Air Products and Chemicals Inc (APD) 2018 Q2 法說會逐字稿

Good morning, and welcome to Air Products and Chemicals Second Quarter Earnings Release Conference Call.

Today's call is being recorded at the request of Air Products.

Please note that this presentation and the comments made on behalf of Air Products are subject to copyright by Air Products and all rights are reserved.

Beginning today's call is Mr. Simon Moore, Vice President of Investor Relations.

Please go ahead, sir.

Thank you, Vickie.

Good morning, everyone.

Welcome to Air Products' Second Quarter 2018 Earnings Results Teleconference.

This is Simon Moore, Vice President of Investor Relations.

I'm pleased to be joined today by Seifi Ghasemi, our Chairman, President and CEO; Scott Crocco, our Executive Vice President and Chief Financial Officer; and Corning Painter, Air Products' Executive Vice President responsible for Industrial Gases.

After our comments, we will be pleased to take your questions.

Our earnings release and the slides for this call are available on our website at airproducts.com.

Please refer to the forward-looking statement disclosure that can be found in our earnings release and on Slide #2.

Now I'm pleased to turn the call over to Seifi.

Thank you, Simon, and good morning to everyone.

Thank you for taking time from your very busy schedule to be on our call today.

We do appreciate your interest in Air Products.

The talented, motivated and committed team at Air Products delivered yet another excellent set of safety and financial results in the second quarter of fiscal year 2018.

Our adjusted earning per share of $1.71 were up 20% versus last year.

This is the 16th consecutive quarter that we have reported year-on-year EPS growth, and the fourth consecutive quarter we have delivered EPS growth of more than 15%.

We continue to be the safest and most profitable industrial gas company in the world with EBITDA margins over 34% for the quarter.

And most importantly, we have a great team of focused and committed people at Air Products who work hard every day to serve our customers and create value for our shareholders.

Now please turn to Slide #3.

We continue to improve our safety results with a reduction of 71% in our lost time injury rate and a reduction of 57% in our recordable injury rate.

These results can only happen when all of our 15,000 employees around the world are totally focused on safety and continuous improvement.

This same commitment to operational excellence is what is driving our strong financial performance.

Now please turn to Slide #4, which is our goal for the company: to be the most -- the safest, most diverse and most profitable industrial gas company in the world, providing excellent service to our customers.

Now please turn to Slide #5.

Our overall management philosophy that we have talked to you about many times in the last 4 years.

We continue to be focused on shareholder value, cash generation, capital allocation, and an empowered and decentralized organization.

On Slide #6, you can see our 5-point plan, which has been the road map to our success over the last 4 years.

Now please turn to Slide #7.

We have delivered on the promises that we made to you over 3 years ago.

We have become the safest and most profitable industrial gas company in the world.

We have divested our noncore assets and created the best balance sheet in the industry.

And we have delivered greater than 10% per year earning per share growth in each of the last 3 years with our guidance for this year implying yet another year of over 10% growth.

In summary, we have delivered what we promised.

And as a result, we now have the balance sheet and are well positioned to grow Air Products as we move forward.

We continue to see great opportunities in the 3 areas that I have talked to you about previously.

To mention them again.

First, acquisitions of small and medium-sized industrial gas companies or assets or businesses from other industrial gas companies.

Second, the opportunity to purchase existing industrial gas facilities from our customers where we own and operate the plant and sell industrial gases to the customer based on a fixed fee under a long-term contract.

This is what we call asset buybacks, and we see opportunities for oxygen, hydrogen and syngas plants around the world in this category.

And the third area of opportunity is very large industrial gas projects around the world, driven by demand for more energy, environmental requirements and emerging market growth.

Now please turn to Slide #8, where I would like to provide an update on one of our exciting projects, that is a great example of the growth opportunities I just talked about.

We announced the $1.3 billion Lu'An syngas joint venture in September of last year.

As a reminder, the joint venture will be 60% owned and majority controlled by Air Products.

Lu'An provides coal, steam and power to the joint venture, and the joint venture will supply syngas to Lu'An.

The joint venture will be paid a fixed fee value by Lu'An under a long-term contract.

Our team has been working closely with Lu'An and the many government agencies in China to get final approval so that we can formally close the transaction.

We had indicated before that we expected this to be done by this summer.

I am very pleased to announce today that due to the outstanding efforts of Air Products' team and the efficient and cooperative support of government entities in China, we formally closed this transaction just a few hours ago.

I'd like to repeat that, since this is not in our press release because it happened just a few hours ago, we now are formally closed on the transaction with Lu'An, and we own the facilities.

Now that the transaction is closed, we will begin receiving our monthly fee from Lu'An based on the gradual start-up of the facility.

That is why we have included a modest contribution of about $0.04 in our updated 2018 full year EPS guidance, as well as including approximately 400 -- $500 million in our CapEx guidance.

I would like to confirm that we expect this transaction to contribute about $0.25 to our earning per share for full 2019.

This project is a perfect fit with our strategy and a great example of the investment opportunities in our core Industrial Gases business.

