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spk05: Good day, and thank you for standing by. Welcome to the Lindy PLC Third Quarter 2021 Earnings Teleconference. At this time, all participants are in a listen-only mode. Please be advised that today's conference is being recorded. After the speaker's presentation, there will be a question and answer session. I would now like to hand the conference over to Mr. Juan Pelaez, Head of Investor Relations. Please go ahead, sir.
spk16: Thanks, David. Good morning, everyone, and thank you for attending our 2021 Third Quarter Earnings Call and webcast. I'm Juan Pelaez, Head of Investor Relations, and I'm joined this morning by Steve Angel, Chief Executive Officer, 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 of this presentation. Steve will provide some opening remarks, and then Sanjeev and Matt will give an update on Lindy's business outlook and third quarter performance, after which we will wrap up with Q&A. Let me turn the call over to Steve.
spk02: Thanks, Ron, and good morning, everyone. Lindy employees delivered another solid quarter, continuing Q2's record EPS performance. despite increasingly challenging market conditions. Operating cash flow and return on capital reached record levels, and our project backlog nearly doubled, providing a strong foundation for high-quality long-term growth. We also stepped up our commitment to reducing our greenhouse gases emissions footprint, and Sanjeev will share that roadmap with you. But frankly, this isn't something new. It's what we committed to our shareholders since the merger and have been delivering on ever since, irrespective of the macro environment. Most of you know this, but I think it bears repeating. Our operating culture runs deep at Linde. Our people take great pride in demonstrating continuous improvement across the key operating metrics in their business. The best day of the month for our management team is when we review the operating performance of each of our regional business units. This is what we do for fun in Danbury, among other things. Now, I'm sure you've seen the announcement earlier this week where I will become the chairman of the board and Sanjeev will become CEO effective March 1st. His appointment is the culmination of a diligent three-year succession planning process in which Sanjeev clearly demonstrated he was the right choice to lead this company going forward. I will continue to provide guidance, both from the perspective of a director and a significant shareholder, but my primary responsibility shifts to chairing the board of directors while Sanjeev takes over day-to-day management of the company. Supporting Sanjit is a highly capable and experienced leadership team. I have been CEO for 15 years, and I have never felt better about how the company is positioned. Obviously, our strategy is working well, and the team is executing at a high level. Some say we are a well-oiled machine. I wouldn't disagree. We are a company for all seasons, and I'm confident Lindy's best days lie ahead. Before handing off to Sanjeev, I would like to take a moment and thank Wolfgang Reitzler for his partnership in bringing our highly successful merger to fruition, and our directors and investors for their continuing support. Lastly, I want to thank our employees worldwide for creating the leading industrial gases and engineering company in the world. I'll now hand the call over to Sanjeev.
spk13: Thank you, Steve. I'm honored to be given the opportunity to lead this outstanding company into the future. I appreciate your confidence and support over the years. Before I jump into the slides, I wanted to build on Steve's comment of a seamless leadership transition. Here at Lynda, we are proud of our industry-leading performance. It starts with living our core values while maintaining a disciplined execution culture. As CEO, I fully intend to build upon our foundation. My focus will be on areas that are aligned with the interests of our shareholders. Profitable growth, optimize the business, cash generation, and of course, the truth serum for our industry, ROC. Lynda will remain focused on the things that create value for Lynda owners, such as strong pricing and productivity culture, an active commitment to sustainability, a disciplined investment philosophy, a shareholder-friendly capital policy, and of course, pursuing high-quality and sustainable growth initiatives with emphasis on ROC. Ultimately, it's about being the best performing industrial gases and engineering company in the world. Stated differently, you can expect a seamless transition with minimal change. Now, with that said, let's move on to slide three for an update on our growth initiative. Last quarter, I mentioned some key growth drivers, including the secure project backlog, the creative base CapEx investments, and the strength of our growth in low capital intensity areas such as healthcare, food and beverage, engineering, and our packaged gas business. Today, I'm happy to report that our project backlog has increased from $7.5 billion to $13.4 billion, or up 81% sequentially from the last quarter. You will recall this backlog only includes contractually secured incremental growth with fixed payments to ensure targeted returns. We're also beginning to see a return of the capital cycle, especially in upstream operations such as natural gas production. That bodes well for our overall pipeline of opportunities. On top of that, the electronics sector continues to be very active. We recently announced a $600 million investment, sale of gas investment indeed, to supply a world-class fab in Phoenix, Arizona. This is supply only the first phase of this project, and we expect to see further opportunities as that area builds out. Overall, I'm pleased to see how the entire Lynda team has come together and is leveraging our combined strengths to secure high-quality growth opportunities. through our leading high-density industrial gas network, combined with the world-class engineering capabilities. This backlog, combined with our supply network density, enables profitable and secured growth for years to come. Now, before moving to the quarterly results, I want to update you on Linda's new and more ambitious greenhouse gas emission goals. A good way to start this is to first explain the role our products play in people's lives and the overall economy. You'll find this on slide four. We make products that are critical for society. Products such as medical oxygen for hospitals, ultra-high-purity nitrogen for semiconductors, liquid nitrogen for food freezing, krypton to insulate windows, and hydrogen to produce cleaner fuels, to give you just a few examples. In order to make these products, we expect to have a total of 39 million metric tons of Scope 1 and Scope 2 emissions this year. As you know, the production of gases requires significant amounts of electricity. When such electricity is generated using hydrocarbons, we are penalized for those indirect emissions called Scope 2 emissions. We also have Scope 