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Praxair (NYSE:PX)

Q1 2013 Earnings Call

April 24, 2013 11:00 am ET

Executives

Kelcey E. Hoyt - Director of Investor Relations

James S. Sawyer - Chief Financial Officer and Executive Vice President

Analysts

P. J. Juvekar - Citigroup Inc, Research Division

Vincent Andrews - Morgan Stanley, Research Division

Duffy Fischer - Barclays Capital, Research Division

Laurence Alexander - Jefferies & Company, Inc., Research Division

David L. Begleiter - Deutsche Bank AG, Research Division

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

Ernie Ortiz

Mark R. Gulley - BGC Partners, Inc., Research Division

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Q1 2013 Praxair Earnings Conference Call. My name is Sue, and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would like to turn the call over to Kelcey Hoyt, Director, Investor Relations. Thank you.

Kelcey E. Hoyt

Thanks, Sue. Good morning, and thank you for attending our first quarter earnings call and webcast. I am joined this morning by Jim Sawyer, Executive Vice President and Chief Financial Officer.

Today's presentation materials are available on our website at praxair.com in the Investors section. Please read the forward-looking statement disclosure on Page 2 of the slides and note that it applies to all statements made during this teleconference.

Please also note that our discussion of earnings in the first quarter, including year-over-year and sequential comparisons, excludes the impact of the Venezuelan currency devaluation, which was announced during the quarter. This devaluation resulted in a charge to our earnings of $23 million and $0.08 of earnings per share. A reconciliation of these results to GAAP reported numbers appears in the appendices to this presentation and the press release, including full-year guidance and year-over-year comparison.

Jim and I will now review Praxair's first quarter results, including the current business environment and updated earnings guidance. We'll then be available to answer questions.

James S. Sawyer

Thank you, Kelcey, and good morning, everyone.

Praxair turned in solid results for the quarter despite a landscape of mixed global economic conditions. While North America was the key earnings growth driver in 2012, several weak spots developed in the first quarter, notably reduced drilling activity and consequently lower volumes in our oil service business. Additionally, the machinery and nonresidential construction sectors weakened as a result of deferred capital spending decisions due to the uncertainty of sequestration.

However, our key on-site customers in steel, refineries and chemicals remain strong. China improved substantially during the quarter with significant volume growth and new project startups. Brazil seems to be turning the corner as well with improving results in March, which is a good bellwether for the rest of the year. Europe continued to disappoint and came in well below our expectations. However, our restructuring actions remain underway and we will continue to evaluate the right cost structure for the region. Once we see some volume growth in Brazil and Europe, we'll be able to deliver strong operating leverage to the bottom line.

On March 1, we closed the acquisition of NuCO2. The business operations and growth outlook appear to be as good as, or better, than we anticipated. We expect the business to be accretive to earnings by about $0.02 per quarter going forward.

Looking ahead, we are narrowing our earnings guidance range for the remainder of the year. We're raising the bottom of the range by $0.05 to $5.90 of EPS. This reflects the additional contribution to earnings for the NuCO2 acquisition. We are also lowering the top end by a nickel to $6.05 because we just don't see enough meaningful economic growth for the remainder of the year in the U.S., Canada and Europe. In fact, the IMF just lowered its GDP forecast for every country in which we operate. Therefore, we see less potential for base business volume growth for the remainder of the year. Nonetheless, our earnings guidance implies steep sequential earnings growth to the second, third and fourth quarters. We're confident in delivering these results as projects currently under construction start up. Additionally, we are expecting ongoing earnings contribution from pricing programs and productivity improvements. In fact, for the fourth quarter, we expect to be again delivering double-digit earnings growth year-on-year.

And now, I will let Kelcey explain in more detail, her first quarter results.

Kelcey E. Hoyt

Thanks, Jim.

Please turn to Slide 3.

Consolidated sales in the first quarter were $2.9 billion, up 2% versus the prior-year quarter. Foreign-currency translation negatively impacted sales by 2% as foreign currencies, primarily the Brazilian real, was weaker against the U.S. dollar as compared to the prior-year quarter. In the first quarter, we lapped the majority of the currency headwinds from devaluations during 2012. If currencies stay at current levels, we expect minimal currency translation impact for the remainder of the year.

Total Praxair volumes were steady year-over-year and sequentially, and include a negative 1% impact from day count effects. Fewer working days had a more significant impact this year than is typical as last year included an extra day for leap year and Easter occurred at the end of this quarter versus April in 2012. This is incremental to the typical first quarter seasonal effects of the Lunar New Year, Carnival in Brazil and customer turnarounds in North America.

