Reporting on the business and technologies
driving today's global industrial gas industry

Industrial Gas Company News
By Fred H. Siemer, CFA
2007.12
Economic Overview — If Wall St. rises on a wall of worry, the stock market should be setting new highs. Although the liquidity squeeze caused by the collapse of the housing bubble and the sub-prime mortgage crisis has been somewhat ameliorated by the 0.5% reduction in the Federal Funds Rate, a new crisis has arisen regarding the inability of the major banks to finance the billions of dollars of SIV and other mortgage backed paper. Much of this off-balance sheet debt may have to be written down and carried on the books of these commercial banks. Secretary Paulson has moved to establish a $100 billion pool funded by the major banks to provide liquidity to maintain the integrity of these obligations, thus freeing up funds for normal commercial lending operations. Many view this fund as a “bailout” of the banks, primarily Citibank, and it is not certain that this move will be a success. It seems certain, that for the near future, it will be more difficult to obtain commercial loans. This uncertainty and the difficulty in judging the extent to which problems in the housing sector will spill over to the economy overall are pressuring stock prices. Estimates for 2H GDP growth for 2007 are now generally below 2%, but this must be too low considering the growth of 4+% in Q3. As we are now in the Q3 earnings-reporting season, investors are nervously focusing on corporate profits. Although companies with exposure to housing and autos undoubtedly will have poor prospects, the companies we follow in the chemical and industrial sector should still report strong yty earnings comparisons. This mixed bag of corporate earnings reflects the mixed results for various components of the economy.

Certainly there are clear negatives. Sales of New Homes dropped 8.3% in August mo.-to-mo. Homes priced above $500,000 were particularly hard hit. Only about 6,000 homes at this price level were sold in August, down from 11,000 in August of 2006. The Architecture Billings Index fell to 51.1 in September from 53.9 in August. The inventory of unsold homes continues to grow, suggesting the housing slowdown will last into 2008. Orders for Durable Goods fell 4.9% in August from the 6.1% strong gain in July. This decline raised concerns for Business Spending. A key component of spending, orders for non-defense capital goods, excluding aircraft, fell 0.7% mo-to-mo. in August. The unemployment rate rose by one-tenth of a point to 4.7%, the highest level in a year. But even here, the employment reports give a mixed picture. Wage growth is one of the few remaining sources driving consumer spending. Hourly Earnings rose by 7 cents in September, a yty gain 4.1%. Recalling that a 4,000 job decline estimate in August may have been an important component of the Fed’s rate cut, we learn that this number has been revised to show a gain of 89,000 jobs. An upward revision was also made to the July job estimate, and in October, 166,000 new jobs were created. In September, the Conference Board’s tally of 4.27MM job openings showed an increase of 17.5% yty. The U. of Michigan consumer sentiment dropped to 82 in October, down 1.4 points from the prior month. All these conflicting signals confuse the market and create uncertainty. Markets detest uncertainty.

Offsetting the mixed signals in employment there are a number of quite positive economic indicators. The Conference Board’s index of leading economic indicators advanced 0.3% in September. World economies remain strong and the weak US dollar is aiding exports. US exports have risen at an annual rate of 8.8% since the fourth quarter of 2005. The Chemical Industry Trade Balance turned positive for the first time in almost two years in June. Industrial production in the Euro-Zone rose 1.2% and 4.3% yty in July and August, respectively. However, consumer price inflation in the EU leapt 2.6% in October suggesting the EU economy is approaching “bubble” status. I am not sure how long the EU Central Bank can hold off on interest rate increases. This would spell further weakening of the US dollar. Core inflation in the US was only 1.8% annualized in Q2, but one wonders how long this can persist with higher import and oil prices. The US manufacturing index remains above the threshold 50.0 yardstick, at 50.9 in October, 52.0 in September, and 52.9 in August. Factory inventory levels contracted for the 14th straight month in September, but turned up suddenly in October - another mixed signal that is causing some economists to downgrade the GDP estimate to 1.1% in Q4. US industrial output rose 0.1% in September despite slowdowns in autos and housing related products. While the value of private residential construction is falling, non-residential construction was up 15.2% yty in August. Perhaps the most important statistic — retail sales — rose a larger than expected seasonally adjusted 0.6% in September. Pessimists point out that this does not guarantee a strong holiday season, but I see the glass as half full. Industrial gases are part of the “Main Street Economy” and so far have been insulated from the “Wall St. Economy.” I feel there is not yet sufficient evidence that suggests the US economy will fall into recession.