1 emissions, which are significantly lower than our Scope 2 emissions but are significant nonetheless. Now these emissions are largely as a result of using natural gas to make hydrogen, which is used by refiners to produce cleaner fuels. Our gases play a critical role in the economy. In addition to saving lives, improving energy efficiency, increasing shelf life, our products also help our customers eliminate or reduce greenhouse gas emissions. In 2020, we generated a total of 37 million metric tons of emissions to make products that helped our customers avoid more than twice our emissions, or 85 million metric tons of CO2 equivalent. In other words, without Linde's products, there would be significantly higher net carbon emissions in our world. At Linde, we have been doing our part to support our planet for many decades, but we know We need to do more. In 2019, we set a goal to reduce the carbon intensity of Linda 35% by 2028. We are well ahead of that goal and expect to exceed it, which is of course good news. But an intensity goal doesn't fully address the absolute scope one and scope two emissions. So we are determined to continue on our mission of making our world more productive, enabling our customers to decarbonize and commit to reducing our own carbon footprint. With that in mind, I'd like to announce Lynda's new medium and long-term emission goals, which you will find on slide five. The first goal is to achieve a 35% reduction in our Scope 1 and Scope 2 emissions by the year 2035, or simply 35 by 35. To achieve this goal, we must materially reduce our scope on emissions, which are driven by hydrogen production. We will do this by focusing our efforts on carbon capture and sequestration, developing blue and green hydrogen production, and progressively transitioning to a zero-emission fleet. Our scope to emissions are related to electricity consumption. Today, we consume approximately 45 terawatt hours of power. a third of which is from renewable and low-carbon sources. In order to achieve the 35 by 35 goal, we will triple our renewable and low-carbon power sourcing by 2035 through new PPAs and by supporting renewable energy projects with off-take agreements and even co-investment. To put this goal in perspective, the amount of renewable energy we will plan to purchase is equivalent of all the power consumed annually in New York City. That's a big number. Of course, in addition to that, we will continue improving the energy efficiency of our plants as well. These goals are being embedded across the entire global organization, being reviewed as part of our operating rhythm, and will be incorporated into our annual variable compensation. This is what gives me the confidence in our ability to deliver these goals, which is no different than how we would approach anything of importance in our company. Now, in addition to the 35 by 35 goal, we are also committed to pursuing our goal of becoming climate neutral by 2050. We will do our part to achieve this goal, but we also need strong policy support and regulatory support. Let me summarize this journey on slide six. We have defined a roadmap to reach climate neutrality. The roadmap is underpinned by numerous initiatives and milestones, which will be embedded into our operating system, providing us the greatest opportunity for success. Going forward, we will continue to share our progress, ensuring accountability and transparency for our stakeholders. I'll now turn it over to Matt to walk you through the numbers.
spk03: Thanks, Sanjeev.
spk07: Please turn to slide seven for an overview of the third quarter results. Sales of $7.7 billion increased 12% over last year and 1% from the second quarter. Cost pass-through, which represents the contractual billing of energy cost variances, primarily in the onsite business, rose 3% over last year and 2% sequentially. Recall that cost pass-through has no effect on profit dollars, but will impact profit margins as we gross up or down sales and variable costs. Foreign exchange was a 2% tailwind versus prior year, but a 1% headwind sequentially, as most currencies have recently devalued against the US dollar. Excluding these items, underlying sales grew 11% over prior year and 1% sequentially. The 8% volume increase over last year was broad-based across all geographies and in markets, as we continue to see recovery from the pandemic. Sequentially, volumes are flat as contribution from project startups were mostly offset by lower volumes in China. Pricing levels are up 3% from last year and 1% from the second quarter as we continue to adjust merchant and packaged gas product pricing in line with local inflation. Note that some of these contracts have lagging recovery mechanisms, which may not take effect for two to six months depending upon the terms and conditions. Operating margin of 23.6% is 150 basis points above 2020, but 60 basis points below the high mark set in the second quarter. Excluding the impact of cost pass-through, operating margin would have increased 220 basis points above last year and had a negligible decline sequentially. As mentioned, merchant and package cost recovery can lag one to two quarters. So going forward, I expect continued pricing momentum. EPS of $2.73 is up 27% over last year from higher volumes and price over a relatively stable cost base. As both Steve and Sanjeev mentioned, Linde has a strong productivity culture, which enables consistent profit growth irrespective of the economic climate. This is also evident in the 16.7% return on capital, which represents another record as profit continues to grow double digit percent over a flat capital base. The reason we've been able to maintain such a steady capital base is due to a combination of disciplined capital management and healthy cash generation, which I'll cover on slide eight. You can see to the left our operating cash progression, resulting in a record level of $2.6 billion in the third quarter. The three main drivers are stronger earnings, timing benefits from last quarter, and engineering contract prepayments. In light of the record sale of plant backlog, I anticipate further project prepayments into the next few quarters. As far as how we allocated year-to-date cash, the pie chart to the right shows $2.3 billion invested into the business and $4.8 billion distributed back to shareholders through dividends and stock repurchases. Note that investments exclude sale of plant since we are paid in advance for engineering projects, which means that we are committing much larger amounts toward contractually secured growth than what's shown on this chart. In addition to generating significant surplus cash, we have access to very attractive capital through the debt markets. In September, we issued almost 2 billion euros at 5-, 12-, and 30-year maturities with all-in coupons of 0%, 0.38%, and 1% respectively. Overall, The combination of excess cash generation and low-cost incremental debt gives us a high degree of confidence to maintain shareholder-friendly allocation policies over the long term.
