Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Praxair (NYSE:PX)

Q3 2011 Earnings Call

October 26, 2011 11:00 am ET

Executives

Kelcey E. Hoyt - Director of Investor Relations

James S. Sawyer - Chief Financial Officer and Executive Vice President

Analysts

P.J. Juvekar - Citigroup Inc, Research Division

David L. Begleiter - Deutsche Bank AG, Research Division

Robert Koort - Goldman Sachs Group Inc., Research Division

Laurence Alexander - Jefferies & Company, Inc., Research Division

Mark R. Gulley - Ticonderoga Securities LLC, Research Division

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Duffy Fischer - Barclays Capital, Research Division

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Operator

Thank you for your patience, and welcome to the Third Quarter 2011 Praxair, Inc. Earnings Teleconference. My name is Candice, and I'll be your coordinator for today. [Operator Instructions] I would now like to turn the presentation over to your host, Director of Investor Relations, Ms. Kelcey Hoyt. You may proceed.

Kelcey E. Hoyt

Thank you. Good morning. Thank you for attending our third quarter earnings call and webcast. I'm joined this morning by Jim Sawyer, Executive Vice President and Chief Financial Officer; and Liz Hirsch, our Vice President and Controller. Today's presentation materials are available on our website at 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 this teleconference.

Jim and I will now review our third quarter results and outlook for the balance of 2011, then we'll be available to answer questions.

James S. Sawyer

Thank you, Kelcey, and good morning, everyone. Please turn to Slide #3 for our consolidated results. Praxair delivered another solid quarter, with earnings per share growth of 16% versus the 2010 third quarter. Our backlog of new projects under contract and construction is a record $2.7 billion, and we continued to win a disproportionate share of new on-site projects. Furthermore, due to our tight capital discipline and focus on productivity, we remain confident in our ability to deliver double-digit earnings growth.

Consolidated sales in the third quarter were $2.9 billion, up 14% versus the prior-year quarter. Sales were higher to all major end markets, with the strongest year-over-year growth in manufacturing, metals, energy and chemicals. Our volumes contributed 6% growth, and price contributed 3%. New project startups in Asia, South America and North America also contributed to the volume growth.

Sequentially, sales grew 1% from higher volumes in most geographies, partially offset by lower volume in Europe, most of which is a seasonal pattern. Operating profit grew to $632 million in the quarter, 15% above the prior year, and the operating margin was a strong 21.8%. Higher volumes, combined with price and productivity savings, were the primary contributors to the growth.

Net income of $429 million rose 14% from the prior year, and earnings per share were a record $1.40, up 16% from prior year. Earnings per share grew faster than net income due to share repurchases under our $1.5 billion share repurchase program authorized in mid-2010. $294 million remains available under this program, which we expect to complete during the first quarter of next year.

Cash flow generation was very strong this quarter. Cash flow from operations was $732 million or about 25% of sales. Cash flow funded $458 million of capital expenditures, primarily for the construction of new on-site plants around the world. In addition, we paid dividends of $150 million and repurchased stock of $251 million, net of issuances.

During the third quarter, we issued $500 million of 10-year notes at a rate of 3%. Our debt-to-capital ratio for the quarter increased to 50.8% due to the increase in debt and the impact of currency translation within equity. Our debt-to-EBITDA ratio remained at a strong 1.7. After-tax return on capital for the quarter improved to 14.8%, and return on equity was 28.3%.

Now Kelcey will discuss our segment results. Please turn to Page 4.

Kelcey E. Hoyt

Thanks, Jim. Sales in North America were $1.4 billion, 11% above the prior year quarter due primarily to underlying volume growth and price. Merchant liquid and packaged gas volumes both showed solid growth versus the prior year as manufacturing continued to improve. Sequentially, underlying sales grew 3%. The impact of the divestiture of the U.S. Homecare business, which was completed in early March of this year, reduced sales for the quarter by 3% year-over-year.

Organic merchant sales grew 12% year-over-year with broad-based demand for most liquid products, including oxygen, nitrogen, argon and liquid hydrogen. Sequentially, organic merchant sales grew 5%, with demand strongest for use of liquid nitrogen in Canadian frac-ing. On-site sales grew year-over-year due to strong metals and chemicals demand. The sequential volume increase was primarily driven by energy and more modest chemical market demand.

Packaged gas sales continues to improve as manufacturing and construction activity gradually increases in the United States. In PDI, our U.S. and Canadian business, same-store sales, which excludes currency and acquisitions, were 14% above last year and steady sequentially. Gases were up 10%, and hardgoods were up 22%. We expect that gas and hardgoods growth will eventually become more aligned as we move to a later stage of the manufacturing recovery.

North American operating profit was $350 million, 11% above the prior year quarter. The operating margin was a strong 24.5%. Through effective implementation of price increases, we offset inflation and power cost increases that typically occur in the hotter weather months.

Merchant pricing trends for all products remain positive. As these contracts are typically of a 3- to 5-year duration, our ability to increase the price is impacted by the timing of contract renewals. We expect to continue to realize low single-digit percentage impact from pricing actions in North America this year.

