Q3 2021 Linde PLC Earnings Call
Good day, and thank you for standing by.
Welcome to the Lindy plc third quarter 2021 earnings teleconference. At this time all participants are in a listen only mode.
Please be advised that today's conference is being recorded.
After the speaker's presentation, there will be a question and answer session I would now like to hand, the conference over to Mr. Wants Elias head of Investor Relations. Please go ahead Sir.
Thanks, David Good morning, everyone and thank you for attending our 2021 third quarter earnings call and webcast.
<unk> head of Investor Relations and I'm joined this morning by Steve Angel, Chief Executive Officer, Matt White, Chief Financial Officer, and Sanjiv, Lobaugh Chief operating officer.
Today's presentation materials are available on our website at <unk> Dot com in the investors section. Please read the forward looking statement disclosure on page two of the slides and note that it applies to all statements made during this teleconference.
Reconciliations of the adjusted numbers are in the appendix to this presentation.
Steve will provide some opening remarks, and then sanjiv and Matt will give an update on <unk> business outlook and third quarter performance.
After which we will wrap up with Q&A, Let me turn the call over to Steve.
Yeah.
Thanks, Ron and good morning, everyone.
Linda employees delivered another solid quarter, continuing Q2's record EPS performance.
Despite increasing increasingly challenging market conditions.
Operating cash flow and return on capital reached record levels.
And our project backlog nearly doubled providing a strong foundation for our high quality long term growth.
We also stepped up our commitment to reducing our greenhouse gases emissions footprint.
And Sanjay will share that roadmap with you.
But frankly this isn't something new it's what we committed to our shareholders since the merger.
<unk> been delivering on ever sets.
Irrespective of the macro environment.
Most of you know this but I think it bears repeating.
Our operating culture runs deep at lending.
Our people will take great pride and demonstrating continuous improvement across the key operating metrics in their business.
The best day of the month of our management team is when we review the operating performance of each of our regional business units.
This is what we do for fun in Danbury among.
Among other things.
Well I'm sure you've seen the announcement earlier this week, where I will become the chairman of the board and.
Sanjay will become CEO effective March one.
His appointment is the culmination of a dull gen three year succession planning process.
Which sanjay clearly demonstrated he was the right choice to lead this company going forward.
I will continue to work to provide guidance.
Both from the perspective of a director and a significant shareholder.
But my primary responsibility shifts to chairing the board of directors.
<unk> takes over day to day management of the company.
Okay.
Supporting Sanjay it is a highly capable and experienced.
Leadership team.
I have been CEO for 15 years.
And I have never felt better about how the company is positioned.
Obviously, our strategy is working well.
And the team is executing at a high level.
So I would say we are a well oiled machine.
Wouldn't disagree.
We are a company for all seasons and I am confident lenders best days lie ahead.
Before handing off to Sanjeev I would like to take a moment.
And thank Wolfgang rightful for his partnership and bringing our highly successful merger to fruition.
And our directors and investors.
For their continuing support.
Lastly, I want to thank our employees worldwide.
For creating the leading industrial gases and engineering company in the World.
I'll now hand, the call over to Sanjay.
Thank you Steve.
Im honored to be given the opportunity to lead this outstanding company into the future.
Appreciate your confidence and support over the years.
Before I jump into the slides I wanted to build on Steve's comment of a seamless leadership transition.
Linda we are proud of our industry, leading performance, let's start with living our core values, while maintaining a disciplined execution culture.
As CEO I fully intend to build upon our foundation my focus will be on areas that are aligned with the interests of our shareholders profitable growth optimize the business cash generation and of course, the truth serum for our industry RFC.
Linda will remain focused on the things that create value for Linda owners, such as strong pricing and productivity culture and active commitment to sustainability.
<unk> investment philosophy.
Our shareholder friendly capital policy.
And of course pursuing high quality and sustainable growth initiatives with emphasis on RSC.
Timidly, it's about being the best performing industrial gases and engineering company in the World.
Stated differently, you can expect a seamless transition with minimal change.
Now with that said, let's move on to slide three for.
For an update on our growth initiatives.
Last quarter I mentioned, some key growth drivers, including the secured project backlog.
Accretive base Capex investments and the strength of our growth and low capital intensity areas, such as health care food and beverage engineering and our packaged gas business.
Today I am happy to report that our project backlog has increased from seven 5 billion to $13 4 billion or up 81% sequentially from the last quarter.
You will recall this backlog only includes contractually secured incremental growth with fixed payments to ensure targeted returns.
We're also beginning to see a return of the capital cycle.
Actually in upstream operations, such as natural gas production that bodes well for our overall pipeline of opportunities.
On top of that the electronics sector continues to be very active.
We recently announced a $600 million investment sale of gas investment indeed to supply a world class fab in Phoenix, Arizona.
This is supply only the first phase of this project and we expect to see further opportunities as that area builds out.
Overall I am pleased to see how the entire Linda team has come together and is leveraging our combined strengths to secure high quality growth opportunities through our leading high density industrial gas network combined with the World class engineering capabilities.
This backlog combined with our supply network density enables profitable and secured growth for years to come.
Now before moving to the quarterly results.
I want to update you on Linda is new and more ambitious greenhouse gas emission goals.
A good way to stop this is to first explain the role our products play in People's lives and the overall economy you will find this on slide four.
We make products that are critical for society.