spk03: I'll wrap things up with guidance on slide nine.
spk07: The fourth quarter EPS guidance range of $2.60 to $2.70 is 13% to 17% above last year and 38% to 43% above 2019. Consistent with prior quarters, we believe it's important to distinguish true multi-year growth from mere recovery of 2020 recessionary conditions versus the third quarter This range represents a sequential decrease due to normal seasonal declines plus an estimated 1% foreign currency headwind. Underlying volumes are assumed to be roughly in line with the third quarter. But if current conditions hold, I'd expect to be at the upper end of this range. This quarterly update results in a new full year guidance of $10.52 to $10.62, which represents a growth rate of 28% to 29% over 2020, and 43% to 45% over 2019. In summary, another solid quarter, despite some challenging conditions. And regardless of the macro, we remain confident and Lindy's ability to continue delivering industry-leading performance.
spk03: I'd now like to turn the call over to Q&A.
spk05: Thank you. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star 1 to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions.
spk03: We'll take our first question from Bob Cort with Goldman Sachs.
spk15: Good morning. Thanks very much. I was wondering if you guys could comment a little bit on the hydrogen markets and your engagement there with customers and partners, how that may have evolved over the last several quarters. Maybe from the context of from the outside, it just seems like there's a massive broadening of participation as people start reaching for that opportunity. Just maybe give us some insights into how you've seen that evolving, Lindy. Thanks.
spk13: Thanks, Bob. I'll take that very quickly. I agree with you that there's been significant and continuing momentum in the space, and I'm very pleased to suggest that we are seeing a reflection of that in the activities that we are actively pursuing. I'll start off by just describing what the opportunity pipeline looks like, because that's reflective of the level of activity that Linda is seeing, and then talk a little bit about the particular areas where we see some of that momentum reflected now. So starting over the projects that we're looking at, as you know, we run this monthly call on the Hydrogen Council that Linda runs internally. You know, we've got about 260 projects in our pipeline. We've got a probability weighted, sort of conservatively probability weighted number in terms of investment decisions of up to four, four plus billion now. And these are decisions we expect to see, you know, happen in the next three years or so. In the past, you've heard me say that we expect to see us investing about a billion a year roughly in this space. And then on top of that, there may be some mega projects that come along as well. So that's just to give you a sense of the level of activity that there is happening around that space. Now remember, and I've said this before, Bob, so you'll kind of recall, Lynda has a unique position in what is happening in the evolving space around clean energy. We've kind of described to you previously Under decarbonization, we look at carbon solutions and we look at hydrogen. In the hydrogen space, we obviously are very mindful and interested in the developments around blue hydrogen. We see that as a very important transition in this clean energy roadmap that lies ahead. And this is where we are seeing significant pickup in terms of activity. We are currently involved in a number of projects, you know, which have a range of investments, and those are progressing well. And again... For projects in this space to make sense, you need three things to be happening. You need the technology provider, in this case that is us, for carbon capture. You need partnerships to ensure that you're then looking at sequestration effectively with partners who have longstanding experience and knowledge of that space. We're currently actively pursuing those as well. And of course, third, very importantly, you need an off-taker. You need a partner who's willing to stay in the game and actually offtake the blue hydrogen that comes off that and is able to create some value as a result of that. First, those three things are very important. And again, I'm pleased to say that we're seeing those partnerships actually take, you know, gather a lot of momentum as we move forward. I'll kind of stop there for a moment and give you, you know, see if that answered your question.
spk15: Yeah, that's very helpful. What about the competitive intensity? Is that landscape has been populated with more and more companies investing maybe trying to edge in on the turf that has historically belonged to the industrial gas companies?
spk13: So the way I'd answer that, I think, Bob, is just to kind of remind you a lot of people. So firstly, lots of announcements. I think you see them, we see them every day. And every morning I wake up to this long list of announcements that are happening. A large number of people who make those announcements have either never seen or heard of hydrogen before this. Most of them don't even understand that we have a colorless molecule that obviously is now defined by very, very many colors. But I mean, putting that aside in terms of experience and expertise, the reality is there will be a number of players who will make a difference in this space. And as part of that, you will see a range of outcomes. You will see us competing where we need to, and you will see us partnering with a number of those as well. This is an area that requires strong partnerships for that initial momentum and the ecosystem development to really happen. And I see that development happen where we are kind of speaking to a range of partners across different areas, helping move this along. So I don't particularly kind of see this as a space that you're going to see the intensity of competition being any different to what we see otherwise.
spk03: Very helpful. Thanks, Sanjeev. We'll take our next question from Duffy Fisher with Barclays.
spk06: Yes, good morning. First, just want to say congrats to Sanjeev on great promotion and thank you to Steve for the decade and a half. And I think from investor standpoint, maybe even more from the way the transition was handled, you know, almost picture perfect. So thank you guys all for that. I guess my question is around LendCare and maybe the medical business in general. If you go back before COVID started, and just kind of analyze how that business has developed with COVID as kind of a driver. How do you see that business structurally different today, and how much has it grown through that period relative to the rest of the business?