Capacity utilization is in the low- to mid-80s, consistent with the trends experienced the first half of the year. The set of opportunities for the acquisition of regional packaged gas distributors remain strong. Praxair targets distributor acquisitions that will bring the most value to Praxair, either through synergies with our existing strong North American footprint or integrated industrial gas model.

We recently acquired 2 packaged gas distributors. In the South, we acquired National Alloy and Equipment, a market leader in Houston, one of the fastest-growing welding markets in the United States. The company's core competency is technical support to the fabricators of high-pressure control packages and drilling risers for harsh offshore environments that require low-alloy, high-strength wires and fluxes. This ability makes National Alloy a one-stop supplier to the oil and gas industry.

In the Midwest, we acquired the assets of Welco, a market leader in Cincinnati, Ohio, which is one of the top 20 welding markets in the United States. This further strengthens our ability to serve customers and build density in the Ohio Valley.

Now please turn to Page 5 for our results in Europe.

Sales in Europe were $358 million, up 11% year-over-year as a result of a strong euro during the quarter. Moving into the fourth quarter however, the euro has weakened, and we therefore expect to show a sequential decline in this segment from currency.

Germany had higher volumes as compared to last year and last quarter. Growth was strongest in manufacturing, metals and chemical markets. Italy had strong sales volume growth year-over-year in merchant and on-site. Packaged gas volumes declined year-over-year. Sequentially, volumes also declined due to summer holiday seasonality, as well as a weak economic environment.

In Spain, sales volumes declined sequentially due to slowing steel production, as well as summer holiday seasonality and the lack of recovery in manufacturing and construction activity. Operating profit was $65 million, 10% above the prior year quarter, primarily due to currency. We continue to experience margin pressure from inflation, but have difficulty offsetting it in price due to competitor activity. In addition, the lower volumes during the quarter also negatively impacted the margin.

In early October, Praxair increased its ownership stake in the Yara Praxair joint venture in Scandinavia from 50% to 66%. The venture has locations in Norway, Denmark and Sweden and serves over 30,000 customers. The business generated sales of approximately $173 million in fiscal year 2010. As a result of acquiring a controlling interest in this joint venture, Praxair will consolidate the sales of the joint venture effective in the fourth quarter of this year.

Previously, the financial results were recorded in equity income. In addition, Praxair will recognize a gain in the fourth quarter as a result of revaluing its existing 50% ownership at fair value in accordance with U.S. accounting standards.

Page 6 shows our results in South America. South American segment sales were $607 million, up 20% from the prior year quarter. Excluding currency and cost pass-through, underlying sales grew 13% versus the prior year quarter from 8% higher volume and 5% higher price. The strongest year-over-year growth came from metals, manufacturing, food and beverage and healthcare markets.

Sequentially, growth in merchant and packaged gases were strongest in the manufacturing markets to support local production. Merchant and packaged gas growth was negatively impacted by CO2 sales that were lower sequentially due to the seasonal impact of the colder, rainier weather. Sequentially, sales to metals markets remain consistent with the second quarter.

During the quarter, there was strength in sales to mills that provide long products to support infrastructure and then some deceleration in mills that supply the flats for autos and appliances.

Operating profit in South America was $140 million, an increase of 20% versus the quarter a year ago. Underlying operating profit grew primarily due to higher volumes, higher pricing, productivity and currency.

Please turn to Slide 7 for our results in Asia. Asia had another very strong quarter. Sales of $341 million grew 19% versus the prior year quarter, due primarily to 12% volume growth. Merchant volume growth was strong across the region, including China, India, Korea and Thailand. Plant startups in China and India contributed to robust on-site growth.

Underlying merchant sales grew 15% year-over-year, with strong growth in all liquid products. We continue to grow volumes through our application technology, which provides environmental improvements and efficiency benefits to customers. This includes conversion of customers from air fuel to 100% oxy-fuel for lead melting furnaces, copper melters, the melting of scrap aluminum and use in glass furnaces. The benefits include fuel savings, reduced emissions and can include reduced capital costs. We are also continuing to grow oxygen volumes for use in ozone for disinfection at drinking water plants.

Sales volume in Asia to electronics customers grew 3% year-over-year and declined 4% sequentially. MSI declined sequentially for the first time in a number of quarters, and semiconductor capacity utilization is down. Pricing was below prior year and impacted by the lower demand during the quarter.

Asia's operating profit margin of 15% reflects seasonally higher power costs in Korea. The rates reset at an increase each year in the third quarter. Cost recovery is typically delayed.

The pricing environment in China remains positive, especially liquid argon pricing. Our local China team did a good job of contracting merchant customers at good pricing when the argon supply was tight late last year during the power curtailment. We have been successful in maintaining those price levels.

Our record project backlog of contracts of $2.7 billion includes $1 billion of projects in Asia. These projects are for a variety of end markets in China, India and Korea. They are under construction and have 15- to 20-year contracts with our customers. These projects in Asia will start up over time between this quarter and 2014. They provide line of sight to support global large project-related revenue growth of 4% to 6% each year.

