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 a question and answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touch-tone telephone. 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.
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 Kelly Futtner, 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 two 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 reporting 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 questions.
Let me turn the call over to Matt.
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 startup 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. 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. 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. First, I'd like to provide a brief update of global business trends, which you can find on slide four. 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. packaged business continues to grow high single digits. Higher volumes in the metals, electronics, and resilient end markets of food, beverage, and healthcare more than offset a 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 startups, 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 onsite metals customers as their volumes ramped up to meet slightly higher demand. However, several of those customers are still below take-or-pay levels.
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 market, although metals and manufacturing comprised half of the improvement with a pickup in industrial activity. Resilient markets also remain 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 startups and organic growth, with project startups 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. 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. 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. In summary, the synchronized industrial recovery, coupled with timely startups 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 price 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 five. 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. As you can imagine, this is a particularly important phase involving many outside parties. 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. 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.
Thanks, Matt. Please turn to slide six in our presentation for our consolidated results. Sales are 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 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 startups. Sequentially, volumes were flat as first quarter seasonally slower, primarily due to Lunar New Year and the timing of Easter.
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 the strongest price attainment, led by China, where structural challenges have eased, coupled with a growing economy. Currency translation was favorable 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 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 onsite project wins in South Korea for the electronics end market, which add up to half a billion dollars.
As we continue this backlog cadence of wins and startups, 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.
Please turn to slide seven. For the second quarter, EPS guidance range is $1.67-$1.72, which represents 14%-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%-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 onsite 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.
Ladies and gentlemen, if you have a question at this time, please press star and the number one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. 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.
Yes. Good morning, fellas. 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?
Duffy, I'm not going to get into a lot of details of the process. That will come out in due time. 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. At this point, there's nothing more I can add to that process.
Okay. Fair enough. If you would go to China, the environmental stuff has been a good news story around them shutting down 2-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?
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 tons a year of steel capacity if you add it all up. Now, not all of them are running. Clearly, the ones that are not running and have not been running won't have much of an impact. I would say the combination of the industrial sort of growth with these coming out is creating a pretty good dynamic there. 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.
Great. Thank you, guys.
Our next question is from Michael Sison with KeyBanc. Your line is open.
Hey, guys. Nice start to the year.
Thanks, Mike.
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. If you think through that as you get into year one, maybe just give us your thoughts there.
Well, I would just say, again, we won't get in 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. 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. 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. It would be great timing to come into a merger like this, in a nice upswing in the economy. I think it's all pretty good from my perspective.
Great. Quick follow-up on Brazil. I'm just trying to get a tempo. Is it getting better or is it not getting better? In terms of the industrial activity side, what's the potential if demand does improve over time?
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 will be affected by the normal seasonal decline. 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. That all being said, the uncertainty around the elections, it's not just obviously Brazil. You have the similar situation in Colombia. You've got some situations going on politically in Peru.
I think when you add it all together, Brazil, as 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. Right now, frankly, we're not even sure of the candidates. When clarity comes around that, I think it could hopefully, it'll have an effect on confidence one way or the other. 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. I think most people are waiting, it's probably prudent, and they'll just see. 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.
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.
Great. Thank you.
Our next question is from the line of Jeffrey Zekauskas with JPMorgan. Your line is open.
Thanks very much. There's a EUR 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?
Yeah, Jeff, I'll just state that our BCA is public. That was part of the S-4 filing we did last year. You'll find that that threshold is a set number. It's based on a certain exchange ratio, but it's a set number. It's not a moving number other than we've fixed the exchange ratio.
If it turns out that the combination divested all of Praxair's European operations and all of Linde's North American operations, exclusive of Lincare and exclusive of the engineering business, would that keep you under your threshold?
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.
Okay. Thank you so much.
Our next question is from Vincent Andrews with Morgan Stanley. Your line is open.
Thanks. 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 packaged gas business?