<unk>, such as medical oxygen for hospitals Ultra high purity nitrogen for semiconductors liquid nitrogen for food freezing crypt onto insulated windows and hydrogen to produce cleaner fuels to give you just a few examples.
In order to make these products, we expect to have a total of 39 million metric tons of scope, one and scope two emissions this year.
As you know the production of gases requires significant amounts of electricity.
When such electricity is generated using hydrocarbons were penalized for those indirect emissions called scope two emissions.
We also have scope, one emissions, which are significantly lower than our scope two emissions, but are significant. Nonetheless. These emissions are largely as a result of using natural gas to make hydrogen which is used by refiners to produce cleaner fuels.
Our gases play a critical role in the economy in.
In addition to saving lives.
Proving energy efficiency, increasing shelf life, our products also help our customers eliminate or reduce greenhouse gas emissions.
In 2020, we generated a total of 37 million metric tonnes of emissions to make products that helped our customers avoid more than twice our emissions are 85 million metric tons of Sidoti equivalent.
In other words without Lindsay products, there would be significantly higher net carbon emissions in our vault.
At Lindsay we have been doing our part to support our planning for many decades.
No we need to do more.
In 2019, we set a goal to reduce the carbon intensity of Linda 35% by 2028.
We are well ahead of that goal and expect to exceed it.
It is of course, good news, but in intensity goal doesn't fully address the absolute scope, one and scope two emissions. So we are determined to continue on our mission of making our world more productive, enabling our customers to decarbonize and commit to reducing our own carbon footprint.
Yeah.
With that in mind, I'd like to announce lenders, new medium and long term emission goals, which you will find on slide five.
The first goal is to achieve a 35% reduction in our scope, one and scope two emissions by the year two.
<unk> thousand 35.
I'll simply 35 by 35.
To achieve this goal we must materially reduce our scope one emissions, which are driven by hydrogen production.
We will do this by focusing our efforts on carbon capture and sequestration.
Developing blue and green hydrogen production and progressively transitioning towards zero emission fleet.
Our scope two emissions are related to electric vehicles assumption.
To date, we consume approximately 45 terawatt hours of power.
A total of which is from renewables and low carbon sources.
In order to achieve the 35 by 35 goal, we will triple Triple a renewable and low carbon power sourcing by 2035.
Through new Ppas and by supporting renewable energy projects with offtake agreements and even co investment.
To put this goal in perspective, the amount of renewable energy, we will plan to purchase is equivalent of all the power consumed annually in New York City.
That's a big number.
Of course in addition to that we will continue to improving the energy efficiency of our plants as well.
These goals are being embedded across the entire global organization.
Being reviewed as part of our operating rhythm and will be incorporated into our annual variable compensation.
This is what gives me the confidence in our ability to deliver these goals.
Which is no different than how we would approach anything of importance in our company.
Now in addition to the 35 by 35 goal.
Also committed to pursuing our goal of becoming climate neutral by 2015.
We will do our part to achieve this goal.
But we also need strong policy support and regulatory support.
Let me summarize this journey on slide six.
We have defined a roadmap to reach climate neutrality.
Our roadmap is underpinned by numerous initiatives and milestones, which will be embedded into our operating system, providing us the greatest opportunity for success.
<unk> forward, we will continue to share our progress and shoring accountability and transparency for our stakeholders.
I'll now turn it over to Matt to walk you through the numbers.
Thanks <unk>.
Please turn to slide seven for an overview of the third quarter results.
Sales of $7 7 billion.
Increased 12% over last year.
And 1% from the second quarter.
Cost pass through which represents the contractual billing of energy cost variances, primarily in the onsite business.
Rose, 3% over last year and 2% sequentially.
Recall that cost pass through has no effect on profit dollars, but will impact profit margins as we gross up or down sales and variable cost.
Foreign exchange was a 2% tailwind versus prior year, but a 1% headwind sequentially as most currencies have recently devalued against the us dollar.
Excluding these items underlying sales grew 11% over prior year and 1% sequentially.
The 8% volume increase over last year.
Was broad based across all geographies and end markets as.
As we continue to see recovery from the pandemic.
Sequentially volumes are flat as contribution from project startups were mostly offset by lower volumes in China.
Pricing levels are up 3% from last year and 1% from the second quarter as we continue to adjust merchant and packaged gas product pricing in line with local inflation.
Note that some of these contracts have lagging recovery mechanisms, which may not take effect for two to six months, depending upon the terms and conditions.
Operating margin of 23, 6% is 150 basis points above 2020.
About 60 basis points below the high Mark set in the second quarter.
Excluding the impact of cost pass through operating margin would have increased 220 basis points above last year and had a negligible decline sequentially.
As mentioned merchant and package cost recovery can lag one to two quarters. So going forward I expect continued pricing momentum.
EPS of $2 73.
Is up 27% over last year from higher volumes and price over a relatively stable cost base.
As both Steve and Sanjiv mentioned, Linda has a strong productivity culture, which enables consistent profit growth irrespective of the economic climate.
This is also evident in the 16, 7% return on capital, which represents another record as profit continues to grow double digit percent over a flat capital base.
The reason, we've been able to maintain such a steady capital base.
Is due to a combination of disciplined capital management and healthy cash generation.
Which I'll cover on slide eight.
You can see to the left our operating cash progression.
<unk> and a record level of $2 6 billion in the third quarter.
The three main drivers are stronger earnings.
Timing benefits from last quarter.
