Linde PLC
XETRA:LIN
If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.
Utilize notes to systematically review your investment decisions. By reflecting on past outcomes, you can discern effective strategies and identify those that underperformed. This continuous feedback loop enables you to adapt and refine your approach, optimizing for future success.
Each note serves as a learning point, offering insights into your decision-making processes. Over time, you'll accumulate a personalized database of knowledge, enhancing your ability to make informed decisions quickly and effectively.
With a comprehensive record of your investment history at your fingertips, you can compare current opportunities against past experiences. This not only bolsters your confidence but also ensures that each decision is grounded in a well-documented rationale.
Do you really want to delete this note?
This action cannot be undone.
| 52 Week Range |
367.4
448.2
|
| Price Target |
|
We'll email you a reminder when the closing price reaches EUR.
Choose the stock you wish to monitor with a price alert.
This alert will be permanently deleted.
You don't have any saved screeners yet
Good day and thank you for standing by. Welcome to the Second Quarter 2021 Linde Earnings Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]
I would now like to hand the conference over to your speaker today, Mr. Juan Pelaez, Head of Investor Relations. Please go ahead.
Crystal, thank you. Good morning, everyone, and thanks for attending our 2021 second quarter earnings call and webcast. I'm Juan Pelaez, Head of Investor Relations, and I'm joined this morning by Matt White, Chief Financial Officer; and Sanjiv Lamba, Chief Operating Officer.
Today's presentation materials are available on our website at linde.com in the Investors section. Please read the forward-looking statement disclosure on page two of the slides and note that it applies to all statements made during this teleconference.
The reconciliations of the adjusted numbers are in the appendix to this presentation. Sanjiv and Matt will now give an update on Linde's business outlook and second quarter performance, and we'll then be available to answer your questions.
Let me turn the call over to Sanjiv.
Thanks, Juan, and good morning, everyone. Linde employees, once again, produced stellar results in the second quarter, achieving multiple new records, including a 24.2% operating margin, a $2.7 earnings per share, and 15.7% return on capital. Volumes grew 15%. Pricing increased 3%, along with global recent inflation. And we continue to optimize the business through many productivity initiatives.
I'm really proud of how the Linde team delivered industry-leading performance, despite the many challenges we constantly face. And I expect to continue this performance for many years to come.
Last quarter, I presented to you the Linde strategy, which outlined the leavers that we use to grow EPS, more than 10% per year. Given the results so far, I think it's safe to say we are well on our track. That said, I believe it's also important to have a clear path to future revenue expansion, which I'd like to discuss on the next slide.
So, on slide three, you'll see that when previously I had highlighted to you that Linde has a unique advantage of being able to offer its customers a sale of gas or sale of plant option. Our engineering capabilities are a clear competitive advantage, allowing us to participate in almost every type of growth opportunity, while maintaining our investment criteria. Going forward, we are therefore going to present the sale of gas and sale of plant backlog combined. This quarter, our total project backlog stands at approximately $7.5 billion, representing contractual growth with high-quality customers and secured cash flows.
Now, in addition to this project backlog, in parallel, we also invest around $1 billion per year on base business growth opportunities. These are great opportunities to deliver high-quality long-term growth, but they're either under $5 million in spend or don't contain contractual fixed fee elements for secured incremental growth. Base growth projects typically also have shorter execution times, a margin accretive and support our network density strategy.
Some examples include the clean energy projects we announced earlier this year, the hydrogen liquefier in the U.S. Gulf Coast that we recently started up and, of course, more than 25 small on-site projects that we have already run this year. We saw glass, pulp and paper, mining and other growing end markets with these small on-sites.
In addition, the business continues to leverage a dense network, with winning new merchant and packaged accounts, which further enhances the quality of our business. I stated we currently have approximately $7.5 billion of contractually secured growth projects, which we'll execute over the next three to four years, plus $1 billion per year of incremental base growth CapEx.
The revenue expansion from these investments exclude organic growth already been captured from our existing dense supply network across a diverse spectrum of end markets. Of course, the growth demonstrated how we leverage this through the current economic recovery that you're seeing.
As I sit here today, we are currently reviewing a pipeline of hundreds of prospective projects, not included in this backlog, which easily represent more than $10 billion of potential investment opportunities, including a significant number of electronics and clean energy projects and, of course, sale of planned projects. Both sale of gas and sale of plant are great ways for us to grow, while maintaining our investment discipline.
Given our strong execution capability, I remain bullish on Linde's outlook and growth prospects. Regardless of what happens with inflation or macro economic trends or the pace of secular growth drivers, we have a proven business model that can generate compound value growth for our shareholders today and decades into the future.
Now, before I hand it to Matt, I want to make a comment on our ESG goals. I mentioned to you in last quarter's call that we are developing new ambitious ESG goals, which we expected to share in the near future. We've been diligently working with our business leaders around the world to determine these targets and more importantly, to incorporate them in our operating rhythm. Based on that progress, I expect to disclose these new ESG goals before the end of the year.
I'll hand over now to Matt, who will take you through the financial results and guidance. Matt?
