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

Praxair, Inc. (NYSE:PX)

Q4 FY07 Earnings Call

January 23, 2008, 11:00 AM ET

Executives

James S. Sawyer - EVP and CFO

Elizabeth T. Hirsch - Director of IR

Analysts

David Begleiter - Deutsche Bank Securities

Michael Sison - Keybanc Capital Markets

Edward Yang - Oppenheimer & Co.

PJ Juvekar - Citigroup

Kevin McCarthy - Banc Of America Securities

Chris Shaw - UBS

Laurence Alexander - Jefferies & Co.

Jeffrey Zekauskas - J.P. Morgan

John McNulty - Credit Suisse

Christopher Lewis - Impala Asset Management

Operator

Good day, ladies and gentlemen and welcome to the fourth quarter, 2007 Praxair, Inc. earnings conference call. My name is Amanda and I will be your coordinator for today. At this time, all participants are in a listen-only mode. We will facilitate a question-and-answer session towards the end of today's conference. If at anytime during the call you require audio assistance, press star zero and an operator will be happy to assist you. I would now like to turn the call over to your host for today, Mr. James Sawyer, Executive Vice President and Chief Financial Officer. Please proceed sir.

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

Thank you, Amanda and good morning to all of you out there, and thanks for attending the earnings call and webcast. Pat Clark, Vice President and Controller, and Liz Hirsch, Director of Investor Relations are with me. I will begin by giving an overview of our 2007 results, Liz will then review the fourth quarter, and afterward I will discuss our business outlook and earnings guidance for 2008, and then we will be available to answer questions. Today's presentation material is available on our website at www.praxair.com in the Investor section. Please read the forward-looking statement disclosure on page 2 and note that it applies to all statements made during this teleconference.

Turn to page 3 for our full-year summary. Praxair had another year of outstanding results. We reported record sales, earnings, and cash flow. Sales reached $9.4 billion, 13% above 2006. Sales growth came primarily from volume growth and higher pricing. In addition, several core business acquisitions we made during the year contributed 2% to sales growth and we also had positive currency impact. We grew operating profit 18% to $1.8 billion. The faster growth in operating profit as compared to the growth in sales came primarily from a 60 basis point increase in gross margin. We continued to drive this margin up through our focus on higher pricing and good cost control. Productivity programs and a tight reign on SG&A expenses also contributed to the overall improvement in operating margin to 19% for the year. Full-year net income was $1.2 billion, 19% above net income in 2006. Earnings per share were $3.62, grew 21% versus the prior year, again demonstrating our ability to grow earnings faster than sales. Our higher earnings, combined our capital investment discipline, resulted in improvement in our after-tax return on capital from 14.6% to 15.3% for the year.

Please turn to page 4 to look at a summary of our full cash flow. We generated over $1.9 billion of operating cash flow, which was a $206 million increase from last year. This was a result of net income growth and tight control of working capital. Capital expenditures were just under $1.4 billion for the year and this was about $300 million above our CapEx spending in 2006. This primarily supported the record number of growth projects that we are building to supply customers under contract. Our current backlog of 42 large projects is at a record level. Consequently, we expect a similar level of spending in 2008, but our investment discipline remains regress and we are not lowering returns for the sake of top line growth. We spent $437 million in acquisitions in 2007; about half of this was to buy two core industrial gas businesses. First, we purchased Linde's gas business in Mexico. Mexico's economy is growing rapidly and we have a strong business in the country, and the acquisition allowed us to add a high-quality core business with strong growth prospects combined with significant synergies, and the results have exceeded our expectations.

In the fourth quarter, we closed a joint venture in Scandinavia with Yara International’s industrial gas business. This is an exciting opportunity to add to our European presence by entering a growing market with significant opportunities in the energy sector and to bring new customer applications, as well as our best practices in distribution and logistics. Finally, we acquired a number of US packaged gas distributors for the integration with our own business opportunities and an extension of our national footprint. In general, we continue to be very selective about acquisitions and highly disciplined in terms of risk and return. In 2007, we purchased $636 million of stock, net of issuances. $545 million of this occurred in the third and fourth quarters under the $1 billion stock buyback program, which we announced in July. So, we have completed more than half of that program in the first six months, while funding a record level of capital spending in acquisitions.

Our strong cash flow generation comes from our high and increasing returning on capital. We also paid out $281 million in dividends, as we announced this morning, we are increasing our dividend by 25% in the first quarter of 2008. This is a strong indication of the confidence we have in our ability to continue to grow our cash flow, while finding significant growing opportunities in our business. We will continue to balance dividend increases and share buybacks as part of our financial strategy. Liz will now review our fourth quarter results.

Elizabeth T. Hirsch - Director of Investor Relations

Thank you Jim and good morning. Please turn to page 5. We ended the year with a very strong fourth quarter, sales grew 19% to $2.5 billion. 7% of this growth came from currency appreciation, but underlying organic growth was a solid 9% from both higher volumes and prices. We had higher volumes in all geographies with the strongest growth in Asia and South America. By end-market, highest sales growth was in energy and manufacturing, followed by chemicals and electronics. Underlying business conditions were strong during the quarter in most locations and markets, but we are beginning to see the effects of a slowdown in US manufacturing activity in our US base business volumes. Operating profit increased 23% to $484 million. The higher profit came from volume growth and higher price and productivity savings, which exceeded cost inflation.

