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The formula for Return on Invested Capital (ROIC) and its application to the industrial gas business can be broken down systematically. Let’s start with the formula and then identify the “big levers” for each branch of the industrial gas business.

Big Levers for Industrial Gas Business

The industrial gas business is typically divided into several branches like bulk gases, on-site gases, cylinder gases, and specialty gases/services. Each branch has distinct operational levers that influence ROIC.

1. Bulk Gases (e.g., Oxygen, Nitrogen, Argon)

  • Big Levers:
    • Asset Utilization: Maximize the efficiency of air separation units (ASUs) to reduce fixed costs.
    • Logistics Optimization: Minimize transportation costs for delivering bulk gases to customers.
    • Contract Management: Secure long-term contracts with customers to ensure steady revenue streams.
    • Energy Efficiency: Reduce energy consumption in production processes (energy is a significant cost component).
  • Key NOPAT Impact: Operating income improves through lower production and delivery costs.
  • Key Invested Capital Impact: Effective asset utilization lowers the need for additional capital investments.

2. On-Site Gases (e.g., Large customer-specific facilities)

  • Big Levers:
    • Long-Term Customer Contracts: Ensure high asset utilization and predictable cash flows.
    • Capital Cost Management: Build facilities with a focus on cost efficiency and modular designs to reduce upfront investment.
    • Reliability: Minimize downtime to ensure customer satisfaction and avoid penalties.
  • Key NOPAT Impact: Stable, recurring revenue improves margins.
  • Key Invested Capital Impact: Reducing facility costs or extending the life of assets increases efficiency of capital deployed.

3. Cylinder Gases (Packaged Gases)

  • Big Levers:
    • Distribution Network: Optimize cylinder storage and delivery logistics to reduce costs.
    • Cylinder Utilization: Improve asset turnover by minimizing idle cylinders and reducing loss.
    • Pricing Strategy: Implement tiered pricing or premium pricing for specialty cylinders.
  • Key NOPAT Impact: Margin improvements through pricing and lower distribution costs.
  • Key Invested Capital Impact: Higher turnover of cylinders reduces the need for additional inventory investment.

4. Specialty Gases and Services (e.g., Helium, Medical Oxygen, Maintenance Services)

  • Big Levers:
    • Product Mix Optimization: Focus on higher-margin specialty gases like helium or medical-grade oxygen.
    • Service Integration: Bundle maintenance and monitoring services with gas delivery.
    • Innovation: Develop proprietary blends or applications to differentiate from competitors.
  • Key NOPAT Impact: Higher margins from specialty products and value-added services.
  • Key Invested Capital Impact: Investments in R&D and specialized production often have high ROI if focused.

General Strategies for Improving ROIC in Industrial Gas Business

  1. Improve NOPAT:
    • Enhance operational efficiency (e.g., energy use, logistics).
    • Focus on high-margin product segments.
    • Maintain long-term contracts to ensure steady cash flow.
  2. Optimize Invested Capital:
    • Increase asset utilization.
    • Avoid over-investment in redundant capacity.
    • Sell underperforming assets or repurpose them for growth segments.

Key Consideration

Each branch has a different ROIC driver, and tailoring strategies to optimize NOPAT and minimize excess invested capital for specific branches is critical to maximizing overall business profitability.

ROIC Tree for the Industrial Gas Business

Top-Level Formula

ROIC=NOPATInvested CapitalROIC = \frac{\text{NOPAT}}{\text{Invested Capital}}ROIC=Invested CapitalNOPAT​

1. NOPAT Breakdown

NOPAT = Operating Income × (1 – Tax Rate)

Operating Income

  1. Revenue:
    • Volume × Price for each segment (Bulk, On-Site, Cylinder, Specialty).
    • Levers:
      • Increase sales volume through new contracts or market expansion.
      • Optimize pricing for high-margin products/services.
      • Focus on customer retention for long-term contracts.
  2. Operating Costs:
    • Production Costs:
      • Energy (electricity, fuel for air separation and liquefaction).
      • Labor.
      • Maintenance of facilities and equipment.
    • Logistics Costs:
      • Transportation (trucks, pipelines, delivery routes).
      • Cylinder tracking and storage.
    • Administrative Costs:
      • Overhead, R&D, marketing, and sales.
    • Levers:
      • Improve energy efficiency in production.
      • Optimize logistics routes to reduce costs.
      • Invest in automated systems for tracking and process efficiency.
  3. Tax Rate:
    • Lower effective tax rates through incentives or credits (e.g., green energy investments).
    • Levers:
      • Leverage renewable energy tax credits.
      • Operate in favorable tax jurisdictions.

2. Invested Capital Breakdown

Invested Capital = Total Equity + Debt – Excess Cash

Key Components:

  1. Net Working Capital (NWC):
    • Current Assets – Current Liabilities.
    • Levers:
      • Optimize inventory management to reduce excess gas stock and cylinders.
      • Minimize receivables by negotiating favorable payment terms.
      • Reduce payables where beneficial without impacting supplier relationships.
  2. Fixed Assets (PP&E):
    • Plants, pipelines, cylinders, delivery trucks, storage facilities.
    • Levers:
      • Maximize utilization of air separation units and other capital-intensive equipment.
      • Defer or optimize capital expenditures through modular designs or upgrades.
      • Dispose of underutilized assets.
  3. Debt Management:
    • Balancing leverage to optimize the cost of capital while maintaining operational flexibility.
    • Levers:
      • Refinance debt at favorable rates.
      • Avoid overleveraging to reduce interest burdens.
  4. Excess Cash:
    • Minimize cash holdings above operational needs to avoid drag on ROIC.
    • Levers:
      • Deploy cash in high-return projects.
      • Return excess cash to shareholders via buybacks or dividends.

ROIC Tree Visualization

ROIC
│
├── NOPAT
│   ├── Revenue
│   │   ├── Volume (Bulk, On-Site, Cylinder, Specialty)
│   │   └── Price (Premium for specialty products and services)
│   ├── Operating Costs
│   │   ├── Production Costs (Energy, Labor, Maintenance)
│   │   ├── Logistics Costs (Transportation, Cylinder storage)
│   │   └── Administrative Costs (R&D, Overhead)
│   └── Tax Rate Optimization
│
└── Invested Capital
    ├── Net Working Capital
    │   ├── Inventory (Bulk gases, Cylinders)
    │   ├── Receivables (Customer contracts)
    │   └── Payables (Supplier terms)
    ├── Fixed Assets (PP&E)
    │   ├── Air separation units (ASU)
    │   ├── Pipelines and storage
    │   └── Delivery trucks, cylinders
    ├── Debt Management
    │   └── Optimize leverage and interest costs
    └── Excess Cash
        └── Deploy or return to shareholders

Key Insights from the ROIC Tree

  1. Revenue Growth:
    • Expand customer base, upsell specialty gases and services.
    • Maintain price discipline to protect margins.
  2. Cost Efficiency:
    • Energy and logistics are major cost drivers; innovation in these areas can dramatically improve margins.
    • Reduce downtime in production facilities to increase asset utilization.
  3. Capital Efficiency:
    • Minimize idle cylinders and overcapacity in ASUs.
    • Focus on modular, scalable investments to align with demand.
  4. Tax Optimization:
    • Explore energy efficiency and renewable investment tax benefits.

This tree helps prioritize strategies to improve ROIC for each component of the industrial gas business.

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