Air Products & Chemicals Inc (APD) — Q1 2017 Earnings Call Transcript

Thank you, Eric. Good morning, everyone. Welcome to Air Products' first quarter 2017 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 & 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'll 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 on page two of the slides and in today's earnings release. As you know, on October 01, 2016 Air Products completed the spin-off of Electronic Materials, as Versum Materials, and on January 03, 2017, Air Products completed the sale of Performance Materials to Evonik. The Q1 results, prior period comparisons and forward guidance we are sharing today are based on Air Products continuing operations. In other words, they don’t include the discontinued operations of EMD or PMD. 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. I am very pleased to report that our team at Air Products delivered another quarter of strong safety and financial results. Despite the sluggish economic growth worldwide and continued currency headwinds, our team stayed focused on executing our strategic Five-Point Plan. For the quarter, we delivered earnings per share of $1.47, up 9% over last year and in the top half of our guidance range for the quarter. And we had excellent safety performance. Now, please turn to slide number three, I am incredibly proud of our team for operating the whole quarter, about 8 million man-hours without a single employee lost time accident. Considering that we have 16,000 employees working around the globe in a variety of operating environments, a lost time accident rate of zero is outstanding. This performance is the best indicator that all of our people are focused, disciplined, engaged and aware of the highest standards of performance required in Air Products. We did all work hard to strive for this performance in the months and years to come. I want to thank every one of our Air Products employees for their focus, attention and discipline. Now, please turn to slide number four, which is the reconfirmation of our overall goal for the Company. We are determined to continue to be the safest and most profitable industrial gas company in the world, providing excellent service to our customers. Now please turn to slide number five, here you can see our overall management philosophy. We believe strongly that cash generation is what drives long-term value. We believe that what counts in the long-term is the increase in per share value of our stock, not the size of our Company, or growth rates. In addition, Air Products has a significant amount of cash on hand and the effective deployment of that cash is one of the most important responsibilities that I have as a CEO of the Company. Now, please turn to slide number six, our Five-Point Plan that we announced 2.5 years ago. I want to take a moment and expand on the first point, our focus on Industrial Gases, our core business. In September of 2014, we announced that our strategic goal is to focus on our core industrial gases business. In September of 2015, we announced plans to spin-off Material Technologies and set September 2016 as the target date to get the job done. I'm very pleased that as a result of an excellent effort by many people in Air Products and especially the people in our former Material Technologies business, we successfully got the job done in accordance with our plan in two steps. Step one was to spin-off tax-free to our shareholders, our electronics material division as a new company, called Versum Materials, which we successfully started trading on the New York Stock Exchange on October 03, 2016. Step two was to sell our performance material division to Evonik. The transaction was announced in May 2016, and we closed and received $3.8 billion of cash earlier this month. As a result of these actions in completing the first step of our strategic plan, we now have more than $3 billion of cash that we can deploy to make acquisitions to profitably grow our core Industrial Gases business. Talking about growth, I think this is an appropriate time to draw your attention to the fact that we have made announcements on January 08th and again on January 20th, that we have made the preliminary non-binding indication of interest to acquire Yingde Gases, a Hong Kong listed company and a major industrial gas company in China. We seek to engage in a friendly transaction with the company, which we believe would be very beneficial to the employees, customers and shareholders of both companies. As you may know Air Products currently has a business in China with about $1 billion of sales and more than 2,500 employees. And we are very successful operating in that country. Now, please turn to slide number seven, where you can see our three key metrics. As you can note, our metrics moved as a result of the spin-off and sale of PMD, but we remain committed to our goal to be the most profitable industrial gas company in the world as measured by each of these three metrics. We remain focused on driving further improvement as we move forward. Now, please go to slide number eight, which is my favorite slide where you can see our quarterly progress. As you can note, we have improved our EBITDA margin by almost 1,000 basis points in the last 2.5 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’ll come back after comments from Corning and Simon to make some closing remarks, and then we will be more than pleased to answer your questions.

