Praxair (PX) Q1 2018 Results - Earnings Call Transcript

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About: Praxair, Inc. (PX)
by: SA Transcripts

Praxair, Inc. (NYSE:PX) Q1 2018 Earnings Call April 26, 2018 11:00 AM ET

Executives

Juan Pelaez - Praxair, Inc.

Matthew J. White - Praxair, Inc.

Analysts

Duffy Fischer - Barclays Capital, Inc.

Michael J. Sison - KeyBanc Capital Markets, Inc.

Jeffrey J. Zekauskas - JPMorgan Securities LLC

Vincent Stephen Andrews - Morgan Stanley & Co. LLC

Laurence Alexander - Jefferies LLC

David I. Begleiter - Deutsche Bank Securities, Inc.

Stephen Byrne - Bank of America Merrill Lynch

Peter Clark - Société Générale SA (NASDAQ:UK)

Michael Joseph Harrison - Seaport Global Securities LLC

John Roberts - UBS Securities LLC

Christopher Evans - Goldman Sachs & Co. LLC

James Sheehan - SunTrust Robinson Humphrey, Inc.

Donald David Carson - Susquehanna Financial Group LLLP

Kevin W. McCarthy - Vertical Research Partners LLC

Operator

Good morning, ladies and gentlemen, and welcome to the Praxair First Quarter 2018 Earnings Conference Call.

At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host Mr. Juan Pelaez, Director of Investor Relations. Sir, you may begin.

Juan Pelaez - Praxair, Inc.

Thanks, Bridget. Good morning and thank you for attending our first quarter earnings call and webcast.

I am joined this morning by Matt White, Senior Vice President and Chief Financial Officer; and Kelcey Hoyt, 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.

In addition, please note that year over year and sequential comparisons exclude transaction costs and other charges largely related to the potential merger with Linde. The reconciliations to the U.S. GAAP reported numbers are in the Appendix to this presentation and the press release.

Matt and I will now review Praxair's first quarter results, including the current business environment, and provide our earnings guidance for the second quarter. We will then be available to answer your questions.

Let me turn the call over to Matt.

Matthew J. White - Praxair, Inc.

Thanks, Juan, and good morning, everyone. First quarter results were quite strong with 10% sales and 20% EPS growth compared to prior year. Volume and price improvements were attained across every segment and end-market, which supported an operating margin expansion of 140 basis points. A little under half of the volume growth came from the start-up of backlog projects in North America and Asia. In fact, one-third or $500 million started up in the first quarter this year, yet we held the backlog constant at $1.5 billion with new customer contract wins.

So while the backlog may be steady, it is from continual turnover of new project wins replacing those that are removed due to starting up, which clearly helps grow our earnings and returns. And while the global team focused on delivering these results, we continued to make good progress on the merger with Linde.

I'll speak to that more on an upcoming slide, but first I'd like to provide a brief update of global business trends, which you can find on slide 4.

North America is our second fastest growing region supported by the industrial recovery in the U.S. Over half of the 4% volume growth was driven by improvements in chemicals, from new investments starting up in the U.S. Gulf Coast, and manufacturing as the U.S. package business continues to grow high-single digits. And higher volumes in the metals, electronics, and resilient end-markets of food, beverage and healthcare, more than offset 1% decline related to customer turnarounds in the Gulf Coast.

There was modest recovery in the upstream energy business, especially in U.S. and Mexico, from increased well completion activity. However, this growth was from a very low base as volumes are still significantly below peak levels. Overall pricing in the region has been improving along with inflation, enabling margin expansion over both prior year and the fourth quarter.

Project bidding opportunity in the U.S. Gulf Coast remains healthy. Despite the recent large start-ups, the current backlog has over $750 million of U.S. projects under construction, and we're still confident in winning new projects over the next several quarters.

South America continues to lag all other regions and now comprises only 12% of global sales and 8% of global operating profit. Volume growth was slightly better than prior year, but 3% lower than the fourth quarter due to the seasonal effects of Carnival and Easter holiday.

The primary driver of growth relates to on-site metals customers as their volumes ramped up to meet slightly higher demand. However, several of those customers are still below take-or-pay levels. A combination of pricing and cost actions have enabled some margin expansion from prior year but, frankly, South America will remain a challenging place until there is more clarity around the direction of Brazilian politics.

Europe continues to be a steady, stable grower with underlying growth rates improving 3%. Volume growth occurred across every major end-markets, although metals and manufacturing comprised half of the improvement with a pick-up in industrial activity. Resilient markets also remained strong, as we continue to identify new growth opportunities with the acquired CO2 business.

There are a few signs of inflation returning to the economy, primarily in the form of higher power costs, which are driving pass-through up 2% versus prior year. These trends are enabling some pricing opportunities, up 1%, but more efforts are underway to recover the cost inflation.

Asia is our fastest growing region, with sales up 21% and operating profit up 39% from 2017 first quarter. While foreign currency appreciation is driving about 7% of the growth, underlying conditions remain quite robust across China, India and Korea. The 11% higher volumes are roughly split between project start-ups and organic growth, with project start-ups supporting energy and electronics end-markets and the industrial recovery supporting increases in chemicals, manufacturing and metals. The pricing improvement of 3% primarily relates to merchant gases in China, as structural supply challenges have eased with the closing of several liquefiers attached to Tier 2 and Tier 3 steel mills.

