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Praxair (NYSE:PX)

Q2 2012 Earnings Call

July 25, 2012 11:00 am ET

Executives

Kelcey E. Hoyt - Director of Investor Relations

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

Analysts

Duffy Fischer - Barclays Capital, Research Division

Vincent Andrews - Morgan Stanley, Research Division

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

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

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

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

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

John P. McNulty - Crédit Suisse AG, Research Division

Robert Koort - Goldman Sachs Group Inc., Research Division

David L. Begleiter - Deutsche Bank AG, Research Division

P.J. Juvekar - Citigroup Inc, Research Division

Operator

Good day, ladies and gentlemen, and welcome to the second quarter Praxair Earnings Conference Call. My name is Stephanie, and I'll be your coordinator today. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today, Ms. Kelcey Hoyt, Director, Investor Relations. Please proceed.

Kelcey E. Hoyt

Thanks, Stephanie. Good morning and thank you for attending our second quarter earnings call and webcast. I'm joined this morning by Jim Sawyer, Executive Vice President and Chief Financial Officer; and Liz Hirsch, our Vice President and Controller.

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.

Jim and I will now review Praxair's second quarter results and outlook. We'll then be available to answer questions.

James S. Sawyer

Thank you, Kelcey, and good morning, everyone. Please turn to Slide 3 for our consolidated second quarter results. A first glance at the slide reveals the sales and earnings growth were subdued and fell short of our long-term objectives. But I want to emphasize that our results were significantly constrained by negative currency translation, lower pass-through of natural gas price and hires and sales, and deteriorating manufacturing conditions in Europe and Brazil.

Having said that, we had fantastic results in North America, which we expect will continue, and when Brazil and Europe turnaround, we'll be back on our historic trajectory of double-digit earnings growth. We've taken restructure actions in Brazil and are evaluating additional actions across Europe and in Surface Technologies in European plants, which serve the manufacturing sector. These steps will ensure better results in these weak spots without waiting for a rising tide of economic conditions.

There's a chart on Page 11, I would like to refer you to in the appendix for the teleconference slide deck, which shows the volatility of our 6 major overseas currencies and also why we are lowering our guidance for the remainder of the year by about 3%. Year-over-year as of June, the Brazilian real has fallen 22%,the Euro, 11%, the Mexican peso, 16%, and the Canadian dollar 4%, and the Indian rupee, 19%, and the Korean won, 8%. Our year-over-year sales declined 2% to $2.8 billion, but excluding a 6% negative currency impact and a 2% impact from lower gas pass-through of natural gas, sales would have grown 6%. More importantly operating profit, x currency, was up about 9% and EPS about 11%, demonstrating that we're still getting leverage down the income statement in productivity and strong cash flow.

In fact, operating cash flow was a record $725 million, representing more than 25% of our sales.

Our debt-to-capital ratio for the quarter was 53% and debt-to-EBITDA was 1.9x. During the quarter, we paid dividends of $164 million, and repurchased stock of $104 million, net of issuances. $1.3 billion remains available under the share repurchase program authorized in January of this year. After-tax return on capital for the quarter is 14.2%, and reflects the large amount of projects under construction, and therefore, a significant amount of project capital on our balance sheet not yet completed. Return on equity increased to 29.7%.

Now please turn to Slide 4 for our updated earnings guidance. In the third quarter, we see a continuation of similar business trends sequentially, and are issuing earnings guidance in the range $1.35 to $1.40. This guidance reflects the assumption of an additional $0.03 of currency headwind sequentially from the second quarter, as the major currencies swings occurred in late April. On a year-over-year basis, our third quarter earnings expectation reflects negative currency translation impact of about $0.12 per share. As such, for the full year, we've lowered our earnings guidance to $5.60 to $5.70 or about $0.15 to $0.20 from the prior guidance.

The majority of the reduction, or about 2/3, relates to negative currency translation impact based on current exchange rates. Additionally, volumes everywhere outside of North America are falling short of expectations, and we're not anticipating macroeconomic conditions to improve in the second half. Our long-term growth outlook remains strong and we're maintaining our capital spending forecast of $2.1 billion to $2.4 billion against the backlog of $2.5 billion of projects under construction, with committed customer contracts. As these projects start up over the next 2 to 3 years, they will contribute significantly to sales and earnings growth. The backlog remains strong at $2.5 billion, and reflects 5 plant startups during the quarter, as well as signings in 4 new plants under construction for long-term contracts.

The level of new business activity remains healthy overall. We've seen some recent slowdown in proposal activity in Brazil, but have also seen acceleration of proposal activity in North America. So on balance, it remains about the same.

We remain confident in our ability to continue to deliver the expected 4% to 6% top line growth from new projects and the backlog of projects currently extends that framework through 2015. And now, I will let Kelcey explain in more detail our second quarter results by segment, including recent project signings and startups.