Yeah. 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 packaged and merchant. It's divided by the entire revenue, so it doesn't include onsite. The real pricing we're getting is a little better than that. 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. Mexico, as you know, has the higher inflation of both regions, so we're tracking to that as well. We're seeing pretty consistently low to mid-single digit opportunities, as costs are going up. You're seeing power costs go up in certain regions. We're seeing distribution costs going up in certain regions.
As the team goes out to recover that and get it in pricing, and that's what we're able to see right now.
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's an opportunity for the backlog to go up. 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?
Well, as you could imagine, when we make decisions to add projects to the backlog, these are multi-decade views. 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'll be with you for several decades. 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. We want to make the appropriate decisions on what we invest in. From that perspective, I'd say there's not a lot of different things. We are seeing more opportunities. Part of it, clearly, as we stated, is in the U.S. I think tax reform will help that a little bit.
The rest of it primarily is in Asia. These are continued opportunities in our pre-backlog, and we feel pretty good about it right now.
Okay. Thank you.
Thank you. Our next question is from Laurence Alexander with Jefferies. Your line is open.
Hello, two quick ones. I know there's not much you can say about the BaFin process on the takeout of the stub. 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 to that? 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?
Okay, Laurence. I think I got the first question, the second one I may have to clarify because it kind of cut in and out a bit. I will state this much on the squeeze-out process. As I mentioned, it is a structured process, 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. 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. Both of those will be viewed as two different valuations, the higher of those two will be determined. It's quite structured, that is underway with the announcement.
The valuation will be initiated to be done by an independent party. This is all per the German requirements, there's really nothing as an organization that we would do different. We would follow the regulations as required. Your second question, I think, was something on utilizations, I missed the back end of it. Can you maybe repeat that, please?
Sure. 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?
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's a sweet spot 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. Right now, I'd say nothing different than what we normally experience. Clearly, we continue to invest in our plants, as you can imagine, regardless of what the utilization rates are at.
Perfect. Thank you.
Our next question is from David Begleiter with Deutsche Bank. Your line is open.
Thank you. Good morning. Matt, very strong numbers in packaged gases in the U.S., up 9%, clearly above end market activity. What's driving that above market growth? Was it an easy comp or some other factors?
Yeah, David, as you may recall, packaged was one of our laggards probably a year ago. We're having a pretty nice recovery. 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. We're seeing it across every single packaged 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. I would say it's across the board. We are seeing some pickup 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.
There's no one market I could point to right now. 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. We feel pretty good, especially the remainder of this year in our packaged business. I think the numbers continue to be strong, and it's been a nice run. As we've said in the past, when that business recovers, it recovers with some fairly good leverage. That's what we've been experiencing. We've been quite happy with that as well.
Very good. Matt, just on FX, what did FX add to EPS in Q1, and what do you expect for Q2?
Yeah, David. As you know, it's just translational for us. The best rule of thumb is if you take what we show on the sales and just drop that down. 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. For the most part, it follows the top line. Q2, 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 of weeks, so it's pretty volatile. 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-a-vis the U.S. dollar than they were Q1, the comps get tougher. Also I'd say rates, at least on a couple-week basis here, have gotten a little weaker on the foreign. 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.
Thank you very much.
Our next question comes from the line of Steve Byrne with Bank of America. Your line is open.
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 Lincare or any changes in this industry that would change the potential synergy here?
Yeah. At this point, there's really nothing I could say to that. We're not in that business today as Praxair. I don't know much about the dynamics and what's going on in that industry. I think if you want to understand more about what's happening in the dynamics, you're probably best suited to ask Linde directly on that question.
Okay. 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?
Well, we continue to do M&A bolt-ons in our packaged business. They're quite small, you don't tend to see them at the consolidated level. 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 valuation, you're not seeing as many businesses be sold. That's something we continue to do. As you know, we sell gases and we sell hard goods. Clearly, the gases are better margins because we have the full producer economics. Hard goods, we play more of a distributor role. The combined margins are something you would expect of a distributor, a little better, frankly, given the gas that we have. It's a good business and it brings a lot of nice contribution for us.