Net income of $316 million increased 17%, but would have grown 23% had we not had a one-time lower tax rate in the fourth quarter of 2006. Earnings per share of $0.98 grew 20%, but would have grown 26%, excluding the different tax rate. Cash flow from operations was $587 million, which primarily funded capital expenditures of $402 million and the Yara joint venture, which closed in late November. Our debt-to-capital ratio was 43.4% and after-tax return on capital for the quarter was a record 15.7% due to our strong earnings growth.

Now, I will review our results for the quarter in North America, which are summarized on pages 6, 7, and 8. Sales in North America were $1.38 billion, 17% above the prior-year quarter. The acquisitions of Linde Mexico and packaged gas distributors contributed 6% to the quarter's sales growth. Underlying organic growth of 8% versus the prior-year quarter was driven primarily by higher sales to energy and general manufacturing markets. Higher sales to the energy sector came from strong growth in hydrogen volumes to refiners and in nitrogen and carbon dioxide sales to the oil well service markets in the US, Canada, and Mexico. Sales to the manufacturing sector, excluding currency and acquisitions, grew 5% in the quarter, which is lower than what we saw earlier in the year and last year. We are seeing signs of a sequential slow-down in this end-market in the US. On-site sales were 17% above the prior-year period, driven primarily by hydrogen sales. Our refining customers are running well and taking increasing amounts of product and we expect this growth to continue.

Pipeline oxygen sales were strong and also above prior year. Merchant liquid sales grew 15% year-over-year from strong pricing trends and moderate volume growth. Production capacity remains tight in many locations and demand is particularly strong for argon, rare gases, and specialty gases. Helium is in short supply and global demand for the product is growing for solar, flat panel, and healthcare applications. Overall, new business activity is coming from applications in food, oil and gas, metals and mining markets. Packaged gases sales in North America grew 20% versus 2006. Acquisitions contributed 13% of this growth. In PDI, our US and Canadian business, same-store sales growth was 5% in the quarter versus prior year. Gases volumes are steady on a year-over-year and sequential basis, but sales of hard goods in the US are softening in line with slower manufacturing growth. Mexico had another strong quarter with sales up 27% versus 2006. Operating profit grew 26% to $255 million from volume growth and higher pricing, and we leveraged this further with cost savings from productivity programs.

Please turn to page 9 to review our business in Europe this quarter. Sales in Europe was $354 million, grew 16% versus prior year. Underlying growth ex currency effects was 4%. On-site merchant and packaged gas sales showed moderate growth in Spain, Italy, and Germany versus prior-year quarter. We are successfully signing new merchant contracts as we migrate energy and environmental applications into many end-markets. We closed our joint venture in Scandinavia with Yara industrial gases in November. This business had sales last year of about $180 million. We purchased a 50% interest in the company and so the revenues will not be consolidated into our financial statements, but our share of the venture's income will be included in equity income and should be accretive to our earnings next year. We expect to grow the business from new on-site opportunities in the region and by bringing our focus on operating efficiencies.

Overall, operating profit in the quarter grew 18% from the prior year to $86 million, increasing our margin to 24.3%. Page 10 summarizes our results in South America. South American segment sales grew 26% to $444 million, with currency appreciation representing 17%. The economy in Brazil is stable, exports remain strong, and domestic growth continues to improve. 2007 industrial production in Brazil through November was a solid 6%. Underlying growth in our gases business was 15% this quarter. Merchant and packaged gases sales grew 13% and 18% respectively. On-site sales growth was moderated a bit by temporary customer outages. We have rationalized some of the non-GAAP business portfolio and divested a few small businesses. In addition, this quarter our sales of automobile, compressed natural gas conversion equipment were lower than prior year. These sales fluctuate depending on the relative level of energy prices set locally by the government and are not an indication of the strength of the industrial economy. Operating profit grew to $85 million, in line with sales growth and included some ongoing restructuring costs in the quarter.

We started up several projects in Brazil, which will add revenue growth next year and we have won a number of new projects, which are in our backlog. As many of you know, we are planning an Investor Meeting in Brazil in March, in which we will highlight in more detail our strong business in the region and the numerous growth opportunities that we are pursuing. Please look at page 11 for our results in Asia. Sales in Asia were up 24% compared to last year, primarily from strong volume growth. On-site and merchant liquid sales grew to customers in China, India, and Korea. Demand in the region for helium, rare gases, and specialty gases is growing. New business opportunities continue to be robust in China and India. We are actively working on a large number of proposals for gas supplied to electronics, steel, and manufacturing facilities. We are expecting that growth will slow in the Beijing area this summer during the Olympic Games when businesses in certain locations must shut down temporally, but more than offsetting this will be the growth we expect from eight new projects planned to start-up in the region in 2008.

Operating profit increased to $34 million. The level of operating margin in Asia is well below its long-term potential because we are staffed to execute more and more projects and to operate the business at a much larger size than it is now. Please look at page 12 for Surface Technologies’ results. PST's results continued to be strong. In the fourth quarter sales were $134 million versus $115 million in the prior year. Underlying sales growth was 11%, excluding currency appreciation. Demand for airplane engine coatings and industrial gas turbines continues to increase.

