Praxair, Inc. Q4 2009 Earnings Call Transcript

Jan.27.10 | About: Praxair, Inc. (PX)

Praxair, Inc. (NYSE:PX)

Q4 2009 Earnings Call Transcript

January 27, 2010 11:00 am ET

Executives

Jim Sawyer – EVP and CFO

Liz Hirsch – Director, IR

Analysts

David Begleiter – Deutsche Bank

P.J. Juvekar – Citigroup

Amy Zhang – Goldman Sachs

Don Carson – UBS

Sergey Vasnetsov – Barclays Capital

Kevin McCarthy – Banc of America/Merrill Lynch

Laurence Alexander – Jefferies

David Manthey – Robert W. Baird

Jeff Zekauskas – JP Morgan

John Roberts – Buckingham Research

Mike Harrison – First Analysis Securities

Mike Sison – KeyBanc

Operator

Good day, ladies and gentlemen and welcome to the fourth quarter 2009 Praxair Inc. Earnings Conference Call. My name is Crystal and I will be your operator today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session, (Operator instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the conference over to your host for today, Mr. Jim Sawyer, Executive Vice President & Chief Financial Officer. Please proceed.

Jim Sawyer

Good morning and thank you for attending our fourth quarter earnings call webcast. Matt White, Vice President, Controller and Liz Hirsch, Director of Investor Relations are with me this morning. Today's presentation materials are available on our website at www.praxair.com in the Investor Section. Please read the forward-looking statements disclosure on page two and note that it applies to all statements made during the teleconference. May I start this morning with a brief overview of our full year results of 2009. Liz will then review in more detail our fourth quarter results. Afterwards, I'll discuss our current business outlook and earnings guidance for 2010 and we will then be available to answer questions.

Please refer to slide three in the presentation, which summarizes our full year results. Please note that our discussion of earnings for the full year and fourth quarter, including year-over-year comparisons excludes the $0.02 net earnings per share benefit last quarter related to the Brazil tax amnesty program, which therefore reduces our operating full year EPS of 401 to an adjusted 399 and in addition, the 2008 results exclude the cost reduction program charge in last year's fourth quarter and the pension settlement charge in the first quarter. A reconciliation of these numbers to our GAAP reported numbers appears in the appendixes to this presentation and the press release.

Our earnings results in 2009 were very strong, given a very difficult economic and operating environment. Overall sales were just about $9 billion, 17% below 2008. Foreign currency translation reduced sales by 5% for the year due to the strong appreciation of the U.S. dollar in the fourth quarter of 2008. As you know, this resulted in a currency headwind for us of about 9% in the first half of 2009, but then in the third quarter, the dollar weakened again, resulting in the year-over-year tailwind for us in the fourth quarter.

Additionally, sales were reduced by 4% from lower cost pass-through, primarily lower natural gas prices, which are passed through to our hydrogen customers and hydrogen prices. Largest impact on sales was 10% lower volumes year-over-year due to the economic downturn. Higher pricing boosted revenue by 2%. Operating profit was 1.9 billion, 9% below 2008. We mitigated the operating profit decline relative to the drop in sales because we reduced fixed costs significantly starting in the fourth quarter of 2008. Combined with our annual productivity savings, we reduced overall costs by about $450 million for the year. The cost reduction plus higher pricing offset the reduction in our operating profit from lower volumes. While we couldn't control these currency effects, which accounted for the operating profit decline.

Operating margin for the year was 21% a record high and 180 basis points above 2008. Half of this increase was the cosmetic result of lower cost pass-through. The rest was real improvement from cost reduction and pricing. Full year net income was 1.2 billion, a decline of only 7%, because lower interest expense offset some of the decline in operating profit. Our total debt levels didn't change during the year, but interest expense was much lower, as we were able to take advantage of our strong credit rating and the low rate environment.

We are accessing the commercial paper market with ease right through the credit crisis and paying rates below half percent. We saw opportunities in the bond market to lock in lower rates for long-term. We did that. Since last March, we have issued $2.7 billion of debt, with 1 to 10-year maturities at interest rates between 1% and 4.5%. All of this debt refinanced commercial paper and short-term bank debt. As a result, in 2010, our interest expense will be higher than 2009 by about $30 million. But this puts us in a very good position going forward by locking in very low cost long-term debt. Earnings per share were 399, only 5% below 2008, due to fewer diluted shares outstanding as a result of our share repurchase program. Excluding currency, our EPS would have been higher than in 2008.

Our team produced outstanding results in getting positive leverage down the income statement by controlling what they control. We mitigated the impact of 10% decline in volume by lowering costs faster than volume was falling, reducing our cost of debt and repurchasing stock. These cost reductions are sustainable and give us even greater earnings leverage when volumes recover. If we were able to overlay our 2008 volumes on our 2009 cost structure, our EPS would have been well over $5. This gives me great confidence in our long-term earnings outlook, the only questioning being when we will see meaningful volume recovery.

Our after-tax return on capital for the year was 13.8%, below 15.3% in 2008. This reflects lower earnings on higher average capital due to ongoing investment in new on-site projects, which will provide future significant revenue and earnings growth. Please look at slide four. We generated record operating cash flow of $2.2 billion, capital spending for the year was $1.4 billion, about $200 million below 2008. About three quarters of our annual capital spending goes into new projects, which we are constructing around the world. These investments are under long-term contracts with customers, our spending remaining fairly stable compared to the prior year. The decrease was primarily result of several customer requests to defer projects startup dates due to the economic downturn.

After capital spending we generated free cash flow of 816 million, also a record. We spent 131 million on acquisitions, primarily the purchase of the Sermatech's thermal coatings business we are integrating into our surface technology segment. But the majority of our free cash was returned to shareholders in the form of dividends and share repurchases. Results for our business strategy, which drive high return on capital, is that we will continue to generate higher levels of cash flow.