Thank you very much Seifi. Now, please turn to slide nine for a more detailed review of our Q1 results. Sales of $1.9 billion increased 1% versus last year, as higher volumes and higher energy pass-through more than offset an unfavorable currency impact of 3%. Volumes were 2% higher, primarily due to strength in Industrial Gases Asia and continued progress on our Jazan project. This was somewhat offset by the expected weakness in LNG and our other sales equipment businesses, which we mentioned last quarter related to our FY17 guidance. In other areas, volumes were lower in Gases Americas and EMEA. Corning will provide more color shortly. Pricing remains largely unchanged across our businesses. We delivered operating leverage again this quarter, as EBITDA of $652 million improved by 3% and operating income of $408 million improved by 6%. EBITDA margin of 34.7% and operating margin of 21.7%, improved by 80 and 110 basis points respectively as we continue to execute on our Five-Point plan. Higher energy pass-through reduced operating margins by 30 basis points. Operating margin was up 140 basis points, excluding the impact of higher energy pass-through. Versus prior year, net income increased 10% and adjusted earnings per share grew by 9%, ROCE of 12.7% improved by 180 basis points versus last year. Now, please turn to slide 10. You’ve heard Seifi talk about our focus on cash flow. Our free cash flow was $103 million this quarter, down $19 million versus last year despite the higher EBITDA, due to the higher maintenance CapEx and higher cash taxes based on timing. Turning to slide 11, you can see an overview of this quarter's performance in terms of earnings per share. Before I comment on our Q1 operating performance, I would like to spend a moment on the non-GAAP items that totaled $0.32 per share or about $80 million pre-tax. We saw Materials Technologies business separation cost of $30 million or $0.12 per share for legal and advisory fees. As you remember, during the second quarter of fiscal 2016, we made the decision to exit our Energy-from-Waste business and moved it into discontinued operations. During the first quarter of fiscal 2017, we determined it was unlikely that a buyer would assume the remaining assets or contract obligations at the site. As a result, this quarter, we recorded an impairment charge in continuing operations of $50 million or $0.19 per share for an air separation unit in our EMEA segment, which was intended to provide oxygen to the Energy-from-Waste plants. Additionally, in discontinued operations, which is where we report results for the Energy-from-Waste business, we recorded a pre-tax charge of approximately $60 million, primarily associated with a land lease to the Energy-from-Waste assets. We expect to see cost action and pension settlement costs continue through next year. Further actions will be part of the second $300 million of operational improvements and other actions to offset stranded cost from our decision to divest Materials Technologies. Further details on all non-GAAP items can be found in an appendix slide and the footnotes to our earnings release. Excluding these items, our Q1 continuing operations EPS of $1.47 increased $0.12 per share or 9% versus last year. Volumes decreased EPS by $0.07 per share, primarily due to lower activity in our LNG business. Pricing, energy and raw materials, taken together, decreased EPS by a penny. Net cost performance was $0.19 per share, favorable, primarily driven by our productivity actions. Other income and expense on the consolidated P&L is about $20 million higher than last year. Compared to the FY16 quarterly average, OIE is up about $10 million. This is mainly due to the accounting for Transitioned Service Agreements of TSAs, where we are billing Versum and we will also be billing Evonik next quarter through various services, which Air Products continues to provide to both companies. The expenses we incurred are primarily in SG&A. What we billed to recover these expenses gets recorded in OIE. For the quarter, currency was $0.03 per share, unfavorable. Equity affiliate income increased by $0.02 due to better results in Italy and Asia. Interest expense was $0.03 higher due to lower capitalized interest. And our lower tax rate increased earnings by $0.06 versus last year. Our effective tax rate this quarter was 21.2%, about 350 basis points lower than the recent quarter, for three main reasons. First, our underlying rate improved by about 50 basis points, as a result of separating the MT business. Second, we adopted a new accounting standard for share-based compensation that resulted in about 150 basis points reduction this quarter. This benefit will vary quarter-to-quarter, and we expect it will be smaller for the rest of the year. And finally, this quarter’s rate benefited from some favorable one-time adjustments, including foreign tax law changes worth about 150 basis points. We expect the rate for fiscal year 2017 to be about 23%. Turning to slide 12, I'd like to make a few comments on our 31 December balance sheet, and subsequent changes as shown on the pro forma column. Cash on the balance sheet as of 31 December decreased by approximately $700 million versus 30 September to a balance of $600 million, as a result of utilizing the cash from the Versum spin-off to repay commercial paper. The current or pro forma cash balance, after receiving PMD sales proceeds of $3.8 billion, is approximately $4.4 billion. We are currently investing the PMD proceeds in short-term deposits at approximately 1%. Over the next few quarters, we will pay about $1 billion in taxes associated with the significant gain on the PMD sale. Total debt of $4.3 billion as of 31 December is down approximately $1.4 billion from 30 June, which is prior to the spin and the sale. As we have said, our goal is to manage our debt balance to maintain our A, A2 credit rating, and we believe that our 31 December debt balance of $4.3 billion meets that requirement. As you may have seen, in January, S&P upgraded our business risk profile from strong to excellent due to our portfolio transformation to focus on the core industrial gas business, and also our significant EBITDA margin improvement. So, after we pay taxes on the PMD sale and keep about $300 million to operate the business, you can see that we have about $3 billion to invest in our core industrial gas business. Now, to begin the review of our business segment results, I’ll turn the call over to Corning.