Our results for Surface Technologies are shown on Page 8. PST sales this quarter were $163 million, up 10% year-over-year, excluding foreign currency. During the quarter, we had stronger growth in coatings to the energy market for industrial gas turbine and oilfield service components. Industrial coatings were weaker in Europe, but remained stable in the United States. Operating profit in the third quarter was $26 million, 13% above the prior-year period due to price, productivity and volume.

Now I'll turn the call back to Jim, who will discuss our global end market trends and our outlook and updated earnings guidance for the fourth quarter of 2011.

James S. Sawyer

Thanks, Kelcey. Please turn to Page 9, which shows our global end-market trends. This page shows year-over-year and sequential sales growth for our major end markets and represents real organic growth from price and volume, excludes currency, acquisitions, divestitures and natural gas pass-through.

Our energy market sales year-over-year and sequentially were very strong. Refinery hydrogen volumes were strong due to the lack of customer maintenance in the quarter, as well as spot sales out of our cavern in the Gulf Coast of Texas, which also came at a nice margin.

Frac-ing activity was extremely strong as well. Similarly, in Mexico, oil well services to PEMEX were very strong for the quarter.

In electronics, year-over-year increases were primarily driven by targets and processed gases in Asia, along with consumables. Component volumes are lower on reduced equipment spending. UpTime sales, Praxair's systems for safe and efficient dopant gas delivery, were significantly higher for the quarter.

Sequentially, the electronic sector began to soften during the third quarter. MSI demand declined for the first time since the same quarter in 2009. Equipment spending, capacity utilization and chip prices all were subdued during the quarter. Demand for flat panels continues to be low. Capacity has been turned down, which is having moderate impact on pricing.

Sales in the metals industry grew 15% year-over-year. Sequentially, there's been a reduction in volumes in Europe, as well as a lesser extent in North America. We're beginning to see customers schedule maintenance at their plants and run their production on a reduced schedule to manage inventories and price. Expect these turndowns to be temporary. In South America and China, volumes were flat sequentially.

Sales to manufacturing were 12% above last year and 1% higher than the second quarter. Manufacturing strengthened in all geographies except Europe. In South America and Asia, it is being driven by underlying economic growth. In the U.S., packaged gas business however, we're continuing to see continued late stage recovery. Customers are buying cutting machines, robotic packages and positioners.

In addition, our North American packaged gas business is experiencing strong activity in the mining, truck, trailers, automotive, custom fabrication, steel service and oil and gas sectors. This business typically has a shorter line of sight to volumes, but is expected to remain strong for the fourth quarter.

And now please turn to Page 10 for our earnings guidance. As we look towards the fourth quarter of 2011, there's currently uncertainty in the macroeconomic environment. While we are starting to see some sequential deceleration in growth around the globe, we do not see significant decline coming.

Our earnings guidance for fourth the quarter is for EPS of $1.33 to $1.38. This guidance anticipates a headwind from weaker overseas currencies of about $0.05 relative to the third quarter of 2011. This currency headwinds include the real, euro, peso and Korean won.

For the full year of 2011, we expect sales to be in the range of $11.2 billion and diluted earnings per share in the range of $5.40 to $5.45. Our capital spending is expected to be about $1.8 billion for the year. Excluding the fourth quarter currency headwinds, this guidance remains at the upper end of prior guidance.

Our guidance for fourth quarter 2011 is based on our short-term outlook for key market sectors, augmented by specific actions we expect to achieve during the quarter. Specifically in the United States, we expect steel and chemical volumes to be relatively flat for the fourth quarter sequentially. Packaged gas sales, which have recovered very nicely this year, with a rebound in manufacturing, will likely remain strong during the fourth quarter.

Europe will remain stagnant, with continued negative sentiment regarding the government fiscal situation. The key issue which is hurting us there is the continued deferral of purchasing decisions by businesses due to the uncertain economic outlook. Once this uncertainty is resolved, I do believe we will see a recovery in European manufacturing and packaged gas sales like we've seen in the U.S. But it looks like that might a long time to come.

Our emerging market geographies continue to remain strong, South America, India and China and Mexico. Regarding our own business, we expect to start up several plants during the fourth quarter of this year, representing diverse geographies in major markets. Notably, we'll be starting an installed recovery facility in the U.S., chemical facility in Brazil, several steel facilities in South America and India and our second major coal gasification facility in China.

Over the longer term, the opportunity set for major atmospheric gases and hydrogen contracts continues to grow. Additionally, we believe we'll win more than our fair share of new contracts as evidenced by our record backlog.

And now, we will be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of Mike Sison with KeyBanc.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

In terms of Europe, just curious when you look at the packaged gas business, can you give us a same-store sales sort of trend for the quarter and how that compares with the past couple of quarters?

