Earnings Call Transcript
LINDE PLC (LIN)
Earnings Call Transcript - LIN Q2 2021
Juan Pelaez, Head of Investor Relations
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.
Sanjiv Lamba, Chief Operating Officer
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 levers 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, are 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 excludes 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 macroeconomic 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 White, Chief Financial Officer
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. Prices 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 the 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.
Operator, Operator
Thank you. Our first question comes from David Begleiter from Deutsche Bank. Your line is open.
David Begleiter, Analyst
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?
Sanjiv Lamba, Chief Operating Officer
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.
David Begleiter, Analyst
Very good. And Matt, thinking about share buybacks, how should we think about buybacks in the back half of the year?
Matt White, Chief Financial Officer
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.
Operator, Operator
Thank you. Our next question comes from Tony Jones from Redburn. Your line is open.
Tony Jones, Analyst
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.
Sanjiv Lamba, Chief Operating Officer
Tony, thank you. Let me address the CapEx aspect and then I'll have Matt explain the volumes and their reconciliation. Regarding CapEx, one reason we're sharing that pipeline view today is to give you insight into the opportunities we see. As I've mentioned before, I've noticed some improvements in proposal activity for both gas sales and plant sales. Specifically, on the gas side, we've seen increased proposal activity, particularly from the electronics sector and our suite of clean energy projects, as well as more traditional markets like chemicals and others. Therefore, I anticipate that CapEx will reflect the pipeline opportunities we just outlined. The changes are minor, but regardless, I have no concerns about how I expect that pipeline to translate into backlog. Matt?
Matt White, Chief Financial Officer
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.
Tony Jones, Analyst
Thank you. That's great. Good detail.
Operator, Operator
Thank you. Our next question comes from Bob Koort from Goldman Sachs. Your line is open.
Bob Koort, Analyst
Thank you very much. Good morning.
Sanjiv Lamba, Chief Operating Officer
Good morning.
Bob Koort, Analyst
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.
Sanjiv Lamba, Chief Operating Officer
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.
Bob Koort, Analyst
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?
Sanjiv Lamba, Chief Operating Officer
Sure, I'm glad to provide that, Bob, and it's a great question. As you pointed out, this is a rapidly evolving space, especially as we talk more about clean energy. Regarding your specific inquiry, our strategy emphasizes local execution and regionally driven approaches, which we believe offer the most value creation for our business model. For instance, in South Korea, we are establishing a liquefier and developing a complete ecosystem for liquid fueling of heavy-duty vehicles. However, we recognize the importance of a portfolio approach. We anticipate that there will be larger installations that cater to markets which might not be entirely local and could include some export components. We see the distributed model as being both more effective and value-generating, supported by larger production facilities when necessary. For example, in Northern Africa, the access to low-cost electricity enables the establishment of large-scale green hydrogen production facilities. To transport that hydrogen to market effectively, it could be transported to Europe by repurposing some existing pipelines, ensuring cost-effectiveness to gain traction there. Similarly, Chile has advantages with high-quality solar resources for renewable power generation and green hydrogen production, allowing for distribution to nearby markets. Does that provide the insight you were looking for?
Bob Koort, Analyst
Yes. Perfect. Thanks so much.
Operator, Operator
Thank you. Our next question comes from Nicola Tang from Exane BNP Paribas. Your line is open.
Nicola Tang, Analyst
Hi, everyone, and thank you for the insight regarding the project backlog. I wanted to ask about it. The backlog stands strong at $7.5 billion, but its size has not grown much; it was around $9 billion or $10 billion a couple of years back. Regarding the hundreds of projects that could total around $10 billion, can you discuss when those might be incorporated into the backlog? As current projects are completed, there will be a decrease in the backlog. Should we expect growth in the backlog, or will it remain stable at its current levels on a net basis? Additionally, Rajiv, you mentioned observing project activity in traditional industrial sectors. Can you elaborate on the specific areas where you're noticing this increase in activity? I have another follow-up question, but I will hold that for now.