Thanks, Scott. Our industrial gas business began 2017 with another solid quarter, despite the challenging external environment with tepid economic growth and currency headwinds; our unwavering focus on productivity drove margins up in EMEA and the Americas, while in Asia, we grew China retail sales by double-digits. I would like to thank the entire team around the world for staying focused on the things we control, most importantly safety but also serving our customers well and delivering solid business results. Next, I’d like to share another example of the productivity actions we are taking to drive our business improvement. We recently completed a program to uniquely tag each of our packaged gas cylinders in nearly every country in which we operate. Knowing the exact location of each individual cylinder allows us to run our cylinder fill and distribution systems much more efficiently. We’ve also found that it enables us to better protect our assets from being refilled by unauthorized third parties. Now, please turn to slide 13 for a review of our Gases Americas results. Our continued focus on taking the lead productivity actions enabled us to modestly improve margins despite weak volumes and the headwind from higher energy pass-through from increased natural gas prices. Sales of $864 million were up 3% versus last year as 2% lower volumes were more than offset by 5% higher energy pass-through, while pricing was flat. Latin American volumes were down close to 10%, primarily on packaged gases and welding consumables. This lowered overall Americas’ volumes by 1%. North America volumes also impacted overall Americas’ volumes by 1%, as helium and steel weakness offset slightly positive LOX/LIN volumes. HyCO volumes were modestly positive as the volume contribution from our new plant in Canada was mostly offset by customer and plant maintenance outages in the U.S. Gulf Coast. Sequential volumes were impacted by HyCO outages and lower seasonal LOX-LIN demand. Operating income of $224 million was up 6% and EBITDA of $350 million was up 5% versus last year as the benefits from our taking the lead operational improvements more than overcame headwinds from lower volumes. Operating margin of 25.9% was up 60 basis points and EBITDA margin of 40.5% was up 40 basis points. Higher energy pass-through reduced the operating margin by about 90 basis points, meaning that the underlying operating margin was up 150 basis points, excluding energy pass-through. Now, please turn to slide 14. In our Europe, Middle East and Africa business, the team continues to deliver margin expansion despite volume weakness and headwinds from currency. Versus last year, sales of $400 million were down 9% on 2% lower volumes, flat pricing, a negative 1% impact from lower energy pass-through and a negative 6% impact from currency, primarily the British pound. Liquid volumes while packaged gas volumes, on a cylinders per workday basis, were up slightly. But with fewer workdays this year, volumes were down overall. Other than the continued currency impact, we don't believe the Brexit vote had much impact on our business this quarter. Operating income of $88 million and EBITDA of $140 million were both down 5%, but both would have been up slightly on a constant currency basis as our productivity actions more than offset the impact from lower volumes and higher electricity tariff rates. We are working to recover the impact of the higher electrical costs in our liquid bulk business. Operating margin of 22% was up 100 basis points and EBITDA margin of 35% was up 160 basis points, driven by productivity. Sequentially, profits were impacted by currency, the higher electrical costs and volumes. Now, please turn to slide 15, Gases-Asia, where you can see the ramp-up of our new plants and the strength in our merchant business continued to deliver growth. Sales of $438 million were up 6% as volume growth of 10% was partially offset by 1% on price and 3% on currency. Just over half of the volume increase was from new plants, primarily an increase in utility cost pass-through. Our merchant business was up mid-single-digits across Asia and our China retail LOX/LIN business was again up double digits as we've improved the quality of this business. Overall, merchant pricing was down slightly, primarily due to helium as overall Asia LOX/LIN pricing and China LOX/LIN pricing were both positive. We've seen improvement in the China LOX/LIN plant loadings; in fact, we're essentially sold out for certain products in some regions of China. But overall, industry overcapacity still remains. Operating income of $118 million was up 1% and EBITDA of $178 million was down 1%. Profits were flat as the utility pass-through is, by definition, at zero margin and we had headwinds from currency, and about $5 million of positive non-recurring items a year-ago. Operating margin of 26.9% was down 140 basis points and EBITDA margin of 40.7 was down 290 basis points versus last year, driven mainly by the increase in utility cost pass-through. Sequentially, margins rebounded on lower costs. Finally, earlier this month, we announced the next phase of our gas complex in Pyeongtaek City, South Korea. We are building a second plant to support our customer’s semiconductor fab business. This builds on the major project we announced at the same site in 2015. I'll close with a brief comment on the Global Gases segment. You'll recall that this segment includes most of our air separation unit sales equipment business, as well as costs associated with industrial gas business, which are not region-specific. Sales were up, versus prior year, driven by progress on the Jazan ASU, sale of equipment project this quarter, which more than offset weakness in small equipment and other ASU sales. Segment profits were up versus prior year, as we continue to recognize profit on the Jazan project. You'll recall that we had a catch-up profit booking last quarter, which is why profits are down sequentially. Now, I'll turn the call back over to Simon for a comment on our corporate segment.