When we find opportunistic acquisitions and ones that we can justify on synergies, we absolutely will continue to do them. Right now, it's in a nice part of the growth in that business, and we continue to invest in it.
Thank you.
Our next question comes from the line of Peter Clark with Societe Generale. Your line is open.
Yes. Thank you. Hi, everyone. Matt, just a quick question on the backlog to begin with. Obviously, you pointed at the electronic signatures and the Gulf Coast signatures at the beginning of the year. The backlog, obviously, you're seeing 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 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. Then specifically on the backlog, and certainly an opportunity like Freeport now that's 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've had 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 loosen 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.
Okay, Peter. 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 Asian electronics is the project sizes are so lumpy, right? 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 petchem opportunities. With Asia, clearly, to your point, we've added some large electronics. There are others out there as well. 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. It just remains to be seen on the timing and when things are ultimately signed.
We feel pretty good about the trend on both. Frankly, I'm indifferent which one we get as long as these projects meet our criteria, which they do. On Freeport, yeah, we clearly feel good about having those assets there. Anytime you have an opportunity to extend your network into a region and bring both atmospheric and processed gases, we see as a very good thing. We continue to find some incremental opportunities off that, which we're pursuing. We just continue to look for ways to extend the network. I think it's something that we always like to do, and this is what we've been doing since our inception. 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. To your point, they see enough value that they're willing to expend more resources. I think that is a good sign, but we're still coming off a pretty low low. 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.
I'd say trends are good. The customer sentiment seems to be pretty good, and we're seeing some nice roll-up opportunities. 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.
Excellent. Thank you.
Our next question comes in the line of Mike Harrison with Seaport Global Securities. Your line is open.
Hi, good morning.
Good morning.
Matt White, I was wondering if you could talk a little bit 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 basis points sequentially. Is that the take-or-pay minimums coming into play there? 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?
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. To your point, you're getting top line, but not really much margin on it. 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 Packaged Gases just because of normal seasonal shutdowns, which tend to be more favorable margin products. The combination of those two effects, you've got a larger decline in sort of your Packaged 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. That combination is creating, on a sequential basis, an unfavorable margin. Looking at year-over-year sometimes helps get the seasonality piece out.
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. We 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.
All right. 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?
I think it could be. To your point, Helium had a rough go for the last year. 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. 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.
Thank you very much.
Our next question is from the line of John Roberts with UBS. Your line is open.
Thank you. In surface technologies, 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?
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. It's not just a single coater. This is capacity that we're expanding across a couple 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. You front-run the costs in a manufacturing environment like this. The revenue will ramp over the next several quarters. 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. That's something that I expect will get better with each successive quarter.
We're in the middle of kind of ramping that capacity up right now.
Okay. Is the tightness in the trucking market and the new rules for hours drivers can work having any effect on your business?
Well, we've dealt with, as you could imagine, lots of challenges over since our inception of availability of drivers and difficulty obtaining drivers. We, like probably other folks in our industry, do a combination of internal employed drivers and using third-party contract carriers. 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. I would say the current situation, we've seen things like this in the past. We're probably doing a little more internal hiring of drivers than using third parties, just giving some of the availability. This is something that we're used to managing and will continue to manage.
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.
All right. Thank you.
Our next question comes from the line of Bob Koort with Goldman Sachs. Your line is open.
Thanks, guys. It's Chris Evans on for Bob. I wanted to talk a little bit 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?
Well, Chris, 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. There is an amount of room to catch up. Demand is pretty good. That's something that has to be seen. Clearly the team, I think, is motivated and properly has the right metrics in how to look at this. Conditions are good right there, and good right now, it's still, I think China has a ways to go before the pricing can be equivalent to what you see in other markets. I don't know at this stage, we'll have to see.