It is an asset buyback of an expanded scope project under the onsite business model.

Now please go to Slide #9, which shows you the result of our 3 key metrics for the quarter and the year.

We remain committed to our goal to be the most profitable industrial gas company in the world, as measured by each of these 3 metrics.

Finally, please turn to Slide #10, which, obviously, continues to be my favorite slide.

It's great to see sustainable margins in the mid-30s range.

The chart also reminds us how far we have come in only a few years.

Now I would like to turn the call over to Mr. Scott Crocco, our Executive Vice President and Chief Financial Officer, to discuss our results in detail.

Then I will come back after comments from Corning and Simon to make some closing remarks, and then we will be pleased to answer your questions.

Scott?

Thank you very much, Seifi.

Please turn to Slide 11 for our Q2 results.

Sales of $2.2 billion increased 9% versus last year, on 4% higher volumes and 5% higher currency.

We saw volume increases across all 3 regions, partially offset by lower activity from the Jazan project in global gases.

Excluding Jazan, volumes were up 10% with about half from new plants.

Pricing was up 1%, primarily driven by the China merchant business.

Positive currency was driven by the euro, British pound and the Chinese RMB.

EBITDA of $739 million improved by 13%, driven by the higher volumes, positive pricing and currency.

EBITDA margin of 34.3% was up 140 basis points, primarily on the higher volumes.

Sequential volumes were down and margins were up due to the plant sale in China last quarter.

Net income and adjusted earnings per share both increased by 20% versus prior year.

ROCE of 11.8% declined 50 basis points versus last year, despite the profit increase.

This is because the denominator of the ROCE calculation increased as a result of the gain from the PMD sale.

The denominator is based on a 5-quarter average.

Q2 FY '18 includes 5 quarters that include the PMD gain.

While Q2 FY '17 only had 1 quarter with the PMD gain.

Please turn to Slide 12.

We had 1 non-GAAP item this quarter, as we recognized an income tax benefit of $39 million due to the restructuring of select foreign subsidiaries.

Our adjusted Q2 continuing operations EPS of $1.71 increased $0.28 or 20% versus last year.

Overall, higher volumes increased EPS by $0.12 per share.

Price and raw materials, taken together, increased EPS by $0.02.

Net cost performance was unfavorable $0.06, as productivity was offset by a few factors including inflation, higher incentive compensation, a legal settlement and the end of a cost reimbursement for our Port Arthur CO2 project.

In addition, as you would expect, we are incurring higher costs associated with the exciting growth opportunities we are pursuing.

Finally, as I mentioned previously, this cost major factor includes the transition service agreements, or TSAs, we had been providing to both Evonik and Versum.

The Evonik TSA ended in Q1 and the Versum TSA ended in Q2.

We did take actions to reduce the costs associated with providing these services.

But as expected, we saw a small timing gap in Q2.

Going forward, we don't expect to see any impact from the TSAs.

Currency and foreign exchange was $0.09 favorable, primarily due to the euro, British pound and the Chinese RMB.

Equity affiliate income added $0.03 due to currency and underlying strength across several of our JVs, particularly Mexico.

The overall tax rate was a $0.09 benefit versus last year.

As expected, the lower tax rate due to the new tax act increased EPS by about $0.06 per share.

The other $0.03 was due to geographical earnings mix and a larger impact from accounting for share-based compensation.

For the full year 2018, we expect to see a tax rate of approximately 20%, including the benefit of the new tax act.

Noncontrolling interest, interest expense, shares outstanding and other nonoperating income totaled $0.01 unfavorable.

Now please turn to Slide 13.

We had another strong cash flow quarter in Q2, with over $500 million of distributable cash flow.

And investable cash flow was up almost $150 million to a total of $300 million.

Investable cash flow is the amount of cash we have discretion or a choice to deploy to create shareholder value.

In other words, cash available after we pay interest, taxes, maintenance CapEx and dividends.

Through 2 quarters, investable cash flow is almost $650 million.

Turning to Slide 14.

I would like to update you on the capital deployment capacity that we have available for major projects and acquisitions.

We have about $3 billion of cash and short-term investments available to invest as of March 31.

Our debt balance as of March 31 is about $3.5 billion.

As you know, we have an active dialogue with the rating agencies and are committed to managing our debt balance to maintain our current targeted A/A2 rating.

At this point, we believe this should enable a debt level of at least 2.5x EBITDA or about $7.5 billion.

This provides about $4 billion of debt capacity to invest.

So in total, we have about $7 billion we can deploy today, while maintaining our A/A2 rating.

In addition, we expect to generate over $1 billion per year of investable cash.

Again, that's after paying taxes, interest, maintenance CapEx and dividends.

So over the next 5 years, we expect to have at least $13 billion available to invest, which does not include leverage above 2.5x or extra capacity from investing in profitable projects.

Now to begin the review of our business segment results, I'll turn the call over to Corning.

Thanks, Scott.

All 3 industrial gas regional segments delivered strong volume results with a combination of new plants coming onstream and higher base business sales.