And earlier this week, we announced Praxair's single largest project win where we will build, own and operate high-purity nitrogen plants for Samsung's newly constructed fab in Pyeongtaek, South Korea. In addition to this win, there are several other opportunities to support the growing demand for electronic devices.

And finally, in our PST business, aerospace continues to grow high single to low-double digits, while oil and gas is making a modest recovery. Our aviation business has been making significant investments towards capacity expansion to serve the growing demand for aircraft engine coatings. And we anticipate continued ramping of revenues for the next several quarters.

So in summary, the synchronized industrial recovery coupled with timely start-ups of the project backlog have led to 5% volume growth spread across every end-market and segment. Furthermore, pockets of growing inflation have enabled higher pricing attainment in certain regions. The combination of the volume and price contribution have expanded overall operating margins for the fourth consecutive quarter. This backdrop coupled with U.S. tax reform appears to be supporting more customer capital investments and thus, opportunity to increase our project backlog above the current $1.5 billion level.

Before Juan provides more details on the financial results, I'd like to offer a brief update on the merger with Linde, which you will find on slide 5. You may recall at the start of this process, we defined three key phases required to complete the merger. The first two phases, defining the structure and value creation with the execution of the BCA, and obtaining all necessary shareholder approvals through the Praxair vote and Linde tender, have both been achieved. As planned, we are now deep into the third phase, which includes obtaining appropriate regulatory approval and finalizing any relevant remedies associated with those approvals.

The slide shows a high-level timeline of actions underway and milestones required to close the merger by the BaFin-mandated long-stop date in October of this year. The joint team continues to have constructive dialogue with all regulators and is actively engaged with potential buyers of asset divestitures.

Overall, we feel quite good about our progress and ability to complete remaining milestones within the required timeline. However, as you can imagine, this is a particularly important phase involving many outside parties. So I appreciate your understanding that we simply are not in a position at this time to answer any questions on merger progress or details of ongoing discussions with regulators or potential asset buyers.

I fully expect that formal updates will occur at appropriate times when decisions become binding, but until then the team is internally focused on the task at hand.

I'd now like to hand it off to Juan to review the first quarter results.

Juan Pelaez - Praxair, Inc.

Thanks, Matt. Please turn to slide 6 in our presentation for our consolidated results. Sales of just under $3 billion were 10% higher than last year and up 2% sequentially. The table in the upper right breaks down the drivers to the sales variance and you can see that the volume is the largest contributor with 5% growth versus last year.

When comparing to prior year, every major end-market grew led by chemicals, electronics and metals. From a segment perspective, Asia and North America had the largest organic growth from a combination of continued recovery in industrial markets and project contribution. Globally, of our total volume, more than half came from the base business and the rest was driven by project start-ups.

Sequentially, volumes were flat as first quarter is seasonally slower, primarily due to Lunar New Year and the timing of Easter. Furthermore, U.S. Gulf Coast customers underwent significant turnarounds which offset the volume growth in the rest of our North American businesses.

In Europe, volumes grew sequentially 1%, led by the manufacturing end-market, more specifically, in Spain and Germany. South America and Asia were seasonally weaker due to the holidays in the first quarter.

Sequentially, end-market trends were also consistent with expectations, as the industrial growth seen globally was offset by the energy drop in the turnarounds. The price/mix improvement of 2% was achieved from focused price actions across all our segments, primarily led by Asia and North America. As mentioned earlier, Asian merchant had a strongest price attainment, led by China, where structural challenges have eased coupled with a growing economy. Currency translation was favorable at 3%, primarily from strengthening of the euro, Canadian dollar, Chinese RMB and the Mexican peso.

Operating profit of $672 million was $99 million or 17% better than last year, and $16 million or 2% better than the fourth quarter. Operating margins improved 140 basis points year over year and 20 basis points sequentially, led by overall strong fundamentals in the base business, positive pricing, good volume growth and tightly managed cost.

Operating cash flow was $688 million, $22 million below prior-year quarter, mainly driven by foreign withholding tax payments of $65 million in the first quarter.

Capital expenditures were $325 million, and as a result, our free cash flow was $363 million, which we used primarily to pay dividends and reduce net debt by $86 million. We fully expect an improvement in next quarter's cash flow, in line with prior trends.

Project backlog closed the quarter at $1.5 billion, after starting up three new projects in the U.S.; one of them being Yara Freeport. We also announced two new on-site project wins in South Korea for the electronics end-market, which add up to $0.5 billion. As we continue with this backlog cadence of wins and start-ups, our incremental 3% EPS growth from project contribution will extend additional years.

Return on capital has steadily been rising for the past four quarters, now reaching 13%. As we continue to grow earnings, execute our backlog and manage cash generation, we expect our return on capital improving throughout 2018.

With that, now I'll turn the call back to Matt.

Matthew J. White - Praxair, Inc.