The graph on page four illustrates that over the last 10 years, spread between our operating cash flow and capital spending has continued to widen. We will continue to invest in as many high return projects as we can, but we expect to have increasing amounts of cash to return to the shareholders as well. This morning, we announced that we're increasing our quarterly dividend from $0.40 to $0.45 in the first quarter of 2010. With 17th annual consecutive dividend increase by Praxair and we also plan to continue our stock buyback program. Now, Liz will review our results in the fourth quarter.

Liz Hirsch

Thank you and good morning. Please refer to page five. Overall, our results in the quarter reflect sequential improvements in some regions and markets and stabilization in others, in line with the fits and starts of the global economic recovery. Fourth quarter sales were 2.4 billion, in line with the prior year. We lapped the currency headwind we had faced all year and currency translation was the 6% benefit to sales this quarter. This was offset by lower cost pass-through and 4% lower volumes. Volumes are still below prior year, because October of 2008 was a very strong month. In fact, a record month for us. A sharp downturn in volumes last year occurred in November and December. So while year-over-year comparisons have gotten easier, the overall volumes comparison is still negative. Volumes increased 2% sequentially.

By end market, electronics has shown the quickest recovery and volumes are back to pre-downturn levels. Volumes to steel and chemicals are beginning to improve. Manufacturing has been slower to turn around. Overall volumes remain well below where they were prior to the recession, giving us a lot of upside, as the economic recovery progresses. Although volumes were down 4% year-over-year, operating profit of 512 million was higher due to cost reduction, productivity savings and currency benefit.

Operating margin rose to 21.3%. Net income and earnings per share were 340 million and $1.09, both 8% above the prior year quarter's adjusted earnings. Net income increased more than operating profit due to lower interest expense. Our effective tax rate for the quarter was 28%. Cash flow from operations in the quarter was a record $709 million from net income, depreciation and a net working capital benefit. Cash flow funded $355 million of capital spending, 187 million of dividends and share repurchases, net of issuances and debt reduction of $197 million.

Our debt to capital ratio for the quarter was therefore a bit lower at 47.2% and after-tax return on capital increased to 14.1%. Now I'll review our results in North America, summarized on pages six and seven. Sales in North America were 1.2 billion, 7% below prior year, excluding cost pass-through effects, which includes lower natural gas prices and lower power costs. Volumes were 6% below the 2008 quarter.

Sales to steel and chemical customers are improving, in line with higher levels of North American steel production and chemical shipments, but they remain well below peak levels in 2008 before the downturn. Energy was lower this quarter, due primarily to lower liquid sales to oil well services customers in U.S., Canada and Mexico. We expect this business to pick up in 2010 from the current very low volume levels.

Recovery in general manufacturing continues to lag other markets. Manufacturing includes metal fabrication, machinery, non-residential construction, which is a large market for liquid and package gases. Our sales to this market in North America showed modest sequential improvement this quarter by over 16% below prior year. We expect to realize strong operating leverage as these volumes improve.

On-site sales were 15% below the prior year. However, this was attributable to lower natural gas and power cost pass-through. Volumes were 4% above prior year, due to higher oxygen sales on our Chicago area and Gulf Coast pipelines to steel and chemical customers. Volumes were also higher sequentially due to higher demand from chemicals, with steel volumes relatively flat. Merchant liquid volumes were 10% below prior year and were relatively flat sequentially. Sequential pricing trends remain stable. We have yet to see a meaningful volume uplift, although this quarter was better seasonally, as we have fewer than expected holiday shutdowns.

We are also seeing higher levels of proposal activity than we were seeing six months ago, particularly in food and energy. Packaged gas sales were 16% below prior year ex-currency due to lower volumes, reflecting the weak manufacturing environment. In PDI, our U.S. and Canadian business, same-store sales were 17% below prior year, driven by 30% lower hard goods. Gases' same-store sales were 10% below 2008. Sequentially, sales per day were slightly up with the third quarter in gas and hard goods. We continued to see slight sequential growth in gases into January.

Overall, sales remain stable, but we have seen no meaningful upturn in growth. This tracks pretty closely with published industrial production data for the U.S. manufacturing sector. Due to the significant cost reduction achieved in the business this year, we expect to see very positive operating leverage when volumes start to pick up. In 2009, PDI acquired five small distributors. We continue to look for high quality acquisitions in geographies where we have opportunities for synergies.

Operating profit in North America was 261 million and the operating margin was 22.1%, up from 19.7% in the prior year. This margin improvement is primarily due to cost reduction and partially due to lower cost pass-through. Please look at page eight for our results in Europe. Sales in Europe were 351 million compared to 322 million in the prior year. The increase was due to currency appreciation. Volumes were down 4% and pricing was flat.

Sequentially compared to last quarter, volumes increased 3%, contributing to the higher sales. Economic recovery is being led by Germany, with Spain and Italy weaker, but beginning to show some signs of improvement.

On site and merchant liquid volumes both grew sequentially. Merchant liquid volumes are growing from environmental and productivity applications. Sales were higher to chemicals, healthcare, electronics and food and beverage markets. Similar to the U.S., recovery of packaged gases volumes is lagging on-site and merchant. Operating profit was 76 million compared to 83 million a year ago. Last year's operating profit included some currency hedge gains. Sequentially, operating profit and margin improved due to higher volumes, cost reduction and productivity gains.

Page nine shows our results in South America. South American segment sales were $461 million compared to 382 million in the prior year quarter. Excluding currency appreciation, sales were 4% below prior year, due to 10% lower volumes, partially offset by higher pricing and cost pass-through. Brazil's economy is recovering rapidly. Industrial production in November was up 5%. Interest rates remain at historic lows of about 8%, which has provided effective stimulus to the domestic economy.