And engineering contract prepayments.
In light of the record sale of plant backlog I anticipate further project repayments into the next few quarters.
As far as how we allocated year to date cash the Pie chart to the right shows $2 $3 billion invested into the business.
And $4 $8 billion distributed back to shareholders through dividends and stock repurchases.
Note that investments exclude sale of plant.
Since we are paid in advance for engineering projects, which means that we are committing much larger amounts towards contractually secured growth than what's shown on this chart.
In addition to generating significant surplus cash.
We have access to very attractive capital through the debt markets.
In September we issued almost 2 billion euros at 512.
And 30 year maturities with all in coupons of zero percent, 0.38%.
And 1% respectively.
Overall, the combination of excess cash generation and low cost incremental debt gives us a high degree of confidence to maintain shareholder friendly allocation policies over the long term.
I'll wrap things up with guidance on slide nine.
The fourth quarter EPS guidance range of $2 60.
To $2 70.
Is 13% to 17% above last year.
And 38% to 43% above 2019.
Consistent with prior quarters.
We believe it's important to distinguish true multi year growth.
From mere recovery of 2020 recessionary conditions.
Versus the third quarter. This range represents a sequential decrease due to normal seasonal declines plus an estimated 1% foreign currency headwind.
Yeah.
Underlying volumes are assumed to be roughly in line with the third quarter.
But if current conditions hold I would expect to be at the upper end of this range.
This quarterly update resulted in a new full year guidance of $10 52.
At $10 62.
Which represents a growth rate of 28% to 29% over 2020.
43% to 45% over 2019.
In summary.
Other solid quarter, despite some challenging conditions.
And regardless of the macro we remain confident and Linda <unk> ability to continue delivering industry leading performance.
I'd now like to turn the call over to Q&A.
Thank you if you would like to ask a question. Please signal by pressing star one on your telephone keypad.
If you are using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment.
Again press Star one to ask a question.
We'll pause for just a moment to allow everyone an opportunity to signal for questions.
We will take our first question.
From Bob Court with Goldman Sachs.
Good morning, Thanks very much.
I was wondering if you guys could comment a little bit on the hydrogen markets and your engagement there with customers and partners how that may have evolved over the last several quarters.
Maybe from the context of from the outside it seems like Theres, a massive broadening of participation as people start reaching for that opportunity just maybe give us some insights into how <unk> seen that evolving lindy.
Okay.
Thanks, Bob I'll take that very quickly I agree with you that there has been significant and continuing momentum in the space and I am very pleased to suggest that.
We are seeing a reflection of that in the activities that we are actively pursuing I'll start by just describing what the opportunity pipeline looks like because thats reflective of the level of activity that Linda is seeing and then talk a little bit about the particular areas, where we see some of that momentum reflected now.
So starting over the projects that we're looking at as you know we run this monthly call on the hydrogen council that Linda runs internally, we've got about 260 projects in our pipeline, we've got a probability weighted.
Sort of conservatively probability weighted number in terms of investment decisions of up to four four plus billion now and these are decisions, we expect to see happen in the next three years or so in the past you heard me say that we expect to see us investing about $1 billion a year roughly in the space and then on top of that there may be some mega projects that come.
Along as well so thats just to give you a sense of the level of activity that there is happening around that space and I remember and I've said this before Bob So youll kind of recall Linda has a unique position in what is happening in the evolving space around around clean energy.
We've kind of described to you previously under Decarbonization, we look at carbon solutions and we look at hydrogen in the hydrogen space. We obviously are very mindful and interested in the developments around blue hydrogen we see that as a very important transition and the screen energy roadmap that lies ahead and this is where we are seeing.
<unk> pick up in terms of activity. We are currently involved in a number of projects.
Which have a range of investments.
And those are progressing well and again.
While our projects in this space to make sense, you need three things to be happening.
You need the technology provider in this case that is us.
For carbon capture.
Do you need partnerships to ensure that you have been looking at sequestration effectively with partners, who have long standing experience and knowledge of that space. We currently actively pursuing those as well.
And of course, Todd very importantly, you need an off taker you need a partner who is willing to stay in the game and actually offtake. The blue hydrogen that comes off that and is able to create some value as a result of that for us. Those three things are very important and again I'm pleased to say that we are seeing those partnerships actually gather a lot of momentum as we move forward.
I'll kind of stop there for a moment and give you see if that answer your question.
Very helpful and what about the competitive intensity is Atlanta.
And scape has been populated with more and more companies may be trying to edge and on the turf that has historically belonged to the industrial gas companies.
So the way I'd answer that I think Bob is just to kind of remind you a lot of people. So firstly lots of announcements I think you'll see them, we see them everyday and every morning I wake up to this long list of announcements that are happening a large number of people who make those announcements have either never seen or heard of hydrogen before this.
Cost of them don't even understand that we have a colorless molecule that obviously is now defined by very very many colors, but putting that aside in terms of experience and expertise.
The reality is there will be a number of players who will make a difference in this space and as part of that you will see a range of outcomes you will see us competing where we need to and you will see us partnering with a number of those as well. This is an area that requires strong partnerships for that initial momentum in the ecosystem development to <unk>.
Really happen and.
I see that development happened, where we are kind of speaking to a range of partners across different areas.
<unk> moved us along so I don't particularly kind of see this is as.
The space that you're going to see the intensity of competition being any different to what we see otherwise.
