Praxair Management Discusses Q4 2010 Results - Earnings Call Transcript

Jan.26.11 | About: Praxair, Inc. (PX)

Praxair (NYSE:PX)

Q4 2010 Earnings Call

January 26, 2011 11:00 am ET

Executives

James Sawyer - Chief Financial Officer and Executive Vice President

Kelcey Hoyt - Director of Investor Relations

Analysts

Mark Gulley - Soleil Securities Group, Inc.

David Begleiter - Deutsche Bank AG

Michael Sison - KeyBanc Capital Markets Inc.

Donald Carson - Susquehanna Financial Group, LLLP

John McNulty - Crédit Suisse AG

Michael Harrison - First Analysis

Edward Yang - Oppenheimer & Co. Inc.

Laurence Alexander - Jefferies & Company, Inc.

Kevin McCarthy

P.J. Juvekar - Citigroup Inc

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2010 Praxair Inc. Earnings Conference Call. My name is Lacy, and I will be your coordinator for today. [Operator Instructions] I would now like to turn the presentation over to your host for today's call, Mr. Jim Sawyer, Executive Vice President and CFO. Please proceed.

James Sawyer

Good morning, and thank you for attending our fourth quarter earnings call and webcast. I am joined this morning by Liz Hirsch whom you will recall was appointed Vice President and Controller of the Corporation in December; and Kelcey Hoyt, our new Director of Investor Relations. Today's presentation materials are available on our website at www.praxair.com in the Investors section. Please read the forward-looking statement disclosure on Page 2 and note that it applies to all statements made during the teleconference.

I'm going to start this morning with an overview of our full year results for 2010. Kelcey will then review our fourth quarter results. Afterwards, I will discuss our current business trends outlook and our earnings guidance for 2011. We'll then be available to answer questions.

Let me first address several significant one-time issues. First, we decided to sell the U.S. portion of our North American Home Oxygen business. It's no secret that the reimbursement environment for this business has become worse and worse throughout the decade, and the future looks no brighter. So we have ratcheted down into an expected realizable sale value, and we expect the close to expect in the first half of the year. This will reduce sales by $150 million in 2011 with negligible impact on earnings.

Now on the tax side. Over the past several years, we've seen sovereign governments using excessively aggressive actions in order to collect money. We expect this trend to continue going forward not only overseas but also in the U.S. and particularly with state governments. Consequently, we settled our issues in Spain with a handsomely sized payment of nearly $500 million. Last year, we settled the majority of our issues in Brazil and Mexico at no significant cost. Going forward, we don't expect to have any significant charges, and we do expect to close audits in the U.S. and Canada up to 2008.

With respect to the Cod A [ph] fine in Brazil, we've appealed the case, have a very strong defensive position and don't expect it to be fully agitated for many years to come. And lastly, five years ago, there was a concern about welding rod cases brought against the welding industry. At this point, 95% of these cases have now been withdrawn as the plaintiff's lawyers have had little success.

Please refer to Slide 3 in our presentation which summarizes our full year results. Please note that in the presentation, our earnings have been adjusted to exclude the impact of these items. These charges are detailed and are reconciled to GAAP reported numbers in the appendices to the presentation and press release.

That behind us, we closed 2010 on a very strong note. Our full year results reflect strong growth across all of our geographies and major end markets. We started up 20 new plants around the world and established a presence in two new growing geographies, Russia and the Middle East. Our intense focus on productivity and cost reduction allowed us to leverage our 13% sales growth to 19% growth in earnings per share.

In 2010, we achieved about $400 million in cost savings from productivity. Overall sales were $10.1 billion, 13% above 2009 primarily due to 9% volume growth including new plant startups in Asia, North America and South America. Manufacturing, metals, chemicals and energy end markets showed a stronger growth in the prior year. Foreign currency translation increased sales by 2% for the year due primarily to depreciation of the Brazilian real, partially offset by the weekly euro.

Operating profit was $2.2 billion, 15% above 2010, primarily due to volume growth in productivity gains. Operating margin improved 40 basis points to 21.4%. We were able to leverage the economic recovery by continuing to execute on productivity savings and cost reduction.

Full year net income of $1.5 billion grew 18%, also benefiting from higher earnings from our equity affiliate companies in Italy, China, Norway and our new joint venture with ROC Group and the existing industrial gas operating in Kuwait, United Arab Emirates and Qatar.

Full year earnings per share were $4.74, up 19% from 2009, higher than the increase in net income due to fewer diluted shares outstanding as a result of our ongoing share repurchase program. Our team produced outstanding results in getting positive leverage on the income statement by sustaining our productivity efforts implemented during the economic downturn and executing on new projects and new business wins. Our aftertax return on capital for the year was 14.4%, reflecting improved earnings on higher capital due to ongoing investment in new on-site projects, which will provide significant future revenue and earnings growth. Return on equity for the year was 26.4%.