On-site and merchant volumes are higher than prior year and last quarter. However, this improvement is being offset in the aggregate by lower packaged gases due to the pace of recovery of local manufacturing and the typical seasonal slowdown in the fourth quarter due to holiday. We expect strong sales growth in South America in 2010, as our volumes continue to pick up. While on-site volumes and merchant have both picked up from the bottom, which was in the first quarter of 2009, they are still about 10 to 15% below the volumes we had in the peak of 2008 and packaged volumes are about 20% below their peak.

By end market, the strongest sequential sales growth is to metal and food and beverage, with chemicals, manufacturing and healthcare relatively flat. Operating profit in South America grew to 111 million versus 87 million a year ago. The operating margin improvement came from cost reduction and higher pricing, which offset the impact of lower volumes.

Slide 10 shows our Asia results. Asia had a very strong quarter. Sales of 274 million were 24% above 2008, excluding currency and cost pass-through, driven by strong broad-based volume growth. Our base business volumes grew 16%, boosted by large plant start-ups this quarter and higher sales to all major end markets.

Electronics in particular was very strong. Our sales in Asia were up 46% ex-currency. Last year fourth quarter was a severe low for the semiconductor industry, when many fabs and foundries were shutdown. Electronic sales have increased continuously throughout the year and our sales were 18% higher than last quarter ex-currency.

The equipment sale we show here includes a plant that we sold to our Chinese joint venture in the Shanghai Chemical Industrial Park. This company is growing rapidly, as our large chemical customers expand. As an example, in December, this joint venture announced a new 15-year contract with buyer to supply hydrogen and carbon monoxide started in 2012, but the company is not consolidated and so the earnings appear in our equity income line.

On-site volumes grew in China, India and Korea. We started up our 3000-ton per day oxygen plant in China for SOPO's coal gasifier and it is ramping nicely. We also started up a new air separation plant for Samsung Electronics' LCD factory in Korea. Merchant volumes were up over 10% in Asia compared to prior year. We are growing the business by bringing our applications technology into this market. For example, we announced a project to install our patented Dilute Oxygen Combustion technology at a copper smelting plant. This technology will produce significant fuel savings and will reduce flue gas emissions and will increase our oxygen sales.

Our business development pipeline is very strong. We have 12 large projects in Asia in our existing backlog and are working on numerous other opportunities. We were recently awarded a large contract to supply hydrogen and nitrogen to the Indian Oil Corporation's new refinery on the east coast of India.

Our strong position in India and on the ground experience in building plants was important in winning this business. These plants will not start up until 2012,.so we fully expect that we will continue to see strong growth in Asia continue over the next three to five years. Asia's operating profit increased to $42 million from 34 million. The margin of 15.3% is lower than the prior year due to higher cost pass through and lower electronic specialty gas pricing.

Our results for surface technologies are on page 11. PST sales this quarter were 141 million compared to 135 million in 2008. The increase was a result of currency appreciation and the sales contribution from the Aerospace Coatings acquisition we made in this year's second quarter. Base business volumes were lower year on year. Jet engine coatings improved from last quarter, but in the aggregate, this was offset by lower coatings for industrial gas turbines and for general industrial markets such as automotive, steel and printing.

We are beginning to see some sequential improvement in these markets and we do expect IGT coatings to pick up in the second half of 2010. Operating profit of 22 million grew 10% and the margin of 15.6% improved versus last year and last quarter. This resulted from several factors. Higher volumes of high margin EBPVD coatings, cost reduction we did in PST-based business this year and some benefits we are beginning to realize from the integration of Sermatech. It is still our objective to bring PST's operating margins up to the 20% range.

Now, I will turn this call back to Jim, who will discuss our global end market trends and our earnings guidance for 2010.

Jim Sawyer

Thanks, Liz. This quarter we're giving you a different picture of our sales to four of our major end markets. Chemicals, electronics, metals and manufacturing. The chart shows you a trend line of sales to these markets globally, ex-currency effects. We indexed the sales of the third quarter 2008 since that quarter was right before the economic downturn and was our strongest quarter. Over the course of the downturn, the electronics market fell the fastest and the furthest, hitting bottom in last year's first quarter.

During the remaining three quarters, it picked up dramatically and volume reached a record high for us in the fourth quarter. Recovery has been broad-based, stimulating particular by demand for SmartPhones, notebook computers, flat screen sales in Asia, the solar market and Microsoft's release of its new windows operating system. We now expect growth to taper off in 2010. Volumes in the steel and chemical sector troughed in June and July.

They made a nice rebound in the third quarter, particularly associated with government stimulus programs like the Cash for Clunkers program and then they flattened out in the fourth quarter. Unlike electronics, our volumes to the chemicals and metals sectors remain 10% to 13% below their peak in early 2008. However, we are seeing sequential improvement in the rate of about 2% per quarter, so perhaps in 2011, we'll get closer to pre-crisis capacity utilization.

Our manufacturing sector has a large component of packaged gases and merchant liquid oxygen, nitrogen and argon sales to such industries as metal fabrication, machinery, equipment and non-residential construction. This sector was the slowest to fall, as customers were continuing to complete orders and projects which were initiated before the crisis began.

Globally, it hit bottom in the third quarter, but in the U.S. and Europe, it was continuing to decline in the fourth quarter. With volumes at 17% below peak in 2008, this sector is the biggest drag to earnings right now. We believe it will pick up slowly, as business spending for new equipment, machinery and structures will remain low until the economy gets closer to full capacity utilization.

Now, please go to page 13 for some detail on our 2010 capital spending plans. We expect 2010 capital spending to be in the area of $1.4 billion, just about the same level as in 2009. 20% of this spend, about 300 million, is maintenance capital or base business. Spend another $70 million to $75 million for cost reduction projects such as improving energy efficiency of our plants by upgrading compression equipment or turbo machinery.