Very helpful. Thanks Sanjay.
We will now take our next question from Duffy Fischer with Barclays.
Yes, good morning.
First just wanted to say congrats to synergies.
Great promotion and thank you to Steve for a decade, and a half and I think from Investor standpoint, maybe even more from the way the transition was handled almost picture perfect. So thank.
Thank you guys all for that.
I guess my question is.
Owned Linden care and may be the medical business in general if you go back before Covid started.
And just kind of analyze how that business has developed.
<unk>.
Colbert is kind of a driver how do you see that business structurally different today in <unk>.
How much has it grown through that period relative to the rest of the business.
Duffy thanks.
Let me get into it and I'll start off by just taking a step back in and outlining the health care space that we operate in.
And also reminding everyone that we have strong leadership in that space. So we think of our healthcare business in two different areas. We look at hospital care, where we are the primary provider of medical gases to hospitals and of course, our homecare business, where as you referenced linked care is a very very important player in the U S.
We obviously have smaller homecare businesses elsewhere in the world as well so thinking structurally above that business, let me just kind of safety.
<unk> there are two things happening as we speak obviously, you've heard you've heard us talk about how we.
How that business is supported.
And save lives and supported hospitals and patients at home and over the last 18 plus months now. So clearly it's played a very important role linker in particular in the U S will almost seen as a second line of defense supporting Covid patients at home through the respiratory.
Offerings that we have what has happened as a consequence of the pandemic is that a number of regulators and governments have in mind.
The best way to describe it has woken up to the realities of how they need to manage this more professionally in terms of storage in terms of piping in terms of infrastructure necessary for these.
These high levels of medical gases and oxygen in particular to be delivered to their to their infrastructure and network. We've been participating in many of those conversations in fact, most governments have reached out to us seeking support and help and structuring those conversations and we are obviously, leading many of those conversations across the world today.
Where we are helping governments and regulators to make sure that they have a well thought through infrastructure program and a development process around how they will manage this going forward are kind of.
Endemic preparedness, a little bit later in the day, but nonetheless important to make sure for the future. The reason I mentioned this is because this means as we move forward, we're going to see continuing activity in the space, we will be participating in those in those activities and expecting a level of growth out of that we've said this before.
You've heard us describe mid single digit growth for our healthcare business overall and I still maintain that we will see that obviously in the link care world in particular tuck in acquisitions is something that we are very interested and excited about so we will continue to see those come through adding on to that mid single digit are contributing.
That mid single digit that I referenced earlier on as well so I do see this as solid secular growth trends.
I see it progressing with that strong mid single digit growth that I described earlier on and I see us seeing kind of areas in the world, where we will see that probably grow it not probably will grow at a higher pace Asia being one such example, again because of the strength of our footprint that we have the ability to make sure that we leverage that footprint for that incremental.
Growth in Asia as an example.
Terrific and then maybe just a quick one as we start to look into 2022. When you look at just the new project.
Growth coming on stream, how will that impact 2022 relative to what we've seen over the last couple of years.
Alright so.
I have to say I expected that question.
Good.
Now, let me take I'll take a step back and just go back to what we said maybe a couple of earnings calls before we committed.
Delivering a 10 plus percent EPS growth for the midterm.
As you can imagine I feel pretty confident about that today as I'm sitting here Theres, obviously supported by this very strong backlog that you just referenced.
I have to say that this strong backlog will provide us with mid single digit EPS growth. If you like for the next four years or so so that's a pretty strong contributor right. Therefore, you now on 2022, specifically Duffy I'm going to say to you that in about three weeks' time, we're going to spend three whole days with every region around the world.
Through our planning meeting.
Steve mentioned to you how we have funded Danbury. This is going to be one of those fun events. We will review, we dissect will annualize their numbers and then in the end will agree with them what they need to deliver a 2022. So I'm looking forward to coming back in January and giving you an update on the outlook and our guidance for 2022 once you've had this meeting.
Great. Thank you.
We will take our next question from Nicola Tang with Exane BNP Paribas.
Hi, everyone and congratulations Keith Stephen Sanjay and I first wanted to ask a question on China and I think Mark in your prepared remarks, you talked about weakness in China and I was wondering if you could comment on what you're seeing on the ground. There in terms of sort of direct and indirect impact from energy control measures I guess.
As of today.
And then.
With respect to future investment opportunities.
And then the second question was on Engineering and then congrats on the very Big project.
I think you used to talk about the kind of mid <unk>.
Low to mid teens.
Through the cycle kind of margin that we've been tracking above that for some time now and so I was wondering whether there's any reason to assume that this business would be at a different margin to what we've been seeing.
Thanks, a lot.
Yeah.
Sure Hi, Nicole I can take this one.
So starting with China, yes to your point.
We did see some some volume curtailments as you would expect with the power outages we.
Do feel very confident about our customer base. They are still paying the <unk>. These are tier one customers.
This is something you've seen as you probably know in Pryor.
<unk> in China. When there are some centrally managed slowdown so from that perspective, yes. There there were reductions on a sequential basis now if you look at the APAC segment, you actually see volumes are up 2% sequentially and the primary driver there is because our backlog pretty much offset any of that China sequential decline and then the rest of our APAC business.
<unk> still performed quite well on growth, including some seasonal growth that we tend to see in the south Pacific. So from that perspective, yes, we had some of that we anticipate a little bit of that to continue here into the fourth quarter. So when we talked about volumes assumed to be flat sequentially into our guidance range. It does take into account some.