James S. Sawyer

I don't actually -- we don't actually keep that data. At least, I don't have that data. I don't know if they've got it. But I've got to tell you that it seems like it's definitely down.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay. And that's where the lion share of the weaknesses is coming from?

James S. Sawyer

Well, I think in Europe, we are already down to an 18% operating margin, and it's fairly a place that we're not satisfied with their performance. Having said that, just basically a macroeconomic situation, where, in my mind, Europe, in particular southern Europe, really never recovered from the recession of 2009. Whereas in the U.S., we've had a nice recovery in virtually all economic sectors. And particularly in packaged gases and heavy manufacturing, that recovery has got to wait until people gain confidence to make decisions to buy capital equipment or build machinery or build infrastructure. And with all the shakiness in the financial system, the decision-making process just seems to be on hold by most companies. So I do think that eventually that can come back. But packaged gas sales and argon sales continue to be very weak in all across Europe.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Great. And last one on PDI North America, continues to sound like it's chug along nicely there. Any help on and whether hardgoods is still leading that trend and whether gases is catching up and where were we at in that cycle?

James S. Sawyer

Hardgoods are still leading the trend, with just positive leading indicator, I guess, you would say. Gases are catching up but they're still reinvesting hardgoods. We're basically up about 10% year-on-year on gases and 22% year-on-year on hardgoods. But remember how hard we fell in the hardgoods area in 2009, and we're still not back to the, like, 2007, 2008 same-store sales levels.

Operator

Our next question will come from the line of Kevin McCarthy with Bank of America Merrill Lynch.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Jim, looking back to the latter half of '08, Praxair was one of the first companies to diagnose some of the macro pressures and take action in terms of restructuring. Sitting here today, do you anticipate opportunities for incremental restructuring or cost control particularly in Europe?

James S. Sawyer

Yes. First of all, I'd like to say that I don't see this fall being in any way, shape or form similar to the fall of 2008. I mean, the season, the autumn season, okay? Because basically, except for Europe, there's plenty of liquidity around for small businesses, large businesses and so forth. And there aren't really any bubbles out there that are going to come crashing down. I think what's happened is in most of the world is that the recovery from the 2009 recession is just -- we've kind of finished the recovery phase now, and now we're going to be back to slow growth. Now Europe is obviously an exception to that, as I mentioned before. But we're going to continue to look at restructuring options in Europe because our planned utilization is not at a level which is very efficient right now. So we're going to be taking a look at that in the fourth quarter, but nothing of any major consequence.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Just to follow up on that, Jim, what are your LOX LIN operating rates, not only in Europe, but perhaps you could also comment on Asia and North America?

James S. Sawyer

Right. Well, generally around North America, we're running around 80%, 83%, which is a pretty good number. It's up from 68% to 70% at the depth of the recession. In Asia, in particular China, we're pretty close to being sold out. So we're at a higher level than that. Whereas in Europe, we're still hovering down on the 70% to 75% range.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Okay. And then a final one if I may, Jim. What is the anticipated impact of consolidating the Yara JV on your margins in the fourth quarter? Just trying to think about equity earnings impact and consolidated impact from that action.

James S. Sawyer

Okay, so we've bought a 50% interest in Yara's industrial gas business about 5 years ago. We now agreed with them and we'll be taking that interest from 50% up to 66%. The company has about $200 million roughly in sales. So beginning in the fourth quarter, we'll be consolidating those sales. So roughly $40 million, $50 million a quarter in sales, $5 million plus in operating profit and kind of a minus $2 million in equity income. Now aside from that, and what will clearly show as a nonrecurring item in the fourth quarter, our friends in the SEC and the FASB came out with a very quirky accounting rule which says that if you go from owning less than 50% to owning more than 50% and consolidate a business, you need to fair value your existing investment and run that as income through the income statement, even though, of course, there's no cash flow with that. So that will be a special item in the fourth quarter. I'm not going to say how big it is right now, but it'll just be a stand-alone special item.

Operator

Our next question will come from the line of Bob Koort of Goldman Sachs.

Robert Koort - Goldman Sachs Group Inc., Research Division

Kelcey, I think you mentioned in Asia that you had some delayed recovery of energy price changes. And it made it -- it seemed to imply that you get those changes on an annual basis. I'm just curious. Do your contracts there, are they structured differently? Or why wouldn't want those flow through with the reasonably quick escalator?

James S. Sawyer

Well, this is really specific to the Korea situation. What happens in Korea is that in order for the utility system to manage its utilization rate during peak periods of demand, which is basically July and August and January -- December, January, February. They have very, very high power costs during those couple of months in the year, and then they go back down again. And so the way our contracts are structured there is we just have just kind of fixed power cost. We basically used the average annual power cost there. So it's always a squeeze in margin in the third quarter and in the first quarter. So that's not a long-term issue. It's just kind of a quarter by quarter seasonal issue there.

Robert Koort - Goldman Sachs Group Inc., Research Division

Okay. And is there something, Jim, different structurally about packaged gases in Europe? Because I noted you said they were down, and at least historically in the U.S., it takes a pretty nasty economic environment to get a negative trend in U.S. packaged. So what's going on in Europe that makes that different?