Thanks. Since we're seeing such a strong uptick in some of the merchant and package businesses globally, can you kind of remind us of the potential for margin improvement as you increase utilization rates? What kind of algorithms or metrics should we look at as you get to fill up your plants at higher rates?
Well, our goal is to try and raise our margins every year. If we can get 20-40 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, 4 consecutive quarters. We've got some pretty good year-over-year margin leverage for this first quarter. This is something that we want to just make sure we capture. The key is that we don't lose it, right? We don't allow cost inflation to offset it. That's something that there's a lot of focus in the organization to ensure. I think there is more opportunity. I think there's more improvement.
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. Any kind of improvement there will clearly help the overall margins. It's got to be kind of region by region and what we're able to do on organic volume and pricing. I definitely think there's room for improvement.
Thanks, Matt.
Our next question is from Jim Sheehan with SunTrust. Your line is open.
Thanks. Matt, could you give us some flavor on your merchant utilization rates by region?
Starting North America, what we're seeing is kind of low 80s. Argon is much tighter, and you've probably heard that from other calls. On the LIN/ LOX side, still kind of high 70s, low 80s, but we're continuing to see some upticks there. For the most part, while it's different in the regions, pretty well loaded, but we still got a lot of room and capacity for further expansion. South America, it depends. Yara is quite low utilization, but excluding Yara, we're probably in the mid- to high 70s for most of our areas. 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. We've definitely got some capacity and room there, although we have seen some incremental improvements.
Asia is clearly higher, probably mid-80s. China and Korea are definitely in higher utilization rates. India is a little lower. We're starting to see a better utilization as those economies have been growing pretty much faster than the other ones in the world. All in, we're probably in the high 70s globally, but I would say definitely room for further capacity expansion, and we could meet any incremental demand if required.
Did you quantify any headwind you might expect from customer turnarounds in the second quarter?
Not in the second quarter, no. We 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. No, there's nothing we've highlighted in the second quarter.
Thank you.
Our next question is from Don Carson with Susquehanna Financial. Your line is open.
Matt, on the on-site business, are you seeing any pickup 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?
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. I think you've probably seen that in our end market reporting by segment. It's been a continual improvement. I think that margins are better for them, given what's going on. I think the desire is there to run. It's profitable for them to run. We see the right backdrop. We've seen some good improvements. Clearly, it'll just be as units come on and off with the various mills. 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. I think that outlook still remains fairly good.
A follow-up on the Linde divestiture process, see if you can answer it. On the bidders for the assets that are being divested, have those bidders been pre-approved by either the European Commission or other antitrust agencies?
Yeah. Sorry, Don, I can't get into any details at this point on that process. Rest assured, when the timing's right and we have more information, to disclose, we will disclose that.
Okay. Thank you.
Okay, I think we've got time for one more.
Our last question is from Kevin McCarthy with Vertical Research. Your line is open.
Yes, thank you for squeezing me in. With regard to the packaged gas growth of 9%, would you comment on the split between hard goods and gas and rent? Also in U.S. packaged gases, Matt, I think you referenced some of the pressures in logistics. Can you remind us how you looked to offset that? Is it surcharges or pricing or a combination of those?
Sure. 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. I'd say from that perspective, kind of bracketing around the 9%. We've seen now a couple quarters in a row with these type trends, and I think they've remained pretty solid throughout here, even through the first month of the second quarter here. Regarding logistics cost, 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 packaged, it tends to be more just pricing.
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. I'd say so far to date, we've been keeping up with it. We feel on track with that.
Very good. 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? 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?
Yeah. Clearly, to your point, projects are driving a portion of that in North America. 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 startups, we are growing in Chemicals. I'd say that even despite the startups, that is a positive growing end market, consistent with what you'd see in some of the others on an organic basis.
Thank you so much.
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.
Ladies and gentlemen, this does conclude the program. You may now disconnect.