We will typically look for a three-year payback on these projects. The remaining $1 billion of our capital spending is for new production plants under 15-year contracts with customers, which will deliver sales and earnings growth for the foreseeable future. We currently have a strong project backlog of over 40 large projects, with a record capital value of over $2 billion. These projects are all under construction, with scheduled start-updates from the next quarter through mid-2012.

The pie chart shows you where our capital dollars are going by geographic region. The largest percentage is U.S. and Canada, which may seem surprising, but this is driven by two very large hydrogen refinery projects in the U.S.. After that, Asia represents the largest segment with over 20% of our growth capital. Our investments are primarily going to China and India and then South America with 16%.

These two regions, plus Mexico are what we call our emerging markets, all together, 45% of our growth capital is going there. These economies are growing much faster than the developed world and are investing huge infrastructure to support demand from huge populations with a rising standard of living. By 2011, we expect that about 65% of our new project spending will be in China, India, Brazil and Mexico. At this time last year, there was a lot of uncertainty about the pace of new project signings around the world due to the collapse of commodity prices, the banking crisis and the subsequent global recession. But after a pause early in the year, things have picked up again.

We signed a number of very significant projects this year and are looking at numerous others. Capital value of our backlog is very high and this is why we can tell you that on top of whatever lift industrial production gives our existing base business, our backlog will deliver 3% to 5% annual revenue growth in 2010, 2011 and 2012. And as we continue to sign new projects, this will extend out until 2015.

And now please look at page 14 for our earnings guidance. As many of you know, Venezuela devalued its exchange rate in the first week of January and as a result, we expect to record a one-time charge in the first quarter, which will reduce EPS by $0.08. This impact is caused by the fact that we used the U.S. dollar as our functional currency in Venezuela. This is often referred to as hyper inflationary accounting. Therefore, we need to revalue our Bolivar-denominated working capital from the old 2.15 official exchange rate to the new 4.3 official exchange rate. For the remainder of the year, we expect the ongoing impact of the devaluation to be minimal.

Earnings guidance for the first quarter is for EPS of $1.05 to $1.10, excluding the one-time impact of the Venezuela devaluation and $0.97 to $1.02 inclusive of it. Additionally, we're expecting to participate in the one-time voluntary tax amnesty program recently announced by the State of Rio de Janeiro, Brazil, structured similar to the federal program we participated in last year. We do not expect the potential effective this to be material, but we are excluding it in the guidance as well. Excluding Venezuela, our expectation is for earnings in the first quarter to be just a little lower than the fourth quarter, which is often the case due to holidays in South America, Chinese New Year and customer turnarounds.

Our guidance for the full year of 2010 is for sales to be in the area of $10 billion, a 10% increase from 2009. Our initial forecast for full year earnings per share is a range of $4.43 to $4.63, excluding the $0.08 impact in the first quarter for Venezuela and $4.35 to $4.55, including it. This guidance also excludes any potential impact from the Rio de Janeiro voluntary amnesty program.

Consequently, we expect to deliver record earnings in 2010. Our earnings guidance represents an increase of 11% to 16% from our 2009 earnings, which declined only 5% from the prior year. Guidance assumes that pension expense in 2010 will be approximately $16 million, about $15 million higher than 2009. We expect to make cash contributions to the plants in the range of $50 million to $75 million and the effective tax rate is expected to remain at about 28%.

Our full year guidance assumes modest economic growth and slow recovery in major end markets. On top of that, new project startups will contribute revenue growth of 3 to 4% in 2010. Application technologies will contribute a couple points of growth and at current exchange rates, we may have a couple of points of currency tailwind.

We're optimistic that we will continue to see global economic recovery as we progress through the year, but we think it will be slow and deliberate in the U.S. and Europe. Therefore, we're cautious in our outlook until we see stronger signs that the manufacturing sectors are bouncing back. However, as volumes do recover, we have significant upside earnings potential.

Over the longer term, we continue to expect earnings to grow in the low double-digit range, with a modest assumption regarding economic growth. We will grow earnings faster than sales, because our cash flow generation is greater than our capital spending and we can use the excess free cash flow for acquisitions of share repurchases. And now we'll be happy to take your questions. Crystal?

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of David Begleiter with Deutsche Bank. Please go ahead.

David Begleiter – Deutsche Bank

Good morning. Jim on the projects, you went from 42 to 40 in the quarter. Can you detail what – how many were added, how many were startup and is the Richmond Chevron project still not backlogged? And if it does get – they do close the refinery, what happens to the contract? Do they get paid out, or what?

Jim Sawyer

Okay. Let me take both of those questions in line. We started up seven projects in the fourth quarter and we added five new ones. Among the ones that we started up are a Sinopec oxygen/nitrogen system, stainless steel project in China, the SOPO coal gasification project, two projects in the U.S., one related to steel and one related to LNG. And then new plants that we started up, one in Mexico and another one in Costa Rica. Those are the ones we've started up that we took out of the backlog.

We added Indian Oil, very, very large hydrogen and nitrogen project. We added the Bayer project and a polysilicon project, a stove oxygen dilute project and a solar project. The Chevron project is still in the backlog and I'll just give you a little bit of background on it since everybody's been asking about it. But we won this very large hydrogen project to supply Chevron's Richmond refinery about three years ago and initially based on the schedule, it should have started up by now.

But first Chevron ran into a lot of environmental issues before getting their environmental impact statement signed and approved and then more recently, they were hit by a judgment from the local judge to halt construction at the request of a very small environmental group. So consequently, the construction has ceased there and we don't expect it to start up until later in the year and then come on stream in 2012.