Continuing just volume softness based on this but overall, we feel very good about our asset base, we see this as temporary and and to some extent we tend to come out stronger on these things with our customer base. So we'll see how that plays out.
On the engineering Youre exactly right I mean, we have been operating kind of mid teens or a little better and as you can imagine as you know this business has pretty much negative working capital. So what you see on the margins can be a pretty good indication of the type of returns you get or could even be a little better just based on the cash profile. So.
Very good business that we have we're very excited to have this backlog it will contribute to growth we tend to focus more on the E&P side, as well, which helps with the risk management. So from this perspective, we still see margins kind of in this I'll call. It low to mid teens, and we'll see how it plays out though over the cycle.
You will always have timing and how you recognize the percent completion, so quarter to quarter, it's always tough to gauge on any particular, one but over the multi year process. We still think that kind of low double digit to mid teens is still a reasonable estimate through this business as it kind of goes through the cycles.
Thank you.
If I may ask a follow up question around energy Colson, specifically China.
Gregory.
Obviously with your business is clear in terms of the pass through effect towards the latter part you effect, but I was wondering if youre seeing any impact on your customers deciding to idle production at their own facilities.
Higher operating costs.
Yeah sure I can I can handle that one nicola.
You can imagine on the onsite business, we have our fixed payments, whether it's facility payment R&M tops. So from that perspective, we tend not to really have much risk to the production volumes.
Given that it's not really anything I would I would be overly concerned with in fact, if anything what we've seen especially on our more industrial.
Customers they tend to running harder you could think steel you could think refining given the environment, they're in and the margins that they're making on some of these products as far as the merchant and package realizing package, it's a high rent business.
So the volatility of the customer's demand will really only affect the gas molecules and what we're seeing especially in Americas and parts of Europe still seeing pretty strong growth across that package business. So I think thats been quite good.
But on the merchant side, no, we really haven't seen any significant.
Negative changes, it's been up pretty much across the board and you could imagine the customers want to produce right. They want to make as much product as they can in this environment given their opportunity to get some pricing. So from that perspective, we haven't seen any material effect on that there may be some small pockets, but nothing thats coming up to the aggregate level.
<unk>.
Great. Thank you so much.
Yes.
We will take our next question from Tony Jones with Redburn.
Yes, good morning, everybody.
Wanted to come back on the margin so.
On X cost pulse III basis margin throughout all regions in some cases materially just wanted to check whether there are any positives in there that we should be thinking about that could with us as we go into 2022.
Are we getting now also to a stage where this is about as good as it gets thank you.
Yes, I can answer that.
No.
Joining us right you can see the margins moving opex pass through year on year, our margins are up.
And.
Long showing by all of the segments within that so I think we see that momentum of what we've been working on kind of playing out in Q3.
I don't really as I mentioned earlier.
We are going into the spending cycle in 2022.
I have to say one of the one of the variables as we think about this is it.
How does inflation play out and how does other energy costs play out in the year ahead, I don't really want to be forecasting that to be honest, but what I do want to give you is some assurance on the pricing, which then clearly then flows into the margin fees and addresses your question, which is you can expect us to.
Always be keeping pace with inflation global inflation.
And that really is a reflection of how we will do that management around the pass through elements in particular and pricing beyond that and that's what will then come back through the leverage we have down to the operating margin that youll see so hopefully.
We'll come back and tell you in January what we think is the outlook for 2022 with a bit more precision, but for now you can expect us to keep pace on the pricing side with any cost inflation that we've seen.
Just to add a comment to SaaS <unk> said. This is this is Steve.
<unk>.
I think as we go forward I don't like to ever hear the word peak margins because that'll never believed in peak margins and when we say our best days are ahead, you've got to keep in mind that we are going through a period, where there has been a tremendous amount of cost that came through the system, mostly in the form of power. If you were to look at EMEA for.
For example.
Costs increased 25% to 30% between Q2 and Q3. So that's a lot of cost that comes at you at once.
We instantly pass that through us.
Matt mentioned on the onsite piece, but it takes a few months up to six months to be able to recover all of that through the budget and the package business, but if you think going forward over time and you've heard us describe this model before.
We take the top line and we're able to leverage that through pricing and productivity to deliver increased EBIT margins over the long term and we've been able to do that for many years and thats really going to be the model that we will be in going forward.
Especially as we clear this immediate wave of cost inflation, that's coming through the system and we deal with that.
A very positive way in the coming quarters.
Thank you that's really helpful and if I could just a small.
Follow up on the 35 by 35 targets appreciate that also the update there.
We've heard from some chemical companies like extra costs or capex required to get to state ability targets is that going to be the case for Lindy and maybe if so you could help us think debate about what that could look like thank you.
So Tony as we put those targets up and we've built a roadmap around that clearly you would've seen in our description of how we want to achieve that we are working our mission here is to support our customers in their decarbonization attempt and ensuring that we have the technology.
And the solutions necessary for that now we make those commitments keeping in mind the broader decarbonization trend that is happening and of course in our support of that we will need to make investments along the way, which we look at on a project by project basis and each of those investments. We've said this previously obviously need to kind of live up to our investment criteria.
They will of course be supported by incentives.
Pricing carbon penalties as the case might be which actually makes that economic case necessary for that transition to successfully happened as we move forward. So I fully expect us to kind of see.