Please turn to slide 7. For the second quarter, EPS guidance range is $1.67 to $1.72, which represents 14% to 18% growth from last year. Year-over-year currency tailwind is anticipated to be lower than the first quarter as we begin to lap easier prior-year comps, especially in the euro, Canadian dollar and Mexican peso. The tax rate is still expected in the range of 23% to 25%, and likely closer to the middle of that range, consistent with the first quarter.

Excluding tax and currency, this guidance represents a double-digit growth rate, driven by an assumption of similar levels of demand continuing through June.

To sum things up, we had a very good start to the year and are anticipating a continuation into the second quarter. The Praxair team has been able to capitalize on an industrial recovery through higher organic volume growth and securing new on-site contracts.

In addition, the recent reflation effect in certain economies has presented pricing opportunities that have not been present for several years. The combination of these factors should enable continued growth with positive operating margin expansion.

I'd now like to turn the call over to Q&A.

Question-and-Answer Session

Operator

Our first question comes from the line of Duffy Fischer with Barclays. Your line is open. If your phone's on mute, please unmute your phone.

Duffy Fischer - Barclays Capital, Inc.

Yes. Good morning. You guys announced with Linde two days ago that you would look to buy back potentially the 8% holdout that didn't tender. Can you just walk through the technical aspects of that, the timeline? Kind of assuming a close date is X, how that would play out. And then can you do partial or do you have to do all 8% if you decide to do it?

Matthew J. White - Praxair, Inc.

Yeah, Duffy, I'm not going to get into a lot of details of the process. That will come out in due time. But I can say that it's a very structured process that under BaFin it's something that we will follow per the regulatory requirements and the Linde team and The Linde Group will announce each step as it's appropriate, but at this point there's nothing more I can add to that process.

Duffy Fischer - Barclays Capital, Inc.

Okay. Fair enough. And then if you would, go to China, the environmental stuff has been a good news story around them shutting down second tier steel which brings some liquid off the market. Do you see that continuing or has the bulk of that already happened from what you can see and we're still anniversarying it, but there's not going to be other steps of improvement there?

Matthew J. White - Praxair, Inc.

I'd say it remains to be seen. Clearly, we've been seeing it happen over the last several quarters. I think when you look to China, as far as capacity, last numbers I saw, I think it was about 1.2 billion, 1.2 billion tons a year of steel capacity if you add it all up. Now, not all of them were running. So clearly, the ones that are not running and have not been running won't have much of an impact, but I would say the combination of the industrial sort of growth with these coming out is creating a pretty good dynamic there. And given the amount of steel capacity, I do think there's probably a few more innings for that to happen, but it just remains to be seen.

Duffy Fischer - Barclays Capital, Inc.

Great. Thank you, guys.

Operator

Our next question is from Michael Sison with KeyBanc. Your line is open.

Michael J. Sison - KeyBanc Capital Markets, Inc.

Hey, guys. Nice start to the year.

Matthew J. White - Praxair, Inc.

Thanks, Mike.

Michael J. Sison - KeyBanc Capital Markets, Inc.

When you think about the Linde merger, I know you can't talk about the process, but any updated thoughts on the value creation potential? Particularly it does seem like demand overall is getting better and pricing's a little bit better. So if you think through that as you get into year one, maybe just give us your thoughts there.

Matthew J. White - Praxair, Inc.

Well, I would just say, I mean, again, won't get into a lot of details, but still have confidence on the value creation, still have confidence in the ability to deliver on the stated synergies and cost efficiencies but clearly our industry, as a whole, is doing quite well. I think you're seeing good numbers across the board. I think the Linde report yesterday was quite good. So I think the combination of us seeing a lot of return to growth, collectively, creates opportunities for all of us and I think that's good. And it would be great timing to come into a merger like this in a nice upswing in the economy. So I think it's all pretty good from my perspective.

Michael J. Sison - KeyBanc Capital Markets, Inc.

Great, and quick follow-up on Brazil. I'm just trying to get a tempo. Is it getting better? Or is it not getting better? And in terms of the industrial activity side, what's the potential if demand does improve over time?

Matthew J. White - Praxair, Inc.

Yeah, I think that's the million dollar question, Mike. When you look at the numbers that we have in our segment, slight improvement year over year. Obviously, sequential would be affected by the normal seasonal decline. So when you look year over year, a little bit of improvement. As I mentioned in the prepared remarks, we have seen steel volumes tick up. Not a lot of benefit to us given most of those were under take or pay. Usually in my experience when you see the infrastructure like metals and things start to ramp up, that tends to be a good sign of some form of an industrial recovery.

But that all being said, the uncertainty around the elections – and it's not just, obviously, Brazil. You have the similar situation in Colombia. You've got some situations going on politically in Peru. But I think when you add it all together, Brazil has the biggest one. We just won't have a lot of good idea in terms of how the politics will be run, how businesses will be viewed until the election in October. And right now, frankly, we're not even sure of the candidates.

So when clarity comes around that, I think it could hopefully – it'll have an effect on confidence one way or the other, but if it gives some confidence that there'll be a more, I'll say, business-friendly approach, I think you will start to see some investments. But I think most people are waiting, and it's probably prudent, and they'll just see. And so from that perspective, small improvements here and there. The resilient markets still continue to do well, and that was an area we've had a lot of focus. But until then, we've been managing costs pretty tightly. We are getting some price and we've just got to work through these next quarters until there's more clarity.