Kelcey E. Hoyt

Thanks, Jim. Please turn to Page 5 for our results in North America. Sales in North America were $1.4 billion, 2% above the prior-year quarter. Underlying sales grew 6% from 4% higher volumes and 2% higher pricing. The effects of cost pass-through, primarily lower cost natural gas, which is contractually passed on to hydrogen customers, reduced sales by 4%. Negative currency translation from Mexico and Canada reduced sales by 2%. Underlying energy market sales in North America were very strong and grew 21% year-over-year. The most significant driver was our on-site supply systems to Gulf Coast refinery. Gulf Coast refinery distillates production is growing and customer margins are improving as customers benefit from lower hydrogen prices, which are tied to the price of natural gas. We also continue to deliver strong spot sales out of our Gulf Coast hydrogen storage cavern to meet customer needs.

Our oil well service business in Mexico continues to run at very high levels and delivered strong volume growth in Mexico. This business primarily provides liquid nitrogen and pressure pumping services to the oil and gas sector. Sequential energy sales were steady, with the growth in the United States and Mexico moderated by the typical second quarter seasonal slowdown in frac-ing for natural gas liquids and oils in the Alberta region of Canada during the spring thaw. Underlying manufacturing sales grew 12% year-over-year and 3% sequentially, with growth in all 3 countries, the United States, Canada and Mexico.

Packaged gas sales remained robust in line with manufacturing strength. In PDI, same-store sales, which excludes currency and acquisitions, were 9% above last year. Gases were up 8% and hard goods were up 10%. Packaged gas primarily serves the manufacturing market but sales were also strong year-over-year to metal fabrication and sequentially strong as well to chemicals and refining.

Underlying sales growth to metals customers were solid at 3% year-over-year. This was due to strong liquid argon sales for stainless steel and metal fabrication, as well as oxygen sales on our pipelines in the northern United States to steel mills. The underlying fundamentals of most North America end markets are good. Underlying on-site sales grew 8% year-over-year and sales from merchant volumes grew 2% year-over-year with liquid hydrogen, nitrogen and argon growth partially offset by weakness in CO2 from reduced dry gas frac-ing.

North America operating profit was $363 million, 11% above the prior-year quarter. Excluding the negative impact of currency translation, the operating profit would've grown 14% from the prior-year quarter. The operating margin was a very strong 26.1%, reflecting volume growth, higher pricing and productivity, which more than offset cost increases and the negative impact of currency translation. Lower cost pass-through, which reduced sales with minimal impact on operating profit, contributed 1% to the operating margin in the quarter. The pipeline of activity for potential further packaged gas acquisitions remain strong. During the quarter, we made packaged gas acquisitions in Orange, California and Tonawanda, New York. We also acquired Canadian Cylinder & Gases, an independent distributor of industrial and specialty gases and welding equipment, located in Prince George, British Columbia. This will enhance our ability to serve current and future customers in this high-growth region of Canada.

During the quarter, we expanded our packaged gas presence in the Northeast region of the United States, to supply industrial and specialty gases as well as hard goods, to meet growing demand. This new location serve the Boston, Hartford and Providence markets.

In Mexico, we started up oxygen supply to Fonderia, a producer of steel billets for the construction industry in North Central, Mexico. The plant with a capacity of 120 tons per day will increase Fonderia's productivity and its production and help Fonderia meet its energy efficiency and environmental requirements. The new facility also increases our production and supply capacity in the region.

Proposal activity for new, on-site plants in North America is increasing. And we are seeing strong activity in energy, chemicals, manufacturing and metals markets. Earlier this week, we announced a signing of a long-term contract to supply Vale, a leading international mining company, with oxygen for a new nickel processing facility being built in Canada. Praxair will build, own and operate an energy-efficient cryogenic air separation unit, with a capacity of approximately 400 tons per day, which is expected to start up in mid-2013. This project is a good example of how our products help our customers improve the environment. Vale will utilize the oxygen to remove sulfur and iron from the nickel. The process will enable Vale to process the nickel ore concentrate directly into finished metals without having to smelt it first, avoiding sulfur dioxide and dust emissions. Nickel is used to produce stainless steel and other alloys and used in various industries, including aircraft.

Now please turn to Page 6 for our results in Europe. Sales in Europe increased 3% for the second quarter versus 2011. The sales increase was due to the acquisition last year of an increased ownership interest in Europe Praxair located in Scandinavia, which is now consolidated. Underlying sales were comparable to the prior year as 2% higher pricing offset lower volume. The weaker euro reduced sales by 9%.

Price actions in the region are sticking, and we are getting traction across all countries in Europe. Just as we do with any with any price action, in any region around the world, we'll review margin contribution of individual customer accounts and we'll continue to drive price increases in the region.