EBITDA was up in all 3 regions with particular strength in EMEA and Asia.

I would like to thank our team, who remains focused on driving improvement in our existing business while we pursue exciting new opportunities like Lu'An.

Now please turn to Slide 15 for a review of our Gases Americas results.

For the quarter, sales were up 3%, primarily driven by higher volumes.

Hydrogen demand was again strong, despite the lower Gulf -- the lower Gulf coast demand during early in the quarter due to severe winter weather there.

The merchant business achieved positive growth, overcoming the terminated wholesale contract I mentioned last quarter.

Overall Latin American merchant volumes were slightly higher versus prior year on strength, particularly in Brazil.

Overall pricing impact was again slightly positive, but rounded to flat as our pricing actions were partially offset by negative mix.

We continue to work hard on pricing and just announced an argon price increase.

The extreme weather, I mentioned, impacted both our and our customers' operations.

Our team worked tirelessly in challenging conditions to minimize the impact to our customers.

I would like to extend my gratitude to the whole team for their excellent work and dedication.

EBITDA was up 3% compared to prior year, as contributions from higher volumes and underlying productivity more than offset the adverse weather impact and several of the cost items that Scott mentioned.

Sequentially, volume was down due to the winter weather impacts, while EBITDA improved due to reduced maintenance costs.

In Q3, we expect maintenance costs to increase as several major plant turnarounds are scheduled for our hydrogen business.

These plants operate at high temperatures and typically have major turnarounds every 4 years or so.

So the maintenance costs will vary quarter-to-quarter and year-to-year.

Some of these plants have been in operation for over 20 years, and the good news is that we've been able to extend the original contracts.

As you would expect, more work is done during an outage for these older plants.

And this is part of our commitment to reliably serve our customers.

Partially offsetting the higher maintenance, we expect a positive impact associated with a customer terminating a contract for an old flue-gas desulfurization plant.

Now please turn to Slide 16 to review our Europe, Middle East and Africa business.

Sales were up 36% with volumes up 20%, pricing up 1% and currency up 15%.

Our new hydrogen plant in India, in its third full quarter of operation, contributed about 3 quarters of the volume growth.

Other onsite volumes were up, driven by strong hydrogen demand in our Rotterdam franchise.

And despite Easter shifting into Q2 this year, merchant volumes were up supported by both liquid bulk and packaged gases with a modest contribution from a few small acquisitions.

Overall pricing was up 1% as a result of our pricing program success.

EBITDA was up 29% compared to prior year, underpinned by the new plant in India, merchant sales and pricing actions, and favorable currency.

EBITDA margin of 32% was down 160 basis points, but excluding the new plant in India, which is comparatively high natural gas costs, EBITDA margin was up slightly from prior year.

Please turn to Slide 17, Gases Asia, where we continued to deliver strong sales and profit growth.

Sales increased 28% compared to prior year, driven by 17% higher volumes, 3% positive pricing and 8% favorable currency impact.

New onsites contributed just over half of the 17% volume growth.

Base business contributed about 1/3, while net acquisitions and divestitures added another 2%.

Pricing for the region was up 3% versus prior year and down 1% sequentially.

The supply and demand balance and our shift to retail sales in China remain positives for us.

As we predicted in our last call, sequential pricing dipped slightly due to demand easing with the Lunar New Year holidays and the spot opportunity last quarter.

Between our approach to the market and the improved market conditions, we believe we are positioned to continue the positive pricing trend which began in Q3 of FY '17.

Strong volume, higher pricing and favorable currency drove the 30% EBITDA increase.

EBITDA margin was up 70 basis points, primarily due to higher pricing.

Sequential comparisons were impacted by the contract termination and plant sale in the prior quarter and the Lunar New Year.

Excluding the plant sale, profit was nearly flat compared to Q1 despite the Lunar New Year slowdown.

Seifi provided an exciting update on the Lu'An project.

The team welcomes this new opportunity while we continue to execute on the base business, productivity and safety.

In February, we announced a significant win to supply Samsung Electronics' second semiconductor fab in Xi'an, China.

Air Products has been successfully supplying Samsung's first Xi'an fab since 2014.

This is our third major announcement related to Samsung since the beginning of the year.

The others being Pyeongtaek and Tangjeong, Korea.

Finally, please turn to Slide 18 for a brief comment on our Global Gases segment, which includes our air separation unit sale of equipment business as well as central industrial gas business costs.

Sales and profits were down as we get closer to the end of the Jazan sale of equipment project.

We expect this to result in lower revenue in FY '18, while profits should be about flat.

We continue to make great progress on the Jazan project, and as we have said, expect onstreams in phases early in fiscal 2019.

Now, I'll turn the call back to Simon for a comment on our corporate segment.

Thank you, Corning.

Please turn to Slide 19.

Our Corporate segment includes our LNG business, our helium container business and our corporate costs.

Sales were flat as LNG project activity remains weak.

However, there are some signs of renewed interest in future LNG projects.