spk13: Javi, thanks. Let me get into it, and I'll start off by just taking a step back and outlining the healthcare space that we operate in. and also reminding everyone that, you know, we have strong leadership in that space. So, you know, we think of our healthcare business in two different areas. We look at hospital care, where we are the primary provider of medical gases to hospitals, and, of course, a home care business, where, as you referenced, Link Care is a very, very important player in the U.S., but we obviously have smaller home care businesses elsewhere in the world as well. So thinking structurally about that business, you know, let me just kind of say to you there are two things happening as we speak. Obviously, you've heard us talk about how that business has supported and saved lives and supported hospitals and patients at home over the last 18-plus months now. So clearly it's played a very important role. Link Care in particular in the U.S. was almost seen as a second line of defense supporting COVID patients at home through the respiratory offerings that we have. What has happened as a consequence of the pandemic is that a number of regulators and governments have, in the best way to describe it, has woken up to the realities of how they need to manage this more professionally in terms of storage, in terms of piping, in terms of infrastructure necessary for these high levels of medical gases and oxygen in particular to be delivered to their infrastructure and network. We've been participating in many of those conversations. In fact, most governments have reached out to us seeking support and help in structuring those conversations. And we are obviously leading many of those conversations across the world today where we are helping governments and regulators make sure that they have a well-thought-through infrastructure program and a development process around how they will manage this going forward. A kind of pandemic preparedness a little bit late in the day, but nonetheless important to make sure for the future. The reason I mention this is because this means As we move forward, we are going to see continuing activity in this space. We will be participating in those activities and expecting a level of growth out of that. We've said this before, Davi, you've heard us describe mid-single-digit growth for our healthcare business overall, and I still maintain that we will see that. Obviously, in the Link Care world in particular, tuck-in acquisitions is something that we are very interested and excited about. So we'll continue to see those come through, adding on to that mid-single digit or contributing to that mid-single digit that I referenced earlier on as well. So I do see this solid secular growth trend. I see it progressing with that strong mid-single digit growth that I described earlier on. And I see us seeing, you know, kind of areas in the world where we will see that probably grow, not probably, will grow at a higher pace, Asia being one such example. Again, because of the strength of our footprint there, we have the ability to make sure that we leverage that footprint for that incremental growth in Asia as an example.
spk06: Terrific. And then maybe just a quick one. As we start to look into 2022, when you look at just the new project growth coming on stream, How will that impact 2022 relative to what we've seen over the last couple years?
spk13: All right. So I have to say I expected that question, so that's good. Now, so I want to maybe take a step back and just go back to what we said maybe a couple of earnings calls before, right? We committed to delivering a 10-plus percent EPS growth for the midterm. As you can imagine, I feel pretty confident about that today as I'm sitting here. This is obviously supported by this very strong backlog that you just referenced. I have to say that this strong backlog, you know, world providers with mid-single-digit EPS growth, if you like, for the next four years or so. So that's a pretty strong contributor right there for you. Now, on 2022 specifically, Tafi, I'm going to say to you that in about three weeks' time, we're going to spend three whole days with every region around the world you know, going through our planning meeting. You know, Steve mentioned to you how we have fun in Danbury. This is going to be one of those fun events. We will review, we'll dissect, we'll analyze their numbers, and then in the end, we'll agree with them what they need to deliver for 2022. So I'm looking forward to coming back in January and giving you an update on the outlook and our guidance for 2022 once we've had this meeting.
spk03: Great. Thank you.
spk05: We'll take our next question from Nicola Tang with Exane, BNP Paribas.
spk01: Thanks, everyone, and congratulations to both Steve and Sanjeev. First, let's ask a question on China. I think, Matt, in your preferred remarks, you talked about volume weakness in China. I was wondering if you could comment on what you're seeing on the ground there in terms of sort of direct and indirect impacts from the energy control measures, I guess, both in terms of today's the impact today and in terms of with respect to future investment opportunities. And then the second question was on engineering and congrats on this very big project. I think you used to talk about a kind of mid or low to mid-teens through the cycle kind of margin, but we've been tracking above that for some time now. And so I was wondering whether there's any reason to assume that this new business would be at a different margin to what we've been seeing in the recent past. Thanks a lot.
spk07: Sure. Hi, Nicola. I can take this one. So starting with China, yes, to your point, we did see some volume curtailments, as you would expect, with the power outages. We do feel very confident about our customer base. They're still paying the MTOPS. These are Tier 1 customers. This is something you've seen, as you probably know, in prior times in China when there are some centrally managed slowdowns. So from that perspective, yes, there were reductions on a sequential basis. Now, if you look at the APAC segment, you actually see volumes are up 2% sequentially. And the primary driver there is because our backlog pretty much offset any of that China sequential decline. And then the rest of our APAC business still performed well. quite well on growth, including some seasonal growth that we tend to see in the South Pacific. So from that perspective, yes, we had some of that. We anticipate a little bit of that to continue here into the fourth quarter. So when we talked about volumes assumed to be flat sequentially into our guidance range, it does take into account some continuing just volume softness based on this. But overall, we feel very good about our asset base. We see this as temporary and And to some extent, you know, we tend to come out stronger on these things with our customer base. So we'll see how that plays out. You know, on the engineering, you're exactly right. I mean, we have been operating kind of mid-teens or a little better. And as you can imagine, as you know, this business has pretty much a negative working capital. So what you see on the margins can be a pretty good indication of the type of returns you get or can even be a little better just based on the cash profile. So very good performance. George Arnaoutakis, Ph.D.: : Business that we have we're very excited to have this backlog, it will contribute to growth. George Arnaoutakis, Ph.D.: : We tend to focus more on the end P side as well, which which helps with the risk management so from this perspective, you know we still see margins kind of in this. George Arnaoutakis, Ph.D.: : i'll call it low to mid teens and we'll see how it plays out though over the cycle. George Arnaoutakis, Ph.D.: : You will always have timing in how you recognize the percent completion so quarter to quarter it's always tough to gauge on any particular one, but over the multi year process. we still think that kind of low double digit to mid-teens is still a reasonable estimate through this business as it kind of goes through the cycles.