Thank you, Corning. Our corporate segment consists of our LNG and helium container businesses, as well as corporate costs, which are not business-specific. Sales and profits were down versus last year on significantly lower LNG project activity. As we have said, the lack of customer decisions on new LNG projects is having a significant impact on our business and we still expect at least a $0.25 headwind in LNG for FY17 versus FY16. We did see a positive impact from our productivity actions. Now, please turn to slide 16, and I'll turn the call back over to Seifi for a discussion of our outlook.

Thank you again, Simon. Before we take any questions, I would like to make a few comments about our outlook. Please turn to slide number 16. As we move forward, I want to report to our shareholders that Air Products is in a very strong position. In the past 2.5 years, we have totally reorganized the Company in accordance with our Five-Point plan. We have implemented meaningful productivity plans, resulting in 1,000 basis improvement in our margins. We have put in place a very robust and effective regionally focused organization with highly qualified managers in place. Our safety performance has vastly improved, an indication that we have the engagement and participation of all of our 16,000 employees. The productivity programs we have implemented and the new ones underway will continue to drive our earnings per share as they have done in the past 10 quarters. In addition, we have focused our portfolio on our core Industrial Gases business, and as a result of the divestment of non-core assets, we now have an excellent balance sheet, which is by far, the best in the industry. Reflecting our financial strength, this morning, we announced a quarterly dividend increase of $0.09 or 10% to $0.95 per share per quarter for the dividend payable in May. We have never had a larger cent per share dividend increase. We remain confident in the tremendous growth opportunities to invest in our core business, which is Industrial Gases, and our strong financial position allows us to also reward our shareholders directly through dividend increases and profit acquisitions. So, in short, we are confident about the steps of our Company, but we are a global Company with only 40% of our sales in the United States. We do not manufacture products in the U.S. that are exported to other parts of the world. We also do not manufacture products in the rest of the world that are imported into the United States. Our business is local to where our customers are around the world. Therefore, like any other global company, we are not immune to macroeconomic or geopolitical events that can impact our business. The new administration in the United States has not yet articulated its full economic portfolio and policy. In Europe, six months after the referendum, it remains unclear how the UK government will address the exit from the European Union. Is it a soft Brexit, hard Brexit or Brexit at all now that the UK Parliament has to vote on the issue? In addition, it is impossible to predict how other countries will react to the new economic and political developments in the United States and Europe. All of these events can have significant impact on the level of economic activity and the exchange rates in the areas we operate in. As a result, we are now more cautious in our outlook. Our guidance for the full year 2017 EPS is $6 to $6.25 per share, which at midpoint, is an increase of 9% over last year; one of the most bullish predictions than any other industrial gas or chemical companies that I have heard of. Our guidance for EPS in the second quarter of fiscal ’17, that is next quarter, is $1.30 to $1.40 per share. At this time, I do want to once again thank all of our employees at Air Products for our excellent safety and financial performance in the first quarter. Our entire team is focused on delivering industry-leading performance as we move forward. Now, we will be delighted to answer your questions.

This is Katherine Griffin on for David. Maybe first could we just talk about the drivers of the lower guidance, and what you guys are expecting?

Drivers of the lower guidance…

Yes.

Well, people keep talking about lower guidance. I just want to stress, our guidance is a 6% to 11% increase versus last year. So, I mean the stress on the lower kind of is interesting for me. But in terms of why did we take our guidance down, there are four key elements. Number one our base for last year ended up to $0.10 lower than what we thought, and we closed our books at the end of September. If you recall, we said it was going to be partial and before. We have reported this public within the beginning of January it is 564, so that is $0.10. Our LNG business is doing worse than we thought because we haven't had any orders for our LNG, that is $0.05 more negative. Our volumes, we are being cautious and that will affect us about $0.05. We might be wrong on that, but that is what we are forecasting right now. And then the currency is about $0.05 worse. So that adds up to about $0.25 that is the difference between our guidance today versus it was at the end of October.