Now, there's rumors circulating that Chevron may actually shut down that refinery. Chevron has not made any statements about shutting downtown refinery to us or to the media. So I consider that to be very unlikely that they will shut it down. If they did, we clearly get reimbursed from what we spent and we would have to renegotiate a return from them for canceling the project. That project is about $250 million in capital spend and depending on the price of natural gas, we'll be using, starting 2012, about $250 million in sales and $25 million in operating profit.

David Begleiter – Deutsche Bank

And Jim one more question, what's your view on merchant gas pricing in North America in 2010 versus 2009?

Jim Sawyer

Merchant gas pricing is doing just fine. We're not getting the same type of price increases that we got several years ago, but we did announce the price increase to certain customers in December and that's been successful. So on average, I would expect merchant pricing to stay relatively flat, because we've got some price increases going on and some new customers being signed up at slightly lower prices. So I expect overall for them to be flat.

David Begleiter – Deutsche Bank

Thank you very much.

Jim Sawyer

Okay.

Operator

Your next question comes from the line of P.J. Juvekar with Citi. Please go ahead.

P.J. Juvekar – Citigroup

Yes, hi. Good morning. Jim, question on the hydrogen business, with the spread between light and heavy crude having come down, what do you expect will happen to hydrogen volumes in 2010 on the same-store basis?

Jim Sawyer

On the same-store basis, which would be I guess the existing plants that we've got running primarily in North America, I expect them to run at the same full rate they have been running at in 2009, maybe even some pickup in 2010. I don't see any decline there because all of the refineries we serve and continue to operate and they will continue to use their cracking and stripping systems and will continue to be hydrogen – now, I think what's changing in the picture is new project activity and because there's really a glut of refining capacity in the United States, we're not expecting a lot of new hydrogen project activity in the United States.

However, we're in discussions on about three major hydrogen projects outside of the United States, in China, India and South America and as I said before, we won the IOCL Indian oil company project there. And what's happening is that refiners are building grassroots new refining capacity in Mexico, in South America, in Brazil, Colombia and Argentina and India and China. So when they build that new capacity, they are going to be building state of the art capacity, which is going to require hydrogen.

P.J. Juvekar – Citigroup

Good and secondly, among your three types of businesses, on site, merchant and packaged, which one do you think would be the leading indicator and which one would lag the economy?

Jim Sawyer

Well, I think you need to break that down a little bit more. If you look at what's going on right now, the package business is the most sluggish business. It's off the furthest and it's not showing a lot of signs of coming up, because a lot of the packaged gas business goes into manufacturing, which really hasn't picked up yet. I think the on-site business would be the first to pick up, as volume grows in steel and chemicals and then after that, merchant and packaging.

Now, we do sometimes look at the package business hard good sales and specific category of hard good sales, which are welding equipment and laser equipment as kind of a leading indicator that that business is going to pick up because you have job shops that run out of capacity and all of a sudden need new equipment and we are starting to see a pickup in orders on the equipment side, which should be a good leading indicator for the packaging business.

P.J. Juvekar – Citigroup

Great. Thank you for the detail.

Operator

Your next question comes from the line of Koort with Goldman Sachs. Please go ahead.

Amy Zhang – Goldman Sachs

Thank you, good morning. This is Amy Zhang sitting for Bob. My first question is really South American margins of 24% for the quarter, probably the strongest level we have seen about four or five years. So can you just provide us some color on that? Is that because of the volume growth in that region, or is something else happening? And how should we think about the margin progress in that region in 2010 and 2011?

Jim Sawyer

Well, I think South America is a good example of what we would like to be seeing around the world. And what I mean by that is when we did the substantial cost reductions back in 2008 and early part of 2009, South America was very aggressive in taking out costs, as was the North America. But since then, volumes have really started to recover in South America. And so now we're starting to get the margin impact of volumes starting to recover on top of the significant cost reduction.

Amy Zhang – Goldman Sachs

Okay, thank you. And then the second question is a follow-up question on merchant pricing trend. I heard you said overall, you expect, pricing trends for the year to be relatively stable. So can you just give us a little bit more color on Asia, the merchant market and given there's new capacity coming online, you probably have a different business mix there, more to the electronic business. So on year-over-year basis and obviously the pricing, was there some pressure sequentially flat, so going forward and do you expect that trend to continue or we can see some pickup in pricing, given the strong demand in the region?

Jim Sawyer

So far, I haven't seen a pickup in pricing and what we refer to as liquid is basically atmospheric gases, liquid oxygen, liquid nitrogen, liquid argon. The electronics business is really outside of that and it's more specialty products and there continues to be a lot of price pressure on the specialty products in electronics. But there's a lot of capacity available in China, in Korea and India in most merchant products. So as volumes are picking up, it's still in the phase where it's picking up and just moving to a higher level of capacity utilization. But we haven't seen a trend yet where we would get any significant price increases there.

Amy Zhang – Goldman Sachs

Thank you so much.

Jim Sawyer

Okay.

Operator

Your next question comes from the line of Don Carson with UBS. Please go ahead.

Don Carson – UBS

Thank you. Hi, Jim. Couple questions. One is on the returns that you see in the backlog and how they compare to historical returns and I think specifically of hydrogen. I know historically you avoided much of a participation in hydrogen, particularly in the U.S., you didn't like the returns. What makes these Asian projects different? Is it your local decision? Is it just the nature of the projects? If you could comment on that and then just a follow-on on your European markets and why they are coming down, is that the inverse of South America, just with volumes weak, just not getting the operating leverage potential that's there?

Jim Sawyer

Right. Well, let me just take Europe on first. That's fairly simple. It is basically the inverse of South America, where it's more difficult to take costs out of Europe. So proportionally, we didn't take as much cost out of Europe as we can out of U.S. or South America and Europe is really one of the most sluggish markets right now, pretty much across the board in terms of all the products, end markets and particularly packaged gases, which is generally a good market business for us in Europe. So that's why Europe is still stuck, still stuck in the rut in terms of margins there.