Overall, sales grew 5% excluding currency and the impact of fewer working days. Organic growth came primarily from higher sales to metal, energy, chemicals and manufacturing customers, including new plant startups in Asia and South America. Acquisitions contributed 1% growth, primarily from U.S. packaged gas distributors acquired last year, as well as NuCO2, which closed March 1 of this year.

Sequentially, sales grew 3%, excluding currency and the impact of fewer days primarily from growth in North and South America. In Asia, volumes were lower with the seasonal impacts of the Lunar New Year. Operating profit was $623 million as compared to $627 million in the prior-year quarter.

Excluding currency and day count effects, operating profit was above prior-year driven by price, productivity gains and acquisitions. The EBITDA and operating margins remained strong at 31% and 21.6%, respectively.

During the first quarter, we continued to take advantage of low long-term interest rates, as well as our tight issuance spreads to treasuries, and issued 3 tranches of debt for a total of $1.4 billion, with terms of 3-, 5- and 10-year, and rates of 0.75%, 1.2% and 2.7%.

In addition, we closed the acquisition of NuCO2 and refinanced other long-term GAAP maturities. About 90% of our debt is now termed out with long-term securities. Our debt-to-capital ratio was 55.8% and debt-to-EBITDA was 2.1x.

Net income of $414 million decreased 1% from the prior year, in line with operating profit. Earnings per share of $1.38 was comparable to the prior-year quarter as the impact of lower net income was offset by a 1% reduction in the number of diluted shares outstanding as a result of net repurchases of common stock.

During the quarter, we repurchased $117 million of stock, net of issuances. $833 million remains available under the $1.5 billion share repurchase program authorized in January of last year. Our after-tax return on capital this quarter is 13.3%. There are really 3 factors causing the decline in NOPAT return on capital. First, earnings growth has been mitigated by the recessions in Europe and Brazil. When the volumes come back, we will get strong operating leverage without any new capital.

Secondly, similar to any capital project spend, the acquisition of NuCO2 is dilutive to return on capital and below the corporate average for the first few years.

And lastly, we are moving into the late stage of the CapEx cycle. We have over $2 billion of construction in progress which has not yet started up. This is really a timing issue as the plants begin to start up. Praxair's return on capital will start to trend upward in 2014 and '15 as earnings contribution begin and merchant loadings ramp on our existing capacity plus the new projects.

Now please turn to Page 4 for our results in North America.

Sales in North America were $1.5 billion, 4% above the prior-year quarter. Organic sales were steady as increased price of 3% was offset by similar volume decline. Acquisitions grew sales 3%, including packaged gas distributors, plus the acquisition of NuCO2, micro-bulk carbon dioxide, which closed on March 1 of this year. Refinery and chemical customer maintenance programs reduced on-site volumes 6% year-over-year and 4% sequentially. Pipeline oxygen sales to steel mills remain very strong. With low-cost natural gas, our steel mill customers are utilizing increased natural gas injection in their blast furnaces in lieu of coal. Natural gas in the blast furnace requires about 25% more oxygen than coal. Merchant volumes were steady year-over-year as underlying growth was offset by reduced frac-ing activity in the United States.

U.S. packaged gas sales grew by 5%, with the net effect of acquisitions and day count contributing 3%. The acquisitions we made in the past year are in the process of being integrated, which will improve profitability. Gas sales were up 6% and hard goods sales were down 5%. The decline in hard goods is a reflection of future uncertainty among business owners, as well as the government, who are postponing purposes of equipment and inventory. In particular, nonresidential construction and machinery are weak. However, the other markets, including general manufacturing, agriculture and oil and gas, are doing well.

North American operating profit was $358 million, 1% below the prior-year quarter. The increase in operating profit from higher pricing, acquisitions and productivity savings was more than offset by lower volumes, partially attributable to fewer working days and higher pension costs.

The operating margin remains very strong at 24.6%. Effective March 1, we acquired NuCO2, the largest provider of fountain beverage carbonation in the United States with approximately 162,000 customer locations. The NuCO2 micro-bulk beverage carbonation offering is a service model of choice for customers offering fountain beverages as it is cost effective, reliable and less labor-intensive for the customer.

