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Praxair (NYSE:PX)

Q4 2011 Earnings Call

January 25, 2012 11:00 am ET

Executives

Kelcey E. Hoyt - Director of Investor Relations

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

Analysts

David L. Begleiter - Deutsche Bank AG, Research Division

P.J. Juvekar - Citigroup Inc, Research Division

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

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

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

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

Robert Walker - Jefferies & Company, Inc., Research Division

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Robert Koort - Goldman Sachs Group Inc., Research Division

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

John E. Roberts - The Buckingham Research Group Incorporated

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Fourth Quarter 2011 Praxair Earnings Conference Call. My name is Kathy and I'll be your operator for today's call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today's call, to Ms. Kelcey Hoyt, Director of Investor Relations. Please proceed, ma'am.

Kelcey E. Hoyt

Thanks, Kathy. Good morning, and thank you for attending our Fourth 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.

Please also note that our discussion of earnings for the full year and fourth quarter, including year-over-year comparisons, excludes $0.02 of net earnings per share benefit related to a non-cash gain in the fourth quarter of 2012 as a result of revaluing our previous ownership percentage in the Yara Praxair joint venture in Scandinavia at fair value in accordance with U.S. accounting standards after we acquired majority interest this quarter.

Earnings also exclude charges taken during the quarter primarily relating to severance and business restructurings in Europe of industrial gas and Surface Technologies. A reconciliation of these numbers to our GAAP reported numbers for 2011 and 2010 appears in the appendix to this presentation and the press release.

Jim will start the call with a brief overview of our results and outlook, then I'll review the slides for the full year and quarter results and then turn it back over to Jim for the guidance and business outlook. We will then be available to answer questions.

James S. Sawyer

Thank you, Kelcey, and good morning, everyone. Praxair finished 2011 delivering record results with full year sales growth of 11%, operating profit growth of 14% and EPS growth of 15%, turning right along the midpoint of our long-term growth objectives. We continued to deliver solid execution and productivity, which fueled operating profit growth in excess of top line growth, and industry-leading return on capital and return on equity which allowed us to grow EPS even faster.

For the fourth quarter, sales grew 7%; operating profit, 10%; and EPS, 9%. If you adjust out the change in foreign currency rates, which largely occurred in September, the fourth quarter would have been right on trend with the full year. We're continuing to see strong organic growth in most of our markets, with the exception of Europe and the global electronics end market. We did see slowing growth in Brazil in both the third and fourth quarters but are optimistic that growth will pick up in Brazil in the second half of 2012. More importantly, the U.S. economy, and particularly the manufacturing sector, finished the year on a strong note and we expect this to continue well into 2012.

We’re issuing earnings guidance of $5.70 to $5.90 for 2012, representing 5% to 9% year-over-year growth. While this is slightly below some of the analysts' estimates, we don't believe the impact of currencies had been fully factored in. At current exchange rates, our year-over-year comps face a 5% headwind or about $0.25 of EPS. The biggest exchange rate impacts are in Mexico, India, Brazil and Europe.

I'm not always a good forecaster of currencies, but hopefully, we could have some upside in Mexico and India. However, this could be easily offset by further downside in Europe and Canada. Who knows? We do try to be nimble in adjusting our business operations to changes in macroeconomic conditions. Consequently, we've undertaken modest restructuring of our European industrial gas business, consolidating plants and reducing headcount by about 5%.

Similarly, we're restructuring our European Surface Technology operations, closing a facility in Switzerland which is no longer competitive at current exchange rates and consolidating other operations. We're also making modest headcount reductions in South America and in our electronics business.

At the end of 2011, we largely completed the $1.5 billion share repurchase program which was announced in July of 2010. Yesterday, our Board of Directors approved a new share repurchase program of $1.5 billion, which depending on market conditions, we anticipate completing in 2013.

As we expect to be able to continue our strong cash flow generation and growth in our operating profit, our plan is to repurchase enough shares to reduce the share count by about 2% annually without diminishing our credit ratios, our solid long-term debt rating of A and our low-cost funding capability.

Additionally, the board approved a 10% increase in the dividend to a $2.20 annualized payout. This is consistent with our past practice of double-digit annual dividend increases and our desire to keep the dividend yield comparable to the S&P 500 average while simultaneously repurchasing shares and continuing to grow our capital investment program.

Last year, we spent $1.8 billion in capital, the majority of which went to new on-site projects where we have signed take-or-pay contracts with customers. For 2012, we expect to increase CapEx to $2.1 billion to $2.4 billion. Our signed backlog of new on-site projects increased from $2.2 billion to a record $2.7 billion during 2012.

New project activity remains robust. We're in the part of the economic cycle recovery where our customers’ capacity utilization is increasing and they are planning on new projects and expansions particularly in the emerging markets.

As the gestation period of our projects is 2 to 3 years from proposal to start-up, we expect the revenue and earnings contribution from new project start-ups to significantly increase in 2013 versus 2011 and 2012.

Now I'll turn the call back over to Kelcey, who will review in more detail our 2011 results.

Kelcey E. Hoyt

Thanks, Jim.