Corporate costs were up slightly in part due to the higher growth-related costs that Scott mentioned.

For FY '18, we still don't anticipate an earnings headwind for the Corporate segment.

Now I'm pleased to turn the call back over to Seifi for a discussion of our outlook.

Thank you, again, Simon.

Let me take a few moment to talk about Air Products' exciting future.

Our team around the world feels very proud of what we have achieved in the last few years.

Our safety, productivity and operating performance continue to provide us the opportunity to build on our success.

As I said before, we now have the balance sheet and organization to aggressively pursue growth.

We remain very optimistic about Air Products' future.

While we cannot predict or control worldwide political or economic developments, we do have control over the operational performance and growth of Air Products.

And we are confident that we will continue to deliver on our commitments.

As Scott discussed, our very strong balance sheet and cash flow provide us the capacity to invest at least $13 billion over the next 5 years.

I continue to believe that we will be able to develop, win and execute projects in our core industrial gas business so that we can deploy all of this capital in the next 5 years.

We continue to see great opportunities in mergers and acquisitions, asset buybacks and large new projects, as well as significant number of more typical industrial gas projects.

Now please turn to Slide #20.

We are all working very hard every day to be the safest, most diverse and most profitable industrial gas company in the world, providing excellent service to our customers.

Continuing our positive momentum, we have again increased our guidance for the year to a range of $7.25 to $7.40 per share.

At midpoint, this is up $0.08 from the guidance we gave you last quarter, in part due to the closing of the Lu'An project.

Our new guidance represents 15% to 17% growth over our very strong fiscal year 2017 performance.

We remain confident in our ability to deliver on our commitments to grow EPS by at least 10% each year in the foreseeable future.

For quarter 3 of fiscal year 2018, our earning per share guidance is $1.80 to $1.85, up 9% to 12% over last year.

Including the Lu'An project, we now expect our capital expenditure to be in the range of $1.8 billion to $2 billion in fiscal year 2018.

Now please turn to Slide #21, where I want to point out, as I have done before, that we believe our real competitive advantage is the commitment and motivation of the great team we have at Air Products.

This is what allows us to generate the superior safety and operational performance that you can see today.

I want to thank all of our 15,000 people around the world for their total commitment and hard work, and I'm very proud to be part of this winning team.

Now we are delighted to answer your questions.

(Operator Instructions) And we will take our first question today from Don Carson with Susquehanna.

Just a question on base business.

Scott, you mentioned that if you take out Jazan, your volume was up about 10%, half of the new plant, half base business.

There appears to be a pickup from last quarter when I think base business was only contributing about 2%.

So can you comment on the base business outlook or merchant loadings improving?

And as a result, should we be expecting some good incremental margins going forward from the base business?

Scott, would you like to?

Sure.

As you pointed out, we had good performance on the base business across each of the geographies with fundamental improvements.

And who knows what the future holds, but we feel as though the loadings will continue to improve.

I think it's been mentioned in the past, we've been in Asia, we're in the low 80% capacity utilization, and in Europe, we've crept up to a 1% of these.

So that's improved as well.

So we feel very good about what we see in this quarter and are cautiously optimistic about the outlook.

Don, this is Seifi, if I may add.

We do see positive momentum in volumes.

And, obviously, if there is positive momentum on volumes, pricing will follow.

So we are actually more bullish than we have been before.

And Seifi, what's the competitive environment for bidding on some of these major new projects?

I assume your primary competitors have other issues that are causing not to be as aggressive in going after some of these new projects.

So who is the real competition and what does the competitive environment imply for returns on these new projects?

Well, the competitive environment hasn't changed that much.

Our major competitors are all very strong, and they compete with us on every project, and the customers make sure that they get competitive bids.

But as you know, we had a return expectation on these projects, which we have disclosed very publicly, at least 10% internal rate of return.

And because of the competitive pressure, the returns are below that.

They just don't take the projects.

So that's our guiding principle, whether there is competition or not.

We, obviously, have had a lot of good projects and significantly higher than that.

But that is our threshold.

And if another one of our competitors wants to take the project for lower return, then they get it.

And the next question will come from John Roberts with UBS.

Could I just confirm that you're still in discussions to possibly acquire some of the assets for sale related to the Praxair-Linde merger?

John, I cannot comment on that, please.

Okay.

And then the $0.18 non-GAAP benefit in the quarter, could you just talk about what were the activities that generated that?

It's part of a restructuring of a acquisition that we did some time ago, when we moved some legal entities and were able to get that sort of a benefit.

And so, as I mentioned, some foreign subsidiaries win made some adjustments that contributed to that.

We have been working on this thing for a while.

It's a matter of the consolidation of some of the subsidiaries that when you consolidate it, you get a tax benefit, and that is what the number is.

And then, maybe since the first question couldn't get answered.

The unfavorable cost year-over-year on Slide 12 that you had, what would you expect going forward without the TSAs and CO2 reimbursement issue?

We will continue to have those kind of costs, because -- I mean, it is a fact that we are working on a significant number of projects.