Excluding the Spanish tax settlement in the fourth quarter, we generated record cash flow of $2.4 billion in 2010. This strong cash generation reflects a high return on capital. This cash flow funded capital spending of $1.4 billion primarily for new on-site plants around the world that will come on stream over the next three years. The results of our business strategy to drive high return on capital will continue to generate higher levels of cash flow.

As the chart demonstrates, we've grown cash flow over 10 years at a compound annual rate of 10%, and we expect to be able to continue this performance. Cash flow also funded $148 million of acquisitions primarily the purchase of an ownership interest in ROC Group. We'll continue to invest in as many high return projects as we can though we expect to have increasing amounts of cash to return to shareholders as well.

During the year, we purchased $400 million of stock net of issuances including about 1/3 of the $1.5 billion share buyback program we announced in July. We paid dividends of $550 million during 2010. This morning, we announced that we're increasing our quarterly dividend for $0.45 to $0.50 in the first quarter of 2011, an 11% increase and our 18th consecutive annual increase.

Now Kelcey will review our results in the fourth quarter.

Kelcey Hoyt

Thank you, and good morning. Please refer to Page 5. Overall, our results in the quarter reflect continued improving sequential trend with strong volume growth in emerging markets and continued steady recovery in North America and Europe. Fourth quarter sales were $2.6 billion, 9% above the prior-year quarter primarily due to 8% volume growth. Sales were higher in all of our major end markets. Manufacturing, metals, chemicals and electronic have the strongest growth versus the prior-year quarter. New plant startups in Asia and in the United States contributed to the overall growth. Sequentially, sales grew 3%. Volume increased 2% due primarily to growth in Asia and North America. Sales through energy and electronic customers were the strongest sequentially. Currency effects increased sales by 2% due to the strengthening of foreign currencies versus the dollar during the quarter.

Operating profit of $563 million grew 10% from the prior-year quarter due primarily to higher volumes and productivity savings. Operating margin rose to 21.5%. Net income was $388 million, 14% above the prior-year quarter, and earnings per share grew 15% to $1.25. Operating cash flow and a moderate increase in debt funded $451 million of capital expenditures this quarter, largely for new production plants under long-term contracts with customers. The company paid $137 million of dividends and repurchased 265 million of stock net of issuances. Our debt-to-capital ratio for the quarter was 47.5%, and aftertax return on capital for the quarter was 14.4%.

Now we'll review our results in North America which are summarized on Page 6. Sales in North America were $1.3 billion, 11% above the prior-year quarter due primarily to 9% volume growth. Sales growth was broad based across our major end markets. In particular, we are seeing stronger pickup in packaged gases which have lagged the stronger recovery in on-site and merchant. Sequentially, sales grew 2% due to higher volumes, and we expect the sequential growth to continue into 2011 as the manufacturing segment of the United States economy continues to recover and customer demand improves.

In addition, we are seeing strong demand from the energy sector. Hydrogen volumes to refineries were strong this quarter, and our natural gas frac-ing business in Canada picked up. On-site volumes were higher 4% sequentially, primarily due to the strong refinery hydrogen. On-site oxygen was relatively steady sequentially due to solid demand from steel customers with continued recovery of infrastructure in nonresidential construction market.

Merchant sales grew 13% from the prior year. Sequentially, merchant sales increased 3% excluding the seasonal reduction in carbon dioxide, food and beverage demand. Merchant pricing trends for liquid oxygen, nitrogen and argon are positive with some momentum from recent price actions. Argon, which is only made as a byproduct of oxygen and nitrogen is now in tighter supply consistent with the recovery. Overall pricing trends are flat due to higher volumes of liquid hydrogen at lower prices which are indexed to natural gas.

North America and packaged gases sales were 9% above the prior year and 2% above last quarter reflecting the strengthening manufacturing environment. In PDI, our U.S. and Canadian business same-store sales were 9% above last year. Gases and hard goods were both higher with hard goods growing faster than gases as expected during the beginning of an economic recovery cycle. However, overall sales are still well below peak from 2008, providing additional upside as the recovery continues.

Volumes in Mexico grew 10% from prior year due to stronger demand from auto, glass and steel customers. We continue to be very positive about new business opportunities in Mexico especially in the energy sector.

Operating profit in North America was $311 million, and the operating margin was a strong 23.7%. This reflects strong operating leverage versus the prior-year quarter due to higher volumes and productivity.

Please look at Page 7 for our results in Europe. Sales in Europe were $339 million and excluding foreign currency, up 6% from the prior year driven by 4% volume growth. Sales growth was driven primarily by chemical and metals markets. Production in Germany continues to recover, while Spain and Italy remain weaker as a result of economic crisis, lack of available credit and poor manufacturing and construction activity. On-site volumes in Germany were higher year-over-year and sequentially due to stronger pipeline sales to steel and chemical customers. Merchant volumes grew 20% year-over-year and 9% sequentially.

In Spain, on-site and merchant volumes grew year-over-year and sequentially with packaged gas slower to recover as construction and met fab remained weak. Operating profit was $68 million compared to $76 million a year ago due primarily to negative currency effects and some restructuring costs in the quarter. Operating profit margin improved from the third quarter when we had some planned outages and expenses associated with the new business startups in the Middle East and Russia.