Could you discuss what you are observing in the competitive landscape of the Chinese industrial gas market, specifically regarding on-site merchant and packaged business?

You mean about business in China in general, or about…

Yes, in general.

I would like to turn that over to Corning, to kind of expand on that.

Katherine, I will primarily discuss on-sites and liquid bulk. Our involvement and that of other major players in packaged gases is somewhat limited. On the on-site side, the market appears stable, and we are witnessing step changes as new plants are commissioned. We are having ongoing discussions regarding bidding activity. As for liquid bulk, as I mentioned earlier, we are seeing continued loading at our plants and an increase in retail sales. Overall, this indicates that despite any external news, there is fundamental momentum in the Chinese economy and in our business.

Does that answer your question?

Yes, thank you very much.

Pertaining to any potential M&A activity, you used very broadly comment on your strategic thinking updates, I imagine it's probably all of these things. But just to focus on on-site businesses, geographic diversifications, skill and density benefits, opportunistic valuations. Just any color on how you’re thinking about the evolution of your longer-term portfolio, and any risks that you are or are not willing to take from an asset perspective? Thank you.

We are, in general, as we have said many times, focused on making acquisitions that will increase our percentage of on-site business. That is one of the reasons that we are pursuing the acquisition of Yingde, which is a company with almost more than 85% on-site. So that, in general, is the direction that we are going, and we do have a lot of opportunities. We had talked about asset buybacks, most of that asset buybacks are in the on-site business. So that is a direction that we are going. In terms of geographically, we obviously are focused on areas where we think there is going to be growth. If you look to chase growth, you have to go to places where the population is growing or the standards of living are going up. Because if you don’t have those things you can talk about growth as much as you want, but you are not going to get it. So, therefore, we are focused on China, which we believe has great potential. We are focused on India. We are focused on Mexico and we are focused on the Gulf Coast of the United States. So, there are some opportunities in Europe and also in Russia. So, we are looking at around the world. But the emphasis is more on the on-site business, which is consistent with what we have said before.

And generally on macro expectations, you hit on a few things in the UK. But as we’re heading further into ’17, it appears that activity in LatAm is actually picking up a little bit. Europe's mix, but on the whole moving in the right direction, I suppose. Just given that some major elections are coming up, just how are you thinking about general macro and also the willingness of growth in business investments? Thank you.

In Europe.

In Europe and in Latin America, as well. Thank you.

Latin America is experiencing some weaknesses, particularly in Chile and Brazil for our business. This excludes Mexico. In Europe, we haven't seen significant changes so far; our business is stable. While it's not remarkable, it isn't declining either. The only risk we face in Europe is if there are major fluctuations in currency exchange rates, which may affect the earnings per share we report.

Your price raw materials variance was negative in the quarter. Can you talk about pricing in the different geographic areas, and whether you expect this variance to improve in the course of the year?

I think we have a detailed explanation. But I'll ask Corning to address that.

Probably the most exciting region for us in terms of, let's say on the cost side if you are thinking about margin, was definitely in Europe. And in Europe, typically, France is a net exporter of attractively priced nuclear power and had a number of power stations down at one point I think around 40. And that's really disrupted the power market on the Continent. So, that's been a challenge for us. We’re working to recover that in our business, and that gets an opportunity for this going forward.

Does that answer your question, Jeff?

Can you also talk about industrial gas pricing in the United States? And how you think that trend might change in the course of the year?

Yes, so pricing in the U.S. is somewhat impacted right now, I'd say one of the biggest movers for us is the overall helium market. And that we continue, I think, have gone through a period where we have over-supply and the world is working its way through that. I think looking forward on pricing I'd rather not make too many forward statements in that department. But I think the helium is one very much driven by supply and demand as that gets absorbed and in the U.S. DLM to be helium facility moves towards greater maturity and ultimate closure, I think is going to be an offset to that.

Does that answer your question?

Yes, thanks very much.

Can you quantify any impact from stranded costs that you felt in the quarter?

Scott, do you want to make some comments on this?