Thanks, Sanjiv. Please turn to slide four for an overview of the second quarter results. Sales of $7.6 billion are up 19% from 2020 and 5% sequentially versus prior year volumes increased 15% across all supply modes and end markets.
Manufacturing, chemicals, and metals drove this increase, since Q2, 2020 was the low point for cyclical markets. Sequentially, volumes increased 4%, which marks the fourth consecutive quarter of volume expansion, demonstrating our leverage to the economic recovery. Price increased 3% versus prior year and 1% sequentially, as all geographic segments continue to manage inflation. This is also evident in the 2% energy costs pass-through related to on-site contracts.
Operating profit of $1.8 billion increased 39% over prior year and 9% sequentially. Operating margin of 24.2% was 350 basis points over last year, despite a 50 basis point headwind from cost pass-through. This represents the eighth quarter in a row we have increased operating margin more than 200 basis points from a combination of volume expansion, pricing actions and productivity measures. EPS of $2.70 increased 42% from 2020 and 8% from the first quarter.
We've also provided the Q2, 2019 growth rate of 48%. As mentioned last quarter, I believe it's important to distinguish true growth, which this clearly demonstrates from mere recovery. ROC, which is one of the most important metrics in this industry, rose to a record 15.7%. It has increased every quarter since 2018 from steady profit growth over a prudently managed capital base. In fact, Linde has consistently proven the ability to deliver industry-leading high-quality growth by following a disciplined capital allocation model.
Slide five provides more color on that capital allocation model, including overall cash management. You can see the progression of operating cash flow on the table to the left, with the first half up 27% over last year. Note that we had $300 million of higher cash taxes this quarter when compared to Q2 last year. Since this is only timing related, I expect operating cash flow to improve year-over-year and sequentially in the third quarter.
To the right, you can see how we allocated capital for the first half this year. Stated simply, we want to grow the business, invest back into the business and reward our shareholders with increasing dividends and share repurchases. I think the pie chart below confirms this approach. We invested $1.5 billion into the business and returned $3.2 billion back to shareholders.
I'll wrap up with guidance, which you can find on slide six. This slide is similar to last quarter, including how we set the guidance ranges. Third quarter guidance is $2.60 to $2.70. This represents 21% to 26% growth over prior year and 34% to 39% growth over 2019. Compared to Q2, this assumes no sequential improvement in the underlying economy and a 1% foreign currency headwind.
For full year 2021, we are raising prior guidance by $0.50 to a new range of $10.10 to $10.30. This $0.50 increase is from the Q2 outperformance and the higher Q3 guidance range. In other words, and consistent with last quarter, we have not updated the fourth quarter at this time. Rest assured next call we will provide an updated and more meaningful fourth quarter guidance.
And if volume trends are stable or improve, we'll be at the upper end or above this range. Until that time, we remain highly confident in our ability to grow 2021 EPS at least 23% from last year and 38% from 2019, while positioning Linde for industry-leading long-term value creation.
And now, I'd like to hand the call over to Q&A.
Thank you. [Operator Instructions]
And our first question comes from David Begleiter from Deutsche Bank. Your line is open.
Thank you. Good morning. Sanjiv, you map this 15% of volume growth in the quarter, what do you think that was versus the industry? Did you gain share do you think this quarter versus competitors?
David, thanks for that question. So, as you saw, solid growth and we mentioned across all end markets as well. The reality is we saw that economic recovery come through. We've set as part of our strategy. We'd leverage that economic recovery. That's what we're seeing happen around. I would say that in some markets we have seen some share gain, but that's kind of an ongoing business transactional element that we see all along.
Very good. And Matt, thinking about share buybacks, how should we think about buybacks in the back half of the year?
Yeah. So David, as you know, from our capital allocation policy, we'll continue to sweep excess cash towards buybacks. So, year-to-date, we've been over $2 billion. We're on a good pace. And as I mentioned, I expect Q3 cash to be higher. So, I see no reason why we need to deviate from kind of our current pattern. But obviously, our priority continues to be to invest in growth, which we're going to do. And as Sanjiv mentioned, we have a lot of opportunities there, but we'll also be repurchasing shares pretty much every day in the market.
Thank you.
Thank you. Our next question comes from Tony Jones from Redburn. Your line is open.
Thank you and thanks for letting me ask questions. Good morning. Yeah. I've got two, actually. One was on volumes. So, if I look at say Q2, 2019 and then sort of adjust for the price and cost pass-through this quarter has just reported, sort of implies volumes are up about 3%, 4% versus that Q2 in 2019, but slightly down in Asia. Firstly, I guess, is that right? Does it maybe imply some further optionality in Asia-Pacific? And can we use that sort of underlying 3% to 4% volume growth versus 2019 the next couple of quarters?
And then a second question, sorry. If I'm asking quite a few things here. CapEx in the cash flow and also as a percentage of sales, looks like it's been trending down for awhile, but the project backlog looks really solid. How should we think about that? Or is it just the post-pandemic timing effects of investments? Thank you.
Tony, thanks. Why don't I jump into the CapEx piece and then I'll ask Matt to just talk through the volumes and reconcile them. Just on CapEx, I think one of the reasons we are providing that pipeline view today was to give you a sense of how we see that opportunity.