Please turn to Slide 3 for an overview of 2011 full year results. As Jim commented earlier, our results in 2011 were very strong. Overall sales were $11.3 billion, 11% above 2010 primarily due to 8% organic growth from volume and price, including new plant start-ups in every geographic segment. Energy, metals, manufacturing and chemical end markets showed the strongest growth from the prior year.

Foreign currency translation increased sales by 3% for the year primarily due to the weakness of the U.S. dollar against the Brazilian real, euro, Mexican peso and Canadian dollar during the first 8 months of 2011.

Operating profit was $2.5 billion, 14% above 2010 primarily due to volume growth, productivity and price. In 2011, we achieved $375 million in cost savings from productivity. Operating margin improved 50 basis points to a record 21.9%.

Full year net income of $1.7 billion grew 13%, lower than the growth in operating profit due primarily to higher interest expense related to 2 long-term debt issuances during the year.

During 2011, we issued $1 billion of debt with 10-year maturities at interest rates of 3% and 4.05%. We did this to take advantage of low long-term rates in our tight issue spreads to treasury. The proceeds were used to reduce commercial paper, such at year end, 85% of our debt portfolio was fixed rate and only 15% was floating rate. Thus, we have significantly reduced our exposure to rising interest rates.

Earnings per share of $5.43 grew 15% versus the prior year on a 2% lower share count as a result of our ongoing share repurchase program. Our after-tax return on capital for the year was 14.7% and return on equity was 28.2%.

Please turn to Slide 4. We generated operating cash flow of $2.5 billion for the year, which was a record. Capital spending for the year was $1.8 billion, about $400 million or 30% above 2010. This increase is driven by the strong growth in the backlog during 2011. About 75% of our annual capital spending goes into new growth projects under long-term contracts with customers, about 20% to maintenance spend and the remaining 5% in cost-reduction projects with a payback period typically of about 3 years.

We spent $294 million on acquisitions primarily related to packaged gas distributors in the United States, a joint venture in the Middle East and increased ownership of our business in Scandinavia.

In 2011, we purchased $742 million of stock, net of issuances, and paid dividends of $602 million.

Please turn to Slide 5 for our results in the fourth quarter. Overall, our results in the quarter reflected continued strength across North America and strong growth in Asia. Growth in Brazil was positive but slower. In Europe, underlying results were below prior year. Moreover, the U.S. dollar strengthened against foreign currencies in September due to macro concerns and the 4% tailwind that we had enjoyed in the first 3 quarters became a 1% year-over-year headwind in the fourth quarter.

Fourth quarter sales were $2.8 billion, 7% above the prior year primarily due to volume and price. Metals, energy, chemicals and manufacturing had the strongest growth versus the prior-year quarter. New plant start-ups in North America, South America and Asia contributed to the overall growth.

Sequentially, sales declined 3% primarily due to the impacts of negative currency translation. Overall volumes decreased 1% sequentially due primarily to declines in Europe.

Operating profit of $619 million grew 10% from the prior-year quarter due to volume, price, cost reduction and productivity savings. Operating margin rose to 22.1%.

Net income was $414 million, 7% above the prior-year quarter, and earnings per share grew 9% to $1.36. Net income increased less than operating profit due to higher interest expense, while EPS grew faster due to the lower share count. Our adjusted effective tax rate for the quarter was 28%.

Operating cash flow of $791 million and a modest increase in debt funded $572 million of capital expenditures, $149 million of dividends and the repurchase of $148 million of stock, net of issuances. Our after-tax return on capital for the quarter was 14.5%.

Now I'll review our results in North America, which are summarized on Page 6. Sales in North America were $1.4 billion, 7% above the prior year. Excluding foreign currency and the U.S. Homecare divestiture, underlying sales growth was 10%. Sequentially, organic sales grew 2%, but currency and cost pass-through reduced sales by 4% due to the weakening of the Mexican peso, lower natural gas prices and power pass-through.

Merchant volumes in North America increased 6% versus prior year. Merchant volumes grew in the United States due to stronger sales of liquid nitrogen, oxygen, argon, hydrogen and helium primarily to the metals, chemicals and manufacturing markets. Canada and Mexico merchant volumes grew primarily from liquid nitrogen sales to the energy market. Packaged gas sales continue to exhibit a strong recovery in line with U.S. manufacturing. Same-store sales growth was 14% year-over-year.

During 2011, PDI acquired several distributors, following our very focused strategy in the specialty gases sector, regions where we see strong economic growth and properties where we can increase the quality of the acquisition through synergy with our existing packaged and merchant gases.

Operating profit of $364 million grew 17% from the prior year quarter due primarily to price, productivity and seasonal reliability bonuses. Operating margin rose to 26%, an all-time high for North America, as our businesses were running on all cylinders: on-site, merchant and packaged in the United States, Canada and Mexico. Our 4% year-over-year price improvement and the divestiture of the U.S. Homecare business were significant drivers of margin improvement. In addition, the 2 world-scale steam-methane reformers at Whiting, Indiana, contributed high margins because the customer contracts do not include revenue from the sale of natural gas. Sequentially, lower natural gas prices reduced sales but not operating profit, which is reflected in the higher operating margin.