In December, we started up a new EBPVD coater in Indianapolis to meet GE's needs for more parts and more coatings per part for their next generation aircraft engines. This will increase our coating production capacity by about 20%, all under contract and will support revenue and earnings growth beyond 2008. PST will also be adding capacity to coat oil well service parts for FMC in India. This plant will start-up towards the end of 2008. Operating profit grew 50% to $24 million from volume growth, higher prices, and the benefits from productivity initiatives. The business' operating margin percentage increased 400 basis points from the margin in the fourth quarter of 2006.

Now, I'll turn this call back to Jim who is going to discuss our end-market trends, our outlook for 2008, and our earnings guidance.

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

Thanks Liz, and please turn to page 13, which shows our year-over-year sales growth for the primary end-markets. And I think as you know, we can slice and dice our numbers by region, by country, by end-market, and also slice and dice them by product line, that would give you tonnage gases versus merchant gases and so forth. But, I think the end-markets is useful for most people. Sales to the energy sector continued to be strong and we are up close to 30% in both fourth quarter and the full year. This year the growth came from our North American, hydrogen, and oil well services business. We expect that energy markets will continue to be a major source of growth for the foreseeable future.

High oil and gas prices, environmental regulations, combined with strong demand from fast strong emerging markets, will continue to fuel growth. We anticipate significant growth in our global hydrogen, enhanced oil recovery, and oil and gas well fracking business. Gasification projects for cheaper chemical feedstocks and further out for power require large oxygen supply systems. In addition to the large on-site projects I am referencing, combustion efficiency applications will continue to drive growth in merchant gases. Global electronics had a strong year and fourth quarter. Our sales in Asia outpaced other geographic regions as this is where semiconductor and flat-panel display manufacturers are building new production capacity with new technologies.

As we look into 2008, we do expect to see a slow down in wafer production, which would reduce demand for our consumables. We continue to rationalize pieces of our portfolio and focus on opportunities for on-site supply so that processed gases and material science consumables, where we have unique technology. We are also rapidly entering the sales of gases and deposition equipment for the solar cell manufacturing industry with several important contracts signed in 2007.

Sales to the metal sector were up 16% in the quarter and 8% on average for the year. The relative strength in the quarter was because US steel production was weak in the fourth of 2006 and therefore the comparable was different, but the overall trend rate is up about 8% in Europe. Less than 40% of our global sales for the sector are to US producers. Growth is coming from Brazil, China, and India, countries that are advantaged in terms of input costs and raw materials. These industries are large oxygen users and we have strong market positions in each of these countries, which bodes well for new business opportunities.

Manufacturing was one of our strongest markets in 2007 with growth of 19%, but excluding acquisitions, it would have been 12%. For the fourth quarter, sales were up 28% and 16% less acquisitions. This market includes a diverse set of customers and industries, including glass, cement, construction, and metal fabrication, and growth in the last several years has been driven by non-residential construction and infrastructure building out in emerging economies, including transportation and capital goods manufacturers. We sell on-site merchant and packaged gases into this broad segment and so far we have been largely insulated from the slowdown in housing, but as economic condition slows in other places we could be impacted. As some of you have noticed, in December, US industrial production was flat although some industries were positive and some negative. In Canada, with industrial production slowing steadily through 2007, we have seen our base business volume growth slowing as well. Although our total volumes are still a lot higher due to our new applications technologies and exposures to segments of the market, which are still growing.

Global healthcare showed solid growth in 2007, up 9% year-over-year. Our global business reached $1 billion in 2007, about 50% of which is in North America. Our businesses outside of the US are all growing nicely. Our US hospital business is growing very well from new technologies and services and expanding list of hospital networks as customers. The growth and profitability of our $300 million US home care business continuous to be problematic due to ongoing reimbursement rate reductions by Medicare, which impact about 40% of our revenues in the business. We are continuing to reduce our cost structure to offset the pricing volumes.

Sales to the aerospace sector are primarily from our PST business, which is very strong due to jet engine builds and new coatings in the hard section. We are also a large supplier of gases, including liquid hydrogen to NASA and generally for aviation. Food and beverage market continues to be highly resilient and non-cyclical and we are growing the business every year through new applications. Page 14 gives you some detail on our planned capital investment in 2008. We expect our capital spending in 2008 to be about $1.4 billion, on par with our spend in 2007. 20% of this amount or about $250 million to $300 million is for maintenance CapEx in our base business. We will spend another $65 million to $75 million on cost reduction projects. These projects are projects where we will, for example, replace compressors or turbines in an existing plant to improve energy efficiency. We typically look for a three-year payback on these investments.

The major portion of our capital spending will be for new production plants, which are supported by contracts with customers. Most of this capital is for new on-site air separation plants backed by 15-year take or pay contracts with our customers. In addition, we have announced a few projects where we are adding production capacity to existing plants in select regions where customer demand is strong and the market is very tight. In these cases, we know where the incremental [inaudible] and we also reap the cost reduction benefits by eliminating, in many cases, premium distribution costs, which we incur if we have to truck product long distances to keep our local market supplies.