spk01: Thank you. And if I may ask a follow-up question around sort of energy costs, and not specifically related to China, but, you know, more globally. Obviously, you know, with your business, it's clear in terms of the plaster effect or the lagged plaster effect. But I was wondering if you're seeing any impact on your customers, you know, deciding to idle or reduce production at their own facilities because of their own higher operating costs.
spk07: Yeah, sure. I can handle that one, Nicola. As you can imagine, on the on-site business, we have our fixed payments, whether it's a facility payment or an MTOP. So from that perspective, we tend not to really have much risk to the production volumes. Given that, it's not really anything I would be overly concerned with. In fact, if anything, what we've seen, especially on our more industrial projects, customers, they tend to running harder. You could think steel, you could think refining, given the environment they're in and the margins that they're making on some of these products. As far as the merchant and package, realize in package, it's a high rent business. So the volatility of the customer's demand will really only affect the gas molecules. And what we're seeing, especially in Americas and parts of Europe, still seeing pretty strong growth across that package business. So I think that's been quite good. But on the merchant side, no, we really haven't seen any significant negative changes. It's been up pretty much across the board. And you could imagine the customers want to produce, right? They want to make as much product as they can in this environment, given their opportunity to get some pricing. So from that perspective, we haven't seen any material effect on that. There may be some small pockets, but nothing that's coming up to the aggregate level.
spk01: Great. Thank you so much.
spk05: We'll take our next question from Tony Jones with Redburn.
spk09: Yes, good morning, everybody. I wanted to come back on the margins. So on an ex-cross-pass-through basis, margins are up, all regions, you know, in some cases materially. Just wanted to check whether there are any positives in there that we should be thinking about that could reverse as we go into 2022. And are we getting now also to a stage where this is about as good as it gets? Thank you.
spk02: Do you want to answer that?
spk13: Yeah, I can answer that. So, Tony, that's right. You know, you can see the margins moving up. X paths through year-on-year, our margins are up. And, you know, a strong showing by all the segments within that. So I think, you know, we see that momentum of what we've been working on kind of playing out in Q3. Now, you know, I don't really, as I mentioned earlier on, you know, we're going into the spanning cycle on 2022. I have to say one of the variables as we think about this is how does inflation play out and how do energy costs play out in the year ahead? I don't really want to be forecasting that, to be honest. But what I do want to give you is some assurance on the pricing, which then clearly then flows into the margin piece and addresses your question, which is you can expect us to always be keeping pace with inflation, global inflation. And that really is a reflection of how we will do that management around the pass-through elements in particular and pricing beyond that. And that's what will then come back, you know, through the leverage we have down to the operating margin that you'll see. So hopefully, you know, we'll come back and tell you in January what we think is the outlook for 2022 with a bit more precision. But for now, you can expect us to keep pace on the pricing side with any cost inflation that we've seen.
spk02: Just to add a comment to what Sanjeev said, this is Steve. You know, I think as we go forward, I don't like to ever hear the word peak margins because I never believed in peak margins. And when we say our best days are ahead, you've got to keep in mind that we are going through a period where there has been a tremendous amount of cost that came through the system, mostly in the form of power. If you were to look at EMEA, for example, costs increased 25% to 30% between Q2 and Q3. So that's a lot of cost that comes at you at once. We instantly pass that through, as Matt mentioned, on the on-site piece, but it takes a few months, up to six months, to be able to recover all of that through the merchant and the package business. But if you think, you know, going forward over time, and you've heard us describe this model before, we take the top line and we're able to leverage that through pricing and productivity to deliver increased EBIT margins over the long term. And we've been able to do that for many years, and that's really going to be the model that we will be in going forward, especially as we clear this immediate wave of cost inflation that's coming through the system. And we deal with that in a very positive way in the coming quarters.
spk09: Thank you. That's really helpful. And if I could, just a small follow-up on the 35 by 35 targets. I appreciate also the update there. We've heard from some chemical companies that there's like extra costs or capex required to get sustainability targets. Is that going to be the case for Lindy? And maybe if so, you could help us think a bit about what that could look like. Thank you.
spk13: So Tony, as we put those targets up and we've built a roadmap around that, clearly, you know, you would have seen in our description of how we want to achieve that. You know, we are working Our mission here is to support our customers in their decarbonization attempt and ensuring that we have the technology and the solutions necessary for that. Now, we make those commitments keeping in mind the broader decarbonization trend that is happening. And, of course, in our support of that, we will need to make investments along the way, which we look at on a project-by-project basis. And each of those investments, we've said this previously, obviously need to kind of live up to our investment criteria. They will, of course, be supported by incentives and carbon pricing or carbon penalties, as the case might be, which actually makes that economic case necessary for that transition to successfully happen as we move forward. So I fully expect us to kind of see those economically feasible cases work out, ones that will actually have to meet our investment criteria as we support this broader transition for industry. As you know well, Tony, whatever we emit ourselves, is really there to ensure that we're helping our customers either abate, avoid, or completely eliminate emissions. And that goal continues to be what we'll focus on going forward.