85% of NuCO2's business is with restaurant chains and they're well-positioned in the top 100 chains. The revenue model is similar to our industrial gas model, typically 5-year contracts with monthly facility fees that include escalation formulas tied to inflation. We are on track to start the 2 worldscale hydrogen projects under construction for Valero at St. Charles and Port Arthur, and the hydrogen supply to serve Motiva in Louisiana during the second and third quarters. These projects will increase our hydrogen capacity in the United States by more than 25%.

Valero's 2 new hydro crackers will break down hydrocarbon molecules in order to produce more refined gasoline and diesel fuel per barrel of crude input. In addition, we are planning to start up 4 air separation plants in North America during the remainder of 2013.

Proposal activity for new on-site plants in North America remains strong in chemicals, metals, energy and manufacturing. Earlier this week, we announced the signing of a long-term supply agreement with North West Redwater to build, own and operate an air separation unit in Alberta. The plant capacity will be 2,000 tons per day of oxygen, and associated volumes of nitrogen and merchant argon. The North West Redwater gasification process will consume oxygen to produce hydrogen, which is then used to upgrade bitumen to diesel and other higher value hydrocarbon products. Initially, the refinery will convert 50,000 barrels per day of bitumen. The plan is scheduled to start up in mid-2016 and will be Praxair's third worldscale plant in the province.

Now please turn to Page 5 for our results in Europe.

Sales in Europe were 2% below the prior-year quarter. Higher pricing was offset by lower sales volumes due to weaker industrial activity, which resulted in lower packaged gases volumes in Spain and Italy. Fewer working days reduced volumes by 2% versus the prior year. Operating profit of $62 million was down 9% due to the negative operating leverage from lower volumes, higher maintenance costs and startup costs in Russia.

We are in the commissioning phase of starting up our second plant in Russia and are on track to start up a worldscale 3,000 ton per day plant to serve EVRAZ steel early in 2014. Our cost restructuring activities are underway, and we are in the process of consolidating packaged gas facilities in Southern Europe. The segment is well-positioned for margin improvement as volumes stabilize in Southern Europe and we begin to further load the new plants in Russia.

Page 6 shows our results in South America.

South American segment sales were $531 million, 6% below the prior-year quarter due to negative currency impacts of 10%. Underlying sales grew 3% from higher volumes and higher pricing. Higher on-site and merchant liquid volumes increased sales by 2% and were driven by new on-site production facilities. Volumes to packaged gas customers were below prior-year, largely attributable to fewer working days.

By end market, year-over-year sales increased to metals and healthcare customers, and were relatively flat to manufacturing customers. About 20% of Praxair sales in South America come from 8 countries outside of Brazil. Underlying sales in these countries grew 9% versus the prior year and were steady sequentially, with growth in chemicals, food and beverage, healthcare and manufacturing.

Operating profit in South America was $114 million versus $115 million in the prior-year quarter. Currency translation reduced operating profit by 9%. Excluding currency effects, operating profit in the quarter increased 8% from the prior year due to higher productivity, lower energy costs and the result of last year's fixed cost actions.

South America currently has 6 projects in the backlog across 4 countries, which includes Brazil, Peru, Argentina and Uruguay, that will serve the manufacturing and metals market. These projects are scheduled to start up over the next 12 months.

Please turn to Slide 7 for our results in Asia.

Sales of $367 million grew 10% versus the prior-year quarter. Strong volume growth increased sales by 11% due to higher volumes in China, India, Korea and Thailand. New plant startups in China, primarily from metals and chemicals customers, contributed significantly to this volume growth.

Asia's operating profit of $63 million increased 11% from the prior-year quarter. Operating profit improved from higher volumes, partially offset by lower merchant gas pricing primarily in China. China's backlog currently includes 9 projects under contract, including 5,000 tons per day supply to an integrated chemical complex in Chongqing and 3,000 tons per day of oxygen supply to Yangkong for its gasification process.

In India, we have 3 projects under long-term contracts under construction, including 1,800 tons per day of oxygen to supply JSW Steel, 2,500 tons per day of supply to Steel Authority of India and 90 million standard cubic feet per day of hydrogen for Indian Oil.

Korea's backlog includes 4 projects under construction, including 3 plants to serve Samsung for electronics and 1 plant for a manufacturing customer. Our results for Surface Technologies are shown on Page 8.

Surface Technologies sales for the quarter were $163 million, a decrease of 2% compared to the prior-year excluding currency and comps pass through. Higher pricing in the quarter partially offset the impact of lower volumes. Operating profit of $26 million was comparable to the prior year. Lower sales volumes, primarily coatings for industrial and military aviation, were offset by higher pricing and lower cost resulting from productivity and previous restructuring actions.