Our outlook for the North America business is quite positive. Current business transfer energy remain robust. Refinery hydrogen volumes remained steady, typically impacted only by turnarounds which will occur in the first half of the year as part of the normal seasonal pattern. From a project perspective, we are tracking as expected with our hydrogen pipeline under construction in Louisiana and the 2 SMRs under construction to serve Valero's new hydrocrackers in Port Arthur, Texas, and St. Charles, Louisiana.

Frac-ing in Canada remained strong due to robust activity to recover high-value natural gas liquids. During the quarter, we supplied high volumes of liquid nitrogen to the region, and we don't see that slowing until the seasonal spring thaws impact the ability for the trucks to access the sites during the second quarter of 2012. Oil well service volumes in Mexico to supply liquids and services to PEMEX have been strong and are expected to remain so with the high price of oil.

We are very upbeat about the outlook for manufacturing in the United States, going forward. U.S. manufacturers are now globally more competitive with high productivity, low material cost and a favorable international trade picture.

Chemical sales in 2011 were strong with a resurgence in the competitiveness of U.S. producers, advantaged by low natural gas prices. This is not expected to reverse in the near term, and we remain well positioned to continue to supply the industry.

While steel producers in the United States took their typical fourth quarter seasonal shutdowns and the opportunity and lower pricing to do maintenance, January volumes have been positive and we expect our steel customers and volumes to remain robust for 2012.

Please turn to Page 7 for our results in Europe. Sales in Europe were $380 million, 12% above $339 million in the prior year quarter. This was due to increasing our ownership from 50% up to 66% of our Yara Praxair joint venture in Scandinavia, which now calls for us to consolidate the sales of the company. Excluding this consolidation, sales declined due to lower volumes.

Overall volumes declined 4% year-over-year and were 3% below the third quarter primarily due to lower packaged gases in Spain and Italy. The continued economic uncertainty is a deterrent to any potential infrastructure investment or construction activity that would boost packaged gas sales. Volume trends in Germany, Benelux and Scandinavia are stable, although we did see temporary on-site sales decline to steel and chemical customers during the quarter for inventory destocking and maintenance.

Operating profit was $61 million, as compared to $68 million in the prior year quarter, and was negatively impacted by the lower volumes, primarily in Spain and Italy. During the fourth quarter, we took actions to reduce headcount and consolidate facilities which are running at low capacity utilization. And during January of this year in Europe, we announced a price increase for merchant and packaged gases, which we hope will help to stem the margin decline in Europe.

Page 8 shows our results in South America. South American segment sales were $532 million compared to $516 million in the prior year quarter. Excluding currency depreciation, sales were 8% above the prior year primarily due to 5% higher price and 1% higher volumes. Sequentially, sales declined 12% due to 8% currency and 4% lower volumes.

During the quarter, some of our customers curtailed production for longer than the typical seasonal holiday shutdowns, as well as some acceleration of maintenance from the first quarter of 2012 to the fourth quarter of 2011 during this period of slower economic activity primarily in the steel and manufacturing markets. However, food and beverage grew due to seasonality as well as new customer signings.

Operating profit in South America grew to $118 million versus $114 million a year ago. The operating margin was maintained through strong productivity and price actions. About $350 million of the current project backlog relates to projects for South America that will start up during 2012 and 2013. In addition, the pipeline of new business proposals remained strong in the areas of energy, manufacturing, steel and chemicals.

Slide 9 shows our results in Asia. Asia had a good quarter. Sales of $325 million were 6% above 2011 due to volume and price. Our base business volumes were assisted by large plant start-ups in India and China. Electronics volumes were flat year-over-year.

Sequential volume growth slowed, in line with local industrial production. Sequential volumes in China for the manufacturing and chemicals sector remained positive, but overall volumes declined 2% primarily due to electronics as we experienced reduced demand from solar-producing customers.

Volumes in India and Korea continued to grow, but we experienced lower volumes in Thailand due to production disruptions from the floods. In Thailand, demand is picking up again in met fab and electronics as our customers' production comes back on-stream and we are seeing some slightly higher volumes from the pent-up demand.

We continue to grow the business by bringing our applications technology that enhance productivity, improve quality, reduce cost and implement environmentally friendly options into the market.

During the quarter, Praxair India set up a new state-of-the-art research and technology center in Bangalore. The facility provides a full range of research and development capabilities for various customer industries such as metal fabrication, pharmaceutical, steel and water treatment. Our growing team of engineers and scientists have expertise in understanding and meeting the requirements of our customers' processes and is a key part of our global technology organization.

In India, merchant volumes increased 12% year-over-year, and sequentially, 11%. Approximately 1/2 of our merchant volume growth in the region is won through application technology. We've increased high-value argon sales through converting customers from CO2 welding to the use of argon-based inert gases, which provides better quality and improved productivity for the customer. Pharma applications and the related sales of liquid nitrogen for reactor cooling contributed to the growth in sync with ramped-up generic drug volumes for export. Our met fab experience allows us to differentiate ourselves and grow volumes to bring value to the customers.

Asia's operating profit increased $52 million -- to $52 million from $50 million due to volume and price.