spk03: Thank you. That's great. We'll take our next question from Peter Clark with Societe Generale.
spk11: Yes, thank you again. Congratulations to Sanjeev and Steve for that one hell of a deal. And I guess the share price reflected the thought that went in the transition there. I've got two big picture questions, really. Looking at the engineering backlog and the way it's grown, I think, Steve, you were commenting not so long ago that you saw 50-50 as sort of a very nice mix in terms of what was internal, what was external. Obviously, as the cycle's picking up, we're scoring now, we're at 75-25%. Just your thoughts on that. I accept, obviously, you're looking at your return criteria, et cetera, but just your thoughts on that as we go through the cycle. And the second one is your comments about best days ahead, hopefully. Obviously, your return on capital now is 200 basis points above where Praxair were 10 years ago at the peak. Just wondering your thoughts on the return on capital. Obviously, a lot of momentum to support that. but how you see this sort of on a structural basis as we move forward. Are we structurally higher now with all the benefits of the merger against what we thought we could get in gases prior to that? Those are my two questions. Thank you.
spk02: Well, given I'm not going to be the CEO past March 1st, I really don't want to provide too much long-range thinking about return on capital, but I think if you go back to what I said about being able to take growth, convert it to higher levels of profitability, good capital management. Over the time, we should be able to march the return on capital number up a little higher. With respect to the 50-50 comment, You know, if you think about when we book cellar gas projects, they typically are in the hundreds of millions of dollar range. So if you look at the TSMC project, that's $600 million of capital investment that would be tied for our largest with Samsung. So when we see cellar gas, it tends to be, that's a very big project. And clearly, you know, we landed some very large projects, third-party projects with Lindy Engineering. And that obviously shifted the weighting in terms of whatever that is, 75%, 80% of the total backlog is third-party sales. It's driven by these very large projects. Matt alluded to this. These very large projects have very strong contractual terms. They're very high-quality contracts, I will say. We have cash flows that... Incoming cash flows that certainly are well ahead of our cost outlays as we work through these projects. So they're excellent projects, and we're delighted to have them.
spk03: Thank you.
spk05: We'll take our next question from David Baglider with Deutsche Bank.
spk08: Thank you. Looking at EMEA in Q3, can you quantify the amount of power costs that were not passed through or recaptured during the quarter?
spk07: Yeah, so, David, this is Matt. That's not a number we're going to provide publicly, but I think if you look at kind of the sequential margin profile and you adjust for the stated cost pass-through that obviously associates itself with the on-site business, some of those differentials of the remaining amount are things that we would want to be chasing related to some timing related. And as you can imagine, EMEA has a much larger package and merchant percent than on-site So that will also play into having a larger proportion of costs that need to be captured on a delay. And one thing I just want to be clear on is this lag is normal. This lag is inherent in the industry. We have faced this lag since our inception, you know, going back decades. It just so happens in this particular quarter, the movement of the energy prices, the movement of some of these numbers are faster in a shorter time period. So given that, you're going to have some recovery that'll be next quarter and the quarter after. But EMEA would be probably disproportionately larger than most other regions with that lag, just given the packaged and merchant exposure.
spk08: Got it. And given that, would you expect price mix to accelerate further in Q4 from the 3% we had in Q3?
spk07: So as I stated in the prepared remarks, yeah, we absolutely anticipate and expect the pricing momentum to continue. And this is something that as we go and recover this, that will play into it. So that's our expectation.
spk08: Thank you.
spk05: We'll take our next question from Jeff Zakowskis with J.P. Morgan.
spk14: Thanks very much. The backlog for sale of plant went up $6 billion sequentially. Can you talk about that? what it is that you're going to build. If you can talk about the customers, that would be great. If you can't, how did it grow so much? And does that mean that your CapEx order of magnitude is now going to be, I don't know, five and a half billion higher than you thought over a number of years to execute that? And then lastly, So if you're getting, I don't know, $480 million into your cash flow statement from prepayments, I take it that you'll fund that with capital expenditures later on. So in a certain sense, your cash flow from operations is overstated. Can you talk about those issues?
spk07: Yeah, maybe, David, I could start with the cash, and then Sanjeev could talk about the backlog project itself. So just to make sure we level set and get the accounting correct, this is sale of plant. So this never touches CapEx. This is under percent completion accounting. So what happens is the backlog that we have actually translates essentially one-to-one to sales. $1 backlog equals $1 sales. And as we construct it, it goes to inventory. And then when we meet the criteria, it's released out of inventory to sales. So therefore it never actually hits CapEx given the nature of how this structure works. And then as the prepayments come in, they sit on the balance sheet as a liability. And then obviously we work and deliver the performed work, which then goes against that liability to relieve that liability as we deliver. So this is a classic percent completion accounting style. So given that, and maybe let's talk about the cash flow real quick. In this business, in this industry of engineering and percent completion, when you're in a declining backlog, what tends to happen is your cash outflows are obviously higher than your inflows because you are delivering on the work, the engineering, the procurement. And you basically think of like a book-to-bill ratio, right? So as your book-to-bill ratio starts to drop and drop and drop, you're going to have more cash outflow than inflow. Now that trend is reversed. So we've actually had more outflow than inflow over the last few quarters because we were building off a backlog that was shrinking. Now it has grown dramatically. That process is reversing. As I mentioned in the prepared remarks, we have a few quarters. We expect some prepayments given the size and increase of this. And then we'll work them down over the next several years as the outflows go. But you still have more backlog that if you win, it can mitigate that. So that's how to think about this. It's not in CapEx. That's why I said in prepared remarks, the growth that we have is much greater than what's being shown in CapEx because of this delivering, as Sanjeev had mentioned, you know, we're going to be probably mid-single digit in terms of our contribution. So hopefully that makes sense, but I can hand it off to Sanjeev to talk about the project.