With that, I'd like to turn this call over to Q&A. [Operator Instructions]

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from P.J. Juvekar, Citi.

P. J. Juvekar - Citigroup Inc, Research Division

Just quickly, a quick question on China. You saw some good growth in China. I think, Jim, you mentioned that in your prepared remarks. Some of the chemical and industrial companies are not seeing much growth. So is this something related to your business or your project startups that you're seeing better growth than others?

James S. Sawyer

Yes, P.J. I would say that the China -- we basically saw in underlying base business, 0 growth in 2012. We started to see some of the underlying base business pick up in the form of higher merchant volumes and so forth. But the largest share of our improvement in sales and operating profit comes from starting up new plants.

P. J. Juvekar - Citigroup Inc, Research Division

And secondly, your net debt to capital is now 56%. So what is the upper level or upward band where you think you can take this and be comfortable with the ratings?

James S. Sawyer

Right, that's a good question. We still have very strong ratings and we're single A. And if you look at the spreads in treasuries that we issue our bonds at, they are basically as well with any company out there issuing debt, even AAs. And consequently, we have a lot of headroom in order -- if we needed to raise debt. We don't plan on raising debt any higher than this level, but if we needed to raise debt higher than this level, we still got a lot of headroom to stay in the single A category.

Operator

And your next question is from Vincent Andrews, Morgan Stanley.

Vincent Andrews - Morgan Stanley, Research Division

Could you talk a little bit about the pace of the business sequentially through the quarter by region? I know you just touched on a little bit in Asia, and maybe more specifically, what happened in March in Brazil? I know some of that is related to seasonality down there, but what is it that gives you the confidence that they're turning the corner?

[Technical Difficulty]

Kelcey E. Hoyt

Vincent, I'm sorry, it's Kelcey Hoyt. We had a technical difficulty with the phone, if you want to go ahead with your question.

Vincent Andrews - Morgan Stanley, Research Division

My question is if you could talk a little bit about the pace of business sequentially during the quarter by region. I know you mentioned that Brazil seems to have turned the corner in March, if you can kind of just discuss what gives you the confidence there. And then as we run into April, what are you seeing, and maybe the other piece you could touch is sequestration in the U.S. And at what point do we think we're going to get beyond that absent some change in government policy?

James S. Sawyer

Okay. Well, let me start out with Brazil. It seems to have turned the corner from a very slow 2012 and particularly the fourth quarter, but we did have improvement in March. It is definitely not up to the volumes that we had seen a couple of years ago, but it is up sequentially in March from the third and fourth quarters of last year. And based on what I'm seeing right now, April seems to be a good continuation of March. So I'm expecting that Brazil will do better in 2013 than it did in 2012, but not up to the full potential of prior years. And I'm really speaking about the industrial economy there. There are many, many roadblocks and bottlenecks in the economy, and the federal government is probably the main sponsor of nonresidential construction and they are moving very slowly on -- forward with projects. So that's an issue there and also, the competitiveness of the steel industry is an issue as well. So as I said, we're doing everything we can to offset a relatively weak economy. If you look at the last statistic, industrial production was negative by 4% in Brazil. But we are hopeful that we will become positive as the year progresses. Then North America, I think it's a bit of a puzzle. And I think that anything in construction and military spending in materials is going to be weaker with the government austerity program. It's probably a surprise, but the government accounts for 50% of all nonresidential construction. And about 1/3 of our products go ultimately, in some way, shape or form, into construction. And so with the austerity programs going on and spending off[ph] , that's not a positive sign. So hopefully, that will straighten out as the year progresses. But the very nice lift that we saw in industrial production in 2011 and 2012 seems to have flattened off, and people are holding back on decisions to invest in new capital. And the leading indicator we have of that is in our packaged gases business, where our gas sales are up but our hard goods sales are down by 4%. And that's kind of a leading indicator of people spending money on capital and equipment. So I think, as I said before, that last year, the big improvements came in North America. I think this year, we're going to have to see more help from South America, Asia, and Europe is really problematic because industrial production is negative in every single country in Europe and negative by 6% in Italy and 8% in Spain. That's a big drop. And that's reflected in our results, as well as many other companies' results. So I think the outlook is cloudy for the whole global construction and industrial machinery area.