As you can see from the pie charts on this page, just over half of the capital is going to projects we are building in North America. The largest projects are energy related, including hydrogen plants for refiners such as the large hydrogen plant in Northern California for Chevron's Richmond Refinery, which we are building and which is scheduled to start up in 2009. The second largest region for investment is Asia. We are building a large number of projects in China, India, and Korea for customers in steel, copper, chemicals, refining, and electronics. We will also be investing in a number of growth projects all over South America. The region is growing rapidly and our strong market position enables us to be very competitive, winning new projects.

The end-market chart shows the diversity of our customer base. Energy is still the largest growth market and the projects are mostly in North America. Going forward, we expect continued growth in this sector from hydrogen outside the US and from EOR and gasification projects for chemical and refining feedstocks. The metals projects include oxygen supply systems for steel and other commodities like copper, nickel, zinc, aluminum, and so forth, and they are primarily located in South America and Asia. The diversity of our capital projects on our customer base is one factor that adds stability to revenue and earnings growth in our business.

Now, please turn to slide 15 for our financial outlook and earnings guidance. As we look at 2008, we are quite positive on global business fundamentals, particularly in the sectors of the economy we serve, like energy, mining, environmental protection, infrastructure replacement, food and healthcare. Outside the US, we expect to continue to see strong growth in South America, Mexico, and Asia where the capital investment cycle is very strong. For the full year of 2008, we expect year-over-year sales growth of 10% to 14%. If demand in our end-markets continues to hold on par with 2007, we could reach the top of the range. On the other hand, if we have a recession in the US with flat GDP and negative industrial production, we would likely end up towards the bottom of that range. This forecast also assumes that foreign currencies will be generally stable at the current rates of exchange.

Expected earnings per share will be in a range of $4.00 to $4.20, which represents growth of 10% to 16% versus 2007. This guidance excludes a negative $0.03 impact that we expect in the first quarter related to a lump sum pension settlement for retired senior executives. Our earnings guidance assumes a slightly higher tax rate in 2008 in the range of 26% to 28%. For the first quarter of 2008 we expect earnings per share in the range of $0.93 to $0.99, again excluding the $0.03 potential settlement charge. This represents 15% to 19% growth versus the first quarter of 2007. EPS is lower in the fourth quarter as the first quarter is typically slower due to holidays, seasonal beverage demand, a slow-down in winter construction, and large customer plant turnarounds in the US Gulf Coast.

Please look at page 16. Based on our outlook, we have increased our quarterly dividend by 25% from $0.30 to $0.375 per share per quarter. This chart shows that in the last five years we have increased our dividend on average by 26% per year, which is faster than our rate of earnings growth. This demonstrates that we have a lot of confidence in our ability to continue to generate cash flow in excess of our requirements to fund our significant growth in capital spending. This is the payback of running a business with a high return on capital. And as you can see on page 17, we have increased our after-tax return on capital by over 400 basis points in the last ten years to 15.3%. And this as allowed us to grow our operating cash flow by an average of 10% per year over the same period and you can see how the two charts track each other. But, during this time, we have internally funded a significant increase in capital projects, while simultaneously reducing our debt-to-capital ratio and buying back stock. These capital projects are adding strong profitable growth for our business and thereby augmenting our ability to generate more cash flow for shareholder value creation.

We feel confident about continuing to deliver outstanding performance for our customers, our employees, and our shareholders in 2008 and beyond. And now I would be happy to take your questions.

Question and Answer

Operator

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

David Begleiter - Deutsche Bank Securities

Good morning.

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

Hi, David.

David Begleiter - Deutsche Bank Securities

Hi Jim, the slow down in the base business you referenced, when did that begin and can you quantify the magnitude of that slow down?

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

I am really talking very specifically about US manufacturing, okay? And that would be the leading indicators for that, really our TDI weekly sales, okay? And we measure the TDI weekly sales both in terms of gas sales also in terms of hard good sales, and then even within the hard good sector, we break it down between, what we call, capital hard good sales, which would be drill presses, and valving equipment, and laser cutting equipment, on the one hand, to consumable sales. So, as the cycle builds up, what you typically see is that the capital sales in the hard goods grow the fastest the first, and then along comes the gases and along comes the consumables. What we saw was that the growth in the capital goods orders really peaked about a year ago and the rate of growth has been slowing in that. So, that to me is the leading indicator and that started over a year ago. The sales of gases still continues to grow nicely, but not as fast as it was growing a year ago, and the same thing with hard goods. Now, let me just make one more point on that question, which I think makes it difficult in my mind for everybody to watch exactly what is going on in the economy, because we have not seen anything that looks or feels or smells like anything’s going off of a cliff, unlike what you hear a lot of people talking about. One thing that we do see change from season, just from year to year, is that December sales and volumes are always difficult to predict and are difficult to report in 20-20 hindsight because a lot of factories take a week off during the Christmas holidays and depending on when the holiday, when New Year lands, and when Christmas lands, they may drop off fewer or more days. What we found is that a lot of customers decided to take two week shut downs during the end of December and that reduced our volumes during those months, and I suspect that it also reduced things like the industrial production index for December and so on and so forth. But, I just like to reiterate that we are just seeing… it’s kind of gradual slowdown in heavy manufacturing for about a year, but we haven't seen any inflection point.