I've said in the past, I've seen some improvements and proposal activity across both sale of gas and sale of plants and on the sale of gas side, that proposal activity, particularly coming from electronics as an example, and, of course suite of clean energy projects and the more traditional markets as well, including chemicals and us and others. So, I do expect to see that CapEx reflecting the pipeline opportunity that we just defined. So, I don't see -- I mean, the changes are marginal anyway, but notwithstanding that I see absolutely no concerns around how I expect that pipeline to flow into backlog. Matt?
Yeah. Thanks. And Tony, yeah, just to answer the volume question, your calculation is close, but it's about 5% globally is what we would have seen Q2 volumes versus 2019 from this quarter. And Asia-Pac actually is leading, it's more around 8%. So, I'm not sure if maybe in the deconsolidation or how you calculated that. But the volumes in APAC were about 8% above Q2, 2021 versus Q2, 2019. And we're pretty much off mid single digits across the board for all the regions.
So, I would say we're seeing the right patterns and the right traction and obviously price 3% to 4% as well when you look at that metric versus 2019.
Thank you. That's great. Good detail.
Thank you. Our next question comes from Bob Koort from Goldman Sachs. Your line is open.
Thank you very much. Good morning.
Good morning.
Yeah. I wanted to ask about the Jurong Island project that was going to start up in 2023. How's that progressing, I think it's your biggest ever investment? And what have you learned if anything about building those gasifiers? Thanks.
Thanks Bob. So, one of our larger investments as you rightly point out, that's progressing well. Obviously, there has been some COVID impact on our schedule as well as of our customer, that's still on track to getting largely mechanically complete by the dates that we'd originally set out plus or minus a few weeks. And to be honest, Bob, we've been running gasifiers at that Singapore site for decades.
So, really, none of this is new for us. From an engineering point of view, we've been building gasifiers for decades as well. So, there's a lot of that organizational learning that we've been able to put into that project. So, it's coming along quite nicely.
And as a follow-up, if I might, you guys have an interesting seat in the whole gasifier hydrogen economy, that's developing. I wonder if you can give us your latest thoughts on which way that's going. Is it going to be globally distributed hydrogen from single complexes in the best electricity areas? Is it going to be locally produced hydrogen? Is it going to be ammonia, any updated thoughts on how you see that ecosystem evolving?
Sure. Sure. Happy to provide that, Bob, and that's a great question. So, it is, as you rightly point out, a very fast developing dynamics space, and we start talk more and more about clean energy more broadly. But just talking about the specifics of what you've asked. So, our view is, when we think about our strategy, we believe local execution and locally driven strategies are where we see the most value creation in terms of our business model and in terms of how we kind of attempt to take that strategy to execution, where we are demonstrating that the South Korea, local market, where we are putting a liquefier in, building a whole ecosystem around liquid fueling for heavy duty vehicles. So, that's kind of broadly our strategy.
Now, I must add to that with all of that obviously, we also recognize there's a portfolio approach that we would be taken to this. And we do expect to see that there will be some larger installations that that would feed markets, which may not be entirely local, which might have some export content to it. But we do see the distributed model as being certainly both more effective and creating greater value, but supplemented in cases by some larger production facilities, but you have some obvious competitive advantages.
I mean, we've talked previously about how you could get in Northern Africa as an example, very low cost electricity that allows you to put a large complex, green hydrogen production facility, and the best way to get that hydrogen to market, as an example, would be to then take it from that large complex and buys it across to Europe, if you put. And again, you'd have to repurpose some of the existing pipelines and make sure that cost effectively gets to Europe for it to have some traction there.
So, that's one example that we think, you would see -- changes that happened in Chile with the -- the desert has -- is similar advantage of very high-quality solar, the ability to take that put into renewable power, generate green hydrogen, and then move it to markets close to it.
Does that give the color you were looking for?
Yes. Perfect. Thanks so much.
Thank you. Our next question comes from Nicola Tang from Exane BNP Paribas. Your line is open.
Hi, everyone and thanks so much for the interesting some color around the project backlog. I wanted to ask a little bit around that. What's the backlog itself -- pretty solid at the $7.5 billion. The size of the backlog itself hasn't really been growing. If anything, I think it was more like $9 billion or $10 billion a couple of years ago. If you talked about those hundreds of projects where like, potentially $10 billion, can you talk about the potential timing of adding those into the backlog? As existing projects come online, and then, that will drop out the backlog. Do you expect to see growth in the backlog, or actually it will be more stable at current levels on a sort of net-net basis?
And then the second question similarly around the backlog was, I was curious, Rajiv, you mentioned that you're seeing project activity or potential project activity in traditional sort of industrial areas. I was curious to understand, what areas -- what you're seeing that pickup in activity? Yeah, and then I've got a next step, but I'll pause that.
Thanks Nicola. So, let me start over with the backlog. And then we come back to the project activity pickup that I referenced. So, as you said, the backlog is $7.5 billion, it gets impacted by startups that we have. So, we are going to have some startups later this year, and we'll see that that impact flow through -- you've actually got some press releases that we had recently around some of those as well.