And as you know, the current rules are -- in the old times when you were working on these projects out of your legal cost and your people cost and so on, you used to charge them through the project.

Now you can't do that, you're expense it.

So if we are going to deploy $13 billion, we need to do -- to bid on a lot of projects, and we are bidding on those, and we are expecting the cost.

So that is a natural thing that is going to be with us as within these projects.

Next is Duffy Fischer with Barclays.

Can you comment just on the strength you said you were seeing down in Mexico?

Is that just general Mexican economy getting better?

Or are you guys taking some market share down there?

Or is there something dynamic happening with your business?

Corning is kind of in-charge of our business in Mexico.

He will make a comment.

Corning?

Let's say, in Mexico -- excuse me, we see improvement across several of the business lines.

The packaged gas environment is good.

There is a lot of infrastructure around pipeline projects, that sort of thing, that are going on and continue.

And we've seen a pickup in the nitrogen injection for the oilfield business there.

So I'd say relatively broad-based.

And just reminding everybody that's an equity affiliate for us.

So you wouldn't actually see the volume in our reported numbers.

Fair.

And then, can you comment on the progression of the Lu'An City project?

What's the time line look like there and when might we get an announcement on that project?

We continue to make progress.

That is a huge project and it involves a lot of different entities.

I don't want to put a time line on it, because from a negotiating point of view, we don't want to sound too anxious.

But we are working on it, and it is moving forward there.

And we will go to Stephen Byrne with Bank of America Merrill Lynch.

What would you say the primary value drivers for owning an operating, both the ASUs and the gasifier in the Lu'An project?

Is there a -- an operating efficiency that you have by having both?

Has the combination improved the return on invested capital?

Or is this an example of more gasifier projects that you would try to differentiate yourself for?

Well, there are several benefits.

One is, obviously, operational efficiency and all of that, that you mentioned.

But the fundamental driver is that, when we were just supplying the oxygen, we had deployed $300 million of our business had a return.

Now we are deploying $800 million of our business, at the same kind of return or even higher.

So that means that this is an opportunity for us to create growth so that we can invest more capital at the kind of returns we are talking about.

So I mean, everybody gets excited about GDP going up 2% and creates growth.

But like this, we are creating growth despite GDP, gives us opportunities to significantly deploy additional amount of capital.

And then Seifi, you always comment on the safety performance of the company.

Would you say commensurate with that there has also been an improvement in operating efficiency of your facilities and/or less downtime?

Well, of course.

Because look at our EBITDA margin.

We've gone from 23%, 24% to 34%.

That is almost $700 million, $800 million of improvement.

Obviously, that has come up through the fact that the company is running better and is much more efficient.

Yes.

I think that is one of the reason -- I mean, safety is the moral responsibility.

We don't want anybody to get hurt.

But a company who has a good safety record at the levels that we are achieving, definitely has excellent operational efficiency.

Next is Jim Sheehan with SunTrust.

Can you talk about merchant operate -- operating rates in North America as well?

I think you covered the other regions, but didn't mention North America.

Corning can comment on that.

Yes.

So we have the termination of a very large, long-term wholesale agreement.

And I'd say, we have largely replaced that on the LOX/LIN side.

I think the argon's going to take a little bit longer.

However, certain tightness in the argon market has certainly helped us to move that along.

And today, I'd say, we are in the mid to slightly below 7 -- mid-70s range in terms of our loading.

But that's an improving story for us.

And I think the ground the team has covered in replacing that volume is just tremendous performance.

Great.

And as far as crude oil prices moving higher, how do you see that factoring into your 2018 outlook?

Is that a major tailwind for you?

Jim, we've always said that crude oil prices doesn't affect our business that much, because we are not very involved into upstream side of the oil business.

So that's not going to be material to us.

And we'll go to Chris Parkinson with Crédit Suisse.

Can you just walk us through just an update on Jazan given a little bit of noise in the quarter?

And what you are up actually (inaudible) for the balance of fiscal year '18?

And more importantly, just anything preliminary under thoughts on the cadence ramp in fiscal years '19 and '20?

So any thoughts on that will be greatly appreciated.

I'm sorry, Chris, the connection is not that great.

So I didn't fully understand you.

Simon, can you help me out?

So, Chris, I think your question was, so if you could give an update on Jazan, kind of where we stand on the project and how it looks over the next couple of years?

Yes.

Sorry, Chris, I didn't hear you on the phone that I'm on.

Chris, we are making...

My apologies.

No, no.

No problem at all.

Not your fault.

We are making excellent project on Jazan.

We are ahead of the schedule.

We are close to 90% done with the project.

And we fully expect that to come onstream at the time that we expected.

So we are -- it's a very positive story for us.

It has demonstrated to our very, very important customer, Aramco, that Air Products can deliver, and Air Products is capable of executing a $2 billion project in the middle of the desert.

So it's a very good story for us, and it's a great achievement for our people.

We are all very proud of them.

Great.

And just second question on backlog.

The vast majority of your backlog is overwhelmingly onsite sticky business.