Those economically feasible cases workout.
Ones that will actually have to meet our investment criteria as we support this broader transition for industry as you know volatility whatever we emit ourselves is really there to ensure that we're helping our customers either abate avoid or completely eliminate emissions and that gold continues to be what we will focus on going forward.
Sure.
Thank you that's great.
We will take our next question from Peter Clark with Society and Raleigh.
Yes. Thank you again, congratulations to our slides you can see from one hell of a deal and I guess the share price reflected the wins in the trends transition. There I'll go to Big picture question is really looking at the engineering backlog and the way. It has grown I think Steve you were commenting that was so long ago.
You saw a 50 50 sort of.
A very nice mix in terms of what was internal what was normal receivables cycle's picking up with schooling southern supply.
Probably 25, just your thoughts on Opex and obviously, you're looking at your return criteria.
So our math as we go through the cycle.
The second one is your comments about <unk>.
Days ahead hopefully.
Obviously your return on capital now is 200 basis points above web proxy.
10 years ago.
Pete.
Just wondering your thoughts from a return on capital global scale and momentum to support that.
Like how you see this sort of on a structural basis, because we'll move forward with.
Who we hire now with all the benefits of America against what we thought we could get some gases clients to that.
Those are my two questions. Thank you.
Okay.
Well, given I'm not going to be the CEO past March one so I really don't want to provide too much long range thinking about return on capital, but I think if you go back to what I said about <unk>.
Being able to take growth converted to higher levels.
Our profitability good capital management.
Over the time, we should be able to March the return on capital number up a little higher.
With respect to the 50 50 comment.
If you think about when we bought shallow gas projects. They typically are in the hundreds of millions of dollars range. So if you look at the TSMC project that 600 million dollar.
Capital investment that would be tied for our largest with Samsung. So when we see solid gas it tends to be a very big project and clearly we landed some very large projects.
Third party projects with Linda Engineering, and that obviously shifted the weighting in terms of whatever that is 75% 80% of the total backlog is as is.
Third party sales is driven by these very large projects.
Matt alluded to two thus these very large projects have very strong contractual terms.
They are very high quality contracts I will say.
We have cash flows that.
Income and cash flows that certainly are well ahead of our cost outlays as we work through these projects. So theyre excellent projects and we're delighted to have them.
Okay.
Thank you.
We will take our next question from David Begleiter with Deutsche Bank.
Thank you.
Looking at EMEA in Q3 can you quantify the amount of power costs or would not pass through were recaptured during the quarter.
Yes, David This is Matt that's not a number we're going to provide publicly but I think if you look at kind of the sequential.
Margin profile and you adjust for the stated cost pass through that obviously associates itself with the onsite business. Some of those differentials could of the remaining amount are things that we would want to be gone chasing related to some timing related and as you can imagine EMEA as a much larger packaged and merchant percent.
Onsite.
So that will also play into having a larger proportion of costs that need to be captured on a delay and and one thing I just want to be clear on is this lag is normal. This lag is inherent in the industry. We have faced this lag since our inception going back decades. It just so happens in this particular quarter the.
Move Ment of the energy prices the movement of some of these numbers are faster in a shorter time period, so given that youre going to have some recovery that'll that'll be next quarter and the quarter after but EMEA would be probably disproportionately larger than most other regions with that lag just given the packaged and merchant exposure.
Got it and given that would you expect price mix to accelerate further in Q4 from the 3% we had in Q3.
Yeah.
So as I stated in the prepared remarks that we absolutely anticipate and expect the pricing momentum to continue.
And this is something that as we go and recover this that will play into it so.
That's our expectation.
Thank you.
We will take our next question from Jeff Zekauskas with J P. Morgan.
Thanks very much.
The backlog and.
First sale of plant went up $6 billion sequentially can you talk about.
What it is that you're going to build.
If you can talk about the customers that would be great. If you count.
How did it grow so much.
Does that mean that your Capex order of magnitude is now going to be.
Don't know $5 5 billion higher.
And then you thought over a number of years too.
To execute that.
And then.
Lastly.
So if you are getting I don't know $480 million into your cash flow statement from prepayments.
I take it that that then we will.
Youll, you'll fund that with capital expenditures later on so in a certain sense your cash flow from operations is overstated.
Can you talk about those issues.
Yes, maybe David I could start with the cash and Sanjay if could talk about the backlog project itself. So just to make sure we level set and get the accounting correct.
This is sale of plant. So this never touches capex. This is under a percent completion accounting. So what happens is the backlog that we have actually translate to essentially one to one to sales $1 backlog equals $1 sales and as we construct it it goes to inventory and then when we meet the criteria it's released.
A inventory to sales. So therefore, it never actually hits Capex, given the nature of how the structure works and then as the prepayments come in they sit on the balance sheet as a liability and then obviously, we work and deliver the performed work, which then goes against that liability to.
To relieve that liability as we deliver so this is a classic percent completion.
Accounting style, so given that and maybe let's talk about the cash flow real quick.
In this business in this industry.
<unk> engineering and percent completion, when you're in a declining backlog what tends to happen is your cash outflows are obviously higher than your inflows because you are delivering on the work the engineering the procurement and you basically think of like a book to Bill ratio right. So as your book to Bill ratio starts to draw.