Michael J. Sison - KeyBanc Capital Markets, Inc.

Great. Thank you.

Operator

Our next question is from the line of Jeff Zekauskas with JPMorgan. Your line is open.

Jeffrey J. Zekauskas - JPMorgan Securities LLC

Thanks very much. There's a €3.7 billion limit to divestitures in the combination. The industrial gas industry, though, is now growing quite nicely. Does that €3.7 billion number get affected by the growth in the industry? Or is it some kind of look-back number?

Matthew J. White - Praxair, Inc.

Yeah, Jeff, I'll just state that our BCA is public. That was part of the S-4 filing we did last year, and you'll find that that threshold is a set number. It's based on a certain exchange ratio, but it's a set number. So it's not a moving number other than we've fixed the exchange ratio.

Jeffrey J. Zekauskas - JPMorgan Securities LLC

If it turns out that Praxair – the combination divested all of Praxair's European operations and all of Linde's North American operations, exclusive of Linde care and exclusive of the Engineering business, would that keep you under your threshold?

Matthew J. White - Praxair, Inc.

Yeah, Jeff. As I stated in the prepared remarks, we're not going to discuss anything related to potential divestitures or regulatory at this time. Our team is actively working on this with the appropriate parties, and we're just not in a position to talk about this in a public way.

Jeffrey J. Zekauskas - JPMorgan Securities LLC

Okay. Thank you so much.

Operator

Our next question is from Vincent Andrews with Morgan Stanley. Your line is open.

Vincent Stephen Andrews - Morgan Stanley & Co. LLC

Thanks, and good morning, guys. Just wondering if we can dig in a bit more on the North American price mix being up 2%. Can you just give a sense of how much of that was driven by the merchant business versus the pure package gas business?

Matthew J. White - Praxair, Inc.

Yeah, so we're seeing pretty much across the board low to mid-single digit pricing. As you know, that 2% we show is only for, as you stated, the package and merchant. It's divided by the entire revenue, so it doesn't include on-site. So the real pricing we're getting is a little better than that. And what we're seeing is pretty good pricing opportunity across the board, primarily in U.S.

Although we are seeing some inflation in Canada and we're getting some of that back in pricing and Mexico, as you know, has the higher inflation of both regions, so we're tracking to that as well. So we're seeing pretty consistently low to mid-single digit opportunities as costs are going up. We're seeing power costs go up in certain regions. We're seeing distribution costs going up in certain regions. So as the team goes out to recover that and get it in pricing, and that's what we're able to see right now.

Vincent Stephen Andrews - Morgan Stanley & Co. LLC

And then just in terms of the backlog, you kind of said a couple of things. One was that it stayed flat, because projects are coming in or going out about the same size, but there is an opportunity for the backlog to go up. And, I guess, I'm just wondering, can you speak to what you think the return profile of the backlog is, both as we move through this year and as you add new projects to it? Do you think the opportunity is for returns to go up? Stay flat? Or where do you think things are?

Matthew J. White - Praxair, Inc.

Well, as you could imagine, when we make decisions to add projects to the backlog, these are multi-decade views. So we're not just looking at right now and what's going on right now because these are projects, if you do it right, that will be with you for several decades. So from that perspective, I'd say the return profiles are still fairly consistent with how we've always viewed it and what our criteria is.

We will look at things like risk and reward and we continue to do that. And we want to make the appropriate decisions on what we invest in. And from that perspective, I'd say there's not a lot of different things, but we are seeing more opportunities and part of it, clearly, was we stated is in the U.S. I think tax reform will help that a little bit and the rest of it, primarily, is in Asia. And these are continued opportunities in our pre-backlog and we feel pretty good about it right now.

Vincent Stephen Andrews - Morgan Stanley & Co. LLC

Okay. Thank you.

Operator

Thank you. And our next question is from Laurence Alexander with Jefferies. Your line is open.

Laurence Alexander - Jefferies LLC

Hello. Two quick ones. I know there's not much you can say about the BaFin process on the takeout of the stub, but I guess one question that keeps coming up is the price setting mechanism. Is that a court modulated mechanism? Or is that effectively similar to going into an equity market and trying to buy up the available shares at market prices with the volatility that goes through that?

And then secondly, as your utilization rates are improving, are you finding any areas where your maintenance costs are tripping on the upside and you're seeing a little bit more cost than you had expected for your maintenance budget?

Matthew J. White - Praxair, Inc.

Okay, Laurence. I think I got the first question, but the second one I may have to clarify it, because it kind of cut in and out a bit. But I will state this much on the squeeze-out process. As I mentioned, it is a structured process and my best understanding of how it works is that there will be a three-month volume weighted average price, based three months back from the time of the announcement, and then there will be an independent what's called an IDW S1 valuation. You may recall one was done on the consolidated merger at the time of the filing of the S-4 and the tender offer.

So both of those will be viewed as two different valuations and the higher of those two will be determined. It's quite structured and that is under way with the announcement, then the valuation will be initiated to be done by an independent party. So this is all per the German requirements and there's really nothing as an organization that we would do different. We would follow the regulations as required.