Our outlook for Asia is quite positive. The region has more opportunities for greenfield industrial gas opportunities than any other in the world, and our project backlog reflects that we are winning our share of opportunities in the region. We are well positioned in China, India, Korea and Thailand and remain focused on growing the business at the right returns. We'll continue to do that through our focus on production and distribution density.

Our results for Surface Technologies are shown on Page 10. PST sales this quarter were $160 million compared to $150 million in 2011, which represents organic growth of 7%. Sales growth came from the energy market, from higher coatings of parts used in oil and gas exploration and from higher volumes of aviation coatings.

Operating profit for the quarter was $24 million, 20% above last year. During the quarter, we took action in the Surface Technologies business to reduce cost in the weaker-performing industrial businesses in Europe primarily through headcount reduction and site consolidation.

The outlook for this business remains positive, as well. The Surface Technologies business serves 3 primary markets: industrial for coatings on machinery such as textiles and printing; aerospace for jet engine parts; and energy, which includes industrial gas turbines as well as parts used in oil and gas exploration.

Now I'll turn this call back to Jim to discuss our guidance for 2012.

James S. Sawyer

Thanks, Kelcey.

Please turn to Slide 11. As I mentioned at the beginning of the call, our initial EPS guidance for 2012 is $5.70 to $5.90, and for the first quarter, it is $1.33 to $1.38. At current exchange rates, this guidance factors in headwind of about $0.25 for the full year due to currency changes and about $0.07 for the first quarter on a year-over-year basis. Interest and pension expense combined will add about a $0.10 headwind year-over-year. Interest expense will increase about $20 million due to increased borrowings and pension expense will increase about $30 million primarily driven by lower discount rates.

On a sequential basis, the first quarter exchange rates are about 1% lower than the just-ended fourth quarter. From a seasonality perspective, the first quarter tends to be our weakest quarter. In North America, construction activity tends to be lower due to the weather, as is beverage carbonation, and we also have a higher level of refinery turnarounds in the Gulf Coast. South America is generally weaker as a result of summer holidays and Carnival, while in Asia, the Lunar New Year eclipses about a week of sales revenue.

On an underlying basis, we're continuing to see good sequential growth in most of our markets. During the fourth quarter, we were really operating on all 4 cylinders in North America, and we expect manufacturing and energy demand to keep growing.

In Europe, there's lots of room for improvement, but we will not be counting on a rising tide to float our ship. Our cost-reduction activities should begin to take effect in the second half of the year in the gases business and in PST. Additionally, we'll be working hard on getting price improvement to offset inflation. So far, we have not been able to accomplish this in Europe, but it is essential in order for us to improve our margins.

So in South America, inflation is creeping up to the high-single digits, and likewise, we will have to compensate with higher prices. We do expect the slowdown in growth in 2011 to be brief as it was punctuated with a number of temporary customer production curtailments. The government has initiated a number of stimulus actions and leading indicators suggest that they are taking effect.

Our outlook for China continues to be robust even though economic growth appears to be slowing. Fortunately, most of our new projects are in sectors like energy and coal gasification which we believe are more strategic to the country and less sensitive to retail conditions.

And now I'd like to turn the conference call over to question-and-answer.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of David Begleiter of Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Jim, just on the backlog. It was flat versus both Q3 and Q2 at $2.7 billion. Would you expect by year end of 2012 that the backlog is flat, up or down from current levels?

James S. Sawyer

I'm expecting that it will be up from current levels. We've got a lot of project start-ups in the fourth quarter of 2012, but more going on in 2013. So most of the project start-ups in the backlog aren't going to be taking place until into 2013 and that kind of accounts for what's coming out of the backlog. As far as what's going to be going into the backlog, we've got over $1 billion of projects that we're in tight negotiation in right now and expect to be announcing over the next couple of months. So while, I think, $2.7 billion backlog is a good kind of long-term equilibrium for us and is enough to sustain our sales growth, as we're projecting, I do think it'll be higher at the end of 2012.

David L. Begleiter - Deutsche Bank AG, Research Division

And Jim, what will the backlog add to both sales and EPS in 2012?

James S. Sawyer

All right, so in 2012, we're looking for about a $0.30 contribution to EPS. In 2013, we think it'll be double that.

David L. Begleiter - Deutsche Bank AG, Research Division

And just last thing, on merchant pricing in Europe, can you provide a little more color on the most recent price increase?

James S. Sawyer

Right. Well, we're holding the flag and trying to raise prices across the board. Just basically, we got power cost increases going on there as well as sort of mandated labor cost increases. And as we've talked about over many times over the years, in order to get margin up, you got to get either productivity above inflation or a combination of productivity and price increase above inflation, and we just haven't been successful in getting that done. So we're going out on our own and raising prices directly to customers and we hope we'll get some traction in that.

Operator

Our next question comes from the line of P.J. Juvekar of Citibank.

P.J. Juvekar - Citigroup Inc, Research Division

In electronics, you saw some weakness and it seems that you're expecting more of a longer downturn in electronics, given your headcount reduction in that segment. And that outlook seems a bit different from several other companies that have reported so far, so can you discuss why you’re sort of more negative in electronics and recovery there?