We recently announced our second project in Russia, a contract to supply oxygen, nitrogen and argon to NTMK, a division of Everest [ph] Group, a leading global steel company with its main steel production facilities in Russia. We will build new energy-efficient air separation plants to supply more than 3,000 tons per day of industrial gases to NTMK in Central Russia. The new plants are scheduled to start up late in 2013 and will replace older air separation plants and produce liquid products for the local market.

Page 8 shows our results from South America. South American segment sales were $516 million, up 12% versus $461 million in the prior-year quarter due primarily to 9% higher volumes and 2% higher price. Year-over-year, on-site merchant and packaged gas sales were higher with gains across all end markets. Sequentially, on-site volumes were relatively steady as a stronger currency impacted the competitiveness of Brazil's steel exports. Merchant volumes grew slightly versus the third quarter due to the seasonal increase in carbon dioxide for food and beverage demand in the warmer months.

Operating profit in South America was $114 million versus $111 million a year ago. Operating profit margin this quarter was temporarily impacted by a significantly higher power cost and a lag effect in the ability to contractually pass the increase through to our customers. Our project opportunities in South America are strong and last week, we announced a project to supply oxygen to ArcelorMittal steel production facility in southeast Brazil. We will build a new air separation unit with a capacity of 780 tons per day with energy-efficient process cycles. The plant is scheduled to start up in early 2013.

Slide 9 shows our results in Asia. Asia had a very strong quarter. Sales of $308 million were 12% above 2009 due to 16% volume growth excluding an equipment failure in the prior-year quarter. We saw a continued strength in electronics with sales in Asia up 17% excluding currency year-over-year and 5% sequentially due to demand for flat panel displays and integrated circuits.

Semiconductor sales continued to be strong due to high consumer demand for smartphones and tablet computers. On-site volumes were 90% year-over-year driven by new plant startups in China and volume growth in China, India and Korea. Merchant volumes grew 30% year-over-year and 9% sequentially with very strong growth in China and India. We are growing the business by bringing our applications technology into this market such as steel audits to help customers save energy and technology to improve drinking water quality.

Merchant pricing trends are positive especially in certain geographic areas with tight supply. This has been offset by lower pricing for electronics specialty and rare gas. Asia's operating profit increased to $50 million, and operating margin grew to 16.2% due to higher volumes.

Our results for Surface Technologies are shown on Page 10. PST sales this quarter were $150 million. Holdings for jet engines are strengthening. The industrial gas turbine market remains soft due to production slowdown at one of our larger customers. Industrial coatings are showing signs of strength in the United States and weakening in Europe. The fourth quarter operating margin was impacted by a pension settlement charge and restructuring cost.

Now I'll turn this call back to Jim who will discuss our global end market trends and our earnings guidance for 2011.

James Sawyer

Please turn to Page 11 which shows our global end market trends. This page shows you year-over-year sales growth for our major end markets excluding currency acquisitions and natural gas pass through. This represents real organic growth from pricing and volume. We've included the sequential growth numbers next to the year-over-year quarters so you can get a sense for the comparisons.

During 2010 what we saw sequentially was a strong pickup in overall growth in the first and second quarters of the year, followed by a flat third quarter and now stronger volumes in the fourth quarter. Growth in the energy market primarily reflects higher hydrogen sales to refineries. Hydrogen demand from refineries has continued to be steady despite the continued lower gasoline and diesel prices because refineries need hydrogen for desulfurization of crude to make low sulfur diesel and other metal distillates.

During 2010, we started the first hydrogen plant at BP's Whiting Indiana refinery with the second plant to come on stream this quarter. We expect future growth to come primarily from new refinery investments in overseas markets for upgrading and new capacity. Potential number in the side of these projects is large, so we continue to see hydrogen as a significant growth driver for us. Sales in this market also include gas sales for enhanced recovery and gas well fracturing. We continue to be positive on new business opportunities related to enhance our recovery, and we're participating in a number of pilot projects around the world.

Electronic sales remained strong. Our physical day per target sales have been strong in line with increased capacity utilization. Sales for the flat panel display market remains steady, plus we've seen some producers convert idle or surplus capacity to touch-screen production as smartphone and tablet demand increases.

Global steel production in Q4 was steady for the third quarter but is forecasted to increase in the first quarter, and we're seeing this already in North America and China. Our outlook is for modest growth to continue in 2011. Fourth quarter sales to manufacturing were 10% above last year and slightly higher than the third quarter. 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 nonresidential construction. The underlying trends remain positive, stronger in the U.S. and emerging markets, the continued weakness in Europe for infrastructure and nonresidential construction remained low.

Now please look at Page 12 for our earnings guidance. Our earnings guidance for the first quarter is for EPS of $1.23 to $1.28. Typically, our first quarter is the softest of the calendar year due to seasonal slowdowns in South America, Asia and slow winter sales in the U.S. construction markets. Our guidance for the full year of 2011 is for sales to be in the area of $11 billion, roughly 10% above 2010. Our initial forecasts for full year earnings per share is a range of $5.25 to $5.40, which represents an increase of 11% to 14% from our 2010 earnings.

We expect 2011 capital spending to be in the range of $1.5 billion to $1.8 billion. About 20% of this spend is maintenance capital for our base business. We spent another 5% for cost reduction projects such as improving the energy efficiency of our plants by upgrading compression equipment for turbo machinery. We will typically look for a three-year payback on these projects. The remaining 75% of our capital spend or approximately $1.1 billion to $1.3 billion is for new production plants under 15-year contracts with customers, which will deliver sales and earnings growth for the foreseeable future.

We refer to Asia, South America, Mexico, Russia and the Middle East as our emerging markets which are growing much faster than the developed world and are investing in infrastructure to support domestic demand from huge populations for a rising standard of living. As predicted this same time last year, about 2/3 of our 2011 growth CapEx is going in these emerging markets. The capital spending guidance is driven by a strong project backlog of 33 large projects with a capital value of over $2.2 billion.

Noted, we earlier forecasted of this number to be close to $2.5 billion by this time. We've had some slippage in this timing of contract signings, but none of them have been lost or gone away. These projects are under construction with scheduled start up dates from next quarter to late 2013. The capital backlog of our project is very high, and this is why we can tell you that on top of whatever lift, industrial production biz, our existing base business, our backlog will deliver 3% to 5% annual earnings growth in 2011, 2012 and 2013. And as we continue to sign new projects, this will extend out until 2016. In fact, the number and size of projects we have currently under negotiation has risen by 20% versus last year. To accommodate this new business, we've established new project execution centers in China and India in addition to those in the U.S. and Brazil. And we fitted our engineering resources so that more than half of our professional engineers and project managers are located outside of the United States. We continue to be bullish on long-term growth in emerging markets and believe we have a competitive advantage and cost efficiency and execution in these countries.

In the shorter term, we expect base volumes in the U.S. to continue to pick up, particularly in manufacturing and packaged gases. Our packaged gas business fell by nearly 25% from peak to trough. We're now halfway back with 13% growth and expect to regain another 10% over the next 18 months.

Southern Europe, particularly Spain and Italy, are still finding new lows. But once the fiscal issues are sorted out there, they will have to recover too. And lastly, we're starting to see some renewed growth in our frac-ing business particularly in Canada as well as in the United States. And I expect that when frac-ing comes back into play as natural gas demand picks up that we will go back to some of the higher earnings levels we had from back in 2007 and 2008.

And now, we'll be able to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of P.J. Juvekar with Citi

P.J. Juvekar - Citigroup Inc

Jim, when I look at the business, it seems like around the world, it seems to be very little pricing power currently. Is this different than the past cycles? Or do you think pricing will come at a later point in the cycle?

James Sawyer

Right. Just to divide it up into three segments. In the on-site business, the pricing is really escalating for power and so forth. So we actually, any price increase we have in there, we attribute to the power pass-through.

In the Merchant business, we have typically been getting an average 2% to 4% price increases annually, up until the recession. When capacity utilization fell from about 86% down to less than 70%, that became difficult to achieve. Now we're back at about an 80% capacity utilization. And we are getting price increases particularly in argon as argon has come under a short supply. That's usually the first gas that comes under supply constraints as demand grows. So we have significant price increases in argon as well as in typical merchant oxygen and nitrogen. You don't see that in our overall numbers because we signed several new contracts, major contracts for liquid hydrogen at lower pricing than we had in the past. And so, that kind of masked it. But we are basically seeing some good pricing in the U.S. in LIN/LOX. We're also starting to see some price increase in power in packaged gases. But I think the volume will come back first before we're able to get pricing back. And then, in China, where the market is finally getting tight, again, we were able to work through some fairly significant price increases. The one thing about this business is that in the merchant side, typically, we have five-year contracts. So there's a lag time between when you're able to, when the markets slows down and speeds up until you're able to get pricing. So I think we're just going into the beginning of another multiyear ability to get price increases as those contracts roll over.

P.J. Juvekar - Citigroup Inc

Just quickly, overall, you had 8% volume growth. Can you break down that into how much was due to new project startups, and how much was due to same-store sales growth?

James Sawyer

Roughly on the sales side and the volume side about 3% from project startups. They contribute about 5% of the higher operating profit, and the other 5% or so from growth in the merchant and growth in packaged and so forth.

Operator

Our next question will come from the line of Don Carson with Susquehanna Financial.

Donald Carson - Susquehanna Financial Group, LLLP

Looking at your guidance for 2011, the midpoint of your guidance, the 12.5% EPS growth. Now I know longer term, you're targeting 12% to 18%. So what do you need to see to get to the medium to high end of that longer-term guidance? Is it more pricing recovery or better volumes?

James Sawyer

Yes, couple things. We need better volumes to just grow in the base business, so that we can get some more pricing there because we basically don't have net pricing in that number now. To the top of the range, 14% is a pretty good target. For us, some of it will depend on how the economy and currencies go. And then the last thing we need is we've got a number of projects that are fully finished or nearly finished but haven't started up yet and not delivering earnings yet, and some of those startup, I think we'll get back more into that cycle. But what we've got in that 12% to 18% is close to stand the cycle. We're just above that last year. Ideally, we'd like to get back to the kind of 15% on average earnings growth on a steady-state basis.

Donald Carson - Susquehanna Financial Group, LLLP

Do some of these major projects come on, do you see server return on that 15% midpoint by say 12%, 13%?

James Sawyer

Yes, yes, I do.

Donald Carson - Susquehanna Financial Group, LLLP

On PDI, you talked about the volume improvement. What's happening to margins there? I guess there's two kind of trends while volumes are improving, hard goods are improving more than gases. Is that diluting your margins? And you talked about how far volumes have fallen since the peak? What's happened to margins since the peak? Have they stayed steady as the mix has shifted over to gas?

James Sawyer

Yes, right. As you mentioned earlier, the hard goods part of it is the more volatile part, more cyclical part with gases being more steady. So hard goods are leading the way with I think roughly 15% year-over-year growth, and they are lower margin sales than the gas sales. So that has tended to compress margins in PDI well at least theoretically.

On the other hand, what we're doing in productivity and cost has pretty much maintained the margins of where we have been in the past. And I think we do have a significant operating margin versus our competitors. And I think we can continue to grow that operating margin as we get some volumes back as well as some more pricing in the marketplace.

Operator

Our next question comes from the line of Edward Yang with Oppenheimer.

Edward Yang - Oppenheimer & Co. Inc.

Could you talk about Europe a bit? The margins were down year-over-year and so is the operating profit, was that all currency? I know in the prior quarter, you had some hedge losses and some startup costs as well.

James Sawyer

No, we do have some miscellaneous restructuring cost over in Europe because we are continuing to get severance over there, not only in the Gas business but also in PSD. We've got a significant amount of plant closure and restructuring cost as we continue to essentially downsize or optimize our systems to match demand. The problem right now is that in Spain, the manufacturing economy in Spain is still going down. And our packaged gas sales are way, way up in Spain which actually are fairly profitable for us in Spain. And basically, the same thing is happening in Italy. So I'm pleased that at this point, Europe has now become a tale of two countries itself with Germany doing very well, and Spain and Italy not doing very well. And that's becoming exacerbated by the continued fiscal concerns in Spain and Italy. But if you look at the level of product flow right now in Spain and Italy, it's kind of like what was the level of automobile manufacturing in the U.S -- the trough of the recession where basically, nobody was buying cars. But after credit became more available, it kicked right back up because people needed cars. And I think we're going to see the same thing in Spain and Italy. At some point in time, they just got to bounce back because the level of the volumes right there are just below what would be sustainable for the economy. I'd expect them to pick back up. That will bring margins back up in Europe as well.

Edward Yang - Oppenheimer & Co. Inc.

How big is Germany relative to Spain and Italy?

James Sawyer

Off the top of my head, I'm going to say that Spain is probably 35% of our business, Germany 30%, Italy 25%, and then the rest up in Norway and France and Netherlands.

Edward Yang - Oppenheimer & Co. Inc.

And Surface Technologies, that looks like it took a step back on the margins as well. Are you still targeting 20% margins there? What sort of slope should we expect to get to that goal?

James Sawyer

I'm still targeting 20% there. Surgical Technologies has a number of markets, a number of plants around the world. And if you look at the best performing ones, they have very, very high margins. Basically, the way to get there for us is they keep weeding out the underperforming ones. And as we do that, we got to take restructuring charges and severance charges. So we took $5 million or $6 million of charges in Europe in PST this quarter which is close to the income statement. And then, on the end markets, I think we are very, very unique position in coating jet engine blades and a very unique position in coating industrial gas turbines. So we kind of go cyclically with the jet engines but we're doing better now. Unfortunately, gas turbines' production has fallen pretty significantly. I think that will pick up. And then the third area is what we call general industrial. And that's a whole range of machinery and so forth. And about half of that is in Europe, and is also suffering from the slowdown in Europe. But if we take that business strategically, we've kind of changed the strategy to really just focus on turbines, both land and air turbines, and are in the process of bit by bit rationalizing some of the plants that were mainly just serving industrial markets. And that just comes up probably over a year, we'll have some plant closure and some cost that hits us to there but we're improving in the quality of the whole business.

Edward Yang - Oppenheimer & Co. Inc.

So it should take a few years to hit that target?

James Sawyer

Yes, I think it should. I think we'll see it at the end of this year absent any other severance and restructuring cost. The severance and restructuring costs were just quite small relative to all the fracs here. It shows there's a big number in the PST segment when you look at the margins.

Operator

Our next question will come from the line of John McNulty with Credit Suisse.

John McNulty - Crédit Suisse AG

Toward the end of your remarks, you indicated that the backlog had slipped a bit in terms of what you were expecting. Can you kind of give us a little more color as to what's driving that?

James Sawyer

Basically, there are three or four major projects that we expected to sign in the fall, and the finalizing of contracts has slipped across year-end. In two cases, just because of the customer continuing to tweak the scope of the customer's requirements and tweak exactly what they're going to do with the refinery in one case, and how they're going to do the coal gas occasion in another case. And until they finished tweaking their own designs, their own internal requirements, the oxygen requirements or hydrogen requirements don't get finally determined. And that's really actually what's holding those up. But I don't see any long-term thing. And we just got, as I said, we've got about 20% more projects under negotiation right now than we did a year ago. But due to the nature of the customer's projects, like grassroots refineries, they just take longer to get finalized.

John McNulty - Crédit Suisse AG

On the South American power issue and the lag that you're seeing there, can you quantify what that was? And if it looks like things are kind of settling at this point, or is that maybe an issue going forward after all?

James Sawyer

It's restrained now going forward. But we had a double-digit increase in power cost, nearly 20% increase in power cost year-on-year. And really what's happened there is that -- and the same thing happened in most parts of the world that as everybody went into recession, the demand for electric power went down. And the price of electric power went down. And then as demand for electric power is picking up, low rates are picking up around the world. And so, we have to be able to pass those through to our customers. But we have a lag effect this time in Brazil in particular. And so, we'll be getting the pricing back from our customers that we paid in the fourth quarter for electric power.

Operator

Our next question comes from the line of Kevin MacCarthy from Bank of America Merrill Lynch.

Kevin McCarthy

Jim, with regard to the sequential trend in tonnage volume in North America, how much of that is stronger hydrogen demand? It looks like refining spreads have improved significantly in recent months? Maybe if you can talk about your outlook for hydrogen in the early days of 2011?

James Sawyer

I'm just going to talk sequentially, right now about that because that's kind of where the trend is. Actually, sequentially, steel volumes were lower in the fourth quarter than the third quarter, and those are pretty high margin dollars. We expect those to pick up again in 2011. So actually all the on-site volume growth was in hydrogen, and we expect that to continue both coming from our existing plants there onstream, also coming from the startup -- the second world scale reformer [ph] from the BP Indiana this quarter. And I think you may see a number of new project signings for Gulf Coast hydrogen going forward.

Kevin McCarthy

On the merchant side, Jim, you reported sequential improvement of 3% excluding the CO2 seasonality. How large is that CO2 seasonality? It looks like it's perhaps skewing the numbers a fair amount given the segment average of plus two, and when would you expect that seasonality to pick back up?

James Sawyer

Well, the strong seasons for CO2 is the spring and summer because the beverage carbonation and beer typically falls in the fourth quarter and the first quarter. So that actually masks some of the improvement. But basically, we saw a sequential improvement in volumes in nitrogen and oxygen and argon and liquid hydrogen. And with about a 3% rates, if you annualize that, that's about 12% rate. So we're still seeing a pretty good volume growth there.

Kevin McCarthy

Jim, in Brazil, you mentioned the appreciation of the real, I guess you're at 167 now. I supposed that will help you on translation. But what are you seeing on the ground there with regard to volumes and your customers' trade balances. Is that having any appreciable impact?

James Sawyer

I think it will continue to do so if it stays there. Basically, you can divide our customers into really two types. One is for the local consumption, which is continuing to be very strong as the local economy grows and consumer spending grows. The other part being going into steel and non-ferrous metals. And Brazil's competitive cost around the world has always been extremely favorable, a little bit less favorable with the currency the way that it is. But I think, generally, it will always be favorable compared to a number of countries. And actually, a lot of that steel there is shipped to China and Asia, not much of it is actually shipped to the United States. But I think, it will pick up. The other thing about Brazil is it's summer now, and they start summer out with Christmas and they ended with carnival. First quarter is usually pretty weak or generally in Brazil.

Operator

Our next question will come from the line of Mike Sison with KeyBanc.

Michael Sison - KeyBanc Capital Markets Inc.

In terms of the global end market trends, the Energy business is up 15% in the fourth quarter. It's certainly stronger than what you've shown in the third and the fourth? Is that a good run rate going forward in terms of what to expect from that end market in 2011?

James Sawyer

Yes, I think we've got good room to grow there. Because I mentioned the higher general rate and the other parts of our energy market are enhanced oil recovery. We got a major project coming on stream this year and enhanced oil recovery, in addition to the hydrogen projects coming on stream. And hopefully, we'll start to see our natural gas frac-ing business start to get back because that went from a very profitable strong business in 2007 to practically nothing in 2009, and it's partly a function of the price of natural gas. It's also a function of volume, and if you look at volume in terms of megawatt hours produced by facilities. And as volume goes up, the natural gas producers are just going to have to get more gas out of the ground, and frac-ing is one of the ways that they do that. I guess that's why I'm cautiously optimistic about rebounding frac-ing.

Michael Sison - KeyBanc Capital Markets Inc.

Just so I have the math right, your implied guidance for sales for '11 is roughly 9% increase versus '10. It sort of sounded like you might be at the low end of that 3% to 5% in terms of contribution for new products in '11. So does that assume that your base business grows plus 6% in 2011?

James Sawyer

Well, I mentioned that we're selling the homecare service. That's going to take $150 million in sales out of 2011 versus 2010. So that brings us on a pro forma basis back to just under $10 billion in 2010. And projects starting up, a couple of them are basically tolling agreements and don't have much sales growth but at a very, very high operating margin. So that's why, I'm starting to talk about the projects, we're adding roughly 3% in sales growth and about 5% of operating profit.

Michael Sison - KeyBanc Capital Markets Inc.

Last question, you noted solar again in the electronics end market, was an area that continues to be good for you guys. What's sort of your outlook for that business or segment in 2011, and any thoughts on what sort of underpins that solar installments, that type of thing?

James Sawyer

Whenever that somebody starts up a solar panel production facility, they need a variety of gases. They need argon, hydrogen, nitrogen and a bunch of other gases. Typically, they are merchant-sized customers rather than on-site sized customers. So they're not huge customers each time somebody starts up a plant there. But there are quite a number of plants starting up in the U.S. But I think more importantly, China is starting a number of solar panel plants. We just signed three new contracts there, and there are quite a few being built in Europe as well. So I'm not really a believer that solar energy is really going to do what some people think it ought to do over the next 10 years. But there still is continued growth there, and I think that will continue.

Operator

Our next question comes from the line of Mark Gulley with Soleil Securities.

Mark Gulley - Soleil Securities Group, Inc.

Question on tax rates. Yesterday, DuPont talked about the fact that the tax rate is heading down -- of course, yours is going up over the years because they're seeing low tax rates in emerging markets where the growth is good. Of course, you're growing rapidly in emerging markets as well. So could you get a tax rate benefit from a geographic mix with respect to your tax rate?

James Sawyer

I don't see it going down. We've got some fairly low tax rates in China and Brazil and some other countries. But offsetting that, I just believe we're going to have higher tax pressure in the United States. So I don't see it going down much.

Mark Gulley - Soleil Securities Group, Inc.

Looks like the Middle East, one of your large international competitors, has done a lot of work in the Middle East and has enjoyed some success there. You seem to be a bit of a fast follower. Do you think that you're in good shape to compete for on-site business in the Middle East, given the fact you're a little bit late to the party?

James Sawyer

I think we are. I think what our two European competitors have done essentially has been in the plant field that's in the Middle East. And most of what they're talking about there is the sale of plant, which is typically the way the Middle East has operated particularly in the petrochemical sector. Those plants are large. They're government owned, and they've been typically a plant. And we are more focused on building an over-the-fence model and not just a stand-alone over-the-fence model but an over-the-fence model that also serves merchant and packaged gases.

So our acquisition of ROC gives us the distribution on the merchant and packaged gases and business contacts with some customers. We are now seeing people in other industries like the steel industry and the glass industry and so forth, with an appetite to sign on-site contracts. And I think, that's pretty much what we're going to be focused. There are a number of what I call industrial parks that are being cited in the Emirates, in Kuwait, in Saudi Arabia where they were in a diversified economy, away from petroleum and petrochemicals. And so, they're setting aside these industrial sites in trying to attract all other kinds of manufacturing industries into them. And I think that's primarily where we're going to find our growth.

Mark Gulley - Soleil Securities Group, Inc.

Lastly on Brazil, you got a nice market share there. It's a good part of your growth, and you seem to be on the roll with respect to the World Cup Olympics and of course, offshore oil. So can you kind of talk about what you foresee as your longer-term growth rates in Brazil given those large opportunities I just cited?

James Sawyer

Well, certainly, those opportunities are going to require more construction -- the World Cup there and they're building all these stadiums and Olympics and so forth. There's going to be a lot of infrastructure investment going on which we will see directly in our Merchant and Packaged Gases business, actually scattered quite wildly around Brazil specifically for the World Cup. So I'm pretty bullish on out there. I think in the short run, I think Brazil really will grow rapidly. Industrial production in Brazil was up 12% in 2010. And they are moving now to begin raising interest rates. We're now in the aftermath of an election. And so, I think there's going to be some more fiscal responsibility in Brazil and maybe about 5% industrial production in 2011.

Operator

Our next question will come from the line of Laurence Alexander with Jefferies.

Laurence Alexander - Jefferies & Company, Inc.

The emerging markets bucket, as you define it, what is the current percentage of sales? And how long do you think it might be if ever you start seeing pipeline projects or pipeline networks being built in each of those regions?

James Sawyer

Merchant [ph] is roughly 35% are the sales there. And we define -- I guess when we talk about merchant, we don't include electronic gases in there. It's basically oxygen, nitrogen and hydrogen and helium. We expect that right now, about 35% of our sales are emerging markets. We expect that to grow to about 45% by 2015.

Laurence Alexander - Jefferies & Company, Inc.

And in terms of getting pipeline projects in either Russia or the Middle East in three to five years?

James Sawyer

The pipeline will be merchant. In terms of Russia and the Middle East, we are under negotiations with several more on-site customers. I think if we can find some on-site customers who are sort of located nearby each other, we'll be able to build a pipeline business, I think, that's probably, most likely up near the ural mountains and that whole material development zone. We don't have any plans right now to build pipe to connect customers and plants together.

Laurence Alexander - Jefferies & Company, Inc.

Lastly, a few years ago, you were highlighting that as energy prices rose and cost pressure increased for your customers, it was leading to a bump in energy efficiency investments and projects that increased your backlog. Are you seeing that happen now with oil prices where they are or has the threshold pinpoint moved?

James Sawyer

It's really a function of natural gas prices. If you build facilities, glass makers and cement-makers and so forth are burning natural gas as their source of energy. And as you know, natural gas really hasn't moved.

Operator

Our next question will come from the line of Mike Harrison with First Analysis.

Michael Harrison - First Analysis

On Asia, first of all, we've seen operating margin there kind of fluctuate, swing pretty wildly between about 13% and 16%. You're back to the 16%-ish range now. Is that level kind of where we should expect to see it going forward? And do you think we're going to continue to see as much fluctuation next year, or is it going to stabilize?

James Sawyer

Well, we'll continue to see fluctuations, and I'll tell you why. There are basically, what I will call, three components of our Asia earnings. There's our standard on-site merchant industrial gas business which has about 22% operating margin. Then about 40% of our sales in Asia are electronics sales. And those margins really are quite volatile. And then lastly, as I mentioned before, we're building two new execution centers, one in China and one in India. And so, we have sort of a disproportionate amount of overhead spending relative to the sales over there. The way I'd termed it once, we're building infrastructure for a $2 billion business in sales. Right now, we have $1 billion business in sales. So all those three things kind of come together. When we've got some overhead expenses, that's going to hurt operating margin.

And in the electronics, it's fairly volatile. More than the boost in operating margin this quarter was a significant improvement in prices in China and particularly in argon. To make the long story short, I think the long-term core business in industrial gases will be, is right now, and it will continue to be a 20%-plus operating margin business going forward. But 40% of it right now is electronics which does pull the average down.

Laurence Alexander - Jefferies & Company, Inc.

One of your competitors was talking about increasing merchant capacity in India. I was wondering if had any concerns so we could see merchant capacity in India get a little bit ahead of itself in the near-term?

James Sawyer

Merchant capacity in India did get ahead of itself. There was quite a bit of building for a long time, and then we went into a slowdown. And now, it's coming back to a kind of higher level. But basically, what we're continuing to try -- you can always make merchant products cheaper if it's byproduct from an on-site plant. And so, we tend to focus on that rather than just building a stand-alone merchant project.

Michael Harrison - First Analysis

On the large supply tightness that you're seeing in North America, do you have plants where you're capable of producing LAR, and you're currently not producing, and do you have any plans to add more LAR production capability to any of your last minute plans?

James Sawyer

We have far and away the greatest amount of LAR production in North America. And a lot of that is byproduct from the largest oxygen plants. So our large oxygen plants in the Gulf coast and the Midwest have significant argon production capacity. But when the on-site customer reduces its volume, for example, we have non-oxygen plants on the Chicago area pipeline, then we start to shut down those plants depending on how much demand there is from customers along the pipeline. And so, if you're not producing oxygen, you're not producing argon. And if you want to run the plant just to produce argon, it's quite expensive. And so we tend to get around that by surcharging our customers for the fact that we're running the plant just to make argon. But you know, argon is only a couple percent, 2% of what comes out of the plant.

Operator

Our final question comes from the line of David Begleiter with Deutsche Bank.

David Begleiter - Deutsche Bank AG

Jim, just on your Russian plant. Are you requiring a high return on investment due to perhaps the risk in that country?

James Sawyer

Yes. We're doing a number of things. We're getting a high teens return without telling potential future growth in liquid market. We think that with some growth in liquid market, that should go higher. And then a couple of other things that we're doing to try to deal with the risk situation is, we have a very binding contract there that is actually executed offshore. So there's higher risk there for sure, but I think we're getting a sufficient return and taking enough mitigation steps to still make it worth our while.

David Begleiter - Deutsche Bank AG

On the large project backlog and really the negotiations for new projects, are the returns and pricing holding steady? Are they trending up slightly or not?

James Sawyer

I would say generally speaking, over time, returns and pricing are holding steady. I haven't seen anything that's been a low return.

Operator

Ladies and gentlemen, this concludes the question-and-answer portion of our call. I would now like to turn the call back to Mr. Jim Sawyer for any closing remarks.

James Sawyer

Thank you all for joining the call, and we look forward to working with you again in 2011. Take care. Goodbye.

Operator

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect. Good day, everyone.

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