Now, in terms of timing of the projects coming into the backlog, as you know, we don't often control that timing, more often than not one controls the timing, because you kind of doesn't let us announce many of these wins, but notwithstanding that, you will see in the second half an improvement in that backlog come through, because we are very close on a couple of projects, which we think will be formally closed out, but just contract signed before we can bring them on.
Again, Nicola, you know this, but I'll just recap it. Our conditions for putting something as a backlog are very stringent. They have to be secured by a contract. It must be more than $5 million, obviously for the larger projects, that doesn't matter. And it needs to have a guaranteed cash flow profile, which ensures that, that backlog then has incremental, guaranteed incremental growth.
So, those conditions have to be met and we see a number of projects that will flow into the backlog later this year. And then some obviously in the early part of next year as well. So, I've been reasonably confident on the developments that we are going to see in that backlog, both on the sale of gas and the sale of plant side.
Now, I'll move on to the proposal activity. So, I'm going to talk about one area in particular where we see a significant amount of activity. And you've heard me references before, Nicola, at one time as a surprise, which is electronics. And really you've been hearing in the press, obviously a lot about chip shortages, but the reality is, that industry has been looking at ramping up its production capabilities for about 12 months now. And there are a whole sub projects that are all in various stages of development by TSMC, by Samsung, by Intel, by GlobalFoundries. There's a long list of people who are going to be investing in that space. And therefore, a large part of our time at the moment in that proposal activity is being spent around electronics area in particular, Nicola.
Now, in addition to that, we're also seeing some chemicals projects. We're also seeing even -- and it might surprise some, but even in the seal area, we're seeing some projects. The one other area Nicola, which kind of is really linked to clean energy, but where we seeing refining, chemical, even steel companies engage actively with us, is around reduction in their emissions, or in the case of refining, what can we do around carbon capture and making -- reducing their emissions? How can we help them create technical solutions?
I've said this before in the last call that, we have a full suite of technologies around this. We have the ability working with partners to provide a holistic solution to many of our customers in that space. And again, we're seeing a lot of activity pick up on that and move forward.
That links quite nicely to my last question on sort of the decarbonization point. I was wondering if you had any initial thoughts on the use for 55 proposal and potentially what it means for Linde and/or the wider gases industry, I suppose? And whether there's any sort of progress on CO2 framework on the U.S. side and somebody, what can that mean for you?
So, Nicola, you've heard me say this before. That's for decarbonization more broadly and the hydrogen economy, particularly the pickups, we need a couple of three things to happen, obviously regulation with deep. We've seen that happen very much in Europe. I think your point is absolutely valid that, we see Europe provide the kind of penalties and incentives, the guidance sticks, which are allowing momentum to build in that space quite actively and aggressively.
So, that was good to see. We are participating in that, whether it's gypsy funding, whether it's other incentives, whether it's the broader coalition that is looking at contract for differences to make sure that we're leveraging facilities elsewhere to support European economies.
I've also said -- and of course, just to make the points in the U.S., we are encouraged to see progress happening in that area as well. Now, that the U.S. currently offers 45Q, our view is that that is inadequate for any substantial momentum to build up in the space, but I'm encouraged by -- conversations going on in the House. And hopefully the Senate that'll move some of the incentives and proposals forward in that space. So, I'm looking forward to seeing developments there quite closely.
So, I guess, the other couple of things that need to happen, which I think, create the momentum that we need. And I am at the risk of repeating myself from the last call, we do need to see that the technology roadmaps ensure that the technology for either green and blue which is currently available and scalable, creates the cost curve that is necessary for large scale adoption to happen. That remains -- I won't say that the challenge that is actively being worked on, but there is a timing challenge to that. And I know take years before we get to a point, but green in particular, has the ability to have a cost-effective solution available at scale, good solutions that are available today. We provide many of those ourselves, but I recognize that there was still a scale up, that is currently lacking in the green hydrogen space.
And finally, I think we need to be working very closely with making sure that the endpoint consumption in this case, if we're talking about heavy duty, vehicles, buses, or trucks, or indeed trains and ferries, that technology development in that space is happening actively. Hence the number of partnerships that we do to make sure that we're right in the middle of those developments, and we are encouraging and promoting them as much as possible.
So, I know I've provided the border answer than you were looking for, but I think this was worth recapping, because these are the things that are ensuring that the momentum that we see today sustains, and you actually see investment and development in that space.
That's great. Thank you so much.
Thank you. Our next question comes from Jeff Zekauskas from JP Morgan. Your line is open.
Thanks very much. Your returns on capital have moved up, which is natural given your cost reduction programs and the growing economy. Have your returns on capital though in your on-site projects really changed over the past couple of years? That is, are the returns on capital and an on-site going up or staying the same?
Jeff, this is Matt. How are you? So, our investment criteria is the same. So, we've maintained that throughout and therefore, how we look at the projects and the expectations we have, remained the same. But to your exact point, given the density model that we have, we're getting significant growth on this business on a non-capital intensive basis. And then, we continue to deliver on our projects, startup our projects and execute those projects, which deliver on the expected returns that we entered into them on. And the combination of the two is giving us a significant acceleration in return on capital. And at this point, we continue to see this happen and as long as these trends continue, it should bode well for that metric going forward.