James S. Sawyer

Well, we did have a pretty nasty negative trend in packaged gases. Our packaged gases were down 25% from peak to trough, I guess, I would say. And particularly, really about 1/2 of packaged gases goes to welding and metal fabrication and so forth. And a significant part of that is involved in people investing in new equipment and capital projects. So we've ramped up out in the U.S. It was kind of delayed from the recession, but as people got the motivation to start buying cars and mining equipment and railcars and all kinds of stuff, the packaged gas business is up. But packaged gases in Europe is just kind of like the way the auto industry was in the U.S. in 2009. Nobody was making anything, and nobody was buying anything. And that's just where it is right now.

Operator

Our next question will come from the line of P.J. Juvekar with Citi.

P.J. Juvekar - Citigroup Inc, Research Division

You talked about the impact of the Brazilian real of $0.05 for 4Q. Can you explain the tools that you used to hedge the net income in that country and how far do your hedges go out?

James S. Sawyer

Right. Well, basically, we don't do a lot of hedging, and we basically tried to hedge out a quarter going forward. But that doesn't necessarily coincide with the accounting period because you have to mark to market hedges at the end of each quarter. So we're basically going to see lower sales sequentially and maybe 3% lower operating profit sequentially from currency. Now of course, that depends on where the currencies end up at the end of the quarter, which we don't know right now. But we're just basing that guidance on what the current currency markets are.

P.J. Juvekar - Citigroup Inc, Research Division

Okay. And then secondly, your debt-to-capital now has crept up to 51% as you've been spending to fund the backlog. Are you at the high end of your range of where you want to be? And how do you think about that?

James S. Sawyer

No. Not at all. And the reason is that, first of all, if you look at credit statistics, what people look at is debt-to-EBITDA and cash flow coverage and so forth. And we're at about 1.7x debt-to-EBITDA. We're financing ourselves at 5 basis points overnight, and we just did a 3% 10-year bond yield. So we're financing ourselves cheaper than almost anybody out there. So we don't have a concern. We could have a higher debt ratio than we do right now. We're clearly not at the top of that range. We don't -- basically our long-term strategy is to generate about 25% of sales in operating cash flow and reinvest depending on project load, between 15% and 20%, which still leaves us a lot of cash flow left over to buy back stock. And so we'll be buying about 1% to 2% of the shares outstanding. And that can fall at an equilibrium level without hurting any of the product statistics at all.

P.J. Juvekar - Citigroup Inc, Research Division

But is it fair to say that lower interest rates will allow you to take on more debt?

Kelcey E. Hoyt

Lower interest rates allow us to take up more debt.

James S. Sawyer

I don't think we really look at it like that. I think that our business is really geared around our customers and our customer projects. And to the extent that we've got high return on-site contracts signed with customers and plants to build, we're going to do that. We have a large $2.7 billion of projects, and I have to say this, we define that as being projects where they are actually under construction and they have a signed contract with the customer. Beyond that, we've got another $4 billion to $5 billion of projects that we're kind of in the hunt on, if you will. But it's hard to do a quantitative measure of that because some of them are something we might sign tomorrow that's almost a done deal. Others could be a glimmer in some customer's eye that never gets built. But there's clearly a significant amount of proposal activity and RFPs going on there. That hasn't slowed down. And so walking around your question a little bit but we're basically going to fund those projects as we win them. And then the capital structure will work itself out. But we basically termed out all of our short-term debt into long-term debt because of the low interest rates. We may be doing a little bit more as we got some debt maturities coming along next year, but we've got a lot of debt capacity.

Operator

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

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

I was interested in your thoughts on electronics. That's historically been one of the more volatile end markets. In the third quarter, a lot of companies saw some surprising weakness there. Do you think we've bottomed in that end market?

James S. Sawyer

I'm probably the worst prognosticator on electronics. And so it's not one of the key things that we follow. But there's a lot of kind of negative things going on there. First of all, the gas and product prices continue to go down. And the semiconductor fabs and chip companies continue to exercise a lot of pressure on pricing or products that you sell into that market. Secondly, computer demand is off, and I think that, that will continue to be the trend as people move into tablets and so forth. Thirdly, flat-panel screen demand is off, mainly as a function of consumer spending power or lack of consumer spending power. And then lastly, there's an oversupply right now of photovoltaics and all of the materials that go into making photovoltaics because that's a sector that's been subsidized by the governments, primarily in Europe. And now the governments have sort of run out of money and aren't going to keep subsidizing it. So I'm not a good forecaster on electronics, but the outlook doesn't look great to me at least for a while.

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

Well, have you seen your base volumes in that end market pick up at all since the end of the third quarter?

James S. Sawyer

No, they continue to be down.

Operator

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

Laurence Alexander - Jefferies & Company, Inc., Research Division

I guess, 2 questions. First, as you look at the backlog and also the projects that, as you put it, are in the hunt, how do you see the mix changing over the next few years between your China, Asia exposure and your Latin American footprint?