<unk> and drop and drop youre going to have more cash outflow than inflow now that trend has reversed. So we've actually had more outflow of an inflow over the last few quarters. Because we were building off of backlog that was shrinking now it has grown dramatically that processes reversing as I mentioned in the prepared remarks, we have a few quarters, we expect some prepayments given the size and <unk>.
Increase of this and then we'll work them down over the next several years as the outflows go but you still have more backlog that if you win it can mitigate that so that's how to think about this it's not in Capex. That's why I said in prepared remarks, the growth that we have is much greater than what's been shown in capex because of <unk>.
This delivery and as Sanjay had mentioned, we're going to be probably mid single digit in terms of our contribution so hopefully that makes sense, but I can hand, it off to sanjiv to talk about the project. Thanks, Matt So.
Jeff Let me just kind of talk through the project a little bit and give you a little bit of color on that so we have the 6 billion incremental two large wins that we're talking about are the reason why youre seeing the significant buildup in our in our backlog. We are very happy with these investment with these projects.
To tell you.
It's a very high quality customer I am going to name the customer now just for you which is gas from its a customer with whom we have excellent relationships. We have got great experience thus far.
<unk> got solid contract terms, which makes us pretty comfortable around taking on these large projects.
So as Matt referenced strong cash flows.
I remind you also that these cash flows tend to come in the inflows are ahead of any commitments. We make so we tend to be net positive as far as our cash goals that concern and of course, it's in an area, where we've got good experience of execution.
So again, you put all of that together.
The projects now what are we building let me just give you a little bit of color on that so we are building. Some gpp's. So this our gas processing plants for Gazprom and the site call Lugo and we're also building in a separate project also had that same site, which is a separate win but an important one also is an LNG plant full.
For them.
I expect natural gas developments will continue given the energy.
Challenges that the world is seeing and this is kind of a major milestone as Gazprom continued down the path of investing in that space.
Okay, Great and then.
Secondly, I think your cash balance was $4 7 billion.
Is that too much what should your normal cash balance b as you manage for cash flows.
Yeah, Jeff I can answer that well when you are getting paid to take commercial paper 65 basis points, you do end up a little bit of a grossing up of your cash and your CP. So yes, we were still getting paid up to five years on the curve with Europe. So our cash balances are swelling a little bit now those are U S. Dollar cash balances. So they are earning a return.
But we're also earning a return on what we're borrowing so at this point that is causing a bit of swelling.
But as you've seen between our projects that we're undertaking between some of the shareholder friendly actions, we're taking we're going to keep working those cash balances down.
Okay, great. Thank you so much.
Okay.
We will take our next question from Geoff Haire with UBS.
Hi, Thanks, so much for the opportunity.
I just wanted to ask a slightly longer term question.
And maybe the Sanjeev.
The sustainability targets, you've put on a grid, but I think you did mentioned that too.
Sure.
To achieve the 2030 by 35, you need government support what happens if you don't get it.
Can you do yourself without any government support, particularly thinking about green hydrogen.
Other sorts of areas.
Thanks, Jeff.
It's a good question. So I think when you think about the sustainability targets that we've put out there at 35 by 35.
There is you have to think about the framework within which this is happening. So clearly there are activities that we can undertake and we are undertaking today, which will continue to move in that direction is our efficiency program. This is about fleet replacement et cetera. So there are a number of initiatives that are ongoing and will continue to we will continue to work towards which will execute too.
Words that but it's also correct to say that even today there are government initiatives.
Government incentives available so.
We're not suggesting that there is a complete void over here and then we need a complete kind of remake all steps in the U S. We have the 45 Q that is being effectively utilized to look at investment profile. Like this now I have to be honest and tell you that I'd much rather that 45, Q, which currently provides $45 to $50 per ton last year to be anywhere between.
<unk>, 90% to $110 per <unk>, that's where I would see the inflection point is with momentum for development of these projects would significantly ramp up because that would be an economic case for it.
In Europe, clearly, there's the Etfs the trading scheme that is currently valuing seo to anywhere between $60 to 65 euros.
So again as we see that move forward, where there is a plan similarly in Canada, and South Korea and Australia.
Name a number of countries, where these incentives or penalties are coming into play today. So we are working in that environment, we think that more support is necessary.
But there isn't a complete lack of support so a number of our projects will be relying on the support infrastructure that is available through the incentives and penalties to leverage off that to continue down that keep the decarbonization trend and of course, as we look longer term to carbon neutrality.
In our assumption when we think about our roadmap clearly we've got some levels of support available the range anywhere between 100 to $200 per ton of Cotwo.
Equivalent terms longer term to make sure that we get to.
That level of.
The neutrality that we're talking about climate neutrality that we're talking about as being the goal to be achieved by then.
So I can just put a point on synergies.
Sure.
Excellent response to that if you think about de carbonization and the cost of capture on the cost of sequestration. It can vary $80 to 120 something like that.
And to really tip the scales in terms of capital investment.
To decarbonize youre going to need something like that in terms of a carbon price. So up till now the 45 Q can work in certain projects with a $50 the low carbon fuel standard in California provide some support <unk> as we look forward to really make meaningful strides of de carbonization youre going to need.
A stronger carbon price that's our view.
Thank you.
Okay.
Our next question comes from P J <unk> with Citi.
Yes, hi, good morning.
On your slide 18.
The slide on Blue hydrogen.
Is that where youre seeing some order activity today.
And then looking at your joint venture with ITM and Electrolyze theirs.
How do you see blue versus green hydrogen backlog.