In terms of the backlog of projects and internal rate return on projects, we analyze our projects using a discounted cash flow, internal rate of return for 15 years with no residual value and it's on an after-tax basis. The projects that we get the highest returns on are the ones where I would describe it as we have a synergy between our old business and our new business.

An example of that would be connecting a new customer to an existing pipeline system or having a new on-site system that we also can use significant amounts of liquid oxygen and liquid nitrogen off of that project. And consequently, the projects in our core geographic areas, the ten geographic areas that we have a major market share in, are the ones that have the highest returns, that's Canada, U.S., Mexico, Brazil, China and India and Korea. But also as the size of the projects gets bigger, the contribution from the co-products proportionally gets smaller and in the case of hydrogen projects, you really don't have the synergy of being able to sell the liquid oxygen, liquid nitrogen at the same time as having the on-site contracts.

So, I know by definition, larger projects have lower returns and hydrogen projects have lower returns. And in the past couple years, the average IRR on the projects in our backlog has been about 18%. That's been composed of a lot of smaller projects with way above 18% returns as well as the larger projects that are in the mid or low teens. As we move forward and the backlog moves to some of these more larger projects and more hydrogen projects, I expect the average IRR to come down to maybe the 15% range.

Don Carson – UBS

Thank you.

Jim Sawyer

Yes.

Operator

Your next question comes from the line of Sergey Vasnetsov. Please go ahead.

Sergey Vasnetsov – Barclays Capital

Good morning.

Jim Sawyer

Hi, Sergei.

Sergey Vasnetsov – Barclays Capital

You had 16% growth in large plants setups in Asia. Could you comment which business lines those were in and how they affect growth for the year?

Jim Sawyer

Yeah. I mean, the fastest growth rate by business line has been in electronics. Okay and, you know, that chart that I showed earlier in the presentation shows that our electronics volumes are actually at a record level right now, whereas other end market volumes just haven't picked up as much. So that's where the fastest growth is and you also might notice from the chart is that the operating margins are down a little bit, but that's for the same reason, that proportionally, electronics is growing faster and it tends to have a lower operating margin.

Sergey Vasnetsov – Barclays Capital

On the same slide 10, you talk about strong business development pipeline as disabling Asia. How would you compare your discussion activity in early 2010 versus previous years, '06, '07, '08?

Jim Sawyer

I think that the business, the pipeline as I see it in South America and China and India are just as strong as what we were seeing around the world, say three years ago and that continues to go fast. We expect a lot of energy-related projects in all three countries, both enhanced oil recovery and hydrogen and coal gasification projects.

Sergey Vasnetsov – Barclays Capital

Okay. And by attracting the pipeline, I would imagine you're referred to your expected – investments in those projects, right?

Jim Sawyer

Yes. I mean, the return on investments is pretty much the same around the world, project by project. But the big Indian Oil company, hydrogen project, is more of a mid-teens project, kind of, bringing the average down a little bit and so are the large gasification projects in China.

Sergey Vasnetsov – Barclays Capital

Okay. Thank you.

Jim Sawyer

There's still very high return projects, at least for 5% above our cost of capital.

Sergey Vasnetsov – Barclays Capital

Okay. Good. Thank you.

Jim Sawyer

Yes.

Operator

Your next question comes from the line of Kevin McCarthy with Banc of America/Merrill Lynch. Please go ahead.

Kevin McCarthy – Banc of America/Merrill Lynch

Good morning, Jim. How are you?

Jim Sawyer

Fine. How are you, Kevin?

Kevin McCarthy – Banc of America/Merrill Lynch

I was wondering if you could comment on the sequential outlook for profits in Asia, factoring in the very strong volume patterns there, perhaps counterbalanced by Chinese lunar New Year and the comments that you made on electronics. How would that net out, if we think about it from a profit perspective early days in 2010?

Jim Sawyer

Yes. I mean I think Asia, if you look at it from a cyclicality point of view, has a weak quarter in the first quarter and that's because of the fewer work days that they have and roughly week or two that they take off for the lunar new year. So typically we'll see first quarter both sales and operating profit dip slightly versus the prior fourth quarter. Over the longer run, we're continuing to grow rapidly there. Our operating margin as we reported, is lower than around rest of the world, but that's largely a function of the fact that we've got a huge staff over in Asia. We've moved our coal gasification Center of Excellence over to China. We've moved our procurement group over to China and we've got a very large expenditure doing what we call FELG proposals on the new projects there. So that margin will probably get closer to the high teens, but it's just a growth area for us where we've got a fair amount of overhead cost.

Kevin McCarthy – Banc of America/Merrill Lynch

Okay. And to follow up on U.S. hydrogen, Jim, you provided quite a bit of color on the Chevron project. I was wondering if you could comment on the time lines and update us there for BP and I believe you have a smaller Shell project as well both later this year.

Jim Sawyer

Yes. The BP will be starting up. There are actually two world class streams in the BP project and the first one will start up in the summer and the second one will start up in the fall. So by the end of the year, we should be pretty much at full capacity at BP in Whiting, Indiana. The Shell project, I think starts up toward the end of the year.

Kevin McCarthy – Banc of America/Merrill Lynch

Okay.

Jim Sawyer

It should start up – It should start up right around the beginning of the third quarter.

Kevin McCarthy – Banc of America/Merrill Lynch

Okay. Thank you very much.

Jim Sawyer

Okay.

Operator

Your next question comes from the line of Laurence Alexander with Jefferies. Please go ahead.

Laurence Alexander – Jefferies

Good morning. I guess first question, you mentioned in your remarks that you have become more cautious on electronics growth rates as we get later into the year. Can you flesh out what you're looking for there?