But can you comment on any particular end markets you'd like to further increase your exposure to over time?

Is CO2 something we should be paying incremental attention to given the recent transaction?

Just any broad insight on your thinking there would be appreciated.

Absolutely, Chris.

In -- on a very macro basis, we always say energy, environment and emerging markets.

But particular sectors, we are very focused on the oil and gas sector, obviously, in the downstream side, especially chemicals, and also coal gasification.

Those are the areas that we are very focused, and there are significant amount of projects, as you know.

A lot of the major oil companies are switching from just providing crude to going downstream.

You see a major shift in what Aramco is doing.

There is a shift because of the cheap natural gas in the U.S. And there is, obviously, the coal gasification in China, and there are significant large projects in emerging markets.

So as I said, energy, environmental requirements and emerging markets, that's what we are focused on.

And we, obviously, like the onsite business.

We'll go to David Begleiter with Deutsche Bank.

Seifi, just on America's pricing.

Is pricing proving to be more difficult to get this cycle than prior cycles, and if so, why?

David, pricing, we are selling LOX and LIN and LAR.

Basically, we are selling a commodity.

Pricing is subject to supply, demand and utilization of our facilities.

Industrial production in the United States in the last year, 2 year is up around 4%.

And we've always said that if you see industrial production go up, utilization rates going up, then pricing will follow.

So that's just the natural course of it.

And we seem to be in that cycle right now.

And if you see the results of everybody else, it points to that direction.

It just the overall industrial production activity.

Very good.

Understood.

And just in Q3, you mentioned some additional maintenance costs in the Americas offset by the contract or machine.

Could you quantify those elements that might impact Q3 Americas profitability?

Quantifying it would be difficult, because then we give too much information very competitively.

But the fact is, as Corning mentioned, a lot of these plants that are undergoing so-called turnaround are very old plants that we have won contracts 20 years ago.

The good news is that all of these contracts have been renewed, and therefore, this is a little bit of a life extension.

Some of that we report in maintenance CapEx and some of that is on ordinary maintenance expenditure that goes to our bottom line.

It's a positive development, better than a negative development.

Next is Vincent Andrews with Morgan Stanley.

Seifi, I'm just wondering, as you think out over the next 5 years and the $13 billion.

I mean, do you think there's going to be an opportunity to raise that sort of 10% minimum return target?

I'm just thinking improving economy, rising interest rates, those types of things.

Do you think this would be an opportunity to bring that up?

To answer your question, Vincent, when we say 10%, 10% is the minimum.

We have won a lot of projects higher than that to date.

So whenever we are bidding on a project, we, obviously -- we do not price things on a cost basis.

We price things based on the competitive nature and quite honestly, what the market bears.

So we have had projects, which have been 15%, 16%.

And the 10% that we keep mentioning is -- that is our kind of bottom line, that below that, we don't take projects.

Okay.

So nothing will change there.

And just as a follow-up.

Could you just remind us what you are expecting from foreign exchange in guidance versus last quarter?

Scott, you want to mention this?

Sure.

So let me take you through.

Thanks for the question, Vince.

Let me take you through.

So as we mentioned, this quarter we had versus prior year currency impact of $0.09.

And at a high level, that's -- the euro is at $0.03, RMB and the pound is at $0.02, and then everything else makes up for the remainder of about $0.02.

That's on top of what we had last quarter of about $0.06.

And as you know, what we end up doing is we just move sideways from wherever the latest rates are.

So when we look forward now for the full year, currency would be kind of more on the -- closer to the $0.25, we'd previously said maybe $0.10 to $0.15, but just on what's developed, it's more like $0.25.

Let me also, just for everybody, just to reiterate a couple of the sensitivities that we tried to provide here.

So first grounded in, these are transactional exposure, right?

So there's no economics, it's just doing mathematic -- I'm sorry, translational exposure.

It's just mathematics to bring it back into the U.S. dollars.

So for the euro, a 10% swing of the euro is about $0.09 per year EPS.

Same with an RMB.

10% swing is about $0.09.

And then the pound, Korean won, the Tai dollar and the Canadian dollar, each individually would be about $0.03 to $0.04 on an annual basis EPS, if there is a 10% swing.

So I wanted to take you through that a little bit and share with you not only what we're seeing and projection for the year, but also the sensitivity.

So, hopefully, that's helpful.

And we'll go to P.J. Juvekar with Citi.

Seifi, do you consider syngas as a core industrial gas?

And when you bid for these projects, like Lu'An or YK, are you running into other gas suppliers in the traditional competitors or is the field wide open for you?

No, we do run into them.

They have their ambitions of their own and in a lot of the projects that we've done, they have been there.

They have relationship with these customers.

So it's not as if we have a totally open field.

And a lot of times, our customers don't share with us exactly whom they were talking to.

But we are approved on the basis that on every project that we do, they are there, and our competitors are very smart people.

They see this thing as an opportunity, and they are active.

Okay.

And then geographically, in which region do you think you have the highest leverage to incremental sales?