Sanjiv Lamba, Chief Operating Officer
Thank you, Nicola. Let's begin with the backlog. As you mentioned, the backlog stands at $7.5 billion and is influenced by upcoming startups. We are expecting some of these startups to occur later this year, and we will see their impact reflected in our results. You can also find recent press releases about this. Regarding the timing of new projects entering the backlog, we typically do not control that, as the announcements of wins are often managed by others. However, I am optimistic that there will be an uptick in the backlog in the latter half of the year, as we are close to finalizing a few projects, which will be officially added once contracts are signed. As a reminder, our criteria for adding items to the backlog are quite strict; projects must be backed by a contract, involve amounts exceeding $5 million, and ensure a guaranteed cash flow profile, which contributes to incremental growth in the backlog. We anticipate several projects will be added later this year and some early next year. I feel confident about the forthcoming developments in both the sale of gas and the sale of plant. Now, moving on to proposal activity, I want to highlight a particular area that is experiencing significant activity: electronics. There has been considerable media coverage regarding chip shortages, but the industry has been ramping up production capabilities for about a year. Various companies, including TSMC, Samsung, Intel, and GlobalFoundries, are investing in this area, which means we are dedicating a lot of our proposal efforts here. Additionally, we are observing activity in chemicals projects as well as unexpected projects in the seal sector. Another important area related to clean energy involves refining, chemicals, and steel companies, who are actively engaging with us to reduce emissions. We are exploring how to assist them with carbon capture technologies and providing comprehensive technical solutions through our partnerships. We are witnessing significant activity in this domain as well.
Nicola Tang, Analyst
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?
Sanjiv Lamba, Chief Operating Officer
So, Nicola, you’ve heard me say this before. For decarbonization more broadly and the hydrogen economy, particularly regarding pickups, we need a few things to occur, primarily regulation with depth. We've seen significant developments in Europe. Your point is entirely valid; Europe is implementing penalties and incentives, which are creating momentum in that space. It’s encouraging to see. We are actively participating in this, whether through funding, other incentives, or broader coalitions looking at contracts to leverage facilities elsewhere to support European economies. I've also noted that progress in the U.S. is encouraging. Currently, the U.S. offers 45Q, but we believe that this is not enough to generate substantial momentum in the space. However, I am optimistic about the ongoing discussions in the House and hopefully the Senate that might advance some of the incentives and proposals. I am eager to watch those developments closely. Additionally, there are other aspects that need to happen to create the necessary momentum. I might be repeating myself from the last call, but we need to ensure that technology roadmaps guarantee that both green and blue technologies, which are currently available and scalable, can achieve the necessary cost reductions for large-scale adoption. This remains a challenge being addressed, but there is a timing issue involved, and it could take years before we reach a point. Green technologies in particular have the potential to provide cost-effective solutions at scale, and good options are available today. However, I recognize that we still need to scale up in the green hydrogen space. Lastly, we need to closely collaborate to ensure that the endpoint consumption, particularly for heavy-duty vehicles, buses, trucks, trains, and ferries, is actively advancing in technology development. We have partnered with numerous entities to enhance these developments and promote them as much as possible. I understand that I’ve provided a broader answer than you might have expected, but I believe it’s important to recap these points because they are crucial for sustaining the momentum we see today and for encouraging investment and development in this space.
Nicola Tang, Analyst
That's great. Thank you so much.
Operator, Operator
Thank you. Our next question comes from Jeff Zekauskas from JP Morgan. Your line is open.
Jeff Zekauskas, Analyst
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?
Matt White, Chief Financial Officer
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, start up 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.
Jeff Zekauskas, Analyst
Thank you for that. In the hydrogen sector, are any of the projects you are considering related to ammonia production in regions such as the Middle East or Australia? Are you collaborating with any potential builders of those projects, or is that not the case?
Sanjiv Lamba, Chief Operating Officer
Yes, Jeff, we are actively engaged in that area. To give you a broader perspective on our hydrogen initiatives, we run the Linde hydrogen council, which meets monthly to review our projects. In our latest review, we identified 240 projects across various opportunities in this sector, totaling approximately $4.1 billion in potential capital expenditure. While some of these projects are significant in scale, a large portion consists of smaller mobility projects. Additionally, we've observed an increase in both the number and scale of projects related to carbon capture. We also see hydrogen and ammonia as key components that follow from this focus. To answer your question, we are collaborating with various customers and stakeholders on ammonia projects. It's worth noting that Linde has developed its own ammonia loop technology through Linde Engineering, and we've successfully implemented several ammonia loops in regions like the Middle East, Eastern Europe, and the U.S. This expertise allows us to integrate these technologies and offer attractive solutions to our customers.