INDUSTRIAL GAS PERFORMANCE
I continue to hold a positive view for the industrial gas industry. The industry is a lagging sector in the economy and recent financial problems in Housing related markets have not yet had a material effect on quarterly earnings. The average yty sales growth for the three major US based gas companies was about 7% in Q3 2007, with acquisitions, currency, and gas pass throughs pushing reported average sales gains to 17%yty.

Operating Profit margins for the major players increased from 30 to 80 basis point yty, as selling prices generally increased faster than electric power costs, and new plants enjoyed operating leverage. Average eps gains for the three major US-based firms were running at over 25% yty. Earnings in the latest quarter were up nicely yty, as shown in Figure 2.

While I feel comfortable that the impact from the financial problems in the US will bypass the industrial gas end markets, the gas sector has experienced an upward revision of its earnings base as a result of a boom in infrastructure spending, energy, and environmental/regulatory forced demand. In many instances, such as refinery hydrogen, demand is driven now as much by economics as regulation. Thus, I expect current demand and earnings to be a ten-year secular, rather than a two-year cyclical phenomenon. However, the 20+% gains in sales and earnings of the last two years in transit to a new level of earnings will most likely not be sustainable. The less than 10% gain in 2008 earnings forecast for Lincoln Electric may be more characteristic of the future performance of the basic industrial gas business. Certainly, individual companies can outperform the secular base earnings growth by acquisitions, or penetration of new markets in emerging economies (Note the eps performance of Airgas in Q3 vs. LECCO). If investor expectations match the annual 4-6% volume, 3% inflation pricing, 2% cost reduction growth with add-on’s from dividend increases and share reductions resulting from the superior cash flow from this industry, all will be well with share prices and the investment retention rationale for industrial gas stocks.


COMPANY COMMENTS

Airgas (ARG)
While weakness in housing, autos, and some segments of the commercial construction market has reduced industrial gas demand somewhat in these sectors, strength in energy, shipbuilding, and infrastructure repair continues. For ARG, this propelled yty same store sales gains of some 6% in FQ2. Overall sales were up 27% yty, with acquisitions providing 21% of this increase. Hard good sales were up 7% and gas & rent 5%. Operating earnings advanced 41% yty, and margins at 11.5%, showed a 70 basis point yty improvement, which would be 80bp, if the 4cents/sh integration expense for Linde Packaged Gas had been excluded. Sales for Distribution were $835MM, up 27% yty. Same store sales were 6% of this gain. Operating earnings advanced by 42%. Gas & Rent sales mix was 53.6%, up slightly yty. Sales for all Other operations at $212MM were up 43% yty, with gains in operating earnings of 16%. Earnings per share were 63¢, a gain of 29% on adjusted prior year earnings. The company’s guidance for FQ3 is a range of $0.63 - $0.65/sh, including a 1¢ charge for acquisition integration expense. The growth investment story at Airgas has always been about acquisitions. The company is considering several additions, primarily in the Distribution Segment. Purchase EBITDA multiples are expected to be in the 6.5-7.0x range. Demand remains strong in almost all geographic regions and the company expects eps gains of up to 30% yty to $2.58-$2.63/sh in FY2008. Current results are somewhat constrained by supply shortages of helium, although the argon supply situation has eased somewhat. Resolution of these supply problems, new acquisitions, and the integration of the Linde assets will be a source of future earnings growth. Management’s ability to finance a major new CO2 plant at Deer Park, TX, with a long-term supply contract. and to consider several new acquisitions, speaks to their confidence for the prospects for Airgas and the Industrial Gas Market. Recall that my analysis of the company’s financial position requires continued growth in earnings to avoid credit rating downgrades. (see Cryogas International, November 2007).