Or in other words, where do you think you have the highest incremental margins going forward?

Right now, the highest incremental margin that we have is actually the United States for the total business, which is around 42%.

But as we move forward, we think the highest growth area for us will be emerging markets.

It will be China.

It will be Middle East.

It will be places like, I mean, Russia and places like that.

Those are the markets where there are significant growth opportunities in terms of the actual sales dollars.

But in terms of margins, currently, our highest margin region is the United States.

And now we'll go to Kevin McCarthy with Vertical Research Partners.

A number of companies across the chemical industry have cited rising logistics costs as a challenge.

I'm wondering if you're seeing that?

And if so, what mechanisms you have in place or might need in the future to combat that tension?

For us, that is not an issue, Kevin.

You know our business very well.

Our business is very, very local.

And logistics would apply if you have a extensive packaged gases business, which we don't.

So for us, that is not an issue, Kevin.

Okay.

Very good.

Then second, question on China, if I may.

We've, obviously, seen a lot of supply restrictions for environmental reasons, and those seem to be more pronounced over the winter time.

I'm wondering if there is any impact in the seasonality of Air Products business in China related to that?

Or if that's not a factor, and we can rely on historical patterns?

There is no impact on us.

You can rely on historical factors.

And beside that, the more pressure environmentally, the better it is for us for the long term, because then coal gasification becomes even more pronounced.

And we'll go to Bob Koort with Goldman Sachs.

Corning, I might have missed a bit.

Could you give me a little more sense of in the Americas, how, I think, you should a $23 million sales improvement, but operating profit actually declined?

What were the components that drove that?

So we have the base improvement.

We had some of the cost items that Scott mentioned, that, let's say, are little bit less of an operating costs, but still there in our P&L.

Okay.

And then, Scott.

It seems like may be at the margin since your last update on guidance, the FX numbers are a little better, you're throwing land in their now, and you've got maybe the tax guidance is at the better end of things.

I was a little surprised maybe there wasn't more ambition in the earnings path.

Is that a function of Jazan scaling down?

Is it a function of maybe some of these other costs continuing to stay elevated?

Why not maybe a little bit more ambition on your guide?

Bob, we did -- we are raising our -- by 8% our guidance.

So we were at $7.15 to $7.35.

Now we are at $7.25 to $7.40.

So we have increased the bottom of our estimates by at least $0.10.

So we -- as we go forward, obviously, it's very difficult to predict exactly what the economy does.

We are seeing a positive momentum, and obviously, at the end of next quarter, if things are positive, we will increase our guidance.

But at this time, we thought it's prudent to stay where we are, but we have given you all of the elements.

But you can make your judgment about where we are conservative and when we are not.

And we'll go to Jeff Zekauskas with JPMorgan.

Maybe I'll try Bob's question in a different way.

I think operating profit and EBITDA has been flat for the first half year-over-year, even though you're growing your volumes in the Americas 4% or 5%.

Shouldn't your returns be higher than what you're reporting?

Well, obviously, I would like it to be better.

But we have, as Scott mentioned, Corning mentioned, some of the costs that we have in terms of some of the turnaround costs and some of the costs for pursuing other projects and all of that.

And the fact is that we did have some one-offs that helped us last year that do not exist this year.

So if you really take the one-offs off, we are up, and we are -- I, obviously, go through the details of this thing.

For every dollar of -- incremental dollar of sale, we are getting $0.40 to the bottom line.

So I'm not worried about the fact that we are losing margins and so on.

But when you put all of that for a big company like us in aggregate, the result is what you see.

Okay.

And earlier in the call, I think Scott commented on the decrease in return on capital employed year-over-year from 12.3% to 11.8%.

And I think he attributed it to some onetime items.

But if you look at the return on capital employed through the last 4 or 5 quarters, it keeps moving incrementally lower.

And it looks like your incremental return on capital is around 9%.

Can you talk about what's going on and whether that's noise?

Or when you expect to return on capital to go up?

Scott is most qualified to answer that.

And then if there is anything, I will make a comment.

Sure.

Thanks, Jeff.

And just back to my prepared remarks.

So as part of the gain that we had almost $2 billion in PMD that goes into the base of that calculation.

That dilutes the RC calculation about 200 basis points.

So that's my comment around, just the mathematics as it comes for 5 quarters in the denominator associated with the gain that we booked last year in PMD.

On the increment though -- so that's the math of that.

Back to your basic question around 10% minimum, after-tax internal rate of return on all these projects.

And as those dawn and as they come out of the backlog and start contributing, that will be accretive to the return on capital as well.

One other thing that I would like to add, Jeff, is that the return on capital, the way you calculate it, if you're comparing us to others, since we have a lot of cash, we are showing a -- that decreases.

If you actually -- if we calculate our return on capital, the way other people are calculating it, our return on capital is about 15%.

So there is that subtle thing also.

And we'll go to Mike Harrison with Seaport Global Securities.

A couple of questions on the Lu'An JV and just kind of modeling-related questions.

You talked about that as receiving a monthly fee.