James S. Sawyer

Yes. Well, first of all, I would say that I'm never the best person in the room to forecast what's going on in electronic demand. But basically, you've got semiconductor demand, and then on top of that, you've got flat-panel screens and solar panel activity, both of which are smaller than the semiconductor in terms of volumes. But the solar panel situation is not good, as most governments that have been subsidizing solar power are no longer subsidizing solar power. And flat panel demand has slowed down, as well. We've taken some cost reduction in our business in electronics but not a significant amount. We basically kind of restructured our management team, but we're not closing any facilities there.

P.J. Juvekar - Citigroup Inc, Research Division

Okay. And then secondly, this may be the first time in many years that U.S. is strong and emerging markets are looking a bit weaker for you. Can you compare your margin operating rates in different regions, currently?

James S. Sawyer

Right. Let me just start with Mexico and South America. The principal problem in Mexico, which I think people didn't really foresee coming, is that the peso is at about 14 to $1 now and it was about 12 to $1 3, 4 months ago, and that's the biggest part of our call-down, if you want to call it that, in our earnings guidance. But underlying, we're seeing strong activity in Mexico, record volumes, good price increases and a strengthening demand from PEMEX which is our single largest customer. In Brazil, you had the economy really start to slow down in the third and fourth quarter. Part of that was the function of the currency getting too strong during the beginning part of the year. And part of that was due to some bottlenecks in production and shipping and so forth. And then, you get into the summer season in Brazil, and what we saw in the fourth quarter was a lot of our customers taking temporary shutdowns to reduce inventory, remembering that, that's both the summer and the holiday period for them, but that is largely temporary in nature and we expect those plants to be starting up again and moving forward into 2012. So we're continuing to be very optimistic on South America. India, underlying demand continues to be strong. But the Indian rupee's moved up to 52 now, so that's hurting our translation, but we don't see any weakness there. And in China, we really haven't seen weakness in our end markets. We've had difficulty getting price increases the way we would like to get price increases. Labor costs are up significantly in China, as are power costs, and so we need to get more price improvement in China. But the outlook for new business development and the proposals that we're working on continues to grow as it moves away from the steel and chemical sectors and moves into the coal gasification and power areas. So we're -- we've got more projects in China we're working on now than ever before. And the questions are really deciding which ones are practical to work on and which ones are not practical to work on. Thailand, we had a big impact in the fourth quarter from the floods. Our biggest plant in Thailand was underwater for the entire fourth quarter, as a lot of our customers' plants, and that'll take another 6 months to straighten out there. And then Korea, our biggest customer, Samsung, and so we saw some slowdown in the semiconductor sector there with Samsung, but we've got $300 million of projects starting up with Samsung about a year from now, and expect that long-term growth to go quite favorably. So if I really sum it up, we haven't seen a lot of, over the -- across-the-board weakness in emerging markets. We've got some specific issues in some specific locations. Now moving over to Europe: Europe has really been weak for us in the fourth quarter. Usually, the third quarter is the weakest quarter in Europe because it's the summer holiday quarter. I've never in my life seen the fourth quarter be weaker than the third quarter, but here it was this year, so we'll just have to wait it out and see in Europe. But I'll just come back to North America because we're very bullish on North America where volumes continue to grow, customer orders continue to pick up, the packaged gas business is strong and getting stronger every month. So I think we're most optimistic right now about North America.

Operator

Our next question comes from the line of Jeff Zekauskas of JPMorgan.

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

Jim, last year, you used to talk about hydrogen opportunities in Brazil. Can you give us an update on how that's going?

James S. Sawyer

Yes. Well, we're still working on hydrogen opportunities in Brazil, and of course, they would be with Petrobras. We've been working with Petrobras on an exclusive basis, developing hydrogen proposals and negotiating plans with them, but they've had a lot of delays in a number of areas themselves and have not yet had to make a commitment on whether to insource or outsource the hydrogen needs at the comparative [ph] refinery and several other refineries, but we're anticipating that decision to come soon.

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

Okay. And then lastly, there was, obviously, there was a large step-down in volume growth in your South American and Asian businesses relative to the previous 3 quarters. And so I was wondering, do you think that South America and Asia on a volume basis will grow faster in 2012 than 2011, or slower, or at the same rate.

James S. Sawyer

I would say that, in both areas, the fourth quarter was a bit of an anomaly in the sense that we had the plant outages in Thailand which offset other growth in Asia, and similarly, we had production curtailments in Brazil which offset other growth. Absent those 2 things, I'd see the underlying growth, like what we saw in the first 3 quarters of 2011, to repeat itself in 2012.

Operator

Our next question comes from the line of Don Carson of Susquehanna Financial.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Jim, you talked a bit about pricing, and in Europe, you said you're going on your own. So my question is, just what's the, what are competitors doing? And I know you didn't really comment on sort of what operating rates are in different markets, so maybe talk a bit about Europe. But also, in the U.S., I noticed you had a very aggressive price increase on Jan 1 of up to 15% and sort of across the board, and I know that takes time to get through, but if you could just talk about your outlook for pricing and then the competitive environment for getting price increases in the different geographic markets.