David Begleiter - Deutsche Bank Securities

Jim, in Europe, any signs of slowing in your key areas around Germany?

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

No, Germany is growing very strongly. Growth in Spain is… Spain used to be the country where we always had the fastest growth. Growth in Spain is moderating a little bit, but Germany is very strong.

David Begleiter - Deutsche Bank Securities

Lastly, you gave us your large project backlog, how many projects were added, how many started up in the quarter?

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

Total, in the backlog, we started up seven and we added eight. And the ones that we added, none of them are in the United States, the most of them are in Asia, and a couple of them in South America, and one in Europe.

David Begleiter - Deutsche Bank Securities

Thank you very much.

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

And I would say these are projects where we signed the contract… a binding contract and we're under construction now. So, they are real committed projects and then, what I would call, the letter of intent stage or places where you are discussing things with customers, the level of activity, the level of proposals, feasibility studies continues to go up quarter-after-quarter and it’s truly unprecedented.

David Begleiter - Deutsche Bank Securities

Thank you.

Operator

Your next question comes from the line of Robert Koort of Goldman Sachs. Please proceed.

Unidentified Participant

Good morning. This is [inaudible] for Bob.

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

Yes, you don't sound like Bob.

Unidentified Participant

He is on a conference call now.

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

Okay.

Unidentified Participant

I have a couple of questions on behalf of Bob. First of all, I have a question about this Asia margin… operating margin, we saw that margins obviously have declined year-over-year for three consecutive quarters, can you please just give us some color on that? And then now what's your expectation for the Asian margins in 2008? And then if you have any long-term target, can you just discuss about that?

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

You got a look at… and we look at our Asian business as sort of a start-up business, which is going through a lot of growth. For us, it is about a $600 million business, on a reported basis, about $1 billion, so with combined sales and joint ventures. But, we guys are staffed up to be a little more than $2 billion or $1.5 billion business, which means that we have just got people already working there for where we think the business is going to be a couple of years down the road and that's what I mean by looking at it as sort of a start-up business, where your incurring expenses ahead of getting revenue. But, for example, in Asia our backlog right now is 12 projects. We started up one in the quarter. We had three new wins in the quarter. We have added over 200 engineers to Asia. We are building two specialty gas labs over there. And it is just a question of making permanent investments, which adds fixed cost and so forth. But, as the projects come on stream, the average project will have an operating margin well into the mid-20s. So, as they come on stream you will see the operating margin growing.

Unidentified Participant

Got you. And then the second question related to the merchant pricing competition in Asia. We are continuing to hear about that strong merchant pricing competition, particularly in China and India, I was wondering [inaudible] pricing strategy in those two countries, and then also are you able to hold your merchant margins in those two countries?

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

Yes, absolutely. Merchant pricing has gotten a lot better. For a while, electricity price was going up and merchant pricing wasn’t following that. But at this point in time, we're definitely holding the margins and getting pricing for excess capacity on higher electricity cost.

Unidentified Participant

Okay, understood. And then lastly, I have a question on your steel exposure. If you are heading into an economic recession or a significant slowdown in the US over the next two to three quarters, will you worry about your large exposure to the steel industry in the US, given that the steel... the US steel industry has been an economically sensitive sector and it’s very important for Praxair’s on-site business?

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

You see that from time to time and we have had times where they close for inventory management and two years ago we went through a couple of quarters of volume being off 20%, but came right back again. At this point in time, the US steel manufacturers are very bullish for 2008 and that's really from a couple of reasons. The first one is that the inefficient producers in the US really all shutdown about five, six years ago. So, the ones that are left are world scale efficient producers. Secondly, with the dollar where it is… US is normally about a 30% importer of steel, with the dollar where it is and the other currencies where they are, those imports are not… don’t make sense anymore and so there will be more US steel production. And lastly, we are really starting to see some exports of US steel, particularly in areas of stainless steel and drilling pipe, which really aren’t available in many parts of the world. So, we are pretty positive on it.

Unidentified Participant

Okay, thank you very much.

Operator

Your next question comes from the line of Michael Sison of Keybanc Capital Markets. Please proceed sir.

Michael Sison - Keybanc Capital Markets

Good morning. Nice quarter. Jim, when you think about your year-over-year sales growth for 2008, 10% and the 14%, how much of that is… I guess to some degree insured from the backlog that is expected to come on stream this year?

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

Well, normally, what we’ve said over the forecast, 5% to 6% is new projects on top of the base business, okay? And on top of that we’ve got base business growth going on, and we sure will have a couple of slow acquisitions. So, that kind of gets you to the… at least to the 10% level.

Michael Sison - Keybanc Capital Markets

And that formula, if you will, in terms of the new project backlog, pretty sustainable for the next few years.

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

Absolutely. The backlog just keeps getting bigger.

Michael Sison - Keybanc Capital Markets

Okay, great. And just a quick question on… just give sort of a color on TDI. Are you expecting… you certainly didn’t see that much of a slow down in same-store sales in the fourth quarter, it was up 5%. Do you see that 5% slowing in the coming quarters and maybe you can give us a feel for… of the 5%, was it more volume, was it price, was it about even?