Should we think about that as being more of a tolling arrangement in which you receive sort of relatively low revenues at relatively high margins?

Or do you end up taking any ownership of the raw materials, which would make it higher revenue and lower margin?

We do not take any ownership of the raw material.

Okay.

So it's more of a tolling -- okay.

Yes.

And then in terms of -- you mentioned the annual EPS expectation of $0.25.

But for fiscal '18, you're only including $0.04, if I understood correctly, in the guidance.

Is that due to some start-up headwinds?

And how much should we think of those start-up headwinds as costing you in the third and fourth fiscal quarters?

No, it's not a start-up headwind, Mike.

It is that our 4 gasifiers, my friend.

And we get paid the monthly fee based on these gasifiers coming onstream.

So obviously, we are not starting all of the 4 gasifiers at the same time.

So when the first gasifier comes onstream, we get a certain amount.

The second, the third and the fourth.

And we expect to have all of the 4 gasifiers onstream by 2019, which is in October, and then we will get what we will get on an annual basis.

All right.

If I can ask you one other question, just related to the commentary on the LNG heat exchangers.

Obviously, still under some pressure now, but sounding like that activity is picking up.

What's your forecast for may be what that does as we look at 2019?

We have not seen, and we are not expecting any substantial increase there.

Therefore, we have said that we don't really expect that business to come out of the doldrums until 2020.

But if it comes sooner, that would be a positive.

But I don't expect it.

And now we'll go to Mike Sison with KeyBanc.

Seifi, when you -- Lu'An's going to be a nice contributor here in '19.

You have other projects when I take a look at the major project slide coming on in '19.

How much can those contribute to earnings growth next year?

And so -- yes, so that's the question.

We don't disclose that specifically.

But I have said that we expect 2019 that we increase our EPS by at least 10%.

So some of that will come from those.

But if you don't mind, we don't want to disclose the specific contribution from new projects, because then it makes it very easy for people to calculate exactly what our returns are, and we don't want to do that.

Okay.

And then, as a follow-up.

Your electronics market on that project slide has been a good area for you this year and in the backlog.

How big of an opportunity -- how much capital can you deploy in that market over the next couple of years?

Well, that market is growing very fast right now.

I think this year, if you add up, we probably have contributed more than $300 million of new projects in there.

And what will happen next year depends on the new fabs that people build and all of that.

But I'll let Corning to make a little bit more comment on this.

Yes.

I was just in China meeting with the team, which is where a lot of this activity is, China, Korea and Taiwan right now.

And I would say the prospect list is still quite robust for us.

So we expect another good year of hunting.

Yes.

And I would like to add that we are very, very well positioned, by the way, on that one with the customer and all that.

We'll go to Laurence Alexander with Jefferies.

Could you clarify 2 things?

My impression of the traditional onsites was that once you had the oxygen ASU up and running, you would be paid your fee regardless of if the customer was operating.

But it sounds as if with the gasifiers, if the gasifiers are down in, say, 2020 or 2025, you would then lose that part of the revenue stream.

I just wanted to see if that's correct or that's a slightly different model?

And secondly...

No, no, no.

Sorry to interrupt you.

That is not the case.

The reason that we are getting the fee is we are getting the fee right now for the start-up.

Once we get -- we have all of the 4 gasifiers running, then in 2020, if because of the customer demand, only 2 gasifiers are needed to run, we still get our full BFC.

So the margin is exactly the same.

It's just during the start-up period.

Okay.

And then the second one, I guess, just to flog one of the previous forces, again.

I think, you made a comment that you were more bullish than you were on the last quarter about volumes and then price following in the merchant business.

FX is about a $0.10 tailwind.

The -- you get about $0.04 to $0.05 from the JV.

And -- but you're moving the range by only about $0.10.

So the implication is that the growth investments or the efforts to pursue other growth projects is an incremental maybe $0.05 or $0.07 kind of drag.

Is that the way you're thinking about it?

Or is it more just that you're allowing for some squishiness in the economy just because it's only halfway through the year and you just want to have that cushion?

I guess, what I'm getting at is, are you ramping up growth investments to take advantage of the tailwinds?

I think, I don't want to confirm or not confirm the exact numbers that you quoted.

But we do see the positive effects of the FX.

We do see the positive effect of Lu'An coming onstream right now.

But as we've been saying, we do see higher maintenance cost because of the turnaround of some of the hydrogen facilities, and we do see higher cost in terms of pursuing other opportunities.

I mean, like Yingde last year costed us 50 -- $5 million that we had to absorb in our results.

So those are the 2 principal reasons that we haven't increased our guidance by more than $0.10.

And gentlemen, there are no other questions at this time.

Very good.

Well, in that case then, I would like to thank everybody again for being on the call.

Thanks for taking time from your very, very busy schedule to listen to our presentation.

We do appreciate your interest and look forward to discuss our results with you again next quarter.

Have a great day.

Thank you very much.

And thank you very much.

That does conclude our conference for today.

I'd like to thank everyone for your participation.

And you may now disconnect.