward. So, you know, for us, making sure that we are working that pricing diva, having those conversations with our customers, you know, as we see those inflationary trends continue to come through, you know, it remains right on top of mind for us.
spk06: Got it. Thanks very much for the call. I appreciate it.
spk10: Thank you. Our next question comes from Vincent Andrews from Morgan Stanley. Your line is open.
spk07: Thank you. Just a question, you know, the billion-dollar base CapEx that you talked about, could you just talk to us about sort of what, you know, how sort of robust that menu of opportunity is and, you know, why you choose it to be a billion versus why isn't it 500 million or 2 billion? Is it, you know, as far as the eye can see? How do the returns there compare to, you know, the traditional CapEx backlog?
spk16: Sure. Vince, that's a great question. I'm glad you asked that question because I've been itching to talk a little bit about small onsites. So that's a good lead in there. So let me first just describe that. So essentially, you know, when we have, you know, projects, and I think small onsites is a great example to just illustrate the point. Here we have We have long-term contracts, so these are contracted. We have kind of secured cash flows in there. But individually, these are less than $5 million each typically, what we call our small onsites. And they have short execution timelines. They're accretive, good solid returns. These are projects we'd love to do every day. And the reason I want to particularly talk about it today also is because In the first half of this year, we did more than 25 of these projects already. We've signed up more than 25 small onsite projects already. Now that's a 50% jump over last year. Same period last year, we are 50% higher than that. And I love these projects because great solid return, you know, good, strong execution. These are package plans, so we can go in there and work on them very quickly, and which is why we get that execution advantage as well. And I think the other point to just make over here, and while I, you know, on most points, I think, you know, we think about the merger being over, and that's true. But here is an example of revenue synergies that we talked about. We never really... kind of, you know, we never really put a number to it, but this is a good example of how the revenue synergies from the merger are flowing through. But we brought in two suites of technologies, giving us a really strong position in that space, and we leveraged that actively in kind of winning these deals that you see us put through. Now, all of these come through that base cap expense. So am I excited about that number of, you know, $1 billion? I am. There isn't a cap to it, and, you know, that flexes with, what the business does and what the needs of the market are, and clearly we will flex that with what we see in the market demand. All it needs is those investments have to meet our investment criteria. That's all it needs. Good quality projects, any day, any time, happy to do, small or big. I hope that helps, friends. That was great.
spk07: And maybe just as a follow-up, and I might be reading more into this than I should, but now that you're combining sort of the sale of gas backlog and the sale of plant backlog, It feels to me you're sort of bringing the sale of plant business, you know, a little bit more to the front of the stage than perhaps it's been in the past. And, you know, I see clearly that that's a lower margin business, but it's obviously a CapEx light business versus the sale of gas. So I'm just wondering, am I correct that you're kind of thinking about the engineering business having more prominence on a go-forward basis? And do you have a plan there, you know, to sort of – improve the margins and the returns, or is there more we're going to be hearing about it in the quarters and years to come?
spk16: That's a great question, Vin. So let me just take a step back, if I may, and just talk about the concept of how we think about our business and opportunities, right? So the starting point for us is we want to be able to participate in the full range of opportunities that we see in the marketplace. And to do that, I have a unique competitive advantage, which I am going to leverage in which is the ability to offer an attractive sale of gas model, or in some cases where that customer, looking at those two models, is not particularly keen on that, to be able to offer and get the business with a sale of plant model. So either proposal for me works quite well. Now, the profiles are a little bit different. You're right in saying that doing an EPC type structure for us is asset light. It is obviously accretive. It's cash flow positive for us. So we do think our engineering capabilities and the fact that we have those capabilities executing day in and day out at a tremendous level, is a really strong competitive advantage that we have, and we want to make sure that we leverage that as much as we need to. Now, I do want to just make sure that you understand and recognize that we aren't giving prominence to one or the other. These are two options I have and I use those options where I need to and where I can exercise them and do what's best for the organization. Now, there are two kind of underpinning principles in there. One, I want to be able to approach every opportunity in my space that I have the advantage and the ability to execute on. And two, I want to maintain discipline and my investment criteria. And I think this is that unique advantage that we get, you know, bringing the two together.
spk07: Excellent. Thank you very much. Appreciate it.
spk10: Thank you. Our next question comes from Mike Sasson from Wells Fargo. Your line is open.
spk00: Hey, good morning. Nice quarter there. historically, inflationary environments tend to be good for industrial gas demand. And I'm just curious, given where we're at in this inflationary cycle, do you think there could be sort of a step up in the multiplier for demand for industrial gases as we head into the next couple of years?