Sure. Let me actually expand the question and take it through some things regarding the transition services. And I’ve made some comments in my prepared remarks, but I want to make sure I get everybody granted. First, as I have mentioned, we saw an increase in our other income and expense in our P&L. It was about $0.07 favorable versus the prior year. But when you look at, we all know that this moves around, there are different asset sales and so forth. When you look at the quarter compared to last year's average per quarter, it's up about $10 million. This is principally driven by the TSA that we began to recognize further soon. So, what we’re going to do here is we’re going to provide services to both Versum and Evonik. Evonik will start in this quarter, and they’ll go to the next 12 to 18 months or so. The expenses that we incurred and this are principally in the SG&A line, and then we’re going to offset that in other income and expense. And so, where you saw, at the beginning of the year in this quarter on a run-rate basis, should expect as we have both Evonik and Versum on, we’ll see about $40 million to $45 million per year for transition services. Once we’ve stopped providing those services, there’ll be some resources that activities will go away, and then we no longer need those resources because those activities go away. That will play out over the next year to year and a half. And then, additionally, we have some costs in the corporate segment, which we have to focus on eliminating. So, the TSA will cover the costs in the short-term. Once those end, we’ll take the activities out. We’ll take the costs out. There will probably be, we’ve said in the past about $25 million total stranded cost that once all the activity goes away we’ll work to offset and eliminate. Okay, hopefully that helps.

Absolutely. And then I guess maybe shifting gears a bit towards your M&A strategy, specifically with Yingde, it seems to be consistent with your guided directions that you’ve talked before that go for on-site, and then focus on regions like China. But if you betted that customer base, it seems to be largely focused on steel that might be at risk.

Well, the thing is that, obviously, we have taken everything into consideration when we looked at that. But that company has done a very good job and diversified, although their portfolio is not received. They have about 60, 70 customers and they have a lot of good customers and onsite businesses with the chemical sector. So, they have a balanced portfolio. They are not particularly exposed. And we have taken into consideration what the consequences are of the consolidation of the steel industry in China.

So similar or legal or contracts that you have in other parts of the world should we expect to that?

I believe that, since we are currently in discussions, it would be inappropriate for me to comment on their contracts or any related matters. However, we can proceed with the transactions and discuss everything in detail with you.

Just a question on the capital structure. If you were to use the $3 billion to just go out and buy assets that have EBITDA, obviously that’s a deleveraging effect. Even though, you were at the level at the end of the year, once rating agencies that they were happy with. Is that the way you would expect it to work, or would you take on commensurate debt kind of at the same ratio that Air Products is today to keep their ratio the same through the acquisitions?

Duffy, that’s an excellent question, I am very happy to answer that, because I would like to expand on that. Our goal is to maintain our A ratings. Our goal is not to de-lever Air Products. So, if we have the capacity as we buy acquisitions on all of that, we obviously have the capacity to take on more debt. The key thing is that we want net debt to EBITDA to be on order of magnitude about 2 to 2.2 to maintain our A rating. As you know, some of the other people in the industry have net debt to EBITDA much higher than that and they still have an A rating. So, our goal is not to stop our growth, because we just want to de-lever to having no debt. Now, we want to maintain our A rating, and whatever that implies in terms of the net debt to EBITDA, that’s what we’ll do.

And then obviously the Yingde bid has gotten a lot of headlines. But is it just as probably that some of the other deals or what shake loose this year, some of the asset buybacks, maybe in the Middle East and different places like that?

Well, obviously that is our intent. As you know, we have the firing power to do a lot more than just the acquisition of Yingde. We have a lot more cash. And as you said, the more EBITDA comes in, you can do more. So, we have the capacity to do a lot more. And you can rest assured that we are looking at a lot of different things, and I hope that some of those materialize soon.

With respect to the Yingde discussions, could you talk about how you deal with the currency risk there, do you have a view that the currency is not going to decline further? Or how do you see yourselves mitigating any currency risk in China?

Well, when it comes to industrial gases, this is a local business where costs are kept low, and the income is also low. Therefore, the risks are minimal, with the primary concern being translation risk. Additionally, if we pursue acquisitions, we can always borrow locally, which helps us protect ourselves from exchange rate fluctuations. The advantage of operating in the industrial gases sector is that we are very much a local business and engage in local transactions.

Could you also discuss how you see synergy opportunities at Yingde?

As I said, since we are in the middle of this thing, I think that would be inappropriate for me to address that. I think if we ever do the deal, we will obviously make a presentation and we will give you all the details about all of our expectations.