Jeff Zekauskas, Analyst
Thanks very much.
Operator, Operator
Thank you. Our next question comes from P.J. Juvekar from Citi. Your line is open.
P.J. Juvekar, Analyst
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?
Sanjiv Lamba, Chief Operating Officer
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.
P.J. Juvekar, Analyst
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.
Sanjiv Lamba, Chief Operating Officer
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.
P.J. Juvekar, Analyst
Great. Great. Thank you.
Operator, Operator
Thank you. Our next question comes from Peter Clark from SocGen. Your line is open.
Peter Clark, Analyst
Yes. Good morning, everyone. Thank you. The first question is about market share, specifically regarding the U.S. packaged gas business, acknowledging the differences in mix. I understand that our largest competitor has significant volumes in hard goods and construction, yet we have experienced double-digit growth in this sector. It seems this growth may have accelerated from the first to the second quarter, despite the competitor being hindered by hard goods. Are we capturing some market share, or is it mainly due to mix and regional variations? The second question pertains to investments. You're clearly enthusiastic about the organic investments and their potential. However, I'm curious about potential acquisitions. Are there currently no suitable targets available that meet your return criteria, considering the opportunities you have for internal investment? Thank you.
Sanjiv Lamba, Chief Operating Officer
Thank you, Peter. That's a great question. I have to say I'm really excited about the U.S. packaged gas business and the progress the team is making. They have achieved double-digit growth in both gas and hard goods, and we see strong sequential growth in both areas. While some competitors have commented on this sector, the reality is that we are definitely experiencing significant growth. I've heard anecdotal evidence that we are gaining market share, but I prefer to focus on the numbers, which I believe will provide the right conclusions. We are seeing very strong performance in both hard goods and gases. Regarding acquisitions, Peter, as you can appreciate, considering our size and the lengthy regulatory approval process we've gone through in the merger, we are very aware of the challenges that come with large acquisitions. This has resulted in a smaller pool of opportunities available to us. However, we are eager to pursue tuck-in acquisitions in most of our markets whenever we identify good quality targets that meet our investment criteria. Larger acquisitions are more complex, especially due to the need to understand local regulatory and antitrust requirements, which is often where challenges arise. So, do I anticipate us pursuing acquisitions going forward? Yes. Will you see a number of tuck-ins occurring? Most likely, as we will certainly pursue any available opportunities.
Peter Clark, Analyst
Got it. Thank you.
Operator, Operator
Thank you. Our next question comes from Geoff Haire from UBS. Your line is open.
Geoff Haire, Analyst
Good morning. I have two quick questions. First, regarding the margin improvement you've reported, does that include any benefits from rising energy costs? If so, could you break that down? Secondly, looking at the operating cash flow, which has flattened year-on-year in Q2 and decreased sequentially, you've mentioned higher cash taxes. Are there any other movements within the cash flow this quarter that have negatively impacted it?
Matt White, Chief Financial Officer
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.
Geoff Haire, Analyst
You've reported significant margin improvements nearly every quarter since your merger. I'm trying to understand, given that you have rising energy costs, whether that impacts your margin as well. What would the margin improvement look like after accounting for these increased energy costs?
Matt White, Chief Financial Officer
The increasing energy costs will affect your margins, which we refer to as cost pass-through. This is essentially a straightforward grossing up, causing both sales and cost of goods to increase by equal amounts. While this does not impact our variable or gross contribution dollars, it negatively influences your margin due to the gross up effect. We specifically identify cost pass-through related to natural gas and electricity, which are significant contributors. As inflation rises in these commodities, we will pass the costs along, but they will reduce our margins. For instance, year-over-year, while our margin improved by 350 basis points, this includes a 50 basis point headwind from cost pass-through. Without this impact, we would have seen a 400 basis point increase year-over-year. Our contracts allow for this pass-through, but it will still dilute our margins. Regarding operating cash flow, the additional $300 million year-over-year reflects a $250 million sequential increase, largely due to timing of tax payments. Working capital was around $100 million unfavorable, partly due to our growth, which consumes some working capital. However, our cash conversion cycles and days sales outstanding are strong overall. Engineering timing has also contributed to cash cycle changes, consuming some of their backlog. Despite this, we are confident in our backlog, including plant sales, and I feel optimistic about our Q3 cash flow, with improvements expected in both working capital and cash taxes.