Jim Sawyer

Well, basically what I'm saying is that electronics has rebounded completely to the pre-crisis levels. Okay and I don't really know where it goes after that. But our other end markets in terms of volumes are still more than 10% below the pre-crisis level. And so the point there is that we've got a lot of operating leverage actually in the other end markets in steel and chemicals and overall manufacturing. It's hard to know where semiconductor volumes are going to go, but I think the general consensus is that it will stabilize at this level, at least for a couple quarters.

Laurence Alexander – Jefferies

And then just on the discussion on the tonnage side or with the shift towards larger, slightly lower return projects. Do you see that as being something, a trend that will reverse once we get into a cyclical recovery? Do you see this as a structural shift? And just as a follow-on question on that, are there any opportunities to add more of a market presence in the Middle East? If you could update your thinking there.

Jim Sawyer

Right, right. Well, let me take the Middle East first. There are market opportunities in the Middle East. We've got some projects going on in the Middle East and what we're doing is working on building a kind of fully integrated business there with on-site merchant package and so forth, which we have a good return. In terms of the other point on the large projects, what we expect to see is really pretty strong revenue and earnings growth for the next couple years coming from – coming back toward full capacity in packaged and merchant and on-site. So our base business coming back to our full capacity combined with the large projects coming on stream. After the base business comes back to our full capacity, there should end up being more new projects that are atmospheric gases projects and so forth and so that probably could reverse out but not until economies are getting closer to full capacity.

Laurence Alexander – Jefferies

Thank you.

Jim Sawyer

Okay.

Operator

Your next question comes from the line of David Manthey with Robert W. Baird. Please go ahead.

David Manthey – Robert W. Baird

Hi. Good morning, Jim. Could you tell us as we sit here today what percentage of Prax North America is, on-site business is hydrogen versus atmospheric gases?

Jim Sawyer

Yes. I was going to say it's probably about one-third hydrogen, two-thirds atmospheric gases.

David Manthey – Robert W. Baird

Okay.

Jim Sawyer

But you can't go with that measure because hydrogen in its sales number has a pass through of what you pay for natural gas in it and so hydrogen sales tend to, what I call high asset turnover for the given plant size, you get a lot of sales, but part of those sales are just passing through natural gas and so you get a lower margin on those sales, whereas the atmospherics and particularly on-site atmospherics, basically have very, very high operating margins. So we have to be a little bit careful when you just look at the sales numbers.

David Manthey – Robert W. Baird

Got it. Okay. And then at a constant price for natural gas pass-through, what would that look like in 2011 after these two major plants come online?

Jim Sawyer

Yes. We're expecting about 15% per annum growth. I would say we'll get more to around 40, 45% of our sales in hydrogen but if you want to go back and talk about operating profit, it would still be more like 25% of operating profit.

David Manthey – Robert W. Baird

Okay. Thank you. And then one last question – you talked in the past about a rule of thumb where a $1 of capital expenditures in an on-site drives about $0.60 of revenue. Is that sales per CapEx investment dollar ratio lower for hydrogen plants than it is for typical ASU? And if so, could you give us kind of an idea of what the Delta is?

Jim Sawyer

Yes. It's actually the other way, atmospheric plants, like air separation plants – we don't have the raw materials for air and we don't have to pay for air, so we don't have the cost of goods in there. And therefore you'll invest $1 of capital and you'll get maybe $0.50 sales, but those sales will be at 30, 40% operating margin. In the hydrogen business, you have to buy natural gas, which is a feed stock for the hydrogen. And so depending on the price of natural gas, at a $5, $6 price of natural gas, you could invest a $1 of capital and get $2 of sales or $1.50 of those sales is what you paid for the natural gas. So the – if you are just looking mathematically at it, the hydrogen business has a much higher asset turnover, but lower operating margins.

David Manthey – Robert W. Baird

Okay. Very helpful. Thank you.

Jim Sawyer

Okay.

Operator

Your next question comes from the line of Jeff Zekauskas with JP Morgan. Please go ahead.

Jeff Zekauskas – JP Morgan

Hi. Good morning, Jim.

Jim Sawyer

Hi, Jeff.

Jeff Zekauskas – JP Morgan

How many shares did you buy back in 2009?

Jim Sawyer

Check on that number exactly, but first of all, we have the number of shares that we bought back and also the number of shares in existence during that option exercise. But we bought back in terms of basic shares outstanding just about 2 million shares and then we issued them with, with option exercises. So we're basically offsetting dilution from option exercises during the year of 2009. If you actually look at the quarter ended, the diluted shares are up from 311 to 312, 313. That's primarily because of price of the stock is up and the way you calculate diluted earnings per share is a function of the spread between the market price of the stock and the strike price of the options. And the higher that spread goes up, the more dilution you have in the diluted earnings per share. And so that's why if you're actually looking at the table, you'll see 307 basic shares outstanding and 312 diluted shares outstanding, whereas in 2008, there was only about a $3 million difference. It's primarily just because the stock price is higher now than it was in the end of 2008.

Jeff Zekauskas – JP Morgan

So in your slides when you talk about net share repurchases of $141 million, is there a way to calculate your average price per share that you bought it back?

Jim Sawyer

You wouldn't be able to do that directly from, from…

Jeff Zekauskas – JP Morgan

From that number.

Jim Sawyer

financial statements, because you would have to know the average strike price of the options exercises.

Jeff Zekauskas – JP Morgan

Cool. What was the average price you bought it back, if you do know?

Jim Sawyer

I don't know. That is top of my head, probably in the 60s and 70s.

Jeff Zekauskas – JP Morgan

Okay. And then lastly–

Jim Sawyer

We'll put that detail in the 10-K when we file it so you can see.