Operator

And your next question is from Duffy Fischer, Barclays.

Duffy Fischer - Barclays Capital, Research Division

A couple of questions. First, a number of other companies have talked about it, you didn't mention it but what do you think the weather effect, particularly in North America, was, where we had a really tough winter this year in the first quarter versus very easy one last year for your business and kind of for your customers' businesses?

James S. Sawyer

I'm not really sure. I think in retrospect, some people said that they thought that last year's first quarter was better than normal seasonality because the weather was warmer, and this year's first quarter didn't match that because the weather was colder. That's probably true, but I don't have any data to support that. But we -- as we said, we also had fewer working days. And the fewer working days is like 2% on sales. But those are sales that come to the bottom line at a 50% operating margin because you don't -- your salaries and so forth is the same. So I think that's a drag in the first quarter for almost every company.

Duffy Fischer - Barclays Capital, Research Division

Okay. And then a question on returns. If you look at the business you've won, business your competitors have won, what would you estimate is the difference in the return that's being bid in on-site projects over the last 2 years versus maybe 4 and 5 years ago? Has there been a change, do you think, in the return assumptions that have won bids in the last couple of years?

James S. Sawyer

I don't think there's been a change in the return assumptions. Certainly, in our projects, we're using the same hurdle rates and return criteria that we used to use. I don't think there's been a change in that. But I think one of the things that's happened is that the construction period for these projects is getting drawn out. And so 10 years ago, we would have said that the duration from signing a contract to startup might be 2 to 3 years. Now, I think on these big refinery projects and big grassroots projects for gasification and so forth, these projects just take longer to build. And so what you're seeing is that we, and I suspect our other industrial gas companies, have got more construction in progress on our books for a longer time before we start getting revenue.

Operator

And your next question is from Laurence Alexander, Jefferies.

Laurence Alexander - Jefferies & Company, Inc., Research Division

I just wanted to follow-up on the phrase about being in the late stage of the CapEx cycle. It's been a very long time since the industrial gas industry has seen any sort of a harvest cycle. Can you talk a little bit about how you think EPS, earnings growth and free cash flow conversion would shift if you had an extended period of a falling CapEx backlog?

James S. Sawyer

Well, my guess is that the next 10 years, globally, is just going to be a lower growth time period than the past 10 years. And that particularly will apply to construction and materials. I do not believe that China will ever get back to the amount of construction it had before, and demand in U.S. and Europe is pretty flat. And to a large extent, the Latin American economies have, I think, moved out of the emerging country into the mature country in terms of growth rates. So I think it's been a slow decade for everybody, and we are still building out the projects that were begun in the past couple of years. We do continue to see a lot of activity in project bidding. We have not seen a decline in the activity in project bidding, but I'm guessing that a lot of these projects in China, a lot of these projects in the Gulf Coast that we're bidding on won't take a long time before the customers finally really decide to go forward with them. That's just my personal opinion. So I'm expecting our capital spending will probably go down. I think 2013 was a peak year for us in capital spending. We'll probably be closer to $1.8 billion to $2 billion this year and maybe around there for the remaining period. So I think that means that, well, in 2013, we didn't generate a lot of free cash flow. We're certainly expecting to generate a lot more free cash flow in 2013 and 2014.

Laurence Alexander - Jefferies & Company, Inc., Research Division

And then as you look at sort of your priorities for uses of cash, if you do have an extended period of higher free cash flow generation, will there be any differences from how you went through sort of the late '90s period?

James S. Sawyer

I don't want to be confused by talk about the late '90s period.

Laurence Alexander - Jefferies & Company, Inc., Research Division

Okay. Skip that part, just as you think looking forward?

James S. Sawyer

Tell you what we would -- we're going to stay in the industrial gases space. And there are 3 golden rules about industrial gases in my opinion, and that is cylinder rental, merchant contracts and on-site contracts. And then the key to getting high return on capital and decent growth at the same time is focusing on density, where you can deliver product to customers with less capital investment and less operating cost than your competitors can. So everything we do is going to be like that. Now, if the opportunities for new on-site projects decline and dry up, then we're just going to be distributing more money to our shareholders.

Operator

And your next question comes from David Begleiter, Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Jim, just on your backlog, given the number of project starting up over the next few quarters, should your backlog by year-end be down from current levels or be flattish?