Geoff Haire, Analyst
Thanks.
Operator, Operator
Thank you. Our next question comes from Markus Mayer from Baader Bank. Your line is open.
Markus Mayer, Analyst
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 with this new business.
Sanjiv Lamba, Chief Operating Officer
Thank you, Marcus. Regarding your question about nitrogen and its recovery, we have a few large customers in that area, and it has remained quite stable during this time. We haven't experienced significant volatility; instead, it has maintained consistent levels. When using nitrogen for enhanced recovery, it’s crucial to understand that the process is inherently stable, which means we don’t see much fluctuation. As for startups, we have several lined up. We typically issue press releases to announce these, so while I can't specify them all right now, there are a few set to happen by the end of this year and more expected at the beginning of next year.
Markus Mayer, Analyst
But the kind of magnitude of growth, can you give us some kind of indication?
Sanjiv Lamba, Chief Operating Officer
One way to consider this, Marcus, is that when I reflect on our EPS growth and our backlog, I believe that converting that backlog into startups contributes approximately two percentage points over a three-to-four-year period. That's the perspective we want you to have regarding the backlog we currently possess and how that startup impact translates down to the EPS level.
Operator, Operator
Thank you. And our next question comes from John McNulty from BMO Capital Markets. Your line is open.
John McNulty, Analyst
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?
Sanjiv Lamba, Chief Operating Officer
Sure. John, when we secure a project, whether it's related to gas sales or plant sales, we engage in a detailed costing process. At that stage, we finalize our costs with all the original equipment manufacturers and other vendors. By the time we're in the backlog phase, most of our costs are already secured. This should give you an idea of our position. As we encounter inflationary trends, we are incorporating those factors into the proposals we are creating for customers. We have established strong mechanisms and skilled managers to ensure comprehensive coverage, along with a rigorous process supported by our engineering team.
John McNulty, Analyst
Understood. That's helpful. Tied to that, considering the current inflationary environment, it seems like your European and Asian businesses have experienced some pricing hikes. Given the inflation levels we're witnessing, is there potential for further price increases with the adjustments you're making? I realize current prices are already high, but in light of the environment, how should we approach this?
Sanjiv Lamba, Chief Operating Officer
That's a great question, John. As we've indicated, the overall pricing increase is around 3%, with a significant portion coming from the merchant and package business, while the on-site line contributes very little. Therefore, if you do the math, you'll find that the average pricing across those different segments, particularly from merchant and package, falls within the mid-single digits. Our team has done an excellent job ensuring we stay ahead of inflation, and I've been sharing this with you for about two quarters now. I expect our team to maintain this as we move forward. It's essential for us to focus on our pricing strategy, and we are actively discussing this with our customers as we observe ongoing inflationary trends, which remain a top priority for us.
John McNulty, Analyst
Got it. Thanks very much for the color. Appreciate it.
Operator, Operator
Thank you. Our next question comes from Vincent Andrews from Morgan Stanley. Your line is open.
Vincent Andrews, Analyst
Thank you. I have a question about the $1 billion in base CapEx that you mentioned. Could you explain how strong that opportunity is? Why did you choose $1 billion instead of $500 million or $2 billion? How do the returns compare to the traditional CapEx backlog?
Sanjiv Lamba, Chief Operating Officer
Sure. Vince, that's a great question, and I'm glad you asked it because I want to discuss small on-site projects. Essentially, we have long-term contracts that secure cash flows, with individual projects typically costing less than $5 million. These projects have shorter execution timelines and provide solid returns. We actually have more than 25 of these small on-site projects signed in the first half of this year, which is a 50% increase compared to the same period last year. I really enjoy these projects because they offer strong, reliable execution; they are packaged plants that we can develop quickly, which gives us an execution advantage. I also want to highlight that while we consider the merger finalized, this is a clear example of revenue synergies resulting from it. We have integrated two suites of technologies, enhancing our position in the market, which we will leverage to win these deals. All these opportunities contribute to our base CapEx. Am I excited about the $1 billion target? Absolutely. It isn't capped and will adjust with market needs. We will ensure that all investments align with our criteria, and we are eager to engage with quality projects, whether they are small or large. I hope that makes sense.