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

Yes. Let me comment on the 5%. It's probably about what I expect to be going on for the next while. There is a little bit more price than volume in that number and I think there is more room for price going forward… significantly more room for price going forward, and then it depends on what end of the economy you are selling into, and there is going to be… the economy is going to be spotty in 2008. There are going to be some good sectors and some bad sectors. Healthcare, food, utility infrastructure, oil and gas equipment, farm equipment, money equipment, and so forth are all going to be strong. On the other hand, probably chemicals, electronics, housing materials, autos, and appliances will be weak. So, you just got to pay attention to the end-market there. And then as you look across the geography, where it’s strong and weak. Mexico is very strong, Western Canada is very strong, Texas is very strong, and Pacific North West is very strong. But, I just start to see a little bit of weakness in Eastern Canada, in Ontario, where there are a lot of auto parts shops, and a little bit of weakness in the South Coast and the West Coast where those economies are probably going to be more impacted by the housing issues.

Michael Sison - Keybanc Capital Markets

Great, thank you.

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

Yes.

Operator

Your next question comes from the line of Edward Yang of Oppenheimer. Please proceed.

Edward Yang - Oppenheimer & Co.

Liz, Jim, good afternoon.

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

Hi, how are you?

Edward Yang - Oppenheimer & Co.

On TDI again, are you seeing some more acquisition opportunities in this area?

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

Do we see more opportunities? Yes.

Edward Yang - Oppenheimer & Co.

And is it just a function of just some added stress on maybe some of the smaller players?

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

Well, it’s a function of primarily private individuals who own businesses deciding that they don't want to own those businesses anymore and put them up for sale and that’s just sort of a continuous process that goes along.

Edward Yang - Oppenheimer & Co.

And on Asia again, I think on the last call you mentioned, maybe over the next two to three year timeframe as some of these new projects come on line and you [inaudible] on revenue on your fixed costs that your putting in today that you expect margins to approach about 20%. Are you still relatively confident on that target?

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

Absolutely, yes, like I just talked about.

Edward Yang - Oppenheimer & Co.

Okay. Thank you very much.

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

Sure.

Operator

Your next question comes from the line of PJ Juvekar of Citi. Please proceed.

PJ Juvekar - Citigroup

Good morning.

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

Hi, PJ.

PJ Juvekar - Citigroup

Jim, you talked about Asian margins down because of your investments, are you seeing any sings that your competitors are lowering their hurdle rates to win new business there?

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

Every once in a while we are sure our competitors do a suicide project. But, it is not wide spread and a suicide project doesn't really affect the economics of other businesses.

PJ Juvekar - Citigroup

And who are these people? Are these local competitors or are these international competitors?

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

Mostly it’s global because there aren’t really any domestic players there.

PJ Juvekar - Citigroup

And secondly, can you talk about your project backlog, 32 or 36 projects? I think you mentioned something like you’ve finished seven, you added eight, can you talk about a dollar number? We don't know whether the new ones that are added are smaller than the old ones that you completed, are they bigger, can you just talk about a dollar number, which probably can give us a better idea?

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

I prefer not to go into the dollars of the backlog because it's hard. When you look at the numbers that way, they spread across multiple years, and it's hard for people to sink them up with any particular year's capital spending number. So, it tends to get people more confused than it does help. But, what I will point you to is the CapEx guidance that we gave, which is continuing to grow up and that really just reflects the larger backlog.

PJ Juvekar - Citigroup

Are these projects sort of similar in size?

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

They are getting larger. The average project size is definitely getting larger.

PJ Juvekar - Citigroup

Okay and one last question on your PDI business, cylinders. As economy slows down and you are seeing volumes come down there, but you are making more acquisitions. Is that the strategy to consolidate the business when the market goes down?

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

Well, you would think so. But, most of the decisions by sellers are really lifestyle decisions, and it's really when they decide they want to retire and not manage a business anymore. So, I think the valuation of the businesses would come down as growth came down, but not necessarily the number of businesses that come up for sale.

PJ Juvekar - Citigroup

Right. Okay, thank you.

Operator

Your next question comes from the line of Kevin McCarthy, of Banc Of America Securities. Please proceed.

Kevin McCarthy - Banc Of America Securities

Yes. Good morning, Jim and Liz.

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

Hi Kevin.

Kevin McCarthy - Banc Of America Securities

A broad question about the financial guidance that you issued for 2008 and it relates to operating leverage. If I look at 2007, you had sales growth of 13% that resulted in 21% EPS growth, it seems like you are forecasting a fairly similar sales growth rate for 2008, yet resulting in only 13% EPS growth. If I look at the mid-point, obviously natural gas can reek havoc a little bit with your top line. But, can you help, Jim, understand some of the factors that might be causing somewhat less operating leverage implicit in the numbers here?

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

One of the factors is just a mix issue and it has to do with the hydrogen business, because in the hydrogen business you will invest $1 of capital and you get $2 of sales, but you get them at a relatively low operating margin percent, maybe 10% to 12% because your sales dollars of hydrogen are 80% just pass-through the natural gas cost, okay? So, as hydrogen comes into your mix, it will lower your operating margin percentage relative to your sales. So, on the one hand, we've got more hydrogen coming into the mix, which would tend to depress the operating percentage margin. But, we're getting nice operating leverage out of the base business and so we feel we are comfortable at sustaining and improving the operating margins.