Packaged gas volumes declined 5% year-over-year in Spain, Italy and Germany. This reflects weakness in the metal fabrication and manufacturing markets, which are significant contributors to the lower industrial economic activity versus a year ago. Sequentially, volumes continue to decline in southern Europe, particularly Spain.

Operating profit of $68 million was 6% below the prior year. Excluding acquisitions in currency, underlying operating profit decreased 9%, primarily driven by lower volumes, partially offset by productivity and cost savings resulting from our fourth quarter 2011 restructure.

In addition, we are currently assessing further fixed cost actions to be taken in Europe to ensure we are right-sizing the cost structure of the business to reflect expected longer-term slower growth in the region, especially southern Europe. We are on track to start up 2 of our 4 plants currently under construction in Russia later this year. These 2 plants will serve the chemical and glass industry. New project proposal activity is growing in Russia and Scandinavia, including the metals, energy and manufacturing market.

Page 7 shows our results in South America. South American segment sales were $520 million, down 15% from the prior-year quarter. Underlying sales grew 1% for the quarter, primarily due to improved pricing, partially offset by lower volumes. Negative currency impacts, primarily the weakening of the Brazilian real against the U.S. dollar reduced sales by 16% in the quarter. Higher volumes from new on-site production facilities were more than offset by lower volumes to merchant and packaged gas customers, largely attributable to the lower industrial production rates in Brazil. By end market, year-over-year sales increased to metals, health care and energy customers, and were lower to manufacturing and chemical customers.

Sequentially, underlying sales were steady for the quarter, with higher pricing offset by lower volumes. Negative currency impact reduced sales by 8% in the second quarter versus the first. Operating profit in South America was $110 million, 21% below the prior quarter, primarily due to negative currency translation impacts. X currency, operating profit was comparable to the prior year, as higher pricing offset cost increases primarily related to power, distribution and cost inflation.

In South America, Brazil has just experienced the third consecutive quarter of negative industrial production. In addition, June was our lowest volume month of the quarter, indicating volatility with little sign of near-term improvement. Current Brazil Central Bank consensus industrial production for the year is now 0, which implies an industrial production rate of about 2.4% for the second half of the year. We remain bullish on Brazil in the medium to long-term, given the strong growth fundamentals in place in its emerging economy as it continues to transition from an export-driven economy to a more local consumption driven market with a growing middle class. In addition, there is quite a bit of pent-up demand for infrastructure build-out in front of the 2014 World Cup and 2016 Olympics.

The government has pulled several stimulus levers quickly to stimulate demand, including lowering the interest rate, lowering consumption taxes and currency intervention. However, given the general global macro uncertainty with the European debt crisis and the slower growth environment in China, the stimulus measures are not working as quickly as they historically have.

As such, during the second quarter, we took actions to reduce cost in South America, primarily headcount reductions, and we'll realize the benefits in the second half of this year.

South America currently has 8 projects in the backlog across 4 countries, which include Brazil, Peru, Argentina and Uruguay, and diverse industries, such as metals, chemicals and manufacturing. These projects are scheduled to start up between the third quarter this year and the end of 2013.

During the quarter, we started on-site plant to serve a metals customer in São Paulo state. This location will also supply the surrounding area with merchant product, including liquid argon. We also started an air separation plant in Columbia during the quarter to supply Gerdau, one of the largest suppliers of specialty steel in the world. The plant will also produce liquid oxygen, nitrogen and argon to the local market, in segments such as oil and gas, manufacturing, chemicals, food and beverage and medical. Praxair has production facilities located in all regions of the country, which ensures supply reliability throughout Colombia.

Please turn to Slide 8 for our results in Asia. Sales of $348 million were comparable to the prior-year quarter. Volume growth of 3% came primarily from higher on-site sales in China, India and Korea, including new plant startups for metals and chemicals customers. Overall growth was negatively impacted by lower sales to electronics customers in Asia due to lower demand from semiconductor, flat-panel display and solar customers. Electronic sales were 3% below prior year. Lower merchant and packaged gas pricing, primarily due to the electronics end market, reduced sales by 1% from the prior-year quarter. We expect this challenging price environment to continue in the near term, as long as electronics volumes remain weak.

Asia's operating profit grew 8% from the prior-year quarter and included a gain on land sale. Lower price decreased operating profit as did currency. During the quarter, we started up 2 plants for customers under long-term take-or-pay contracts, both located in China. Praxair China started up a new air separation plant in Nanjing, for Meishan Iron and Steel, a subsidiary of Baosteel. The plant has a capacity of 1,700 tons per day and supplies oxygen, nitrogen and argon to support Meishan Steel's growing demand, as well as deliver added value and energy efficiency, product quality and process safety. This plant nearly doubles the existing oxygen production capacity serving Meishan Steel. We've been supplying industrial gases to Meishan Steel for over a decade and have already built a number of air separation plants for them in Nanjing.