James S. Sawyer

Well, it's going to be lumpy going forward. And that will depend on the projects that we sign, it will also depend on the timing of the projects because, I said, the negotiations on these projects seem to go on forever these days before a customer makes a final decision. And so we are seeing what I would call a stretch out in when we think we're going to sign the project. But we do think that they are out there. We'll probably end up with a backlog somewhere between $2.0 billion and $2.5 billion kind of on a continuous basis. But it will be lumpy, it may be higher than that or lower than that at certain periods of time.

David L. Begleiter - Deutsche Bank AG, Research Division

And just on the 3 hydrogen startups, should they all be from day 1, fully loaded? And what will the impact for them will be this year and next year as well?

James S. Sawyer

Yes, so we have basically 4 items in startups this year. And that's a lot of the capital investment that we've got on our books right now that hasn't started up. That will technically come out of the backlog when we start them up, which will lower the backlog, and there aren't going to be substantial contributors to both sales and operating profit as they do. I can't -- I'm not going to give you a specific number on each project though.

Operator

And your next question is from Mike Harrison, First Analysis.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

Jim, I was hoping that maybe you could walk through a little bit what you're seeing in terms of Lox/Lin supply and demand dynamics in Europe and Asia. Are you guys seeing any increased price competition for new accounts in Lox/Lin in those geographies?

James S. Sawyer

Well, let me talk about Europe first. And I can tell you that our Lox/Lin capacity utilization is in the low 60s now in Europe. It's been going down quarter-by-quarter. And I suspect that the other players in Europe are similar just because there's been so much negative industrial production going on. So there is clearly more capacity in Europe for Lox/Lin than there is demand. Now, we have been focusing on pricing like we do everywhere else in the world. And you'll see that our pricing's up about 1% in Europe, but up about 3% in North America. And that primarily -- I think if Europe was a tighter supply/demand balance, we'd be looking at pricing up 3% there. I forgot -- so Asia, well, I would talk about China. At this point in time, there's probably excess Lox/Lin in China as well. But that depends on the specific region that you're in. And it's really the argon supply and demand which is getting priced from a commodity base. But we're holding price and increasing prices in Lox/Lin. Argon, I think, will come back, but the demand for argon sort of significantly decline when the photovoltaic industry declines.

Michael J. Harrison - First Analysis Securities Corporation, Research Division

All right. And I was hoping also to get a little bit more color on what you're seeing on the oilfield side. It sounds like that's a pretty significant headwind right now, but how do you expect that to play out as the year progresses?

James S. Sawyer

That's hard to say. But what we're seeing right now, it is a mix, okay? And we are seeing definitely, in the United States, onshore, less drilling going on and lower volumes of frac-ing gas that we sell and pumping that we do. That definitely was down in the fourth quarter and continues to be down in the first quarter. I don't know. I think that will come back when the price of natural gas comes up a little bit. Even though -- and so all the frac-ing and oil services demand we have right now is in oil or in wet natural gas. Up in Canada, it's low as well. Mexico, on the other hand, is very strong for us because PEMEX is really working hard to get more oil out of the ground.

Operator

And your next question is Mike Sison, KeyBanc.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Jim, when I take a look at North America volumes, it's been quite a long time, really '09 since you had 2 quarters in a row with negative volumes. I know you have some projects coming on stream and for the rest of the year, but how do you see sort of the base business there playing out this year, and when could you potentially see an inflection point?

James S. Sawyer

Well, the weak spot on North America volumes is primarily the frac-ing business that I was just talking about, because that cycles up and down and that has a meaningful impact on the volume number. So the frac-ing is down. Canadian volumes are down because negative industrial production in Canada. Other volumes to other industries are up. But unfortunately, what's going on not only in North America, but globally, is that we're starting up new projects and adding volume with those, but in certain areas, we've got recessions going on and volumes are negative, offsetting the positive volumes from project startups.

Michael J. Sison - KeyBanc Capital Markets Inc., Research Division

Okay, great. And then it looks like you did a small tuck-in there for NuCO2, and I know you just closed the business. Do you feel better about what you've seen thus far? And when you think about this business longer term, run rate of 2 50 in terms of sales, is it something you can double over a short period of time?

James S. Sawyer

I wouldn't say double it over a short period of time. But we would expect to get high single digit growth in the business for probably the next 10 years. So that may be a 50% or 75% increase or something of that order. But doubling is probably about the limit. We're very happy with how the business is performing. We're now in there operating the business. We've integrated their financial reporting systems. We're beginning to integrate operationally, and it's a very well-run company.