Kevin McCarthy - Banc Of America Securities

That's helpful. So, if I look at your business on a product-by-product basis, in an apples-to-apples fashion, it sounds like you would not be forecasting any margin compression. Is that correct?

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

Absolutely not... no because we're... [inaudible] gross margin percentage, I think a lot of people don't look at that and a lot of people don't show that. But, that's really your sales minus your variable cost, and that's what you’ve got to manage in the business to make sure that your energy cost goes up, you are getting it back in sales. So, we focus very hard on keeping that variable margin high and higher each year, and then at the same time, we are looking at 10% to 14% growth on the top line, you will be seeing fixed cost growth of 4% or 5%, SG&A growth of 4% or 5%, and so forth. So, when you get down to operating profit, you are going to get faster growth in operating profit than you will in sales.

Kevin McCarthy - Banc Of America Securities

Understood. And then finally, if I look at your North American merchant sales growth of 15% in the quarter, what are the constituent contributions from volume and price there?

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

I don't have that directly in front of me. I think it's about half and half… no, it can't be that, it's probably about 10% volume and 5% price.

Kevin McCarthy - Banc Of America Securities

So, it sounds like merchant volumes are growing significantly faster than packaged gas volumes for example?

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

Yes, and some of that is related to fracking business. The fourth quarter was a very strong fracking quarter and that's our merchant products. But, let me just take this opportunity to give you some numbers on a different slice and dice direction because we can give them anyway you want, but our competitors, they are organized by global tonnage and global merchant and show numbers that way, and we have those internally, but our global tonnage sales were up 13% versus 5% on the other side, and our global merchant sales were up 12%, versus 8% on the other side. So, I think we are doing very well in the marketplace.

Kevin McCarthy - Banc Of America Securities

Great. Thank you very much.

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

Yes.

Operator

Your next question comes from the line of Chris Shaw of UBS. Please proceed.

Chris Shaw - UBS

Hi, good morning. How are you doing?

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

Hi, Chris.

Chris Shaw - UBS

Firstly, the equity income, I think it was $13 billion for the quarter. What's that going to be like on a run rate, the new Yara project?

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

Both, the equity income and the minority interest, are going to be growing pretty significantly. What's coming into equity income are things that we don't consolidate, and the largest of those will be the [inaudible] project in the Chemical Park in Asia, which is really, finally, just beginning to become profitable. So, that's bringing a lot of equity income. And then likewise on the minority interest line, we've got minority shareholders of some of our businesses in China, as well as in Europe, and as those businesses grow, the minority number will grow as well. You will see both of for those growing. Equity income are growing faster than minority.

Chris Shaw - UBS

Just back to CapEx for a second. If you are suggesting $1.4 billion for 2008, does that reflect just what you know now or will that expand if you sign more contracts throughout the year because it's not really… it's not that much of an increase over 2007, just to be sure if you had a look at it?

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

That really reflects the number of projects that we've got signed, sealed and delivered. As we sign and seal more during the year, that number could creep up from there.

Chris Shaw - UBS

Okay, great. Thanks a lot.

Operator

Your next question comes from the line of Laurence Alexander of Jefferies. Please proceed.

Laurence Alexander - Jefferies & Co.

Good morning.

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

Hi Laurence.

Laurence Alexander - Jefferies & Co.

I guess first question, in terms of the projects you have in the backlog, does it seem reasonable that CapEx will probably move higher again in 2009?

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

I don't think so. But, that really remains just be seen on how many of the very, very large projects we sign up. If we sign up a lot of large gasification, 10,000 tons a day projects, then that would require our CapEx to be going up in '09. But, absent that, I think we are going to be very good at managing our capital spend. I think most of you know that we have an extremely disciplined cost estimating process, where we have locked in 80% of the cost of a project before we sign a contract with a customer. And we just keep getting more capital efficiencies by building better plants for less money. So, I think we will probably be in the $1.4 billion to $1.5 billion range through the end of the decade.

Laurence Alexander - Jefferies & Co.

Okay. And in terms of productivity which you have... can you discuss the backlog of initiatives and whether if economic demand slows, you have leverage to improve productivity in the back half of the year?

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

Let me just talk about that. First of all, even though it is not raining here, we’ve batten down the hatches already and are holding our fixed costs flat from the fourth quarter into the first quarter in spite of a significant amount of sales growth. And we will keep doing that as long as we don't see economy growing. Now, our total productivity number forecasts… total productivity for '07 was $273 million and I think the number in '08 will be just under $300 million, and that’s obviously we are stretching ourselves doing the most we can with that. So, if you said, what can you do more, I would be doing more already. But, the places where we do have discretion are in places like building more specialty gas labs and stuff like that, that we could put on hold, if we really had to.

Laurence Alexander - Jefferies & Co.

And in terms of the end-market outlooks, what gave your assessment of the trends? Without taking into account recent trends in January and if not, can you briefly address what you have seen so far in January, particularly in the US?