James S. Sawyer

Right. Well, let me start with North America and recognize, of course, that in our on-site contracts, the pricing is basically set from the beginning of the contract other than the fact that it'll escalate by formula with power cost and inflation. So the shorter-term opportunities for price increases are in the merchant and packaged gas. And in the merchant business, the average contract length is about 5 years. So when we talk about a 15% price increase, generally speaking, that'll only apply to customers whose contracts are up for a change in price, okay? And I think that's a fairly -- that's a rate of increase, which divided over a couple of years, is 3% to 4%. That's kind of what our long-term experience has been, not necessarily in recessionary times but in good times. And I think we'll probably get that. In packaged gases, costs are rising pretty much across the board. The cost of gases are going up, the cost of transportation is going up, labor cost is going up. As well as in hardgoods business, the cost of materials is going up. And so we need to get more price increases in packaged gases just to offset our cost inflation and I think we'll be quite successful in getting that. In Europe, it's really a mixed bag. The capacity utilization in Spain and Italy is very low and I think that probably applies industry-wide, whereas in Scandinavia and in Germany, it is a lot tighter. And it's -- the thing about getting a price increase is that, the hardest part, as we say, about increasing prices is convincing your own people to go out and do it. And that's what we're all about right now.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

But Jim, when you mentioned you're doing it on your own in Europe, does that mean that the bigger European-based players are not going after price and that they are more concerned with just keeping their price low?

James S. Sawyer

I can't really, I can't speak for them, but we haven't seen it, though.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Then just quickly, on packaged gases, of that 14% same-store sales, what's sort of the split between hardgoods recovery and gases and rental?

James S. Sawyer

Right. That's continuing with hardgoods leading gases, about 22% growth in hardgoods and 10% in gases. And that should continue to be a leading indicator of more growth because, generally speaking, if we kind of simplify this into a typical job shop with your customer, when they reach capacity utilization, they need to order more equipment to do the job that they've got orders for. And that's really what pushes the hardgoods orders up as fast as they're going up so I think that's a good leading indicator.

Operator

Our next question comes from the line of Mike Harrison of First Analysis.

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

Wanted to ask a couple of questions around steel and in argon markets. You noted some steel weakness in a couple of different geographies. You also mentioned the work that you're doing and seeing nice growth in argon use for welding in Asia. So I was hoping that maybe you could just talk in a little bit more detail about what you're seeing in terms of argon supply and demand across the different geographies.

James S. Sawyer

Okay. Well, I think most people understand that argon is generally a byproduct of oxygen and what we're taking in our larger oxygen plants. Some of the argon is used specifically in the steel industry and particularly in specialty steels like stainless steels and so forth, but it's also used in the packaged gas business in high-quality welding. So right now, in North America, we've been seeing a pretty good steel picture, we've been actually improving as the year ended, and a pretty good, pretty equilibrium balance for argon supply and demand. Over in China, there has been a little bit of excess argon supply on the market brought on by some large plant start-ups by competitors and that needs to get soaked up in the market in order to keep the price of argon up, it's actually down sequentially in China. But the other thing that we work on, and I think we're being very successful in both China and India, is doing what we call application technology and teaching people how to weld with shielding gases like argon where they can get a higher-quality weld and more productivity in the welding. And so that's kind of a long-term opportunity to significantly increase demand for argon, but it comes in lots and lots and lots of small sales efforts.

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

And what about in South America?

James S. Sawyer

South America is fine. I mean, we had some steel companies down at year end for some inventory reduction, but we see that coming back during 2012. And the argon market is very stable there.

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

And historically, you guys have had some currency hedges that, from time to time, have swung earnings one way or another. Did you have any of those hedges in place during Q4, and do you have any in place now?

James S. Sawyer

Oh, no, we -- it's hard to hedge currencies across the quarter and so -- because you have to mark-to-market your hedges on the income statement and run that through the income statement. So we're basically not hedging across the quarter anymore.

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

And can you quantify the impact of Thailand on sales and earnings in the quarter?

James S. Sawyer

Let's see. Probably about, on the earnings side, $3 million to $4 million of operating profit in the quarter.

Operator

Our next question comes from the line of Mike Sison of KeyBanc.

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

When you think about the restructuring cost-saving efforts you did in Europe, does that position the segment to get back to the low 20s in operating margins once demand hopefully returns over time?

James S. Sawyer

Yes. I think we've got -- I think some of you noticed a long time ago. Europe used to be north of 20% in operating margin percentage, and it's come down for, I would guess I would divide it into 3 reasons. One is just lower capacity utilization, lower volumes and there's a negative operating leverage that comes to margin percentages when volumes go down. And whenever volumes come back, we'll get some of that back, but I don't know when that is going to be. Secondly, pressure on power cost and labor costs, without the ability to retrieve that in pricing, has been an impact on margin percentages. And then lastly, and we haven't talked about this very much, but we have a lot of business development expense going on in Russia right now. We've got 4 projects underway and roughly $5 million of sequential overhead increases from the Russian business development expense, we're just, which we're just going to have to eat until the Russian plants start up, which is really going to be a 2013 phenomenon.