Air Liquide
For Q3, AL reported revenue of Euro 2,941MM, a 10.3% increase yty. Foreign exchange was a negative 2.4% and the acquisition of Lurgi Engineering added 0.5%. Sales on a comparable basis were up 7.4% yty. Gases & Services sales of Euro 2,485MM were up 7.9% yty on a comparable basis. All business lines and geographies contributed to this good performance. Operating margins continue to improve in Gases & Services due to productivity improvement programs. Margins should remain stable, rather than expand from current levels, as a result of the higher weighting of Engineering in the corporate product mix. Comparable sales by Region for the Gases & Services Group were 7.6%, 2.7%, 16.1%, and 11.5% for EU, Americas, Asia/Pacific, and Middle East/Africa, respectively. By End- Market, comparable sales were up 5.4%, 6.4%, 20.1%, and 11.1% for Industrial Merchant, Large Industries, Electronics, and Healthcare, respectively.


Revenues in the Americas was Euro 620MM up 2.7% yty. Significant customer plant turnarounds in the US hurt results, which declined 1.9% yty in the Large Industries segment. Sales advanced by 5.7% in Industrial Merchant markets due to good pricing action in the US and sustained growth in South America. Electronics registered growth of 4.2% due to a strong carrier gases market and one-time equipment sales to a major plant start-up. In Europe, sales gains were paced by Industrial Merchant, Large Industries and Healthcare, which advanced 5.5%, 10%, and 10.7%, respectively. Electronics declined by 4% due to lower equipment sales, as no new fab projects were started in the EU in 2007. Asia/Pacific was again the sales growth leader with gains of 34.7% in the booming Electronics market. Sales in the Large Industries sector were up 15.7% primarily due to the ramp up of recently installed capacity. Further new plant start-ups in China will come in the second half of 2008. Healthcare was up by 25.1% by entry into China with the acquisition of Hong Kong based Celki. For the Group, Capital Expenditures will be in the area of Euro 1.45Bil., approximately a 30% increase yty. Year-to-date acquisition expenditures were about Euro1.2Bil. The worldwide Outlook remains positive. AL has seen only limited signs of slowdown in the US, and good growth continues in the EU and A/P. The company continues to project double-digit earnings growth for 2007.

Air Products (APD)
For fiscal Q4, APD reported sales of $2.6Bil up 12% yty. Operating income advanced some 22% yty and reported eps, excluding extraordinary items, was $1.17/sh, a 26% yty gain. Tonnage Gas sales, at $690MM increased by some 12% yty. Volume added 10%. Selling prices declined by 2%, impacted by gas pass-throughs, which declined in the quarter along with prices for natural gas. Foreign exchange and acquisitions each added 2%. Operating income for the Group increased only 1% yty, since results for the prior year were aided by hurricane related insurance settlements. Margins expanded by 170bp, without the benefit of gas pass-throughs, to 15.2%. Volume gains and subsequent operating leverage in new plants were important contributors to these excellent results. Merchant Gas sales at $855MM were up 18% yty. Volume contributed 3% to increased sales, with selling prices, acquisitions, and foreign exchange contributing 4%, 6%, and 5%, respectively. Liquid/Bulk volumes were: — NA down 1%; EU down 2%, with gains of 18% in Asia/Pacific. Shortages of helium and argon were largely responsible for any volume shortfalls. Merchant LIN/LOX pricing was up in all areas. I am encouraged by the pricing action in NA, where a 3% yty gain suggests that industry-pricing momentum still remains positive. Operating income of $155MM increased 20% yty. Margins at 18.1% were up 30bp.

Performance Materials & Electronics sales were up 5% yty. Pricing for gases in Electronics, is still very competitive. For the Group pricing was down 2%. Volume, ex. Equipment which declined 3%, was up 9%. Performance Materials volumes were up 8% yty. Operating income for the E&P Group was up 2% yty, with the 40bp improvement in margins due to restructuring actions taken in Electronics. Energy & Equipment Group sales of $124MM were down 4% yty, largely due to lower LNG completions in the quarter. The backlog has slipped to $258MM, which was down 42% yty. Operating income of $18MM was up 9% yty, but profits are expected to be down yty in 2008.