During the second quarter, we also started up a large, single train, 3,000 ton per day air separation plant in the Wuwei, 100 kilometers from Nanjing to supply oxygen, nitrogen and clean air to the Anhui Wuwei coal-based chemicals project. This is another example of Praxair China's demonstrated capability to supply oxygen to coal gasification units which provide feedstock to the chemical industry.

About 40% or $1 billion of our backlog is for long-term customer projects in China, India and Korea that will start up between this quarter and early 2015. New project activity for the region remains robust. During the second quarter, we announced the signing of a long-term supply contract with Yankuang Group to supply industrial gases to its coal gasification process for the production of methanol and downstream chemicals at its chemical park in northern China. Praxair will construct a large air separation plant with a capacity of 3,000 tons of oxygen per day. The new plant is scheduled to start up in early 2015, and will replace Yankuang's existing air separation unit. The liquid oxygen, nitrogen and argon produced will be integrated with Praxair China's liquid production and distribution network in the region.

Our results for Surface Technologies are shown on Page 9. Surface technologies sales for the quarter were $168 million and comparable to the prior year. Underlying sales increased 4% driven by higher volumes and pricing. Sales increase came from higher aerospace coatings and increased coatings for energy markets, primarily oil and gas. Currency negatively impacted sales by 4% due primarily to the weakening of the euro versus the U.S. dollar.

Operating profit remained unchanged for the quarter at $27 million. Higher volumes and leverage from improved pricing increased operating profit. These benefits were offset in the quarter by currency translation impacts and cost increases, primarily related to employee wages and benefit cost and general inflation. 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 the line of Duffy Fischer with Barclays.

Duffy Fischer - Barclays Capital, Research Division

I was just wondering if in your North American business, you can kind of talk about what the monthly trends were throughout the quarter and maybe into July. And then do you think that your customer base will be impacted by the strengthening dollar and maybe some of their competitiveness goes away so that can actually be a headwind for them going forward?

James S. Sawyer

Okay. Let me take the first part of that. We haven't seen any sequential slowdown on a of month-to-month basis moving all the way back to the first quarter through July. Everything is continuing to be strong and growing. We've had fantastic growth in the manufacturing sector. That may slow down a bit but we haven't seen that yet. And so -- and then in terms of the competitiveness, I think that the strong dollar has been basically caused by the fact that the U.S. economy is doing so much better than any other economy in the world. But I don't think it's at a point where it impacts the competitiveness of our customers as a whole. And secondly, I think that the benefit of lower natural gas prices is helping our customers certainly more than any impact from the currency.

Duffy Fischer - Barclays Capital, Research Division

Great. And then just on the Asia business, maybe I missed it, what was the gain on sale of land that you said was included in net profit. How big was that?

James S. Sawyer

Right. So we have about 7 plants selling liquid nitrogen, or high-purity nitrogen to Samsung, and the Korean government is putting a major highway project right through that area and is asking us to move our plants and buying the land through that process. So we had a land sale gain worth roughly $0.03 a share in Asia segment operating profit. But on an overall basis, that was pretty much offset by restructuring costs that we took, particularly in the South America segment. So on a segment basis, on a year-over-year, Asia is probably $10 million higher than it should be and South America is probably $10 million lower than it should be.

Operator

Your next question comes from the line of Vincent Andrews with Morgan Stanley.

Vincent Andrews - Morgan Stanley, Research Division

Could you just discuss a little bit more -- you talked about there's been stimulus in Brazil and, I guess, there's also, obviously, been a lot of stimulus in China. And could you just sort of talk about both markets in terms of -- does Brazil need more stimulus or does it more time? And then also, what effects, if any, are you seeing from the initial stimulus in China?