Okay. Thank you for that. And in your -- in the hydrogen area, when you contemplate various projects, are any of the projects that you contemplate involved with ammonia being made in some jurisdiction, whether it's the Mid East or Australia or somewhere else that is -- are you working with any possible builders of those projects or you're not doing that?
Right. Jeff, so, our headline that by saying yes, we are. And I want to kind of give you a slightly broader picture as well, I guess, just to give you a sense of where we stand on the hydrogen piece. So, as you know, I've mentioned this before on a previous call that we run our Linde hydrogen council. We meet every month, we review all the projects. The last -- the last review we had a couple of weeks ago was, saw 240 projects across that whole range of opportunities in that space, adding up to, what we call, probability related CapEx, so value about $4.1 billion. So, again, these are -- some of these are larger projects, obviously large -- we see a large number of mobility projects, which tend to be somewhat smaller.
But to your point, one of the areas where we've seen both the increase in the number of projects, as well as large size projects is the space of carbon capture. And beyond that, we then look at hydrogen and ammonia as being two elements, which kind of get added on downstream to that. So, the answer is yes, we were working with a number of different customers and players who are looking at the ammonia loop.
Jeff, you may also be aware that Linde has its own ammonia loop technology out of Linde Engineering. So, we've done a number of these ammonia loops elsewhere, including in the Middle East and in Eastern Europe and in the U.S. So, we have that unique advantage of being able to tie all of those technologies in and provide those solutions, which makes it very attractive to many of our customers.
Thanks very much.
Thank you. Our next question comes from P.J. Juvekar from Citi. Your line is open.
Yes. Good morning, Sanjiv and Matt. Sanjiv, does your deal with ITM give you any advantage in winning green hydrogen projects, since you have the PEM technology through the joint venture, and can you sort of give examples of that?
Yes. PJ, hi. So, yes, of course. So, the deal with ITM is unique in many ways, PJ. The first that we are an equity investor in ITM, that means we are still in the game with them. But more importantly, we have a joint venture with ITM, that there is Linde Engineering/ITM joint venture called ILE, which is where all the scale up on larger projects above a particular size happens. And that is what gives us the unique competitive advantage of having access to grade them technology and being able to support ITM in scaling that up for large projects that we're looking at and pursuing. And again, we are seeing good developments in that space.
A lot of proposal activity, PJ, as I referenced earlier on. We are very close in a number of cases in those discussions with some select customers. So, really pleased to see that ITM linkage and find ourselves leveraging that quite actively, as we develop these projects.
Great. Great. And sticking to green hydrogen, you also had a deal with Plug Power to use their fuel cells to convert some of your Class 6 and Class 8 trucks over to hydrogen. Can you give us an update on that? Thank you.
So, PJ, we are working with Plug Power and we work with Plug Power in many different ways. We supply most of the hydrogen requirements today, as an example, while they don't have their own facilities up. We are also looking at a collaborative development in a number of other spaces, which hasn't been announced yet, but we are kind of progressing on different fronts over there.
One of the things that we have agreed with Plug Power and I must admit here with a few other players as well is that we will be trialing on our trucks fuel cells and then we'll be moving our products to hydrogen. So, we already have a plan in place for the U.S., for Europe and South Korea to be progressing with those trials and seeing how they move forward. So, again, a lot of activity happening in that space. We are really waiting with bated breath, PJ, to get these trucks on the road.
Great. Great. Thank you.
Thank you. Our next question comes from Peter Clark from SocGen. Your line is open.
Yes. Good morning, everyone. Thank you. The first question is around -- it’s a actually following on from the first question you had about the market share. Particularly looking at the U.S. packaged gas business, because I know there's differences in mix. I know the biggest competitor out there has a lot of hard goods, a lot of construction, but you've been seeing double-digit growth now in that business in the first quarter, you probably accelerated and what you saw in the first quarter, in the second quarter, and they're still actually down particularly dragged back by the hard good. So, I'm just wondering, are you taking some share, or is it all about mix and maybe regional?
And then, the second question is around the investments. Obviously, you're very excited with all the organic investment you have, and the potential for that. I'm just wondering on the potential acquisition line, are you just not seeing many potential targets that fit the criteria on return, given what you can do internally with your money? Thank you.
Thanks Peter. A great question. So, I have to admit, Peter, I am thrilled with the U.S. packaged gas business in the way -- that team is really moving forward at the moment, but they've received double-digit growth, both on gas and hard goods. We see strong sequential growth on both of those elements as well. So, I know I've read, some of our competitors talking about that space, but the reality is we are certainly growing very strongly in that space. And I see us kind of moving forward.
Anecdotally, obviously, people will tell you that we are taking share, but I don't particularly want to comment on that. That is anecdotal, but you can look at the numbers. And I think, the comparison will kind of tell its own -- get you to the right conclusion. So, again, very strong performance over there on both hard goods and gases.
If I move on to investments and talk a little bit about the acquisition space. So, one of the challenges, Peter, as you'll appreciate, given where we stand in our size and having come -- lift through three years of regulatory approvals on the merger, we are very sensitized to how large acquisitions can happen. So, we are left with a much smaller pool of opportunities there. We will do tuck-in acquisitions in most of our markets any day, a good high-quality tuck-in acquisition, we will go after and we will do that, as soon as we find them. And, of course, they have to live up to our investment criteria requirements, as you know well.