James S. Sawyer

I think that we're going to -- we're basically going to be winning a lot more projects in China and India and Korea. Those economies are much bigger actually than the South American economy, not to take anything away from South America. But those economies are bigger. There are more projects going on and so forth. I think South America will continue to be strong, with the standard of living going up. And that applies to not only to Brazil but the other countries in South America. So I would say that we'll have a higher mix coming out of Asia than South America. And then sort of the third area being North America, which continues to be basically driven by energy and refining.

Laurence Alexander - Jefferies & Company, Inc., Research Division

And then just in very broad terms, as you think about 2012, can you give a sense for what sort of tailwinds you're thinking for the on-sites that you already have in the backlog? And given your commentary on the end markets, do you expect it to be -- are you seeing sort of signs of pent-up demand so that 2012 could end up being back-end loaded as if there's some resolution on the sovereign risk side? And then lastly, do you have sort of an early rough sense for what the pension headwind for 2012 might be? I guess, pension and FX?

James S. Sawyer

Right, okay. Well, first I would say I think the global economic growth in 2012 will be less than it was in 2011. Pretty much across the board, and Europe might be negative. I think the U.S. will be stretching to have a significant amount of economic growth in 2012. But Brazil and Asia will keep growing kind of the way they have been. We should get somewhere in the order of $0.20 to $0.25 of earnings from projects starting up along the way. We'll also get growth from just new volumes, application technologies and so forth. Now offsetting that, we'll probably have about a $0.05 headwind from pension depending on how interest rates get set at the end of the year.

Operator

Our next question will come from the line of Jeff Zekauskas with JPMorgan.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Your cash balance in the quarter was $125 million, and you've done a really nice job of keeping your cash balance very low. And most companies have all kinds of trapped cash in their offshore operations. But you don't seem to, even though half your business is in North America. How do you do that?

James S. Sawyer

Well, it's an issue for everybody because you put equity overseas and then it generates retained earnings and then to the extent you pay a lower tax rate overseas than you do in the U.S and then you decide to bring it back to the U.S., you've got to pay more taxes again. So it's kind of a -- it's a U.S. tax code problem, okay? Now we have the same issue. We generate a lot of cash flow overseas. When we did have that -- we had a window on, I think, it was 1995 -- no, 2005, where you had the option of taking that cash back with only a nominal tax. Not only did we take that cash back but we borrowed money overseas sort of what I describe as dig a hole so you can fill it up later. So we borrowed money overseas to pay down the debt with operating cash flow. But now it's -- now we paid down that debt, now we have that roughly $125 million of cash there. And it'll probably remain about the same, though.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

And then secondly, was the currency benefit in the quarter about $0.05 or $0.06? And has the currency benefit for the year thus far been about $0.15?

James S. Sawyer

Yes. So if you look -- if we're looking year-on-year for the quarter, the currency benefit was probably about $0.05 in the third quarter and the second quarter, less in the first quarter. And based on where the currencies are right now, probably 0 in the fourth quarter on a year-over-year.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

And then lastly, I think when Kelcey was doing her description of the North American business, if I heard her correctly, she said that your merchant organic sales were up 12%. Is that correct? Because if packaged was up 14% and your energy was up 19%, why wouldn't it be that your organic growth rate -- why wouldn't that be stronger for North America as a whole?

James S. Sawyer

Okay. Well, the merchant was up 12%. Some of that merchant though was going into frac-ing, okay, and was a contributor of energy being up.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Okay. Because it just seems like all 3 pieces are very, very high and the consolidated total was a little bit lower.

James S. Sawyer

Yes, I understand that. It's just that a lot of the merchant went into frac-ing in the third quarter. So that drove the energy up as well.

Operator

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

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Jim, you've talked in the past about not wanting to win too big of a share of new business because it means that you're leaving money on the table potentially. I'm sure you're not doing that now. But was hoping that you could comment on what you see is the source of your success right now that you're enjoying in new project wins and why that success is going to be sustainable. And also maybe comment on what the returns look like on some recent wins.

James S. Sawyer

Right. Well, we continued to -- our philosophy, Michael, is that we need to earn a good spread to the cost of capital in order to induce us to invest money in these on-site plants. So kind of a minimum of 5% spread to the cost of capital. And then in other areas, you can do better than that because we bring a bigger competitive advantage to the table, and we basically look at trying to get synergy among the things that we're doing. So where we already have an existing base business and particularly if it's a pipeline system or a good liquid network, you can get a very nice return on a new on-site project, and we do that. Other places where it's more of a jump ball type of situation where nobody has an advantage, the returns are most likely going to be lower than that. But the thing I would mention is that customer's primary concern is over the quality of the product, safety and reliability. And that really is what creates, to some extent, barriers to entry where they wouldn't want to just -- a big chemical company wouldn't want to sign a contract with a small startup company. But I think that we're well regarded by our customers. Our folks out in the field have done a fantastic job of execution, and that helps us both in terms of winning new business and making more money.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

All right. And then was hoping that you could maybe help reconcile your commentary around North American manufacturing being very strong, and maybe kind of what do you think is accounting for that strength versus the weakness that we're now seeing in steel, which I know has historically been more of a leading indicator for you guys? So how do you reconcile those 2? And kind of where do you think we go from here?