I apologize if this has already been addressed; I needed to step away for a moment. But Seifi, I'm curious about your reference in the prepared remarks and press release to the uncertainty regarding President Trump's economic policy. It's clear that there are some issues with China and various concerns from multiple angles. So, I'm interested in what gives you the confidence to proceed with a significant acquisition in China despite the surrounding economic uncertainty.

Vincent, I think what we've said and what we meant to say was that, we don’t know, we didn’t take a position positive or negative. The second thing is that Air Products has been in business for 75 years. During that time, we have had 14 different presidents; we shouldn't and we don’t run the business on the basis of what political party is in power, because we know things change every four years. We are looking at the long-term. China is a place that has the population and the standard of living is going up. Those are the only things that affect economic growth. We see economic growth there for the long-term. Therefore, if we can strengthen our position and be there, I think that would be the right thing to do, and that is our strategy. There might be things in the short-term that might affect things. But we are being paid to keep Air Products afloat for another 75 years, and taking that view that would be the right place to invest.

And just as a follow-up, Scott, I think if I heard you correctly, the electricity costs issue that hurt the quarter. These do not have a contractual ability to recoup? You're going to have to try to recoup them in the ordinary way. As I seem to recall a couple of years ago, there was an electricity issue I think maybe in the U.S. that you were able to recoup quite quickly. So is this a different construct?

I think Corning will address that.

So, for Continental Europe, we have a variety of different contracts that are out there. There are some that are formula that takes a certain period of time, there are others where we've got the ability to surcharge, and we've started that process. So it depends really customer-by-customer and contract-by-contract. But there is the ability to go get this.

Yes, Vincent, maybe just that's around our merchant business, right. And so if you’re then looking at our tonnage business, those are all under a contract with a defined formula for how they approach. And it's really not particularly material in the packaged gases space.

There’s a little bit of a timing here, Vincent, as you know very well.

Production in China, would that potentially lead to a tightening of the liquid oxygen and nitrogen markets?

We did not hear the first part of your question. I think there was interruption. Would you be kind enough to repeat it, please?

Sure. If there is rationalization in China of coal-based chemical production, would that potentially lead to a tightening of the liquid oxygen and nitrogen markets?

I would say not very much, because a lot of these big plants that supply the coal gasification facilities do not have liquid attached.

I would just add, I don’t see coal-to-chemical slowing down, especially the element of that using industrial gases. Coal and electricity, right, there has been an announcement, but that has nothing to do with the industrial gas market. Clean coal to chemical, I think, remains an area of emphasis in China.

I just like to expand on that, because we obviously operate there and we keep track of these things. There was a headline that China has closed on 102 coal-fired power plants. That's a totally different subject than gasification for coal for production of chemicals. That is actually environmentally ten times more friendly and the Chinese government has not slowed that down, and we don’t see any of that at all.

And then just as a follow-up, how would you categorize the role of intellectual property in the industrial gas industry and Air Products’ overlap with global and regional peers?

That’s a broad question. We do have intellectual property related to certain products and applications. However, I would say that no one can claim this will significantly impact their performance compared to others. We don't see that, and it's not comparable to intellectual property for software or similar areas. It’s not a major concern.

On the Asia gases volumes, I think this was at least the eight consecutive quarter of volume growth in high single-digits to low double-digit rates, as you ramp up the new projects. How much of your Asia sales are now in China, and how much longer can you stay in near these high levels of this high base?

So, almost $1 billion of our Asia sales are in China. In terms of the pace, there is two elements of what you see reported right now, some of that is associated with new plants and largely utility pass-through, and that’s going to turn a little bit as our customers progressed in starting up their own facilities. In terms of the merchant market, well of course, that’s subject to overall economic conditions. But you can see we have positive momentum there, I think most importantly positive around retail sales.

And then secondly, if the LNG outlook remained suppressed, could that operation become non-core? Or because its cryogenic gas equipment and engineering, would it still be due to its core in most scenarios?

LNG is core business for us for sure, because there is no question that LNG will come back. Any kind of the projection that you look at for the long-term LNG will come back and that in particular is an area where we do have intellectual property. We are going to keep our LNG business for the long-term. We are going to suffer for two years, but that is the nature of the business. LNG is core to Air Products, we always said that.

Seifi, I do wanted to follow-up on the capital deployment dialogue in response to an earlier question. I think you called out Mexico as a country of interest as it relates to growth along with China, India and the U.S. Gulf. Just wondering if you see any opportunity to increase your stake at infra over the next year or two? And then second piece, have you had an opportunity or is there any interest on the part of Air Products to explore acquisition of any assets that might be cast off from a potential combination between Praxair and Linde? Thank you.