And your second question, I think, was something on utilizations, but I missed the back end of it. Can you maybe repeat that please?

Laurence Alexander - Jefferies LLC

Sure. So the other question was just as utilization rates pick up, are you seeing some of your assets or maybe some of your older units trip up and, therefore, your maintenance budget is moving higher than you would have expected a couple of years ago?

Matthew J. White - Praxair, Inc.

No, I think we continue to maintain our plants as always, regardless of the utilization rates. You've got to do the maintenance appropriately. Clearly, when plants run at higher utilization rates, there is a sweet spot, right, that you like to run them at. When you're bringing them up and down, that's when it gets more difficult, frankly. When you've got to thaw plants and re-bring them to cryogenic. But right now, I'd say, nothing different than what we normally experience and, clearly, we continue to invest in our plants, as you could imagine, regardless of what the utilization rates are at.

Laurence Alexander - Jefferies LLC

Perfect. Thank you.

Operator

Our next question is from David Begleiter with Deutsche Bank. Your line is open.

David I. Begleiter - Deutsche Bank Securities, Inc.

Thank you. Good morning. Matt, very strong numbers in packaged gases in the U.S., up 9%, clearly above end-market activity. So what's driving the above-market growth? Was it an easy comp, or some other factors?

Matthew J. White - Praxair, Inc.

Yeah, David, as you may recall, package was one of our laggards probably a year ago. So we're having a pretty nice recovery. And when I look across the end-markets and our geographies in the U.S. of kind of central, north, the south, east, west, it really is broad based. I mean, we're seeing it across every single package end-market. Most of them are double-digit. Manufacturing is not quite double digit, which is clearly our largest. But we're seeing improvements in our cylinder gases, dry ice. We're seeing a lot of improvements in Tier 2 auto. Aerospace continues to be quite strong. So, I would say it's across the board.

And we are seeing some pick-up in upstream oil a little bit as well. That's something coming off a low base, but that's also an area where we're seeing some improved growth. So there is no one market I could point to right now. And when you look at the industrial production in the U.S., I think that's been boding well for a lot of these packaged end-markets. You're just seeing it across the board. So we feel pretty good, especially the remainder of this year in our package business. I think the numbers continue to be strong and it's been a nice run. And as we've said in the past, when that business recovers, it recovers with some fairly good leverage and that's what we've been experiencing. So we've been quite happy with that as well.

David I. Begleiter - Deutsche Bank Securities, Inc.

Very good. And Matt, just on FX, what did FX add to EPS in Q1? And what do you expect for Q2?

Matthew J. White - Praxair, Inc.

Yeah, David, so as you know, it's just translational for us. So the best rule of thumb is if you take what we show on the sales and just drop that down. So we had 3% in Q1, as we laid out in our sales walk, and that's a pretty good proxy to use on EPS. When you get our Q's by the segment analysis, you'll be able to see the OP effect within each segment on FX. But for the most part, it follows the top line.

Q2 – and when we look at our FX, we lock in the forward rates at the beginning of the month. Clearly, rates have moved here over the last couple weeks, so it's pretty volatile. But I would say we expect definitely something less than 3% for Q2, partly because Q2 of last year, the rates were stronger, the foreign rates, vis-à-vis the dollar than they were Q1, so the comps get tougher. But also, I'd say rates at least on a couple of week basis here have gotten a little weaker on the foreign. So the combination of that two will put it something below 3%. Could be 2%, could be 1% based on where we're at now, remains to be seen.

David I. Begleiter - Deutsche Bank Securities, Inc.

Thank you very much.

Operator

Our next question comes from the line of Stephen Byrne with Bank of America. Your line is open.

Stephen Byrne - Bank of America Merrill Lynch

Yes. Thank you. When you exited your U.S. home respiratory care business, if I recall correctly, your gross margins were essentially offset by the SG&A expense. As you look forward post the potential merger, would you see anything that has changed this dynamic, either the size of your hospital business or the size of Linde care or any changes in this industry that would change the potential synergy here?

Matthew J. White - Praxair, Inc.

Yeah, at this point, there's really nothing I could say to that. We're not in that business today as Praxair, so I don't know much about the dynamics and what's going on in that industry. So it's really – I think if you want to understand more about what's happening and the dynamics, you're probably best suited to ask Linde directly on that question.

Stephen Byrne - Bank of America Merrill Lynch

Okay. And, Matt, where do you estimate your market share now in U.S. packaged gases business? And is that attractive enough for you to consider either greenfield or M&A bolt-ons?

Matthew J. White - Praxair, Inc.

Well, we continue to do M&A bolt-ons in our packaged business. They're quite small, so you don't tend to see them at the consolidated level, but we're continuing to roll up opportunities for mostly family-owned distribution businesses in the U.S. I'd say the opportunity set is lower now, partly with the recovery. People have some different views of valuations, so you're not seeing as many businesses be sold. But that's something we continue to do. And as you know, we sell gases and we sell hard goods.

Clearly, the gases are better margins, because we have a full producer economics. Hard goods, we play more of a distributor role. But the combined margins are something you would expect of a distributor, a little better, frankly, given the gas that we have. But it's a good business and it brings a lot of nice contribution for us. So when we find opportunistic acquisitions and ones that we can justify on synergies, we absolutely will continue to do them. But right now, it's in a nice part of the growth in that business and we continue to invest in it.