James S. Sawyer

Right. Well, let me start out with the Brazil. And on the industrial production has been declining in Brazil beginning last August. So it's pretty much almost one year now. And that's a combination of several things. It started out, to some extent, being a result of what was the very weak -- or very strong Brazilian real, that was making exports from Brazil less competitive, but now it is devalued by 23%. That should reverse itself. Another bottleneck in the Brazil industrial economy is the availability of skilled labor. And I think that, really, what's happened is so much construction activity with Petrobras, with the World Cup and everything else going on, that there's been a shortage in skilled production or construction labor, manufacturing labor, production labor, which has really bottlenecked the economy and caused inflation. So about a year ago, the Brazilian Fed increased interest rates pretty significantly to try to stop inflation. They've now lowered interest rates significantly, and they're doing some other policy moves in terms of: number one, keeping exchange rates weaker; and then, number two, certain taxes on imported items and so forth. Another thing that's happened in Brazil is that the trade with Argentina has pretty much come to a standstill based on what's going on in Argentina. So there's a lot of factors there. I think that the long-term secular growth in South America and Brazil are certainly intact. But they've got to work their way through some of these issues. Now China's a different story. I think it's hard to expect that China's GDP growth would be 15% a year, for ever and ever and ever. So now, IP growth and GDP growth are somewhere between 5% and 10% and I think, on a sequential basis, probably lower than that. Then, in addition, you've got a change over in power and a power struggle going on within the ruling party, which remains to be worked out during the rest of 2012. Now that hurt us quite a bit in the quarter just ended, primarily because of slowdown in demand for argon and lower argon prices. And that was caused primarily by a slowdown in the production of photovoltaics. Long-run, though, the five-year plan for China embraces the end markets that are our growth markets. And that's primarily moving to more coal gasification for energy and for production of chemicals, and more industrialization in the middle area of the country, which really hasn't grown very much. So I think that the secular growth is still intact, but we're going through kind of a downdraft that's more of a cyclical nature. And then, I guess, while I'm talking about it, I'll just add India to the equation there, because India is in a recession, also, due to -- due primarily to sort of government gridlock. And that needs to be worked out as well. But I think the emerging market countries do have -- probably have a high multiple of industrial gas demand growth as opposed to GDP growth, emerging market countries tend to be more focused on construction and manufacturing, and less so on services. And that's really what drives our growth. So we're still in the long term, optimistic about that, and we think that we're best positioned than any industrial gas company in the emerging markets overall.

Operator

Your next question comes from the line of Don Carson with Susquehanna Financial.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

A couple of questions on North America. Can you just outline what your operating rate was in Lin/Lox, and you seem to be one of the few people not talking about shortages in helium. So I'm just wondering if your supply situation is better than others there.

Kelcey E. Hoyt

Operating rates in North America?

James S. Sawyer

Well, okay, so operating rates in North America are strong. On-site oxygen for the steel industry continues to be strong. Merchant Lin/Lox volumes continue to be strong, although a little bit of a falloff in the second quarter in Canada related to our frac-ing business, which has a seasonal gut-down as the ice melts and the roads are shutdown for a while. So operating rate is strong, really across all end markets in Canada, Mexico and the U.S. Now helium, everybody's talking about helium. Helium really only has about -- it is a natural resource that's extracted from the ground, most often as a byproduct with natural gas. And there are really only 6 or 7 major sources in the world. One of the things that, I think, we have done that others have not done is become more backward integrated in the production of helium. And that's dependent on basically the producers of natural gas that, when they're producing natural gas, they also produce helium, and sell it to the industrial gas companies. And some of those natural gas sources have been shut down, creating a squeeze in the availability of helium. So all of our competitors have put customers on allocation, some as low as 50% of their normal need. We hadn't done that until we had to put people on 100% allocation because they were coming to us when they couldn't get supplied by our competitors. So that's caused us to do 100% allocation and then temporarily, an 80% allocation. So we're in pretty good shape on it. But then, helium's going to be scarce commodity. There's a finite amount in the world and we're focused on that, which leads me to just kind of one other point I want to make, as a recent survey done with our customers shows that, when asked the question, "how do you choose your supplier?" More than 70% of respondents say that reliability is the most important factor, with the remaining 30% split between price and technology. So it is important for our customers that we remain a reliable supplier.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Jim, what specifically was your Lin/Lox rates? I know it was running in the low 80s in the previous quarters. Are you still at that level?

James S. Sawyer

It's still running in the low to mid-80s.

Operator

Your next question comes from the line of David Manthey with Robert W. Baird.

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

First off, I was just wondering if you could discuss the competitive landscape in China broadly. It seems that the matured geos around the globe have mostly been sorted out, where you have a #1 and #2 player, and that's been determined by competitiveness and then M&A, eventually. How do you view the Praxair China strategy? What's your strongest foothold in that country, by geo or by industry? And if you could just talk about how you see that playing out over the next 5 to 10 years in terms of the overall landscape competitively in China.

James S. Sawyer

Okay. Well, that really brings up our, what we call our density strategy. And because making a high operating profit and a high return on capital in industrial gas is really is a function of having good production and distribution economics, having a lot of customers close to the plants, and also getting byproduct economics between the on-site and emerging businesses. So we have really focused ourselves on 4 -- 3 and then added a fourth region a couple of years ago. The Beijing region, where we have clusters of plants and clusters of customers. The region from Shanghai to Tianjin, where we have the same thing. And then south, in the kind of Daya Bay region, where Sinopec is big, customer. And then we've added the Chongqing region to that 2 years ago, with coal gasification project and merchant liquids there. So we're not going after every project there. There was a recent electronics project, which we really weren't interested in because it was out in the middle of nowhere. We couldn't get synergies with our other customers there. So there -- all 4 industrial gas companies plus Yingde are competing in China. But it's a big country, there are a lot of project opportunities, and we just have to be selective in terms of the ones that will be most profitable to us.