Vincent Andrews, Analyst
That was great. As a follow-up, I might be reading too much into this, but now that you're merging the sale of gas backlog and the plant backlog, it seems you are bringing the sale of the plant business more to the forefront than before. I understand that this is a lower margin business, but it's clearly a capital expenditure light business compared to the sale of gas. So, I'm curious if I'm correct in thinking that you see the engineering business taking on more importance moving forward. Do you have a plan to enhance the margins and returns, or should we expect to hear more about this in the upcoming quarters and years?
Matt White, Chief Financial Officer
That's a great question. Let me take a step back to talk about how we view our business and opportunities. Our starting point is to participate in a full range of opportunities in the marketplace. I have a unique competitive advantage that I plan to leverage, which is the ability to offer an attractive sale of gas model. In cases where customers are not particularly interested in that model, I can use the sale of plant model to secure business. Both proposals work well for me, though the profiles differ a bit. You are correct that pursuing an EPC type structure is asset light, ROC accretive, and cash flow positive for us. Our strong engineering capabilities and our consistent execution at a high level give us a competitive advantage that we want to maximize. It's important to note that we do not prioritize one model over the other; rather, we utilize both options as needed to do what’s best for the organization. Two underlying principles guide us: first, I want to approach every opportunity where we have the advantage and can execute effectively. Second, I want to maintain discipline in my investment criteria. This combination is our unique advantage.
Vincent Andrews, Analyst
Excellent. Thank you very much. Appreciate it.
Operator, Operator
Thank you. Our next question comes from Mike Sison from Wells Fargo. Your line is open.
Mike Sison, Analyst
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?
Sanjiv Lamba, Chief Operating Officer
Hey, Mike. That's a good question. When we think about inflation, we usually focus on pricing, but you're correct. In an inflationary environment, we actually find some advantages, as we've mentioned before. This is primarily because we can pass much of that inflation onto our customers through our contractual structures. Additionally, it's an opportune moment for us to discuss pricing. Typically, in an inflationary environment, we notice a pickup in industrial activity, recoveries, and constraints that drive that inflation, which is where we actively engage. Yes, I believe we will see some impact on demand as well.
Mike Sison, Analyst
Great. Thank you.
Operator, Operator
Thank you. Our next question comes from Kevin McCarthy from Vertical Research Partners. Your line is open.
Kevin McCarthy, Analyst
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.
Sanjiv Lamba, Chief Operating Officer
Thank you for your question, Kevin. The partnership with Snam is progressing well, and we share a mutual understanding of how hydrogen needs to be developed in mainland Europe. This agreement is essential for moving forward and achieving significant outcomes. However, as with all initiatives, it will take some time. Currently, there's a lot of funding activity occurring in Europe, and we are closely monitoring its development. Regarding your other question about the factors that could either promote or hinder substantial advancements, I must reiterate some points I've made before. To make progress, two key elements need to occur simultaneously. Firstly, we require a supportive regulatory environment in Europe, which we do have, although it is complex and involves multiple administrative processes at both country and European Union levels. A variety of activities must be completed before the necessary funding and incentives can be accessed to enable substantial developments. Secondly, on the technology front, we need a roadmap that allows us to build on certain assumptions. Europe seems committed to green hydrogen, but I believe blue hydrogen will scale up faster than green hydrogen in the coming years. The technology for scaling blue hydrogen is available today, and Linde offers the necessary solutions. For green hydrogen, while Europe is advancing in this area, we must see the technology scale up significantly. This roadmap will likely evolve over the next three to five years. Additionally, low-cost renewable energy is essential, but this resource is not evenly available across Europe, which is why the idea of importing energy from Northern Africa is compelling. We also need a solid technology roadmap for electrolysis to improve capital efficiency, reaching a point where green hydrogen becomes cost-competitive. Both areas are in progress, and we are actively involved as we continue to move forward.
Kevin McCarthy, Analyst
Very helpful. Thank you, sir.
Operator, Operator
Thank you. And we will take our last question from Laurence Alexander from Jefferies. Your line is open.
Laurence Alexander, Analyst
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?
Matt White, Chief Financial Officer
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.
Juan Pelaez, Head of Investor Relations
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.
Operator, Operator
Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and you may now disconnect. Everyone have a wonderful day.