The larger ones become a little more challenging, particularly as we've got to kind of understand the requirements from local regulatory environments or antitrust, et cetera. And that's where typically something larger trips up. So, do I expect to see us doing acquisitions moving forward? Yes. Will you see a large number of tuck-ins happen? Most likely where we find those opportunities come through, we will certainly pursue them, all day long if we could.
Got it. Thank you.
Thank you. Our next question comes from Geoff Haire from UBS. Your line is open.
Good morning. Just have two quick questions. First of all, in the margin improvement that you report, can I just check, does that include any benefit from rising energy costs? And if it does, could you possibly break that out?
And then, just looking at the operating cash flow, which has obviously flattened Q2 year-on-year and down sequentially, you've mentioned higher cash taxes. Are there any other movements within the cash flow in the quarter that are -- and have a negative impact?
Okay. Hi, Geoff. It's Matt. I can answer that. So, I think your first question, just to make sure I got it right. You were asking about margin related to energy. Can you repeat that one again? I kind of lost.
Yeah. So, obviously you've got big margin improvement that you've been reporting, almost every quarter since you've come -- you've merged. I'm just trying to understand is, within that margin improvement, you've obviously had rising energy costs. Does not give you a benefit to the margin as well? And so, I'm trying to look at what the margin improvement would be net of rising energy costs?
Yeah. So, on that one, the actual -- the rising energy costs will dilute your margins and that's what we call cost pass-through. So, we isolate costs pass-through. And obviously what that is, it's as simple grossing up. So, you'll see the sales and cost of goods rise equal dollar amounts. So, therefore, it has no effect on our variable contribution or gross contribution dollars, but it will have a negative effect on your margin, because you're simply doing a gross up effect.
So, we isolate that out as cost pass-through that is primarily natural gas and electricity energy. So, those components tend to drive that. Obviously, as inflation you're seen in those type commodities rises, we will pass them through, but they will dilute our margins. So, for example, year-over-year, I'd mentioned while we're up to 350 bps on our margin, that includes a 50 basis point headwind related to this cost pass-through. So, excluding that, we would have been up 400 basis points year-over-year. So, we are passing it through as our contracts enable, but it will be diluted.
As far as operating cash flow, yeah, to your point, the $300 million that was incremental year-over-year, it's about $250 million sequentially, with the impact of taxes and that is purely timing just when payments were made. In addition, working capital, probably was about $100 million or so unfavorable, part of that is growth and we are growing. So, we're consuming a bit of working capital. But when I look at our cash conversion cycles, our DSOs, they're quite good across the board.
Another piece is simply engineering timing. As you saw engineering was consuming a bit of their backlog. What that is on a cash cycle? You tend to have more of a negative downside, but as Sanjiv mentioned, we have a high degree of confidence of our entire backlog, including sale of plants. So, we feel that's something looking forward will turn around and I feel pretty good about where our Q3 cash flow will be and making some of this timing backup, both on working capital, as well as cash taxes.
Thanks.
Thank you. Our next question comes from Markus Mayer from Baader Bank. Your line is open.
Yeah. Good morning, gentlemen. Two questions from my side. First of all, on your nitrogen business, given the recovery of the oil price, was there already a positive effect on your nitrogen fund or recovery business? And if not, what kind of oil prices you think you need to or your business need to see a recovery there? Can't be back to 2013, 2014 levels.
And the second question will be on the effect of startups you expect this year and also next year that we can basically strip out the underlying business together, this new business.
Thanks Marcus. So, your question on nitrogen and recovery using nitrogen, as you know, we've got a couple of large customers who do that. That's been fairly stable through this period, so we haven't really seen a significant volatility in that. It's been stable and works right through. The geology is, Marcus, that as you are using nitrogen for enhanced recovery, you are then in that process linked to that you can't really step out or provide a lot of volatility, it doesn’t great for the field. So, you see that it's fairly stable levels.
In terms of startups, yes, we do have a number of startups happening. As you know, from time to time, we kind of release -- provide a press release that covers some of those. I don't want to name them, but we do have a few happening towards the end of this year. And yes, beginning of next year as well, there'll be a few more startups that'll happen.
But the kind of magnitude of growth, can you give us some kind of indication?
So, one way to think about that, Marcus, is I'll bring you back to something that we've said in the past, and just gives you a correlation, which is when I think about our EPS growth, I'd say, our backlog and therefore that really -- that backlog getting converted into startups provides us roughly a two percentage point over a three-to-four-year period. That's what we like you to see from the backlog that we currently have. And that's one way to think about how that startup impact comes through down to the EPS level.
Okay. Thank you.
Thank you. And our next question comes from John McNulty from BMO Capital Markets. Your line is open.
Yeah. Good morning. Thanks for taking my question. So, I guess, two of them tied to the same topic, which would be inflation. So, obviously, we're in a really kind of almost hyperinflationary market. Can you remind us in terms of the backlog that you've got and the projects that are in that backlog, how much of the equipment, the materials, et cetera, have already been locked up so that you don't have to worry about inflation? And what percent is maybe not necessarily locked in at this point that we have to kind of think about?