spk13: Thanks, Matt. So, Jeff, let me just kind of talk through the project a little bit and give you a little bit of color on that. So, you know, we have, you know, the six billion incremental two large wins that we're talking about, you know, are the reason why you're seeing this significant buildup in our backlog. You know, we are very happy with these projects, I have to tell you. They are with a very high-quality customer. I am going to name the customer now just for you, which is Gazprom. It's a customer with whom we have excellent relationships. We have got great experience thus far. We've got solid contract terms, which makes us pretty comfortable around taking on these large projects. Also, as Matt kind of referenced, strong cash flows. I want to remind you also that these cash flows tend to come in. The inflows are ahead of any commitments we make. So we tend to be net positive as far as our cash curves are concerned. And, of course, it's in an area where we've got good experience of execution. So, again, you put all of that together, you know, that's kind of the project. Now, what are we building? Let me just give you a little bit of color on that. So we are building some GPPs. So these are gas processing plants for Gazprom at the site called Ust Luga. And we're also building in a separate project also at that same site, which is a separate wind plant. but an important one also is an LNG plant for them. I expect natural gas developments will continue given the energy kind of challenges that the world is seeing, and this is kind of a major milestone as gas farmers continue down the path of investing in that space.
spk14: Okay, great. And then secondly, I think your cash balance was $4.7 billion. Is that too much? what should your normal cash balance be as you manage your cash flows?
spk07: Yeah, Jeff, I can answer that. Well, when you're getting paid to take commercial paper, 65 basis points, you do end up with a little bit of a grossing up of your cash and your CP. So yeah, we, we, we're still getting paid up till five years on the curve with Europe. So our cash balances are swelling a little bit. Now those are us dollar cash balances, so they are earning a return, but we're also earning a return on what we're borrowing. So at this point, that is causing a bit of the swelling. But as you've seen, you know, between our projects that we're undertaking, between some of the shareholder-friendly actions we're taking, you know, we're going to keep working those cash balances down.
spk14: Okay, great. Thank you so much.
spk05: We'll take our next question from Jeff Hare with UBS.
spk10: Hi, thanks very much for the opportunity. I just want to ask a slightly longer term question, and maybe to Sanjeev. Obviously, the sustainability targets you've put out are great, but I think you did mention that to achieve the 30 by 35, you need government support. What happens if you don't get it? What can you do yourself without any government support, particularly thinking about green hydrogen and other sorts of areas?
spk13: Thanks, Jeff. It's a good question. So I think when you think about the sustainability targets that we've put out there, 35 by 35, you have to think about the framework within which this is happening. So clearly there are activities that we can undertake and we are undertaking today which will continue to move in that direction. These are efficiency programs. This is about fleet replacement, et cetera. So there are a number of initiatives that are ongoing and we'll continue to work towards which will execute towards that. But it's also correct to say that even today, there are government incentives available. So we're not suggesting that there is a complete void over here and that we need a complete kind of remake of that. In the U.S., we have the 45Q that is being effectively utilized to look at investment profiles like this. Now, I have to be honest and tell you that I'd much rather that 45Q, which currently provides $45 to $50 per ton of CO2 be anywhere between $90 to $110 per CO2. That's where I would see the inflection point at which momentum for development of these projects would significantly ramp up because there'd be an economic case for it. In Europe, clearly there's the ETS, the trading scheme that is currently valuing CO2 anywhere between 60 to 65 euros per ton. So again, as we see that move forward where there is a plan... Similarly, in Canada and South Korea and in Australia, I could name a number of countries where these incentives or penalties are coming into play today. So we're working in that environment. We think that more support is necessary. But there isn't a complete lack of support. So a number of our projects will be relying on the support infrastructure that's available through the incentives and penalties to leverage off that to continue down that decarbonization trend. And of course, as we look longer term to carbon neutrality. In our assumption, when we think about a roadmap, clearly we've got some levels of support available. They range anywhere between, you know, $100 to $200 per ton of CO2. In equivalence terms, longer term to make sure that we get to, you know, that level of the neutrality that we're talking about, climate neutrality that we're talking about as, you know, being the goal that we achieved by then.
spk02: Can I just put a point on Samji's question? You know, excellent response to that. If you think about decarbonization and the cost of capture and the cost of sequestration, it can vary, you know, $80 to $120, something like that. And to really tip the scales in terms of capital investment to decarbonize, you know, you're going to need something like that in terms of a carbon price. So up until now, the 45Q can work in certain projects. It's $50, the low-carbon fuel standard in California. provide some support too, but as we look forward to really make meaningful strides in decarbonization, you know, you're going to need a stronger carbon price.
spk03: That's our view. Thank you. Our next question comes from PJ Juvicar with Citi.
spk12: Yes, hi, good morning. You know, on your slide 18, the slide on blue hydrogen, Is that where you're seeing some ordered activity today? And then looking at your joint venture with ITM in electrolyzers, how do you see blue versus green hydrogen backlog, let's say, in the next five years? And are your industrial customers wanting to go to blue hydrogen first before, you know, thinking about green hydrogen?