Operator

And your next question is from Edward Yang, Oppenheimer.

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

Could you provide some additional color in terms of the margin decline you saw in North America?

James S. Sawyer

Yes. It's kind of a small number. But the 2 contributors to the margin decline, or really 3, and each of them being quite small, is the packaged gas acquisitions that we made. They added more sales but at lower operating margin percentages because packaged gas generally runs in the mid teens operating margin. Secondly, natural gas prices are up, which means that the pass-through effect is up. You see it's up 1%, I think, in the chart. And that expands sales without expanding operating profit, so there's a little bit of impact there. And then thirdly, the lower volumes to oil well services and frac-ing, those are very high margin sales. But I think we're running a strong business and close to the 25% operating margin I'm not complaining about.

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

Okay. And a lot of downbeat comments about Europe, obviously. But in your slides, you referenced improving volumes in Germany, and I was curious what was driving that.

Kelcey E. Hoyt

The lift in Germany sequentially?

James S. Sawyer

No, I can't speak to that. You know what that is?

Kelcey E. Hoyt

I mean just generally, it's a pickup. Some of it's holiday, some of it's with China lifting a little bit, they get the benefit of that. It's modest, but it is somewhat of a pickup.

Edward H. Yang - Oppenheimer & Co. Inc., Research Division

Okay. And Kelcey, one of your competitors talked about European weakness spreading to central and northern countries. Are you seeing any indication of that?

James S. Sawyer

Yes, I mean it is. It's generally, France is not looking too good right now and Germany has got -- had negative growth for the year also. We landed some new accounts and started up some new projects and so forth. But the German economy was just chugging along nicely, while Spain and Italy were suffering. And I think the German exports are down because they export machinery and demand for machinery and power units and so forth is off.

Operator

And your next question comes from David Manthey, Robert W. Baird.

David J. Manthey - Robert W. Baird & Co. Incorporated, Research Division

I'm interested in the effective selling days here, this quarter's. I believe you said 2% drag. I'm not sure if that was just Europe or if that was companywide in terms of the revenue drag for the fewer selling days year-over-year. That's number one. And then number two, could you discuss, is there a corresponding benefit next quarter particularly because of Easter?

James S. Sawyer

Yes. Basically, everybody had the 29th of February, whatever country you're in. And that's an extra selling day, plus the way the New Year's holiday fell in the middle of the week. That shortened the first week in January, plus we had Easter at the very, very end of March. So that was a compression in selling days. And when we roll forward to the second quarter, I think we'll be up probably 2% or 3% sequentially.

Operator

And your next question comes from John McNulty Credit Suisse.

Ernie Ortiz

This is actually Ernie Ortiz filling in for John. Just following up on NuCO2, are you still comfortable with the $15 million to $20 million in synergies for next year? And now that you've closed on it, do you think they're going to be a little bit hard to get, a little bit easier to get?

James S. Sawyer

Could you repeat the question?

Kelcey E. Hoyt

Synergies on NuCO2, what are we expecting? Are we still expecting the $20 million? How's it going?

James S. Sawyer

Yes, I mean we're expecting to get to $20 million but probably after about 2 years. And as I said, we've integrated the IT systems and so forth. But the greater synergies will come from several factors, the first one being distribution synergies, with our bulk and packaged gas businesses in the U.S. And then the second one will be coming from the sourcing of the CO2 from our plants rather than from competitors' plants. And then the third one will be to the extent that we can take that business model and operate it in some other countries that we're not operating right now.

Ernie Ortiz

Okay. And then you've also given out the end market trends like, say, energy and metal's up 4%, 6% this quarter. Do you see a lot of the end markets changing as we move into the next quarter?

James S. Sawyer

In metals?

Ernie Ortiz

No, just overall. What kind of end markets do you see changing a lot or [indiscernible].

James S. Sawyer

I don't see them changing, moving into the next quarter. But I will say that when we show those percentages in end markets, sometimes, they are distorted by several onetime events like, for example, we have a lot of turnarounds in refinery and chemical in the first quarter of this year. We won't have that in the second quarter. So -- but I don't see underlying demand really changing.

Operator

We'll move to the next question, which is from Mark Gulley, BGC Finance.

Mark R. Gulley - BGC Partners, Inc., Research Division

Just a question on operating rates [indiscernible] in Europe. If operating rates are in the low [indiscernible]

Kelcey E. Hoyt

Mark, can you repeat that? We can't hear you.