Let's say in the next five years and are your industrial customers wanting to go to blue hydrogen for us before.
Thinking about green hydrogen.
P J the way I'm going to answer that question is to kind of take you back a minute.
Stefan just to remind me remind you of some of the messaging that we provided in the previous earnings calls. So I've said before that when people think about what hydrogen is most appropriate and one of the things you have to think about it is the strength individual countries have the assets that they have their countries today have.
Hydrocarbon assets have natural gas as an as an asset we firmly believe that they will pursue the path of blue hydrogen because that is the most meaningful that's the most meaningful way to kind of move forward on this transition.
The reason, it's meaningful because it's to scale. It can be done today, and we're not waiting for technology developments to happen and I'll talk about it in a minute, but youll hear me reflect that comment over there as well so.
The answer is where we see that natural gas resource available in the U S and Canada, Australia, Russia Middle East. We believe we know that those countries are actively pursuing and we are looking at a number of counterparties over there as partners looking at some of those developments ourselves so.
The slide 18 gives you a sense that Linda Linda Engineering technology portfolio allows us to be able to flex any any technical solution. We are uniquely positioned to provide that technical solution for our blue hydrogen output, whether it's using an SMA or whether it's using an ATR.
Whether it's using a fox gasifier, we have the ability and technology to both do provide the technology packages execute them and operate them ourselves because of the expertise we have so thats as far as blue hydrogen is concerned and I do see a lot of momentum building up in that space and we are very active in that space as well.
Let's talk about ITM in order intake.
<unk> taken backlog going forward now you are asking me to predict.
Five years out I have to tell you the only thing I'm going to project five years out is to tell you that the technology roadmap that we have going with ITM through our joint venture with them is to make sure that that product scales up and that product then has the capital efficiency and operating efficiency and scale up.
To be able to execute projects.
Of a reasonable size.
Im going to give you a very quick example of that so today.
We're building loyalty as you know you've heard us announce as before.
A 24 megawatt.
Electrolyze complex there those 24 megawatts will come from two megawatt modules, that's the largest perm electrolyze a module available in the world to date, where.
We are working with ICM to scale that up we are hoping to scale that up based on our technology roadmap in literally months to five megawatts and then beyond that the 20 megawatts et cetera at that point in time, a 100 megawatt module again projects that we're actively working on today that are getting some preferential.
Positioning as far as some European funding is concerned as well those will then move from 50 units of two megawatts, which you can imagine on the most efficient structure to maybe five units of our <unk>.
<unk> units of five megawatts or five units of 20 megawatts as scale up happens along the way so far.
In fact that that scale up is happening. The fact that the technology roadmap is providing that capital efficiency and economies economies of scale is happening right now in preparing us for what's likely to happen in the next five years I don't want to speculate at this stage as to what that likely backlog might look like five years down the road, but clearly I am encouraged by the developments IC.
Great. Thank you for the detailed answer.
As you look at this technology roadmap.
Green hydrogen cost coming down where do you see that.
I know, Steve you had commented on some numbers, maybe a year ago.
And what about this production tax credit of $3 for Green hydrogen.
Did that play out thank you.
BJ.
Production tax credit is actually very it'll be a very good supporting mechanism. We talked earlier on about in the previous question about how we see the incentives support the development of three.
<unk> $3 per kg will be a good support mechanism, we obviously have to read the rules and it hasn't yet come through so.
I am looking with some eagerness to that coming through and getting an understanding of how that all those rules come into play but that would be encouraging clearly we believe that there is an opportunity here for us to move forward, Steve mentioned to you.
<unk>, if we get hydrogen.
Blue or Green Green, obviously more challenge in this in this referenced at about between one to $2 per kg. It's at that point that you see an inflection point and you see widespread adoption of technologies, utilizing hydrogen and really hydrogen becoming a reasonable fee.
In the portfolio feels will have will always have fossil fuel at least for many decades ahead, but it'll be at a more important part of the of that portfolio of fuels and energy basket as it well, Steve you want to add something.
Okay, Sanjay I'll add something so.
Yes, just to build on that I mean, if you were to look at the cost of hydrogen today in order to use the U S vol, coals, which obviously we produce a lot of origin. We use a lot of origin U S Gulf Coast.
Hydrogen is about $1 30, a kilogram and thats at $5 50, natural gas carbon capture would add another 40 to 50.
Maybe on the.
One one southern what range sort of and if you think about green, it's like $4 $5 a kilogram.
And out of that probably $2 50, you call. It is the renewable power cost and so if renewable power was funny then you would still have $2 and we all know renewable power some free so.
We have some work to do to bring those costs down in terms of capital cost operating cost and as you work to work that down below that $2 number then you've got a chance to have something competitive. So you need the combination of low cost renewable low cost capital.
Lower cost.
Operate low cost capital and better efficiencies and then you can drive that number lower and I would say ideally below two but certainly in that range would be is what's needed.
Alright, thank you for the color.
Congratulations.
And our last question comes from Vincent Andrews with Morgan Stanley.
Mr. Andrews. Please go ahead with your question.
Okay.
Okay.
David It looks like he is an issue.
I think with that we can wrap it up okay for everyone aligned. Thank you. So much for attending today's call for your reference a copy of our transfer will be posted on our website within the next 24 hours.
Thank you for listening and anything else, let me now take care.
Okay.
This concludes today's call. Thank you for your participation you may now disconnect.
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