Problems in the US Healthcare Group continue. Volume increases seem difficult to achieve and cost increases for new personnel are dragging down operating profit. Operations in the EU continue to do well driving sales for the Group to $160MM, up 7% yty and operating profit, at $9MM was up yty.

Sales for the Chemical Group at $252MM were up 13% yty. This gain was entirely due to volume, as 2% changes in Price/Mix and Currency were offsetting. In the quarter, APD negotiated the sale of its HPPC, or High Purity Process Chemicals Business. This sale is expected to close at calendar year-end and thus, was classified as a Discontinued Operation for purposes of reported results. The company hopes to close on the sale of its’ Polymers Business by year-end. The company did not receive adequate bids for the sale of its Polyurethanes & Intermediates Businesses, so they will retain owner-ship and report results in the Tonnage Gases Segment. This allocation seems somewhat incongruous. Are the products gases? Are they delivered by pipeline? Are sales contracts fifteen year take-or-pay? Are the customers on-site users of industrial gases? The company’s position is that sales are tied to take-or-pay contracts and that the customers also take pipeline gases from a production complex that has significant gas assets, as well as chemical facilities. I still feel this Business should be reported in a Chemicals Group, along with Performance Chemicals. Moving PU to Electronics and Performance Chemicals was not chosen, since apparently Electronics cannot stand further margin dilution from APD’s persistence in operating non-gas chemicals business. These weak sisters must be hidden in Groups where operating profits can absorb sub-par chemical operations. Burying low margin chemical businesses in industrial gas business segments will only hurt profitability comparisons with competitors, such as Praxair, and result in a continued APD stock P/E discount. Shareholder returns will continue to suffer by the retention of these chemical operations. Meanwhile the outlook for gases is positive and APD is looking for a 100bp improvement in profit margins in FY 2008. Earnings for FQ1 should be in the range of $1.08-$1.13 and in the range of $4.80-$5.00/sh for the year.


Lincoln Electric (LECCO)
Although there has been some weakening in US markets as a result of the collapse in residential housing, strength in worldwide energy and some construction markets continues to provide positive results for Lincoln Electric. For the last quarter, sales increased by 14% to $565MM, volume added 4% to this gain and selling price and foreign exchange added 5% and 3%, respectively. Acquisitions added 2% to sales gains. Adjusted net income increased by 12%, to $50MM or $1.15 per share. The company does not provide earnings guidance, so it is not clear of what import to assign to a result which missed the “Street” guesstimate of $1.20/sh. Global demand again is the primary driver of improved results.

Sales of Lincoln subsidiaries outside of North America increased to $218MM, a gain, in local currencies, of 19% yty. Sales for the Company’s North American operations were $347MM, an yty increase of 5%. Export sales increased 20% to $51MM. Sales gains in North America, while still strong, represented some slowdown in the yty rate of increase. In the quarter, sales gains in Latin America and Asia/Pacific were up about 40% yty. The company is straining to meet demand, and is adding capacity outside of the US. Double-digit sales gains were realized in Europe, but activity may slow somewhat in the coming year. Investors should reflect on the traditional GDP type volume growth rates for the welding products business. The tremendous surge in infrastructure spending in emerging nations has lifted sales and profits for LECCO to new levels, but growth from here on will more reflect traditional patterns, than the boom conditions of 2006/2007. I expect eps growth of about 6% yty in Q4 and 8%for the year 2008. Cash flows in the 9 months of ’07 were $204MM, more than double that of ’06. Future earnings gains of close to 10% annually and prospects for dividend increases and acquisitions, share buybacks offer reasons for retention of the shares.

Harsco (HSC)
Harsco reported strong earnings in the third quarter, demonstrating that strength in commodities and capital goods markets benefits players at all levels of the supply chain. EPS for the quarter, for continuing operations, was $0.83, up some 30% yty. Corporate sales were up 20% yty to a record $927MM. Organic growth contributed 9% to sales, Acquisitions 6%, and Foreign exchange 5%. Operating margins improved by 70 bp to 13.4%. Access Services had sales of $351MM, a gain of 26%. Organic growth contributed 19%, with currency and acquisitions adding 1% and 6%, respectively. Operating income increased some 36% and margin gains of 100 basis points, to 13.7% were realized. Minerals & Rail Technologies, Services and Other Products report sales of $200MM some 35% higher than the prior year. Organic sales growth contributed 14% and the February 1 acquisition of Excell Minerals added 20% to the gain. Operating income increased by some 68%, and margins of 21.1% were 410 bp higher than last year. The outlook for this business sector remains positive, with strong second half performance led by Excell and Harsco Track Technologies, but all six segments of this Group reported higher operating income and margins in the quarter.