We mentioned Mexico because it has significant oil and gas resources, presenting many opportunities for us in hydrogen, nitrogen, and other areas related to the oil industry. Additionally, the country is experiencing depopulation, which also creates opportunities. In terms of increasing our share in core infrastructure, we have strong partners there, and we aim to work closely with them. Our goal is to be in a position to consolidate any acquisition, depending on our partners' willingness. We maintain a good relationship with them and would be happy to increase our share if they desire that.

Any thoughts on Praxair/Linde cast-off assets?

I know you are asking me that, and I don’t want to go there because I don’t want to make any comments about that acquisition. Things might or might not become available, so I just want to stay away from that.

I think the run rate there is going to be nothing to write home about, to be perfectly honest, I mean, because LNG, as I said, it is a core business for us. But the decrease in which that product or that performance has come down was a surprise because we didn’t think that everybody will stop everybody, and this is what they have done.

I was hoping to drill down a little bit more on your volume guidance and the $0.05 headwind. Would you tease out perhaps where you are seeing the greater weakness than you had a quarter ago? I was a little bit surprised given your on-site exposure. Was there any sort of expectation that volumes there might also come down?

The reason we are addressing the volume issue is our concern about Europe due to Brexit. While some may wonder why we are worried, the impact hasn't been significant thus far because not much has changed. The UK hasn't even triggered Brexit or invoked Article 50 yet. Our concern lies in how the markets will react once they do make their move and provide notice. That is why we are exercising caution.

And then just on Yingde, I know that there's been a lot of discussion around the growth in China. Obviously, it looks like a cheap asset. But is there anything else strategically that you are seeing? Clearly, they were not builders of their own assets. Is there operational opportunities that you believe are available there?

Since they are not constructing their own asset, it presents a great opportunity for us. The subsequent plants they develop will be constructed by Air Products. We recognize significant potential in this situation. They are a reputable company with highly capable personnel, and we believe that the synergy between them and Air Products will benefit both employees and customers. Additionally, it will improve our standing in China, contributing to a lot of positive outcomes.

Thanks very much.

Thank you. And we are on top of the hour, so we will take one more question, and then we end the call. One more question please.

Seifi, I know the chart on slide eight is your favorite, but it could lead some observers to conclude that maybe margins have plateaued here. I know that there is some natural gas impact in there that would make the margin better, and it's obviously been challenging environment. But how confident are you that you can get the Company back to a positive margin trajectory in what you see as a challenging demand environment going forward?

Our goal is that, in that chart, is that we will have a margin which is higher than anybody else. I think at 35% EBITDA margin, I have never made a statement that there is a lot more room to go. Our goal was to be higher than other people, and which we are. So, we are not forecasting that that margin will significantly improve. All of the productivity programs that we have will go on maintaining that margin because our costs are going up. But we have never projected that the business has the potential of having much higher margin than that. But if anybody else’s margin goes to 40%, I guarantee you that we will be choosing for 41%. But quite frankly, I don’t see a lot of upside on that margin.

And then I was also hoping that you could comment on your Indura business down in Chile. You’ve mentioned that it was mostly packaged and hard goods that was driving the weakness down there. Are we still looking at a business that's primarily packaged gases? Or have you been successful in expanding the amount of merchant and on-site business in Chile?

Our business in Indura is challenging because it is mostly packaged gases business, and there is not a lot of opportunities to turn that around and have a lot of on-sites because there are not a lot of on-site opportunities in Chile. So, we do have an issue there. Since Corning is responsible for that, I like him to make some comments on that.

Yes, so maybe just to broader picture on the whole South American situation. So, keep in mind when we look at our volumes and how they might compare. First of all, it’s a clean quarter for us. We had no substantial new plants coming on in this timeframe. And also, we're much more focused on Linde in Chile. But we also have Columbia, and our business in Brazil is there for us as well. We are primarily packaged gases. Packaged gases has been impacted more; maybe just for what it's worth, our liquid bulk volumes in South America are positive for us in this quarter. So, it's not like we’re without momentum in that space.

Okay, Mike, anything else?

That's it. Thanks very much.

Well, thank you very much. Then with that, I would like to thank everybody for being on the call today. Again, thanks for taking time from your very busy schedule to listen to our presentation. We appreciate your interest and we look forward to discussing our results with you again next quarter. Have a very nice day and all the best. Thank you.