Operator

Your next question comes from the line of Mike Sison with KeyBanc.

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

In terms of the cost reduction evaluation for Europe, can you talk about what type of things you can do over there to help improve that business near term?

James S. Sawyer

Right. So I think, as most people know, we did some cost reduction back in 2008, when the big recession came, I think we were probably more effective in North America and South America back then, and less effective in Brazil because you have -- we didn't really want to lose any capacity or ability to meet customer's demands, if demand came back up. Now we've sort of concluded that packaged gas business in Spain and Italy probably will never come back to the levels that it was at earlier in 2000, 2010 decade because there was a lot of stimulus going on with subsidies for highway construction, railway construction, infrastructure and so forth, which resulted in dry packaged gas sales. So what we're focused on is consolidating plants in geographic areas, the fewer plants, that will be the main thing that we'll be doing there.

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

Okay. And then for North America, PDI continues to hum along there. Did you see any slowing to any degree in the quarter and when you take a look at the second half of the year, do you see that business moderating or keeping at the same pace?

James S. Sawyer

Oh, I think the sequential growth rate will continue to be fairly strong, maybe not as strong as it was over the past 12 months. But as we get into the third and fourth quarters, when you look at year-on-year comparables, some of that growth is going to start to lap itself, okay? That doesn't mean anything fundamentally different. But when you look at the numbers, they start to lap themselves. But packaged gas demand is strong. One of the things that we're seeing a shift a little bit is that, for a long time, hard goods growth was outpacing gas growth, which was indicating of an expanding demand, but the hard goods growth has much lower margins to it than gas growth. So really not growth we wanted to see. What we did see in the fourth quarter or in the second quarter was higher growth in demand for gases, which is really a pretty healthy development.

Operator

The next question comes from the line of Laurence Alexander with Jefferies.

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

Jim, could we revisit the question on productivity that you touched on earlier? Is -- have your triggers for when to do restructurings in each region changed? If you try to parse -- I just want to parse the thinking behind flagging ahead of time possible restructuring actions in different regions, I mean, you usually don't flag ahead of time.

James S. Sawyer

Right. Well, most of the productivity gains, year in and year out, are not really related to macroeconomic situation. They are related to getting more energy efficiency in the plants, more distribution efficiency and more administrative efficiency. So we continue to drive the normal productivity programs. And I would say that there are 3 points that we are focused on this year, which are partially macroeconomic or really macroeconomically driven. So in South America, you've got wage inflation really accelerating and probably growing faster than we can increase prices. So to maintain your margin, you need to kind of shift your operating philosophy to less labor and, consequently, higher sales per employee. So that's kind of the focus in South America and Brazil right now. And then, in Europe, it just doesn't seem to be coming back. As I just mentioned, we see kind of permanently lower demand in the packaged gases in southern Europe. And then in our PST business, which basically has 3 end markets: aerospace, energy and general manufacturing, most of the general manufacturing is in Europe. And that's just been the achilles heel to having PST grow at the rate that it should be growing at. So we're going to take a fresh look at curtailing some plants and production and headcount in PST. But it's really just focused on the European industrial end market, which is very weak.

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

And then also just elaborate on one of the points on how you cope with wage inflation in the U.S. about -- I think it was, what? About 10 years ago, you did a big push to automate and remote-control as many plants as possible. I mean, with the new systems, is there any reason why similar systems would not be applicable around in Asia or Latin America?

James S. Sawyer

Well, that's sort of a continuous process. I mean, we go through -- every 10 years or so, a generation of technology there. But the technology has a better payback in a business, which is a bigger business, okay? And so, we really haven't fully implemented it in anywhere else in the world the same technology that we have implemented in North America. And -- but we are -- we're moving -- we have been doing that and we'll continue to do that. And basically, it's plant control systems which allow you to start up and shut down the plant without losing much energy efficiency. It's about being able to shift production from one plant to another, depending on the power cost in one location versus another, when you have lots of plants, like we do in North America, that's a very fine tuning thing. When you have few plants, then it's not that much opportunity there. And then, lastly, in distribution economics, it's really state-of-the-art logistics planning tools. And so there's always room for improvement there.

Operator

The next question comes from the line of Mike Harrison with First Analysis.

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

Just looking at the Asia -- the operating margin in Asia, if we exclude that gain on sale, looks like operating margin declined. And I guess I would've expected, given the poor performance of electronics, that you that you would have actually had a positive mix benefit because electronics are typically lower margin? Can you just help us understand what was going on with those margin dynamics?

James S. Sawyer

Yes, I think you just explained it pretty clearly. The electronics is pulling down the margin and, particularly, argon sales to photovoltaic manufacturers and the price of argon are pulling it down. But the sort of non-electronics end markets have much higher margins, and also have significantly higher volume growth rates. You might have also cited it and kind of a disappointing volume growth rate is because we had positive volumes outside of electronics and negative volumes in electronics.