Stephen Byrne - Bank of America Merrill Lynch

Thank you.

Operator

Our next question comes from the line of Peter Clark with Société Générale. Your line is open.

Peter Clark - Société Générale SA (UK)

Yes. Thank you. Hi, everyone. Matt, there's a quick question on the backlog, to begin with. I mean, obviously, you've pointed at the electronic signatures and the Gulf Coast signatures beginning of the year. The backlog obviously has seen the sort of electronics come in, 50/50 now North America, Asia. Just wondering, clearly, you're pointing at some of the Gulf Coast signatures coming. How do you see the geographical split of that backlog as we get towards the tail end of the year, because you also actually pointed at more Asian signatures potentially?

And then specifically on the backlog, and certainly an opportunity like Freeport now is up and running, that's a pretty new hub for you. Just wondering how you see the opportunities in that sort of area developing, given you have that signature?

The last question on the upstream energy, you pointed at it coming off the bottom. Now, certainly some of the specialty chem players are indicating that their customers potentially might lose it on the cost consciousness they've had and might be spending a bit more money to get the oil and gas out or more of the oil and gas out. Just wondering if that's your feeling on fracking gases if there's some momentum here that we can see during the year? Thank you.

Matthew J. White - Praxair, Inc.

Okay, Peter. So I'll try to take them in order here. The first question on the backlog. The challenge, I think, of trying to project the split between, we'll call it, U.S. chemicals and refining North America versus Asia and electronics is the project sizes are so lumpy, right? So the timing of when the projects come in could skew that. We still see a lot of quite large projects in the U.S. Gulf Coast as new opportunities and they're both refining and pet chem opportunities.

With Asia, clearly to your point, we've added some large electronics. There are others out there as well. So it depends on timing. I think we'll probably see a little more move back to U.S. and refining and energy in the coming quarters, just based on where things are. But it just remains to be seen on the timing and when things are ultimately signed. But we feel pretty good about the trend on both and, frankly, I'm indifferent which one we get, as long as these projects meet our criteria, which they do, so.

On Freeport, yeah, we clearly feel good about having those assets there. Any time you have an opportunity to extend your network into a region and bring both atmospheric and process gases, we see, as a very good thing. And so we continue to find some incremental opportunities off that, which we're pursuing. And we just continue to look for ways to extend the network. So I think it's something that we always like to do, and this is what we've been doing since our inception.

And on upstream energy, to your point, yes, we are hearing things, people feeling a little bit better. Oil prices are higher. I think some of the regions, like Permian, are getting crowded. It's getting more difficult to get product out. I think you're starting to see activity in other regions as pricing gets better. I would say too, we probably saw a lot of what's called refracking of wells. Not a lot of new wells; not a lot of new completions when prices were lower. Now that prices are higher and they've kind of exhausted, I think, a large backlog of existing wells, you're seeing people do a little more work, a little more drilling. Probably new completions. And to your point, they see enough value that they're willing to expend more resources.

So I think that is a good sign, but we're still coming off a pretty low low. So even – we've been experiencing double-digit growth, but it's got a long way to go and it remains to be seen if it can ever get back to the level it was, but I'd say trends are good. The customer sentiment seems to be pretty good and we're seeing some nice roll-up opportunities and I'd say U.S. and Mexico is where we're seeing much more of the opportunity right now as we said in the script.

Peter Clark - Société Générale SA (UK)

Excellent. Thank you.

Operator

Our next question comes from the line of Mike Harrison with Seaport Global Securities. Your line is open.

Michael Joseph Harrison - Seaport Global Securities LLC

Hi. Good morning.

Matthew J. White - Praxair, Inc.

Good morning.

Michael Joseph Harrison - Seaport Global Securities LLC

Matt, I was wondering if you could talk a little about the margin performance in South America. You had a sequential decline, or I guess kind of any way you look at it, sales didn't decline very much but margin declined quite a bit, 170 bps sequentially. Is that the take or pay minimums coming into play there? Or can you maybe give a little more color on why we're seeing that swing in margin despite only a modest sequential decline in sales?

Matthew J. White - Praxair, Inc.

Yeah, Mike, I'd say it's a combination of a couple things. Sequentially, we're improving on volumes that are below take or pay. So to your point, you're getting top-line, but not really much margin on it. And in addition, with the normal seasonal patterns, with Carnival and Easter and what we tend to see is, you see a lot less merchant and package gases just because of normal seasonal shutdowns, which tend to be more favorable margin products. So the combination of those two effects, you've got a larger decline in sort of your package and merchant, which is hurting the margin. And then, you've got some improvement in the on-site, which might be at a below take-or-pay level, and that combination is creating, on a sequential basis, an unfavorable margin.

So looking at year over year sometimes helps get the seasonality piece out and year over year we are a little better as you see but still got a long ways to go to get back to the levels that we've become accustomed to in prior years. So we've got our work cut out for us, but that sequential seasonal effect plus these rising volumes in take-or-pay scenarios aren't doing a lot to help margins right now.