The Mill Services Business reported sales gains of 9% yty. Contributions from acquisitions and foreign currency were 3%, and 7%, respectively. Organic sales growth declined by $3MM, or 1%, as steel production at some sites declined more than the 4% average decline for US steel production overall. Higher maintenance costs also impacted earnings. Operating income decreased by about 8%, and operating margins decreased by 160 basis points to about 9.2%. Results for this Group are expected to improve in the second half. Steel production is expected to increase by 6.8% yty in 2008, according to a CIBC analyst report.

For the Corporation overall, the company sees continued strength in the majority of its end-markets and positive global economic conditions in the second half and into 2008. Performance should again be led by Access Services; with Minerals & RR technologies expected to outperform last year’s second half. Thus, the company expects a 22% yty increase in Q4 earnings, using 67cents as a mid-point estimate. Eps guidance was increased to a range of $2.93-$2.97 for the year 2007.

Praxair (PX)
Although gas volume moderated somewhat in the US, demand for industrial gases worldwide continues strong. Sales, at $2.73Bil were up 13% yty, with currency and selling prices each comprising 4% of that gain, with significant new business from the energy sector and continued gains in Asia and South America. Praxair continues to post positive yty quarterly comparisons. Operating Profit was up 22% yty, before extraordinary gains in the ’06 quarter, raising the margin to 19.5%. Net income was 94cents/sh, a yty gain of 25%.

In North America sales advanced 11% yty to $1.3Bil ex. gas passthroughs, which reduced sales by 1%. Price and acquisitions each contributed 4%. Volume was up 2% with natural gas and currency offsetting each other at 1%. Merchant sales advanced 10% yty. Overall sales for on-site gases were up 9% yty. Packaged gas sales were up 12%. The acquisition of Linde’s Mexican gas operations added 4% to sales. The Aerospace Industry is experiencing a boom and Surface Technologies is benefiting. Sales were up 12% in the quarter yty ex. currency. Operating profit increased 50% yty and margins at 18.2% improved from 17.6% in the second quarter, but were down from 20.2% in the prior year.

South America saw a 23% yty gain (ex. Equipment sales down 2%). Contributions were: Volume 9%, FX 10% & Price 6%. Economies in this region have improved, with Brazil becoming a real export power. Sales in Asia/Pacific were up 15% yty (Volume 10%, FX added 6%, and selling prices reduced sales by 1%). Merchant pricing in China is still very competitive. Consistent with the region’s broad economic recovery, demand in Europe is still strong, although quarterly comparisons are moderating. Sales were up 11% yty in the quarter, selling price increases and volume each added 2% to sales growth. Currency translation added 7% to sales growth. Pricing is advancing to offset cost pressures and operating margins improved due to gains in productivity.

The outlook for the remainder of 2007 is quite positive worldwide, as there is strong momentum in energy, non-residential construction and capital markets. The company expects double-digit sales and higher operating margins in Q4. Earnings should be in the range of 95 – 97 cents/sh. in Q4, and has increased its eps guidance to $3.60 for the year. This represents a yty gain of 20%. Capital expenditures should again be about $1.3Bil, and since 70% the projects involved have take-or-pay contracts, incremental sales growth of some 3-4% should be realized. The project backlog is at 41 and proposal activity is at a high level. While sales growth may be somewhat slower in 2008, operating income should advance in the 15% range yty. Cash flow is strong and higher dividends and share buy backs will add to overall shareholder returns.

Chart Industries
Chart Industries had not reported as CryoGas International went to press for December.

Fred H. Siemer, CFA, is President of Siemer Management Co. and has over 25 years of experience in the Chemical and Investment Industries. He established “Chemical Research for Wall St.” in 1985. He can be reached via e-mail at FHSChem1@aol.com.

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