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

Got it. And then can you talk a little bit, Jim, about how the Air Products acquisition of Endura maybe changes the competitive dynamics in South America for you?

James S. Sawyer

I don't think it will change the competitive dynamics at all. We certainly -- we know that we own [indiscernible] the way had kind of an inside track on that. But when it went to public auction, we just could not get anywhere near into the prices that were being offered by [indiscernible] Air Products, especially when you look inside the company and you look at what plants they have and what capacity they have and what contracts they have and significant part of the business is selling nuts and bolts and stuff. So we shied away at that price. But we've got strong businesses in the major countries that Endura operates. A #1 share in Peru and Colombia and a #2 share in Chile. And yes, we're very-- optimistic and positive about the outlook for new on-site projects in those areas. And so tellingly, it's -- I don't see any change happening to our business as a result of it.

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

And just maybe lastly, one of your competitors commented on seeing some steel industry weakness that was impacting their liquid argon volumes in North America. Are you guys seeing anything like that?

James S. Sawyer

No. Well, it's just that -- that's a circular logic. The -- we have much higher -- we were the #1 producer of argon in North America by a long shot, okay? And we have more diverse production of argon amongst different plants. Whereas some of our competitors have really just make argon out of a couple of plants. And so, those would be plants that they're not -- if they're not operating, they're not making any argon, okay. So I know, and we're both -- our competitors are saying they would've made more money if they had more helium to sell, more argon to sell, but they didn't. Because they didn't plan ahead to make sure they had that capacity.

Operator

The next question comes the next question comes from the line of John McNulty with Crédit Suisse.

John P. McNulty - Crédit Suisse AG, Research Division

Just 2 quick questions. First of all, when you think -- when you add up like the competitive advantages versus maybe the cost and inflation issues, when you think about the profitability on projects, how does Brazil compare with the rest of your platforms, say, North America and Asia? In terms of like, returns?

James S. Sawyer

Yes, well, I would say in terms of new project investments, we use the same hurdle rates, maybe a little currency adjusted or interest rate adjusted, country by country. But there's a wide range. Where we're doing projects that are smaller kind of projects, where -- what I call we get a lot of synergy between the old business and the new business, we can get 20%, 30% IRRs on those projects, okay? So Brazil really has a large share of projects that look light. Other projects, which would tend to be more standalone or very large projects, tend to be more competitive and more in kind of the low to mid-teens in terms of IRRs. But that's -- that's kind of the same story around the world.

John P. McNulty - Crédit Suisse AG, Research Division

Okay. Fair enough. And then just with regard to your -- the RFPs you've said were starting to really heat up in the U.S. Can you give us more color where they're coming from? I know you mentioned the Vale contract that you got. But what other areas should we be thinking about in terms of where this demand is really picking up?

James S. Sawyer

Okay. I would say the mining sector is certainly one, with nickel and copper and gold prices high some of the North American miners are expanding. And there are also new process technologies that are environmentally cleaner than -- but also use oxygen in the processing technology. So mining sector is one, and then the chemical sector is another. There are probably about 20 potential, and I use the word potential, chemical project expansions in North America. A lot of ethylene oxide and so forth. So those 2 end markets are where we would be looking to -- where we're seeing increased proposal activity for on-site projects.

Operator

Your next question comes from the line of Bob Koort with Goldman Sachs.

Robert Koort - Goldman Sachs Group Inc., Research Division

Kelcey, I think you talked about the packaged gas trends and I wasn't sure if you can give a little more color between Germany and what's going on in southern Italy. Was it uniform erosion or was it better in the North than the South?

James S. Sawyer

Yes, it's better in the North than the South. It's kind of a -- history has always been that way. But basically, the weakest is Spain, the second weakest is Italy, third is France, Germany is pretty even. And then Scandinavia is growing.

Robert Koort - Goldman Sachs Group Inc., Research Division

And in the North American markets, Jim, have you seen as the rigs are sort of shifting away from dry into wetter gas, does that create challenges or benefits for you guys?

James S. Sawyer

Oh, it creates both, okay. So the frac-ing business for dry gas is practically, completely gone, okay? And that's a bit of hurt to us. But in the so-called wet gas, which has a lot of natural gas liquids and coal bed methane up in Canada, it's strengthening.

Robert Koort - Goldman Sachs Group Inc., Research Division

And if I might just last one, can you source crude helium from offshore and refine it here, or if you were get some from Qatar, elsewhere, would you bring in finished helium?

James S. Sawyer

No. We have a rather small -- we do have a contract from Qatar, and we do bring in some helium from Qatar, as well as all of our North American sources. But the problem is, and I don't think specifically that Qatar is that you've always buying it -- if they're not making natural gas, they're not going to be making helium, okay? So you get in this bind where you're committed to providing product to your customer but your supply source gets interrupted. So you don't want to be too dependent on any one supply source. But it's definitely economics to ship it around the world. I mean, we actually export a lot of helium out of North America to Asia.