spk16: Hey, Mike, that's a good question. So when we think about inflation, typically we spend most of our time talking about what happens to the pricing side. But you're right, inflationary environments, you know, we actually like inflation, as you've heard us say before, largely because, you know, on the pricing side, we have the ability to pass, you know, much of that inflation through our contractual structures onto the customers. And also, it's a good opportunity for us to open a conversation on pricing. Now, typically, when we see inflationary environments, we do see some industrial activity pick up and recoveries happen and constraints that lead to that inflationary environment, that's where we play actively. And yes, I think in some areas we will see some of that play out into demand on the demand side as well.
spk00: Great.
spk10: Thank you. Thank you. Our next question comes from Kevin McCarthy from Vertical Research Partners. Your line is open.
spk04: Good morning. Sanjeev, I was wondering if you could provide an update on the SNAM deal that you announced in December of last year to develop clean hydrogen projects in Europe. How is that partnership going in the early days? Is the paradigm to move inexpensive energy from Northern Africa up to the European continent? And if so, what are the barriers, if any, to making more substantial capital investments in that arena? Does it have to do with technology and production economics, or perhaps more on the commercial side? Maybe you can flesh out how you see the future there.
spk16: Thanks, Kevin. That's a really good question. So the partnership with SNAM has gone well, and we are like-minded in our view of how the market needs for hydrogen in Europe, in particular mainland Europe, needs to be met. And that kind of common understanding and common appreciation of what needs to happen is critical for that partnership development to move forward to, you know, getting something substantial happen. Now, you know, as with all good things, Kevin, these things take time. And there is, as you are aware, a lot of funding activity happening in Europe as we speak. And, you know, as part of that, I think we are waiting and watching to kind of see how that develops. That's in terms of how the partnership itself is moving forward. I want to just take a bit of time and talk about your other part of the question, which is what do we see as elements that will either encourage or create barriers for some of these substantial developments to accelerate and get momentum? Here, and unfortunately, I'll be repeating myself a little bit here, but I said earlier on to Nicola's question that you need a couple of things to be happening in tandem. One, you need to see the regulatory environment with some teeth coming into place in Europe. We do have that. But I must admit at the same time that it is complex. I won't say bureaucratic, but it's almost that. It has a number of administrative controls. It goes through a country process first, then at the European Union level, and then some allocations will happen. And there's a whole suite of activities that need to happen before some of that funding and incentives become actually available for you to be able to go out and make these substantial developments happen. There is that whole piece that is just part of the process. On the technology side, the other piece that I mentioned, you need a roadmap where you can develop on the assumption, and Europe's kind of chosen the path of green. My view is that scale will happen on blue hydrogen before it happens on green. There is absolutely no doubt in my mind that that is true today and will be true for a number of years to come. Technology for scaling up on blue exists today. Linda provides that whole suite of technologies today to be able to do that. So on the green side, which is where Europe's kind of moved forward and I won't say selected, but certainly leaned towards, we will need to see that technology development to scale happen. I think that is a technology roadmap that's kind of three to five years out. You need low-cost renewable energy. Again, that's a development that's in progress and not available everywhere in Europe, as you know, which is why this whole concept of Africa becomes so attractive and Northern Africa in particular. And you also need effective technology roadmap for the electrolysis, you know, to be able to bring that capital and efficiency up to a point. So capital down, efficiency up to get to a point where you can then create a cost advantageous position for green. I see those as both work in progress. We are actively involved in all of those activities as we move forward, but it is still work in progress.
spk04: Very helpful. Thank you, sir.
spk10: Thank you. And we'll take our last question from Lawrence Alexander from Jefferies. Your line is open.
spk09: Good morning. Can you just elaborate on the discussion around pricing? Are you seeing existing on-site customers start reopening contract negotiations or renewals earlier than normal to get in front of the inflationary cycle?
spk03: Hey, Jeff, or Lauren, sorry, it's Matt. I would say no. Things are pretty consistent with as you'd expect. I mean, normal pattern is usually two to three years prior to the expiration of you begin to talk about the renewal and any type inflationary environments usually don't have any impact on that.
spk10: Thank you. Thank you. And that does conclude our question and answer session for today's conference. And I'd like to turn the call back over to Juan Velez for any closing remarks.
spk07: Crystal, thank you. And thank you everyone on the line for participating in today's call. If you have any questions, feel free to reach out. Have a great day.
spk10: Ladies and gentlemen, this concludes today's conference call. Thank you for your participation, and you may now disconnect. Everyone, have a wonderful day.
Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

-

-