Jeff Zekauskas – JP Morgan

And then lastly, if you calculated an EPS benefit from currency in the quarter, what would it be from currency translation?

Jim Sawyer

If you're going from – if you're looking on a year-over-year, we would have about a 6% or 7, 8% tail wind from currency in EPS. If you're going fourth quarter from third quarter, we have about a 2% tail wind.

Jeff Zekauskas – JP Morgan

Okay. Thank you very much.

Jim Sawyer

Okay.

Operator

Your next question comes from the line of John Roberts with Buckingham Research. Please go ahead.

John Roberts – Buckingham Research

Good morning, Jim and Liz.

Liz Hirsch

Hi, John.

John Roberts – Buckingham Research

I'm interested in the 4% price-mix improvement in Latin America, since that's by far the highest in the world. Is that partly a currency issue in that there's some dollar linkages there with pricing and the devaluation somehow is allowing you better pricing or is it just your higher share that you've got in those markets?

Jim Sawyer

No. That's real live pricing on a year-over-year basis. Most of that took place in the fourth quarter of 2008, the first quarter of 2009. But basically, as you can see, sequentially we got about 1% price improvement and year-over-year about a 4% price improvement. And that is generally that's what the atmosphere in Brazil, the environment in Brazil allows us to get there. And we expect that to go forward, because also inflation is higher in Brazil.

John Roberts – Buckingham Research

And secondly, did the PST folks have any opinion on why the infrastructure stimulus spending hasn't trickled down into the welding business or it has and manufacturing is just so weak it's offsetting it?

Jim Sawyer

Yes. I have an opinion about it, which is that and I'm not an expert on the stimulus package. But the only place I've seen a lot of stimulus spending is in asphalt, in road repaving. And I haven't seen a lot of stimulus spending anywhere else in the economy. Perhaps there is some, but I haven't seen it, because the other problem we have in the economy is that the state budgets are getting curtailed also and they need that stimulus money just to stay even.

John Roberts – Buckingham Research

Thank you.

Jim Sawyer

Yes.

Operator

Your next question comes from the line of Mike Harrison with First Analysis. Please go ahead.

Mike Harrison – First Analysis Securities

Hi, good morning.

Jim Sawyer

Hi.

Mike Harrison – First Analysis Securities

You're guiding to $10 billion in sales for 2010, when that's basically the run rate that you were at in the fourth quarter and we should be expecting incremental contribution for the new projects as well as contribution from, as you called it, a modest macro recovery. Can you just help me understand what is going to be working against you on the top line that pushes you to put out such an apparently conservative top-line number?

Jim Sawyer

I would say that as you look at the fourth quarter and you multiply, we would be getting more than 10 billion in sales and all other things being equal, we will get more than $10 billion in sales. But there is always fluctuation in terms of natural gas pass-through, in terms of currencies and so forth. So just think of $10 billion as a big round number and it could be above that by a fair amount, but I doubt it would get up to $11 billion.

Mike Harrison – First Analysis Securities

All right. And then a couple of questions on PDI. How successful was your December price increase compared to previous price increases and considering the weak manufacturing environment you're still seeing?

Jim Sawyer

We've had good success with both the merchant gas price increase and the packaged gas price increase. So we haven't really had much of a problem with those. Obviously, people don't like price increases, but when the customer looks at that price increase, it actually is a very, very small part of his overall cost of doing business.

Mike Harrison – First Analysis Securities

Got it and then, another question on PDI, you noted a sequential pickup in January. Just to clarify, was that on gas rent, on hard goods or both? And is that relative to the sales per day rate in December or for all of Q4?

Jim Sawyer

Well, it was a couple of strong weeks in January and I think that's a positive sign. And I always look at the holiday period as kind of an uncertain period. When you go into the holiday period, you don't know how many factories and so forth are going to be shut down for a week or two weeks or maybe not shut down at all. And so we had a pretty strong holiday period and a pretty strong going into the beginning of January, so it's very stable. I wouldn't say it's jumping up astronomically, but it's been fairly stable, growing at a 2% quarter kind of a rate and we have seen more inquiries for welding equipment and capital equipment, which should be a good sign for gas demand going forward.

Mike Harrison – First Analysis Securities

All right.

Jim Sawyer

And with that, I'd like to take one more question.

Operator

Certainly and the last question comes from the line of Mike Sison with KeyBanc.

Jim Sawyer

Hi, Mike.

Mike Sison – KeyBanc

In terms of your sales outlook for 2010, it's fairly even across the segments or is there one or two that might have a little bit more growth than the rest?

Jim Sawyer

Right. I can slice and dice that three ways. Geographically, we're seeing much greater growth in China and India and South America and much lesser growth in Europe and the U.S. By distribution method, the on-site should be the one that's picking up the fastest with sales to chemicals and steel picking up, followed then by merchant and package. And then by end-market and I guess I got into end-market, we basically expect reasonable improvement in steel and chemicals and then probably later in the year, more pickup on the manufacturing side.

Mike Sison – KeyBanc

Great. And then one quick one on PDI. Do you expect growth on a same-store sales basis in 2010? And what's the incremental margins that you talked about, a lot of potential here once volumes turned around. Is it sort of in-line with what you've talked about for the company, is it little bit more or little bit less?

Jim Sawyer

No, it's a good incremental margin, because we took a lot of cost out of that business and our operating margin in that business is currently about 16%, 17%. And as I think I tried to describe it before, you have to – basically it's a distribution business and you have to drive the routes to customers, where the customers need to be delivered. And if the customers are just taking less volume per customer, your distribution cost doesn't go down very much and that's pretty much what we've been seeing. So, if the volume per customer increases then we should be getting operating leverage at 30% or maybe 35% on higher volume there.

Okay and with that, I'd like to wrap up this fourth quarter and full-year conference call. And thank you all for participating and have a good day.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!