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

Okay. And I noticed on your global end market trends for '11 versus '12 that healthcare was the only segment that didn't grow. Is that an area that makes sense for you to stay in longer term?

James S. Sawyer

The, there are basically kind of 2 parts to healthcare: there's the homecare and the institutional healthcare. As you know, we got out of the homecare business in the U.S. We still have a small participation in the homecare business in Canada and Europe and in South America, but it's not all that significant in total size. And the way that we operate it is pretty well integrated with our packaged and merchant gases business. So I think we share their concern that, just like homecare reimbursement rates went significantly down and made it unprofitable in the U.S., that, that could potentially be occurring in Europe as well. In South America, it's all private pay business so that's not an issue there.

Operator

Our next question comes from the line of Laurence Alexander of Jefferies.

Robert Walker - Jefferies & Company, Inc., Research Division

This is Rob on, Rob Walker, on for Laurence. I guess, first question, kind of given your earnings outlook and the comments around uses of cash, can you remind us what you see as an upper limit in terms of leverage over the next 2 or 3 years?

James S. Sawyer

Okay. Well, first of all, when we look at leverage, we can't really look at our debt-to-capital ratio. It's not indicative of our credit statistics, the way we get rated or anything else. So the more commonly looked-at measure would be debt-to-EBITDA, which is hovering, been hovering in the 1.7x to 1.8x area, which, that combined with our stable cash flows and the diversity of our end markets, gives us an A rating. But actually, our bonds are priced generally at a AA rating so we have no concerns right now about downgrades and all, the rest of that. I believe that we can continue to reinvest at roughly 15%, 16% of sales because we're generating cash flow of roughly 23% to 25% of sales. So we can keep that high reinvestment rate up in capital spending, at the same time, increase the dividend, and at the same time, buy back roughly 2% of the shares outstanding while still staying in the 1.7x to 1.8x debt-to-EBITDA kind of a range. Now we could go up to 2 if we wanted to, that wouldn't be a problem, but I don't think we're going to need to.

Robert Walker - Jefferies & Company, Inc., Research Division

And then just in terms of China, does the recent difficulty in getting pricing there make any of your projects in the backlog look less attractive?

James S. Sawyer

No. First of all, most of the projects in the backlog or all of the projects in the backlog are really supported by on-site contracts where the pricing is locked in escalation formulas. It's in the merchant products. And some of these on-site projects do have forecasted merchant sales going along with them, but the -- any changes in price take place in the merchant products. And the industry structure in China is a little bit different in the U.S. in that there's still a fairly sizable segment of merchant distributors who buy merchant products from tactically owned air separation units of state-owned industries and ship those products to merchant customers. We've got a very deliberate strategy to change that industry structure so that, when we go sign up merchant customers, we sign up customers like we do in the U.S. where we own the tank at the customer and we enter into a long-term fixed price contract with the customer. So it's something that we've been finding hard to do every month when we look at our China results in the merchant business. One of our key indicators is an improving percentage of merchant sales where we're going direct to the end customer and where we own the tank and we have a contract. It's in the other part of it where there are some distributors in the middle and where we've got some competitors who just start up a plant and dump the product on the market with the distributor, that's tends to be where the pricing softness can come from.

Operator

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

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

A couple of questions on currency, just to clarify the response to a previous question. It sounds like you do not have currency hedges in place. I seem to recall that, at one point in time, Praxair was hedging, at least partially, at about 3 months. And I'm wondering whether or not there was a change in that paradigm at some point perhaps related to volatility in the markets?

James S. Sawyer

Right. Well, we've tended to hedge out 3 to 6 months, but what happens is that, if the currency changes take place evenly across the quarter, that can work for you. But if the currency changes take place sort of abruptly in the last minute, last month of the quarter, then you can end up increasing your volatility of earnings from the hedges. So we're not trying to be currency traders, we're not trying to out-guess the markets and currencies. So a couple of times, we’ve found that we've increased volatility rather than decreased it. So we've just shortened any currency hedges so we stay within quarter.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

I see. And then just to follow up, Jim, obviously, there has been a lot of volatility in those markets since early September. For what it's worth, they've come back your way, at least partially, on a year-to-date basis. And so I'm wondering, in crafting your guidance, are you kind of marking currency at year-end '11? Or is that up to recent business stages because the changes have been rather sharp there?

James S. Sawyer

Well, I think what's a little bit confusing is most people are focusing on the euro currency, okay, and that's not a big issue for us. It's actually come back up to close to 130, so it's a little better than it was before, but that's only been about a 5% change. The currencies that have hurt our guidance are the Brazilian real and Mexican peso primarily, but added to that, the Korean won and the Indian rupee, and they really haven't recovered yet. I'm hoping that they will, but our guidance is based on sort of rates as of today in those currencies.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Got it. And then finally, Jim, your depreciation declined about $7 million or so sequentially. Is that simply dollar strength, or are there other factors at work there?

James S. Sawyer

That's simply dollar strength. You just take the same percentage on, that we applied to sales and apply that to depreciation, you'll get the same answer.