Michael Joseph Harrison - Seaport Global Securities LLC

All right. And then, I was wondering if you could give us a little color on what you're seeing in the helium market. It sounds like supply and demand are getting tighter again. Would that be a potential positive for your earnings going forward?

Matthew J. White - Praxair, Inc.

I think it could be. To your point, helium had a rough go for the last year, but supply has become constrained for a variety of different reasons. And we're starting to see some difficulty in maintaining supply and delivering supply across various accounts in the world for the product, which will probably provide some pricing opportunity. But helium has had, like I said, probably a rough year or so, and we do expect that it should do better here over the next year.

Michael Joseph Harrison - Seaport Global Securities LLC

Thank you very much.

Operator

Our next question is from the line of John Roberts with UBS. Your line is open.

John Roberts - UBS Securities LLC

Thank you. In Surface Technologies, maybe you don't add coaters very often, so maybe this is a good opportunity to get a sense of the capital intensity of that business. How much does a new coater cost?

Matthew J. White - Praxair, Inc.

Well, John, I don't want to get into specifics of what a new coater costs, but I would say that it's a multiple asset investment to meet the demand that we have for coating engine parts. So it's not just a single coater. This is capacity that we're expanding across a couple of locations, and it's something that's material enough that we want to call it out. Clearly, we're ramping up costs. We're hiring people. We're training people. We have the facility costs. We're installing the equipment.

So you front run the costs in the manufacturing environment like this, but the revenue will ramp over the next several quarters. So we feel good about the progress, the investments are going to plan, and the demand is there. We know that the opportunity set is there. So that's something that I expect will get better with each successive quarter, but we're in the middle of kind of ramping that capacity up right now.

John Roberts - UBS Securities LLC

Okay. And is the tightness in the trucking market and the new rules for hours drivers can work having any effect on your business?

Matthew J. White - Praxair, Inc.

Well, we've dealt with, as you could imagine, lots of challenges over our – since our inception of availability of drivers and difficulty obtaining drivers. We, like probably other folks in our industry, do a combination of internal employee drivers and using third-party contract carriers. So that's something we flex up and down based on what our volumes look like, based on availability to get contract drivers that meet our safety standards and meet our requirements to be a contractor for Praxair.

So I would say the current situation, we've seen things like this in the past and we're probably doing a little more internal hiring of drivers than using third parties, just giving some of the availability, but this is something that we're used to managing and we'll continue to manage. And as distribution costs rise and if they rise, that's something we need to go out and try to recover in the market, which is what we've been doing.

John Roberts - UBS Securities LLC

All right. Thank you.

Operator

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

Christopher Evans - Goldman Sachs & Co. LLC

Thanks, guys. This is Chris Evans on for Bob. I wanted to talk a little about the Asian price trajectory. It looks like you're going to start to lap some of the benefits next quarter. I just wanted to get a sense, just in the marketplace right now, is there enough support that you could see sequential price improvement later in the year and see a continued year-over-year price gains?

Matthew J. White - Praxair, Inc.

Well, Chris, I mean, our objective is to try and do that. It remains to be seen. I would say that prior to a lot of these increases, the pricing in China was some of the lowest we have in the world. So, there is an amount of room to catch up. Demand is pretty good. So, that's something that has to be seen. But clearly, the team, I think, is motivated and properly has the right metrics in how to look at this. But conditions are good right there and good right now, but it's still – I think China has a ways to go before the pricing can be equivalent to what you see in other markets. So I don't know at this stage, but we'll have to see.

Christopher Evans - Goldman Sachs & Co. LLC

Thanks. And then since we're seeing such a strong uptick in some of the merchant and packaged businesses globally, can you kind of remind us of the potential for margin improvement as you increase utilization rates? Or what kind of algorithms or metrics should we look at as you get to fill up your plants at higher rates?

Matthew J. White - Praxair, Inc.

Well, our goal is to try and raise our margins every year, and if we can get 20 to 40 basis points, I think when you look at the average that we've experienced over a long range, that's something we've been able to deliver on fairly consistently. Clearly, in a time with pricing opportunities and expansion of volumes, that gives us a better opportunity to raise margins. We've done it now, as I mentioned, four consecutive quarters. We've got some pretty good year-over-year margin leverage for this first quarter. So this is something that we want to just make sure we capture, and the key is that we don't lose it, right? We don't allow cost inflation to offset it, and that's something that there is a lot of focus in the organization to ensure.

So, I think there is more opportunity. I think there is more improvement. I mean, I look at something like South America, when you look at it by region, South American margins are some of the lowest they've been. So, any kind of improvement there will clearly help the overall margins. So, it's got to be kind of region by region and what we're able to do on organic volume and pricing. But I definitely think there's room for improvement.

Christopher Evans - Goldman Sachs & Co. LLC

Thanks, Matt.

Operator

Our next question is from Jim Sheehan with SunTrust. Your line is open.

James Sheehan - SunTrust Robinson Humphrey, Inc.

Thanks. Matt, could you give us some flavor on your merchant utilization rates by region?

Matthew J. White - Praxair, Inc.