Sure. John, so, when we get into a point of securing a project, whether it's on the sale of gas or the sale of plant side by then, we get into a very -- a fairly detailed costing mechanism. And we lock in our costs at that stage with all the OEMs in particular, but other vendors as well. So, when we are in the backlog stage of, most of our costs are already locked in pretty much. So that should give you a sense of how we stand.
As we are seeing inflationary trends now, we already factoring that all -- those into the proposals that we're developing and providing to customers. So, again, we have good mechanisms in place, a lot of experience of having managers, John, to make sure that that coverage is very strong and innovate diligent process or rigorous process around it and our engineering team.
Got it. No, that's helpful. And then, I guess, just kind of tied into that, given this inflationary environment, it does look like your European business, your Asian business, we saw some price acceleration. Is that something -- given the inflation levels that we're seeing, that we could see further acceleration from the pricing that you're putting through. And I know it's pretty lofty already, but can we see even more of that, just given the environment, how should we think about that?
So, John, that's a great question. And as we've kind of shown, 3% overall pricing comes through -- you'd know that a large part of the pricing comes through the merchant and package business and very little about really comes through the on-site line. So, therefore, you can do the math and you'll get to a number that says mid single digits on average, on pricing across those different segments, particularly from merchant and package.
Now, our team has done a fabulous job of making sure that we remain ahead of the curve as far as inflation is concerned. We've been telling you this for about two quarters now, and I expect that team to continue to do that as we move forward. So, for us making sure that we are working that pricing. We were having those conversations with our customers. As we see those inflationary trends continue to come through, it remains right on top of mind for us.
Got it. Thanks very much for the color. Appreciate it.
Thank you. Our next question comes from Vincent Andrews from Morgan Stanley. Your line is open.
Thank you. Just a question, the $1 billion of base CapEx that you talked about, could you just talk to us about sort of what -- how sort of robust that menu of opportunity is? And why you choose it to be a $1 billion versus why isn't $500 million, or $2 billion? Is it -- as far as I can see, how does the returns there compare to the traditional CapEx backlog?
Sure. Vince, that's a great question. I'm glad you asked that question, because I've been itching to talk a little bit about small on-site, so that's a good lead in there. So, let me pose -- just describe that. So, essentially, when we have projects and I think small on-site is a great example to just illustrate the point. Here we have -- we have long-term contracts, so these are contracted. We have kind of secured cash flows in there. But individually, these are less than $5 million each typically, what we call our small on-sites. And they have shorter execution timelines. They were accretive, good, solid returns. These are projects we'd love to do every day.
And the reason I want to particularly talk about it today also is, because in the first half of this year, there's 20 -- more than 25 of these projects already. We've signed up more than 25 small on-site projects already. Now that's a 50% jump over last year. Same period last year, 50% higher than that. And I love this project, because great, solid return, good strong execution. These are packaged plants, so we can go in there and work on them very quickly. And which is why we get that execution advantage as well.
And I think the other point to just make over here and while I -- most points, I think, we think about the merger being over and that's true. But here's an example of revenue synergies that we talked about, we never really got a -- we never really put a number to it, but this is a good example of how the revenue synergies from the merger are flowing through. That we brought in two suites of technologies, giving us a really strong position in that space. And we'll leverage that actively in kind of winning these deals that you see us put through. Now all of these come through that base CapEx.
So, am I excited about that number of $1 billion? I am. There isn't a cap to it and that flexes with what the business does and what the needs of the market are. And clearly, we will flex that with what we see in the market demand. All of needs this -- those investments have to meet our investment criteria. That's all it needs. Good quality projects any day, anytime, happy to do, small or big. I hope that have sense.
That was great. And maybe just as a follow-up and I might be reading more into this than I should. But now that you're combining sort of the sale of gas backlog and the sale of plant backlog, it feels to me, you're just sort of bringing the sale of plant business a little bit more to the front of the stage than perhaps spend in the past. I see clearly that that's a lower margin business, but it's a -- obviously a CapEx light business versus the sale of gas. So, I'm just wondering, am I correct that you're kind of thinking about the engineering business having more prominence on a go-forward basis? And do you have a plan there to sort of improve the margins and the returns, or is there more we're going to be hearing about it in the quarters and years to come?
That's a great question. So, let me just take a step back if I may, and just talk about the concept of how we think about our business and opportunities, right? So, the starting point for us is, we want to be able to participate in the full range of opportunities that we see in the marketplace. And to do that, I have a unique competitive advantage, which I am going to leverage, which is the ability to offer an attractive sale of gas model or in some cases where that customer looking at those two models is not particularly keen on that to be able to offer and get the business with the sale of plant model, right? So, either proposal for me works quite well.
Now, the profiles are a little bit different. You're right in saying that, doing an EPC type structure for us is asset light. It is ROC accretive. It's cash flow positive for us. So, we do think, our engineering capabilities and the fact that we have those capabilities executing day-in and day-out at a tremendous level is a really strong competitive advantage that we have. And we want to make sure we leverage that as much as we need to.