Operator

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

Robert Koort - Goldman Sachs Group Inc., Research Division

A couple of questions. First, Jim, the FX issues, does that compromise any of your customers' ability to export product? Or do you think that's a pretty negligible issue?

James S. Sawyer

Well, I would say this: I think we'd say that the real got so strong during 2011 that it did compromise the ability of our steel customers in Brazil to export product and that's really why they started taking these curtailments. Now the real's weakened by about 15%, 20% since that and so I think that puts the Brazilian suppliers in a little bit better position than they were in before. But at the same time, with the dollar getting stronger, it hasn't really impacted our U.S. customers. I think what's happening is that the U.S. economy's really taking a lead in this recovery and I think the U.S. economy will be one of the stronger economies in 2012 and I think currency traders are starting to factor that in. And that's what's -- why the dollar is getting stronger again. But I don't see -- I think what we had -- I think any pain that we had relative to currencies impacting our customers, we already had in Brazil in 2011.

Robert Koort - Goldman Sachs Group Inc., Research Division

Okay. And in Europe, have you gotten to the point where there's anybody hitting take-or-pay thresholds?

James S. Sawyer

No, no.

Robert Koort - Goldman Sachs Group Inc., Research Division

And then in the U.S. market, there’s a lot of chemical expansion activity. Have you guys seen an increase in the hydrogen off-gas availability? Or is there an opportunity to grab some of that?

James S. Sawyer

We have not -- I think there's a lot of talk about some expansions and there are a couple of projects that are coming back on, that had been mothballed for a while and are coming -- a couple of plants have been mothballed for a while that are coming back on-stream, but we don't see that as being any significant source of byproduct hydrogen for us to buy. On the contrary, the low natural gas prices make the demand and the value of import higher than into the refinery, higher than it would otherwise be if gas prices were higher because they don't have to pay as much for the hydrogen relative to the price of oil.

Operator

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

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

Most of my questions have already been answered, but maybe just looking at North American margins, that ticked up nicely during the quarter. And I believe 26%, that is a record quarterly margin for you there. So what was driving that strength?

James S. Sawyer

Yes, I mean, we're really happy. Our North American team has done a wonderful job. That's an all-time high for the way we define our North American segment, which is Canada, U.S. and Mexico. That increase was partially from the fact that we got out of the home healthcare business in North America which had been a drag to operating profit and margin. But also the result of, as I said before, we're kind of running on all cylinders in North America: Packaged is good, merchant's good, on-site’s good, Canada’s good, the U.S. is good and Mexico is good. And we're getting pretty decent pricing as well.

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

Are you seeing more margin leverage on the packaged goods side versus on-site and merchant?

James S. Sawyer

I'm sorry, more...

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

Operating leverage.

James S. Sawyer

Not as much as we would like to. We've seen more volume growth in packaged gases, but there's been a lot of cost inflation and there's a need to get more price in packaged gases before we're going to start to see a percentage margin improvement in packaged gases.

Operator

Our next question comes from the line of John Roberts of Buckingham Research.

John E. Roberts - The Buckingham Research Group Incorporated

Your comment earlier, that you expect $0.30 from backlog in earnings this year, then over $0.60, I think you said, for next year. So we should expect backlog to sort of plateau out here because it sounds like a kind of a surge in start-ups in late 2012 and early 2013?

James S. Sawyer

That's correct. And if you think about it, the, most of the projects that we started up over the last 2 or 3 years were commissioned before the recession, okay? You went into the recession, and in 2009 and 2010, there were few contract signings because customers all over the world weren't really interested in making commitments to build new things. As we moved into 2011 and right around year end last year, we signed the 2 very large contracts with Valero as well as a number of contracts in South America and Asia as well as the contracts in Russia. And so with the 2-year gestation period, those are going to be a bigger wave of start-ups in the fourth quarter of 2012 and in the first half of 2013. We just didn't have a lot of start-ups in 2011.

John E. Roberts - The Buckingham Research Group Incorporated

Got it. And then the inventory correction in the chemicals market that affected the end of the quarter, in January, have you seen the activity reaccelerate there?

James S. Sawyer

Wait, I'm not really up to date on that.

Operator

Our next question comes from the line of David Manthey of Robert Baird.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

The first question is, the price increases you've announced for Europe, could you talk about the magnitude of those announcements? And second, was there any measurable impact from the helium shortages during the quarter?

James S. Sawyer

Right. Well, the price increases in Europe are going to be similar to North America where people who've got contracts rolling over and so forth, they could be 10% to 15% to 20%, but that won't be what you'll be able to average across the whole business. Helium is an interesting product. I think we are the most backward-integrated producer of helium in the industrial gas industry. And so we've been kind of the supplier who’s always had supply when customers needed supply. And customers have been very thankful for that because other times and some other suppliers run out of helium, the customer gets cut off and he comes back to us. So we didn't have any impact from helium. And the one thing we have been doing is raising the price of helium, but we started doing that earlier in 2011 and we expect to continue that into 2013. I think, with that, we're well past the noon hour. And we'd like to thank everybody for joining the call today. And if you have any follow-up questions, please reach out for Kelcey or myself. Thank you very much.

Operator

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

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