Operator

Your next question comes from the line of Mark Gauley [ph] of Gauley [ph] and Associates.

Unknown Analyst

In past currency cycles in Brazil, you've been able to offset currency weakness with some pretty big price increases. Why is that not working quite as well at this juncture?

James S. Sawyer

Well, there's always a lag on that. And -- which happened over prior decades, it seems like every 10 years there some kind of devaluation, which is followed by inflation and followed by us increasing price. This has not been that kind of case yet, but we are getting price up on most of our contracts. But it's going to take some time because customers aren't doing that well because of the recession, and it always takes some time to get it up. So we will get it -- we will get price increases but it takes time to offset the devaluation.

Unknown Analyst

As a follow-up, with respect to your Gulf Coast hydrogen network, are lower natural gas prices and therefore, lower hydrogen prices, is that big enough to move the needle in terms of R&M margins for your customers?

James S. Sawyer

Well, I think -- I think that with low natural gas prices, low hydrogen prices, what their spending on hydrogen as compared to what their spending on crude oil tends to be a smaller amount, okay? And so, when they do their optimization of the refinery, in terms of looking at inputs and outputs, that gives them more degrees of freedom in how much hydrogen they would use. But yes it could also expand their margins a little bit.

Operator

Your next question comes from the line of David Begleiter with Deutsche Bank.

David L. Begleiter - Deutsche Bank AG, Research Division

Jim, just on your backlog, it was down in the quarter by a couple of hundred million dollars. If what see on new plant startups and potential new contract signings, should that backlog by year-end be flat up or down from current levels?

James S. Sawyer

Okay, that's a good question. Basically the backlog was down a couple of hundred million dollars because we started up more projects than we signed during the quarter, okay? And there'll be quarters where it'll go either direction. Now -- but that's kind of what's going into the backlog, what's coming out of the backlog or, I guess, what's the proposal activity remains to be strong. We think that the long-term growth around the world hasn't changed at all. But certainly, in Brazil, with the recession, we've seen a pause in decision-making, which is small compared to what we saw in 2009 and 2010 where we didn't sign very many contracts. But I think that long term, those projects will still be there. Now we're also seeing some delay in the startups of what's in the backlog with some customers who just aren't getting ready to take the product when the project was supposed to start. So some of that is going to stretch some of those 2013 startups into 2014.

David L. Begleiter - Deutsche Bank AG, Research Division

That's helpful. And Jim, just on pricing in Europe, given the weakness of the end markets, how much longer can you get pricing as volumes are down or weak?

James S. Sawyer

Well, I think we're the only ones in Europe who are focused in pricing, at least positive pricing. And we did get positive pricing this quarter and we're going to continue to try to do that.

David L. Begleiter - Deutsche Bank AG, Research Division

And just lastly, U.S. packaged gas sales are higher than air gas. Is that due to your helium activity that's not being constrained, do you think? Or are you gaining share?

James S. Sawyer

We had more acquisition activity and we had higher same-store sales growth. So I can't speak for them. But I think that we're all -- we've got our eyes focused on the selling process and the acquisition process and a pretty good pipeline going there. So with that, we'd like to take one more question.

Operator

The final question will from the line of P.J. Juvekar with Citi.

P.J. Juvekar - Citigroup Inc, Research Division

Just quickly, Jim, you talked about hedging in against the Brazilian real. Can you talk about what kind of hedges do you have in place for second half and what impact do you expect from them?

James S. Sawyer

Okay. With the accounting the way that it is, we really can't hedge that income because you can't get hedge accounting on hedging net income, which means that you really can't hedge across quarter-end, you have to mark everything to market. So we really kind of pretty much reduced our net income hedging to practically nothing.

P.J. Juvekar - Citigroup Inc, Research Division

Okay. And then secondly, we talked about strong volumes in North America in packaged gases. You mentioned automotive OEM had a strong end market. Are there any signs that you are seeing that -- in automotive OEM, or other areas where U.S. is beginning to slow down due to the woes in Europe?

James S. Sawyer

No, we haven't seen any slowdown in volumes there. And I think there's a whole range of industries. I use automotive OEM as an example. But there's machinery industries, farm and equipment industries, mining equipment that are driving metal fabrication and welding. And maybe won't be too long before we start to see a bottoming out in nonresidential construction, which could also be a positive help in the future. Okay. Well that is the end of our call. We've run out of time, but we thank you again for participating in our second quarter earnings call. Our third quarter earnings call will be held on October 24. Have a great summer, and if you got any questions, please feel free to contact Kelcey or myself. Thank you.

Operator

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

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