spk13: The way I'm going to answer that question is to kind of take you back a step and just remind you of some of the messaging that we provided in the previous earnings calls. So I've said before that when people think about what hydrogen is most appropriate, one of the things you have to think about is the strength individual countries have, the assets that they have. Where countries today have... Hydrocarbon assets have natural gases as an asset. We firmly believe that they will pursue the path of blue hydrogen because that is the most meaningful, that's the most meaningful way to kind of move forward on this transition. The reason it's meaningful is because it's to scale. It can be done today, and we're not waiting for technology developments to happen. And I'll talk about ITM in a minute, but you'll hear me reflect that comment over there as well. So the answer is where we see that natural gas resource available in the U.S., in Canada, Australia, Russia, Middle East, we know that those countries are actively pursuing and we are looking at a number of counterparties over there as partners looking at some of those developments ourselves. And the slide 18 gives you a sense that Lynda Engineering's technology portfolio allows us to be able to flex any technical solution. We are uniquely positioned to provide that technical solution for a blue hydrogen output, whether it's using an SMR, whether it's using an ATR, or whether it's using, you know, a FOX gasifier. We have the ability and technology to both provide the technology packages, execute them, and operate them ourselves because of the expertise we have. So that's as far as blue hydrogen is concerned, and I do see a lot of momentum building up in that space, and we are very active in that space as well. Let's talk about ITM and order kind of intake and backlog going forward. Now, you're asking me to project five years out. I have to tell you, the only thing I'm going to project five years out is to tell you that the technology roadmap that we have going with ITM through our joint venture with them is to make sure that that product scales up and that product then has the capital efficiency and operating efficiency in scale up to be able to then execute projects of a reasonable size. I'm going to give you a very quick example of that. So today, as we are building Loina, as you know, you've heard us announce this before, we are building a 24-megawatt electrolyzer complex there. Those 24 megawatts will come from two megawatt modules. That's the largest PEM electrolyzer module available in the world to date. We're working with ITM to scale that up. We are hoping to scale that up based on our technology roadmap in literally months to five megawatts and then beyond that to 20 megawatts, et cetera. At that point in time, a hundred megawatt module, again, projects that we're actively working on today that are getting some preferential positioning as far as some European funding is concerned as well, those will then move from 50 units of two megawatts, which you can imagine on the most efficient structure to maybe five units or 20 units of five megawatts or five units of 20 megawatts as scale up happens along the way. So the fact that that scale up is happening, the fact that the technology roadmap is providing that capital efficiency and economies of scale is happening right now and preparing us for what's likely to happen in the next five years. I don't want to speculate at this stage as to what that likely backlog might look like five years down the road, but clearly I'm encouraged by the developments I see.
spk12: Great. Thank you for the detailed answer. As you look at this technology roadmap and green hydrogen costs coming down, where do you see that? I know Steve had commented on some numbers maybe a year ago. What about this production tax credit of $3 for green hydrogen? How would that play out? Thank you.
spk13: PJ, that production tax credit is actually very, you know, it'll be a very good supporting mechanism. We talked earlier on about in the previous question about, you know, how we see the incentives support the development. That $3 per kg will be a good support mechanism. We obviously have to read the rules and it hasn't yet come through. So, you know, I'm looking with some eagerness to that coming through and getting an understanding of how those rules come into play. but that would be encouraging. Clearly, we believe that there is an opportunity here for us to move forward. Steve mentioned to you in the past that if we get hydrogen, blue or green, green obviously more challenged in this reference, at about between $1 to $2 per kg, it's at that point that you see an inflection point and you see widespread adoption of technologies utilizing hydrogen and really hydrogen becoming a reasonable fuel in the portfolio of fuels we'll have. We'll always have fossil fuel, at least for many decades ahead. But it will be a more important part of that portfolio of fuels and energy basket as it will. Steve, do you want to add something?
spk02: Okay, Sanjeev, I'll add something. So, yeah, just to build on that, I mean, if you were to look at the cost of hydrogen today, and you were to use the U.S. Gulf Coast, which obviously we produce a lot of hydrogen, we use a lot of hydrogen in the U.S. Gulf Coast. Gray hydrogen is about $1.30 a kilogram, and that's at $5.50 natural gas. Carbon capture would add another $0.40, $0.50. Maybe you're in the $1.17 range, sort of. And if you think about green, it's like about $4.50 a kilogram. And out of that, probably $250, you call it, is the renewable power cost. And so if renewable power was free, then you would still have $2. And we all know renewable power isn't free. So we have some work to do to bring those costs down in terms of capital costs, operating costs. And as you were to work that down below that $2 number, then you've got a chance to have something competitive. So you need the combination of low-cost renewable, low-cost capital, lower cost operate low-cost capital and better efficiencies and then you can drive that number lower and I would say ideally below two but certainly you know in that range would be is what's needed great thank you for the color and congratulations and our last question comes from Vincent Andrews with Morgan Stanley
spk04: Mr. Andrews, please go ahead with your question.
spk16: David, it looks like he has an issue. I think with that we can wrap it up. Okay. For everyone online, thank you so much for attending today's call. For your reference, a copy of our transcript will be posted on our website within the next 24 hours. Thank you for listening, and if you need anything else, let me know.
spk03: Take care. This concludes today's call. Thank you for your participation. You may now disconnect.
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