Mark R. Gulley - BGC Partners, Inc., Research Division

Yes. Addressing operating rates in Europe, the low 60s, it would take years and years to -- for those operating rates to get to those satisfactory levels. Therefore, do you see a round of restructuring and plant closures so that capacity really reflects end-use demand?

James S. Sawyer

Well, as we mentioned over the past year, we are doing plant closures and restructurings of packaged gas facilities. So we're reducing the number of packaged gas facilities and redirecting the source of gases to fewer plants to get better operating margin out of that. But I don't see any ASUs or cryogenic plants being restructured.

Mark R. Gulley - BGC Partners, Inc., Research Division

Jim, I was referring to merchant in my question.

James S. Sawyer

Right. Well, the merchant is all made by ASUs, so I don't see that being restructured.

Mark R. Gulley - BGC Partners, Inc., Research Division

Okay. And then switching to on-site, 2 new developments here recently on the on-site side that I thought were intriguing. One was the substitution of natural gas for coal in fuel-making, which requires more oxygen consumption. The other one you mentioned was that brand new plant you announced with respect to, I'll call it, pet coke gasification to make hydrogen in Alberta. Are those 2 applications, are those 2 new developments big enough to kind of move the needle in terms of more tonnage volumes perhaps from your existing base in the U.S.?

James S. Sawyer

Yes. So let me start with the steel. What steel guys are doing is they're using natural gas as a source of carbon and less coke and coal. When they do that, they need more oxygen per ton of steel produced, okay? And so we're operating pretty close to 90% capacity utilization in oxygen to steel mills even though the steel mills are not operating at their peak capacity. So if the steel mills were to operate at higher capacity, we would probably be building some more air separation plants for steel. But we're not there yet. The second one was in...

Kelcey E. Hoyt

The gasification for Alberta.

James S. Sawyer

Oh, Alberta, yes. That's a very interesting project. And this is one that's similar to the theme I mentioned before, I think we've been talking about this project for 5 or 6 years internally. But essentially, the Alberta government takes royalties from the tar sands producers. And they take the royalties in the form of bitumen rather than in cash. And so the Alberta government is sponsoring a project to gasify that bitumen and to making other liquid fuels with it. So we have a contract with them to supply the oxygen to the gasifier.

Operator

Your next question is from Don Carson, Susquehanna Financial.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Jim, just a question on U.S. merchant. Just wondering what your Lin/Lox operating rates are currently and how you see some of that operating leverage unfolding. And what impact will these new ASUs have on your operating rates? And then if you could just comment on what's going on in argon and helium as well?

James S. Sawyer

Right. Lin/Lox operating rates are in the high 70s.

Kelcey E. Hoyt

Sorry, high 80s.

James S. Sawyer

And we don't -- that's kind of -- it's okay, but it's not great. And in terms of helium, we are pretty much evenly matched in terms of our production and sales. Other competitors are still -- have customers on allocation. But over time, more helium will be produced around the world. But it takes time to -- for those projects to get developed. And for the most part, those projects are taking helium off of natural gas streams that are rich in helium. And so they operate subject to the operation of the natural gas field.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

So helium had no negative effect on your merchant volumes then in Q1?

James S. Sawyer

No.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Okay. And then can you talk a bit about operating leverage as you bring these new plants on and as you get a little more base volume growth in the North American business?

James S. Sawyer

Okay. Well, most of what we're bringing on in North America is hydrogen, hydrogen for refining. And note that when we -- in all 3 of those projects, we are buying a natural gas feedstock and pricing the hydrogen inclusive of what we paid for the natural gas feedstock. Consequently, when they come on, you'll see a very nice sales lift and some compression in operating margin percentage, because that's just -- because we're passing on the natural gas cost in the form of sales.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

No. I was referring to -- you mentioned you were bringing on some ASUs in the back half of the year as well.

James S. Sawyer

Yes. They are -- they'll start up. They should be -- typically ASUs are 30% to 40%, 45% operating margin percentage, so they'll be there.

Kelcey E. Hoyt

Well, they're midsized. They're not as large as the hydrogen.

Okay. So thank you for participating in our first quarter earnings call and especially your patience during the technical difficulties. Our second quarter earnings call will be held on July 24. And if you could please also save the date, we are going to have an Investor Day in New York City on Monday, September 16. If you have any further questions, please reach out to me directly. Thank you.

Operator

Thank you for your participation in today's conference. This concludes the presentation and you may now disconnect. Good day.

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