Sure. So start in North America. What we're seeing is kind of low-80s. Argon is much tighter. You probably have heard that from other calls. But on the LIN/LOX side, still kind of high-70s, low-80s. But we're continuing to see some upticks there. But for the most part, while it's different in the regions, pretty well loaded, but we've still got a lot of room and capacity for further expansion.

South America, it depends. LAR is quite low, low utilization. But excluding LAR, we're probably in the mid to high-70s for most of our areas. But that's something that's been pretty flat for a while now in utilizations over the last couple of years. Not much movement there. Europe, again, I'd say mid-70s LIN/LOX, so we've definitely got some capacity and room there, although we have seen some incremental improvements.

And then Asia is clearly higher, probably mid-80s. China and Korea are definitely in higher utilization rates. India is little lower, but we're starting to see a better utilization as those economies have been growing pretty much faster than the other ones in the world. So all-in, we're probably in the high-70s globally, but I would say definitely room for further capacity expansion and we can meet any incremental demand, if required.

James Sheehan - SunTrust Robinson Humphrey, Inc.

Did you quantify any headwind you might expect from customer turnarounds in the second quarter?

Matthew J. White - Praxair, Inc.

Not in the second quarter, no. We had mentioned in the first quarter some fairly large primarily refining turnarounds in the U.S. Gulf Coast and that was about 1% on the North American segment, so roughly half of that globally. But, no, there's nothing we've highlighted in the second quarter.

James Sheehan - SunTrust Robinson Humphrey, Inc.

Thank you.

Operator

Our next question is from Don Carson with Susquehanna Financial. Your line is open.

Donald David Carson - Susquehanna Financial Group LLLP

Matt, on the on-site business, are you seeing any pick-up in production at your North American customers from the steel and aluminum tariffs? Or is it too early to tell what benefit that may have?

Matthew J. White - Praxair, Inc.

Well, Don, I'd probably say it's a little too early to tell, but I can say looking over the last several quarters, we've definitely seen an improvement in volumes across our metals customers in North America. And I think you've probably seen that in our end-market reporting by segment. So, it's been a continual improvement. I think that margins are better for them, given what's going on. So I think the desire is there to run. It's profitable for them to run. So we see the right backdrop, and we've seen some good improvements. And then clearly, they'll just be as units come on and off with the various mills but that's an area I think that the economics for our customer base seems good and it seems to be more of a level playing field for them. So I think that outlook still remains fairly good.

Donald David Carson - Susquehanna Financial Group LLLP

And a follow up on the Linde divestiture process; see if you can answer it. But on the bidders for the assets that are being divested, have those bidders been preapproved by either the European Commission or other antitrust agencies.

Matthew J. White - Praxair, Inc.

Yeah, sorry, Don. I can't get into any details at this point on that process. But rest assured, when the timing is right and we have more information to disclose, we will disclose that.

Donald David Carson - Susquehanna Financial Group LLLP

Yeah, thank you.

Matthew J. White - Praxair, Inc.

Okay. I think we have time for one more.

Operator

And our last question is from Kevin McCarthy with Vertical Research. Your line is open.

Kevin W. McCarthy - Vertical Research Partners LLC

Yes. Thank you for squeezing me in. With regard to the package gas growth of 9%, would you comment on the split between hard goods and gas and rent? And then also in U.S. package gases, Matt, I think you referenced some of the pressures in logistics. Can you remind us how you look to offset that? Is it surcharges or pricing or a combination of those?

Matthew J. White - Praxair, Inc.

Sure. So on the pag, 9% growth, hard goods are double-digit and again, that's coming off the lower base. Hard goods tend to swing more, as you know, so they're up more double-digit. Gases are mid-single digit, some pushing to higher single-digit. So I'd say from that perspective, kind of bracketing around the 9%. But we've seen now a couple of quarters in a row with these type trends and I think they remain pretty solid throughout here, even through the first month of the second quarter here.

Regarding logistics costs, it's exactly what you said. It'll be a combination. Some will be surcharging contractually; some will just be pricing. Depends on the contract; depends on the product. For package, it tends to be more just pricing, and so that's a reason why they need to go out there and make sure we're recovering any of the inflation that we're seeing. And I'd say so far to-date, we've been keeping up with it, so we feel we're on track with that.

Kevin W. McCarthy - Vertical Research Partners LLC

Very good. And then as a quick follow up, if I may, on slide 15 where you provide the end-use market growth trends, chemicals was highest at 14. That's an acceleration from 11 I think last quarter. What is driving that? And if you were to back out new projects, do you think the baseline growth is accelerating there as well? Do you have any color on that subject?

Matthew J. White - Praxair, Inc.

Yeah, so clearly to your point, projects are driving a portion of that in North America. But even without the projects, we are still positively growing, a little bit in Europe; fairly well in Asia still. We're seeing good growth in chemicals on our Asian, primarily on-site businesses and in the U.S. Even excluding the project start-ups, we are growing in chemicals. So I'd say that even despite the start-ups, that is a positive growing end-market, consistent with what you'd see in some of the others on an organic basis.

Kevin W. McCarthy - Vertical Research Partners LLC

Thank you so much.

Juan Pelaez - Praxair, Inc.

Thank you again for participating in our first quarter earnings call. If you have any further questions, please feel free to reach out to me directly.

Operator

Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a great day.