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

Let me explain January this way. Volumes in the first couple of weeks of January have been very strong. I will sum it up, maybe a bounce back from being closed over the holidays. I don't have that number sliced and diced by end-markets and won't get that sliced and diced by end-markets before the end of the month.

Laurence Alexander - Jefferies & Co.

Okay. And then lastly in terms of the hit that you expect to see in Asia from Beijing, is it big enough to be noticeable in terms of a swing from '08 versus '09?

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

I don't think so.

Laurence Alexander - Jefferies & Co.

Okay. Thank you.

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

Yes, okay.

Operator

Your next question comes from the line of Jeff Zekauskas of J.P. Morgan. Please proceed.

Jeffrey Zekauskas - J.P. Morgan

Hi, good morning.

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

Hi Jeff.

Jeffrey Zekauskas - J.P. Morgan

Is your nitrogen project with Pemex on stream? And if it is, at what capacity?

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

It's on stream at 50% capacity right now. That project got delayed basically for two reasons. It’s a two-train project and so… one of them is up full, the other one is on its way up. And it’s a very large plant. We had difficulty with the turbines fire, and smell [ph] in the turbine. When we started up, the turbine had problems, weeks and weeks to go back and get a new turbine there. And then the other delay we had was... there was a very large hurricane down in that area in August, September, and so forth, which didn't affect our plant, because our plant is build up above flood level, but it basically flooded out where all the workers lived around there and so we lost couple of weeks there just because of that. But, we'll see it operating in full swing in 2008.

Jeffrey Zekauskas - J.P. Morgan

Did you have to pay any penalties for not hitting your performance targets and were they material?

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

Not a significant amount.

Jeffrey Zekauskas - J.P. Morgan

Not a significant amount. And then lastly, what is your tax rate going to be up in 2008?

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

Basically, because… as we grow the business, each incremental dollar of earnings tends to be coming in at closer to the statutory tax rate and so the average will be going up. But, it's still a moving target and the best guidance we have is 26% to 28%, but it could be anywhere in that range.

Jeffrey Zekauskas - J.P. Morgan

So, it's a geographic distribution issue?

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

Geographic mix, mainly.

Jeffrey Zekauskas - J.P. Morgan

Okay. Thank you very much.

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

Yes.

Operator

Your next question comes from the line of John McNulty of Credit Suisse. Please proceed.

John McNulty - Credit Suisse

Yes, good morning. When we think about the resiliency of your backlog in terms of when you get paid with some of the concerns about a potential… even global recession, in the event that some of your customers either start to delay projects or even cancel them, when do you get paid? I know you [inaudible] take or pay contracts for these, is it when your end of the facility is basically built, when you’ve basically delivered on what you needed to, or is it when they actually ramp-up plants? Can you give us sort of color on that?

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

Sometimes that’s a little bit of a negotiation with the customer. But, for the most part, once our plant is up and running and meets the performance test, the facility fee starts getting paid. In some cases, you have got customers who say, I want the window to be three months or something like that in case my plants are delayed and that ends up being a negotiation with the customer. But, for the most part, we get paid when the plant starts up.

John McNulty - Credit Suisse

Okay, great. And then the second question would be on your homecare business in the healthcare area, it seems like it's continuing to see headwinds with regard to reimbursement rate cuts. Is there at least a decision on your part that may be coming where you may be getting rid of this business at some point or thinking about a way of rationalizing it?

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

It's a good business and we think we can weather through the storm on the reimbursement rate cuts. We're getting good 8% margins in it. So, we are sticking with it for now, but if could find a way to get some more scale, I think we could improve the margin on the business there.

John McNulty - Credit Suisse

Okay, great. Thanks a lot.

Operator

Your next question comes from the line of Chris Lewis of Impala Asset. Please proceed.

Christopher Lewis - Impala Asset Management

Good afternoon. Could you just talk a little bit more about your PST business in terms of the major drivers, OE versus after-market, and sort of [inaudible] relative to the end-markets you are participating in there?

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

Okay. We're pretty much out of the after-market in PST. We sold the after-market business about a year ago and that's part of the business, which is very poorly positioned strategically. So, on the aircraft engine side, which represents about 60% of the business, we’ve got very strong demand coming from all the engine manufacturers, GEB, our largest customer, but [inaudible]. First one is the demand for engines keeps going up and the second one is that the new engines are run more fuel efficiently then the old engines and the way they do that is they run them harder, and because they run them harder, they need more thermal barrier coatings in the engines, which means that… I guess you would call our penetration into each engine is going up as well. So, that's a very, very good news. Now, on the other hand, some of the end-markets that we supply coatings to are not doing all that well, which would be the textile industry and the printing industry and so they tend to be a little bit of a drag on really with stellar results in the aircraft segment.

Christopher Lewis - Impala Asset Management

Great. Thank you.

Operator

This concludes today's question-and-answer session. I would now like to turn the call back over Mr. John Sawyer for closing remarks. Please proceed sir.

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

Thank you all for joining the conference today, and look forward to seeing you all again soon.

Operator

This concludes today's presentation, you may now disconnect.

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, Inc. Q4 2007 Earnings Call Transcript
This Transcript
All Transcripts