Now, I do want to just make sure that you understand and recognize that we aren’t giving prominence to one or the other. These are two -- these are kind of two options I have and I use those options where I need to, and where I can exercise them and do what's best for the organization. Now, there are two kind of underpinning principles in there. One, I want to be able to approach every opportunity in my space that I have the advantage and the ability to execute on. And two, I want to maintain discipline and my investment criteria. And I think this is that unique advantage that we get, bringing the two together.
Excellent. Thank you very much. Appreciate it.
Thank you. Our next question comes from Mike Sison from Wells Fargo. Your line is open.
Hey, good morning. Nice quarter there. Historically, inflation environments tend to be good for industrial gas demand. And I'm just curious, given where we're at in this inflationary cycle, do you think there could be sort of a step-up in the multiplier for demand for industrial gases as we head into the next couple of years?
Hey, Mike. That's a good question. So, when we think about inflation, typically we spend most of our time talking about what happens with the pricing side, but you're right. Inflationary environment, we actually like inflation as you've heard us say before. Largely because on the pricing side, we have the ability to pass -- much of that inflation through our contractual structures onto the customers. And also, it's a good opportunity for us to open the conversation on pricing.
Now, typically when we see Inflationary environment, we do see some industrial activity pick up and recoveries happen and constraints that lead to that inflationary environment, that's where we play actively. And yes, I think in some areas we will see some of that play out into demand -- on the demand side as well.
Great. Thank you.
Thank you. Our next question comes from Kevin McCarthy from Vertical Research Partners. Your line is open.
Good morning. Sanjiv, I was wondering if you could provide an update on the Snam deal that you announced in December of last year to develop clean hydrogen projects in Europe. How has that partnership going in the early days? Is the paradigm to move inexpensive energy from Northern Africa up to the European continent? And if so, what are the barriers, if any, to making more substantial capital investments in that arena, does it have to do with technology and production economics, or perhaps more on the commercial side? Maybe you can flesh out how you see the future there.
Thanks, Kevin. That's a really good question. So, the partnership with Snam is gone vile and we are like-minded in our view of how the market needs the hydrogen in Europe, in particular mainland Europe needs to be met and that kind of common understanding and common appreciation of what needs to happen is critical for that partnership development to move forward to getting something substantial happen.
Now, as with all the things, Kevin, these things take time, and there is, as you are aware, a lot of funding activity happening in Europe as we speak. And as part of that, I think we are waiting and watching to kind of see how that develops. So, that's in terms of how the partnership itself is moving forward.
I want to just take a bit of time and talk about your other part of the question, which is, what do we see as elements that will either encourage or create barriers for some of these substantial developments to accelerate and get momentum. And here -- and unfortunately, I'll be repeating myself a little bit here, but I said earlier on that -- to Nicola's question that, you need a couple of things to be happening in tandem, right? One, you need to see the regulatory environment, with some -- come into place, in Europe we do have that. But I must admit at the same time that it is complex. I want to bureaucratic, but it's almost out of -- has a number of administrative controls. It goes through a country process for us then at the European Union level, and then some allocations will happen. And there's a whole suite of activities that need to happen before some of that funding and incentives become actually available for you to be able to go out and make these substantial developments happen. So, there is a whole piece that, is just -- it's part of the process.
On the technology side, the other piece that I mentioned, you need a roadmap where you can develop on the assumptions and Europe is kind of chosen the part of green. My view is that scale will happen on blue hydrogen before it happens on green. There is absolutely no doubt in my mind that that is true today and will be true for a number of years to come. Technology for scaling up on blue exists today. Linde provides that whole suite of technologies today to be able to do that.
So, on the green side, which is very -- Europe is kind of move forward and I want to select it, but certainly lean towards, we will need to see that technology development to scale happen. I think that is a technology roadmap. That's kind of three to five years out. You need low cost renewable energy. Again, that's a development that's in progress and not available everywhere in Europe, as you know, which is why this whole concept of Africa becomes so attractive and Northern Africa in particular. And you also need effective technology roadmap for the electrolysis to be able to bring that capital efficiency up to a point to -- capital down efficiency up to get to a point where you can then create a cost advantageous position for green. I see those as -- both work in progress. We are actively involved in all of those activities as we move forward, but it is still work in progress.
Very helpful. Thank you, sir.
Thank you. And we will take our last question from Laurence Alexander from Jefferies. Your line is open.
Good morning. Can you just elaborate on the discussion around pricing? Are you seeing existing on-site customers start reopening contract negotiations or renewals earlier than normal to get in front of the inflationary cycle?
Hey, Jeff, or Laurence, sorry. It's Matt. I would say no. Things are pretty consistent with as you would expect. I mean, normal pattern is usually two to three years prior to the exploration. You begin to talk about the renewal and any type of inflationary environments usually don’t have any impact on that.
Okay. Thank you.
Thank you. And that does conclude our question-and-answer session for today's conference. I'd now like to turn the call back over to Juan Pelaez for any closing remarks.
Crystal, thank you. And thank you everyone online for participating today's call. If you have any questions, feel free to reach out. Have a great day.
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and you may now disconnect. Everyone have a wonderful day.