James S. Sawyer

Well, I think it depends on what happens in North American manufacturing because the pull comes from the manufacturing and then as they make steel to fulfill it. So the forecast for auto builds in the fourth quarter is a significant growth over the third quarter. And I think my sense is that people who make mining equipment and other capital projects, companies have money to invest. Consumers really don't right now. So then the steel manufacturers try to balance their output with the global competition and inventories and so forth. And I think there is a concern that nobody wants to be caught with too much inventory. And so we've seen some production curtailment in Europe, in the U.S., in Canada, in Brazil as they're trying to work off inventories and get pricing up. I mean, what the steel industry needs to do is -- I mean, it's a commodity industry, and they want to get price up to the extent they can. And how they do the is up to them. But I think my guess is looking forward, I don't mind saying, if you wanted to call it a crystal ball, is that this is a sort of a temporary inventory adjustment in steel. But it's not being led by the economy going off the cliff.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

All right. And just lastly, you commented about seeing some seasonality in your CO2 business in South America. How big is that? And I presume it's mostly beverage. Is that bulk CO2 for beverage or high-pressure cylinder?

James S. Sawyer

Well, most of it is sold as high-pressure cylinder. And so it's basically winter time in South America. And it was a cold winter and there just wasn't as much volume in CO2 in South America. But also it wasn't a great quarter for CO2 in North America or Europe either.

Operator

Our next question will come from the line of David Begleiter with Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Jim, the backlog of $2.7 billion seem to be flat versus Q2. Has the backlog in a sense peaked here? Or do you expect to further increase as you head into 2012 in the absolute number?

James S. Sawyer

Basically, when we sign a contract and start construction, we put a project into what we call the backlog just for record keeping, if you will. Just trying to give you guys some visibility over what we're doing. And we added, I think, 3 projects in the third quarter. We started up a couple. And so it was pretty much balanced going from the second quarter to the third quarter. But I would say that $2.7 billion is a pretty big number, much bigger than we've ever had. And if you look at that as a percentage of sales, it continues to go up over the longer term. But it's not going to go up on a smooth basis. It's going to depend on what you sign when and what's our top line. And the other thing I'd comment is that 2011 was not a particularly strong year for project startups because it typically is a 2 year, 2- to 3-year gestation period between when you sign the contract and when you start up the plant. And so while we would start up in 2011, generally speaking, it would have been what we signed in 2009. And remember, 2009 was not exactly a time when people were interested in making a lot of commitments. So we've got a stronger outlook for startups in 2012 and 2013 than we did in 2011.

David L. Begleiter - Deutsche Bank AG, Research Division

And Jim, just on PDI, can you comment on PDI pricing sequentially and year-over-year?

James S. Sawyer

PDI pricing has been doing pretty well. There are a variety of things that we do there in terms of price increases, rental charges and so forth. But as volumes have ticked up and as general inflation has picked up overall, we've been getting pretty good pricing all year long and expect that to continue.

David L. Begleiter - Deutsche Bank AG, Research Division

And Jim, just lastly, can you quantify the impact of the spot refinery sales from the cavern on the EBIT basis in Q3?

James S. Sawyer

I can't quantify that, no.

David L. Begleiter - Deutsche Bank AG, Research Division

Was it material, a few million dollars or...

James S. Sawyer

I can't quantify it. It was something that drove some of the volumes up, though. And also, on a year-over-year basis, we didn't really have any major turnarounds in customers this third quarter, where we did last year in the third quarter.

Operator

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

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Jim, so overall, as you look into next year, it sounds like the higher project, new project growth, maybe at the high end of that 46% historical range, basically offsets your more pessimistic outlook on base business. So you're still kind of expecting 11% type of top line growth and 14%, 15% bottom line. Is that your basic metric?

James S. Sawyer

Well, that's what we expect to do over the long haul. I think we overachieved that in 2010 and 2011. We're more likely to be at lower end of that in 2012. But I would agree with your point is that I am expecting weak economy, not really much help from growth from kind of the rising tide effect, if you will. But we've got pretty a good slate of projects starting up both at the end of this year throughout 2012 and then a big, big slate of projects starting up in the fourth quarter of 2012 or the first quarter of 2013.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

You mentioned earlier Asia has a disproportionate amount of those project startups, and that is your lowest margin region. So really, 2 questions. What happens to Asian margins as you increase these new project startups? Does that take margins down there because the D&A burden from these new projects? And overall, what's the return on capital in Asia versus the 14.8% corporate average?

James S. Sawyer

Right. A couple of things about the Asian market. First of all, as you probably know the end market point of view, the electronics end market is the lowest -- it is the lowest margin, particularly for some of our products that we buy and resell at a small margin. So you take -- x electronics in Asia and our operating margin, it's really right around kind of 20% on our existing business, which is still less than the 24%, 25% that we have in North America or South America. Now that difference is primarily accounted for by the fact that our plants are much newer and we just have a lot more depreciation on those projects than we do in the Americas. So what we're doing in terms of growth and new projects in Asia, they have the same kind of return characteristics as projects that were doing anywhere else in the world. But optically, the operating margin percentage is held down by the fact that about 30% of our sales in Asia are electronics versus about 10% for rest of the company. And by the relative newness of the projects. On a book basis, our return on capital is probably in the -- more like in the 10% to 11% range, with Korea being higher and China being higher and India just a little bit lower. But that's -- as you know, you've got this huge problem on your return on capital that comes from what accountants call construction in progress. So when we build a project, we start putting money on the balance sheet as we start putting steel on the ground, and if it takes 2 years to start up that project. You essentially had 0 return on that capital. And so we've got $1 billion of backlog in Asia, which is about 1 year of sales in Asia, whereas on a global basis, our $2.7 billion of backlog is about 25% of sales. So that's just the optical issue of having a lot of construction in progress going on.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

But overall in spite of that Asian drag, you're still expecting, what, 30, 40 basis point annual potential improvement in consolidated margins?

James S. Sawyer

Yes. And not only consolidated margins, but in return on capital as well. We expect to get back up to the 15% return on capital in spite of about a 3% overhang from construction in progress, and we do expect margins to go up. And really the only reason they haven't it is just because Europe has been going down.

Operator

Our next question will come from the line of Mark Gulley with Ticonderoga.

Mark R. Gulley - Ticonderoga Securities LLC, Research Division

When I take a look at the sales guidance for the full year, you'll put that in the fourth quarter and take a look at where are things going to be, currency and pricing and that kind of thing. I sort of get a very much of a low volume growth number. Am I doing my math right here for the fourth quarter?

James S. Sawyer

All I could say is that we don't put a lot of precision on the sales guidance. I think we said $11.2 billion. It should be higher than that.

Mark R. Gulley - Ticonderoga Securities LLC, Research Division

Okay. A longer-term question, if I could. Brazil is one of your crown jewels in your portfolio. You've got the World Cup, Olympics, and then of course, oil and gas finds in Brazil. When might we expect to see an impact from some of those new markets affect your sales in Brazil?

James S. Sawyer

Well, I think that there's a lot of infrastructure build going on in Brazil for the general economy and then probably augmented by both the Olympics and the World Cup, and the airports needed to be upgraded. Everything just needs to be upgraded. That's basically a lot of packaged gas business and a lot of steel and chemicals and cement and so forth. And so I think that we'll continue to see strong demand pull in Brazil throughout the next 5, 10 years even as we might see consumer spending start to cool off a little bit in 2012.

Mark R. Gulley - Ticonderoga Securities LLC, Research Division

And then lastly, with respect to the oil and gas development in Brazil, are you a participant in that from a standpoint of nitrogen, things like that for offshore drilling?

James S. Sawyer

Not in a big way. We do provide some gases for offshore drilling but -- and welding and some of our Surface Technology business goes into that as well. But they're not doing any enhanced oil recovery there, and they're not doing any frac-ing there, which would be the big volume consumers in oil and gas development.

Operator

Our next question will come from the line of Duffy Fischer with Barclays Capital.

Duffy Fischer - Barclays Capital, Research Division

Just a couple of quick ones. FX for 2012, you kind of walked through what new projects look like today, what pension could be. If nothing changes FX-wise, what would we be looking at in 2012 from FX?

James S. Sawyer

Relatively flat. I mean, I think somebody asked before what we've had in the -- what we've had maybe $0.10 of tailwind in 2011, which is going away in the fourth quarter. So maybe there's a $0.10 headwind in 2012 versus 2011. But that's about our forecast.

Duffy Fischer - Barclays Capital, Research Division

Fair enough. And then what was the strategic rationale for the Yara JV to go from 50% to 66%? I mean, you look at your guys, their debt-to-cap is as low as it's, maybe, ever been so they certainly don't need the cash. Can you walk us through what the strategic rationale was for that? And is there a chance that you can pick up the other 34% over time?

James S. Sawyer

I think long run, we do expect to pick up the remainder over time. But basically, Yara was a spinoff from Norsk Hydro a while back and primarily, it's a fertilizer business, but they bought the industrial gas business within. And so they are expert in partnering with somebody who's got some technology and really came to us on the 50-50 deal. I can't really speak for them about what their long-term strategic objectives are, but we would certainly like to pick up the remainder of it when we got the a chance to.

Okay. I think that's all the time we have for questions. And I'd like to remind you that we'll be presenting at several investor conferences during the fourth quarter. And our year-end quarterly earnings call will be held on January 25, 2012. And please reach out for Kelcey if you got any additional questions. Thanks.

Operator

Thank you, sir, and thank you for your participation in today's conference. You may now disconnect. 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!

Source: Praxair Management Discusses Q3 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts