Linde PLC

XETRA:LIN

Earnings Call Transcript 2018-Q2

[Operator]

Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 Praxair Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded today, July 26, 2018. I would now like to introduce your host for today's conference, Juan Pelaez, Director of Investor Relations. You may begin.

[Juan Pelaez, executive]

Thanks, Isra. Good morning, and thank you for attending our second 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 related to the potential merger with Linde.

The reconciliations to the U.S. GAAP reported numbers are in the appendix of this presentation and the press release. Matt and I will now review Praxair's second quarter results including the current business environment. We will then be available to answer questions. Let me now turn the call over to Matt.

[Matthew White, executive]

Thanks, Juan, and good morning, everyone. The strong momentum continued into the second quarter as sales and EBITDA exceeded $3 billion and $1 billion, respectively. Organic sales growth of 7% is consistent with recent trends, and we successfully increased operating and EBITDA margins for the fifth consecutive quarter as incremental volume growth and pricing actions more than offset the effects of cost inflation. The culmination of these efforts led to a record EPS of $1.72. Furthermore, this was accomplished without significant use of capital as net debt decreased $318 million this quarter, supporting a 13.6% return on capital, which is 150 basis points better than last year.

The organization achieved this performance and captured incremental value through multiple initiatives including price and cost management, prudent investments in the project backlog and a focused and disciplined capital allocation process owned by all employees. And we continued to position ourselves for future growth by winning 3 new on-site projects, increasing the project backlog to $1.7 billion of capital spend, all underpinned by high-quality customer contracts.

Overall, the economic landscape for industrial gases has remained quite positive and we anticipate a continuation of these trends especially in North America and Asia, which are 2 of the best-performing regions.

The North American segment had 52% of sales, has steadily improved several quarters in a row as U.S. industrial production rates have grown 3% to 4%. Approximately a year ago, we anticipated a recovery in the U.S. packaged gas market, which we have experienced with recent growth rates ranging from high single to double digits for both cylinder gases and hard goods. In fact, the manufacturing and industrial recovery in North America has supported increased gas consumption across all supply modes.

Chemicals, aerospace and manufacturing have been the fastest growing end markets due to a combination of large project start-ups and higher levels of demand. The metals end market has been steadily increasing as customer run rates improve, and the resilient end markets of food, beverage and health care continued to grow in line with demographic trends. The North American energy market was softer versus prior year as we experienced a few customer outages, which have since returned to normal run rates. Pricing improvement of 2% is offsetting cost inflation, enabling operating margin to exceed 27%.

Finally, we added another project to the backlog and are confident in our ability to win new on-site business opportunities, especially in the U.S. Gulf Coast. So in summary, North America remains a strong market and we anticipate these trends to continue.

Asia is the fastest-growing segment, with sales and operating profit growth of 19% and 34%, respectively. Similar to North America, higher levels of industrial activity, coupled with cost inflation, have enabled price attainment and volume growth across every end market and supply mode. Metals, manufacturing and electronic end market improvements drove sales growth, but we also experienced a substantial increase in the energy market with the start-up of our CNOOC project.

The pricing improvement of 3% was mostly driven by China merchant pricing actions as years of pent-up inflation is being passed through. Korea and India also have seen price improvements in line with inflation trends. Project backlog opportunities remain healthy as we signed 2 new projects supporting the chemical and electronic end markets.

The Europe segment, at 15% of sales, continues to demonstrate positive growth on a very stable base business. The 2% volume growth is consistent with prior quarter as most end markets have been steadily improving, led by metals and manufacturing. But more importantly, the pricing improvement of 3% is a clear demonstration of the team efforts to recover cost and power inflation.

Margins expanded 30 basis points from prior year but this includes a 90 basis point headwind from higher cost pass-through. Therefore, underlying margins improved 120 basis points from pricing actions in excess of inflation. Also in the second quarter, we have supply disruptions from our crude CO2 suppliers primarily due to unanticipated shutdowns of ammonia plants, which negatively affected margins from higher dislocation costs. The majority of our sources are back up and running, so we do not expect the same level of supply disruption for Q3.

As anticipated, the South American segment continues to lag the rest of the world due to sluggish economic conditions in Brazil. While volume levels grew 4% due to higher steel mill operating rates, the manufacturing end market was quite weak from a nationwide Brazilian trucker strike that contributed to a negative 7% year-over-year industrial production rate for the month of May.

Fiscal and political concerns have created significant devaluations of the Argentine peso and Brazilian real, resulting in a 10% year-over-year currency headwind for the quarter. While conditions are expected to remain challenging for the foreseeable future, our team continues to run a quality business with 27% EBITDA margins and high cash generation.

The PST business posted good results, with year-over-year sales and operating profit growth of 14% and 24%, respectively. You may recall last quarter the ramp-up cost incurred to increase coater capacity in support of the aviation end market. Now we are selling from that new capacity while also seeing positive recovery in the energy and industrial end markets. We anticipate further growth as more capacity comes online to serve the large backlog of engine parts required for jet orders.

So in summary, I'd say we are firing on 4 out of 5 cylinders, as strong performance across most segments more than offsets the weak South America. It's clear that all Praxair employees have maintained focus to deliver value and grow a high quality business, but we've also made substantial progress toward the merger, which you can find on Slide 5.

The current focus of both organizations can be boiled down to 2 major areas: first, to obtain regulatory approvals including potential divestiture agreements; and second, to accelerate merger planning efforts.

As you've seen from recent announcements, there have been a few key accomplishments on the regulatory front. At this stage, there are 6 remaining regulatory approvals required under the BCA as we recently received clearance in Mexico. Milestones are being completed as we work toward closing the transaction prior to the October 24 long stop date.

In addition, Praxair and Linde each announced executed agreements to sell their respective European and Americas assets in support of ongoing regulatory negotiations. Now while the completion of these agreements does not assure approval from the relevant regulators, we continue to work constructively through the process.

In parallel with antitrust efforts, we are conducting integration planning activities in order to prepare for the merger close date. Since we are still competitors, we're unable to begin integration but we can develop detailed plans for day 1 readiness. Examples include plans for organization structure and talent selection, operating rhythm, IT systems, accounting filings and several other initiatives. As you can imagine, with the merger of this size, there is a substantial amount of work and complexity, but we continue to have positive interactions between both companies as we move forward.

Similar to prior quarters, we are not in a position to provide any details on the process, so I appreciate your efforts to refrain from asking merger-related questions. I'd now like to hand it back to Juan to review the second quarter results.

[Juan Pelaez, executive]

Thanks, Matt. Please turn to Slide 6 in our presentation for our consolidated results.

Sales of $3.1 billion were 8% higher than prior year and 2% higher than the first quarter. Year-over-year, volume was the largest contributor, with growth of 5%, of which 40% came from project start-ups and the balance from organic growth. Furthermore, the growth was broad-based, with every end market contributing, although metals, manufacturing, chemicals and electronics led the way.

Additionally, at 4% of our total sales, aerospace was another significant contributor to the overall growth, up 16% year-over-year. For the past 6 quarters, this end market has been growing at healthy rates, primarily led by sales to space technology companies in the U.S. that demand large amounts of atmospheric and processed gases for manufacturing and launches as well as coating to aviation engines mainly through our PST business.

Price contributed to a 2% increase in sales for the quarter, driven primarily by strong price actions in Asia, Europe, and North America in both merchant and packaged. Sequentially, volume growth of 3% was broad-based across all end markets but led by food and beverage, primarily North America and Europe due to seasonality.

In Europe alone, food and beverage grew 17% sequentially given our strong network in the region. Currencies translation was flat year-over-year but negative 2% sequentially as major currencies weakened versus the U.S. dollar. The strengthening of the U.S. economy, coupled with global trade concerns and political uncertainty, have contributed to this trend, and we anticipate will continue through the back half of the year.

Operating profit of $713 million was $92 million or 15% better than last year and $41 million or 6% better than the first quarter. Operating margins expanded 140 basis points year-over-year and 90 basis points sequentially led by overall strong fundamentals in the base business.

Operating cash flow was $790 million and capital expenditures were $351 million, of which 65% was invested in North America, mainly in the U.S. Free cash flow was $439 million, which was used to pay dividends and reduce net debt below $8 billion, the lowest level since 2012 prior to the NuCO2 acquisition.

Project backlog for the quarter rose to $1.7 billion, up $200 million from prior period after starting up 2 large ASUs to serve CNOOC in China and winning 3 on-site projects, 2 in Asia and 1 in North America. Of the total backlog, close to half will supply chemicals, 40% will serve electronics and the balance, the aerospace and manufacturing end markets.

Additionally, we have over 30 small on-site project wins totaling $80 million in investment that we expect to start up in 2019, but are not part of our project backlog since each investment is under $5 million. But similar to the project backlog, these investments have fixed monthly payments and are underpinned by a long-term contract.

As a result of our disciplined capital management and cash focus, the after-tax return on capital closed the quarter at 13.6%. This is the fifth consecutive quarter where we have expanded return on capital and we expect it to continue improving throughout 2018. With that, let me now turn the call back to Matt, who will discuss our third quarter outlook.

[Matthew White, executive]

Please turn to Slide 7 for an outlook on the third quarter. At this point, we are anticipating similar business trends across all segments, adjusted for normal seasonality. For Q3, we expect more stable operating conditions for both crude CO2 suppliers and U.S. Gulf Coast refiners, although helium will remain tight due to certain source outages. Tax rates should remain in the 23% to 25% range.

The most significant difference for Q3 relates to foreign currency rates. You may recall that we had a 3% FX tailwind in the first quarter and no year-over-year FX effect for this second quarter. In fact, for the second quarter, we originally anticipated a 2% tailwind in the earnings guidance, which quickly evaporated to 0%.

Based on recent forward rates, the second half of 2018 could experience translational currency headwinds of 2% to 4% as the U.S. dollar continues to strengthen from higher interest rates and a stronger economy.

Earnings guidance is not provided for Q3 due to the anticipated merger close date with Linde, which is consistent with the full year approach taken this January. Now since it is possible this could be the last Praxair earnings call, I'd like to personally thank all 26,000-plus employees for their tireless effort and support. For over 25 years, the Praxair name has been synonymous with operational excellence, prudent capital management and industry-leading performance. So although the name Praxair may go away, the people will continue to thrive as we join with Linde to create a new, more valuable company. I'd now like to turn the call over to Q&A.

[Operator]

[Operator Instructions] And our first question comes from the line of Vincent Andrews from Morgan Stanley.

[Vincent Andrews, analyst]

Just a question. If we look through North America, and if you look at the pricing in merchant versus packaged gas, could you just give us a sense of the trends there?

[Matthew White, executive]

As you saw on our total North American slide, pricing for the entire segment is up a few percent here. So of the 2%, you may recall that on-site, really we don't show much in price. So that represents all of the merchant and packaged price improvements over the entire revenue balance. So what I would say from that perspective is your low single to mid-single-digit pricing we're seeing both in packaged as well as merchant. As you can imagine, we are seeing inflation across North America. In some case, it's power; in other areas, in distribution costs. So we need to continue to do this, as you can imagine, to recover that inflation. Some of it contractual in our merchant packaged contract. Some are actually pricing actions that we have to go out and get.

[Vincent Andrews, analyst]

Okay. And just as a follow-up. I might have missed this, but did you talk about what the volume was in Asia if you stripped out the product -- the project start-ups?

[Matthew White, executive]

We had said consolidated of the 5%, a little less than half is related to projects and the balance organic for the total consolidated. I'd say Asia is probably a little more projects, closer to half for the entire segment.

[Operator]

Our next question comes from the line of Duffy Fischer from Barclays.

[Duffy Fischer, analyst]

A question on Latin America. The run rate, does it still feel like it's falling? Or have we kind of stabilized at a lower level? And so if we kind of anniversary what we've seen over the last quarter, that gets us a decent look for the next year or so?

[Matthew White, executive]

That's a question we're all trying to figure out. I would say, as you know, our South American business a little more than 3/4 would be Brazil, but I'll start with the non-Brazil section. I think there, we continue to do fairly well. It's more just of a currency issue. Places like Argentina, Colombia, we do have more resilient markets in some of those countries that from a growth rate perspective continue to be pretty good but it's getting drowned out with some of the currency effects. Now within Brazil, clearly, the trucker strike, we lost about an entire week in the month of May and really did not get much of that back. So it's hard to take this particular quarter given that sort of anomaly that happened. But when I look underlying, what we're seeing in Brazil, clearly, we continue to see improvements in the on-site metals as you're seeing more metals being produced. Now part of that is for export. With the real softening, it's making those products more competitive globally, but I'm hoping that some of that could be for use for internal to start some thawing. But it really, until the election, it's going to be hard to see. As you may recall, in North America, when we hit some industrial recessionary conditions going back 4 years ago, metals was the first one to rebound and recover and then, over time, merchant and then packaged. In Brazil right now, we just haven't seen merchant and packaged really turning the corner. Next quarter hopefully will be a better comp just given the lack of any anomalies. But frankly, until the October elections, it's going to be tough. I think we're got to really have to see what happens in 2019. And I think Mexico is kind of a good example. When AMLO was elected, there were obviously some views and concerns. But when he came out announced kind of his cabinet, his views, I think it calmed some of the markets and calmed some of the views, and we'll have to see if that happens in Brazil. So time will tell.

[Duffy Fischer, analyst]

Okay. And then in relatively small business for you, but your Russian business, the headlines have obviously been getting worse throughout the year. Do you see that in your business? Or does that feel like it's still the same structural strategic bet that you've always made, be patient long term and it's still a decent place to be?

[Matthew White, executive]

Well, we always need to be patient long term in this industry, as you know, Duffy, given the nature and the structure of it. Clearly, economic cycles will go up and down. I would say with Russia, to your point, it is quite small for us in the grand scheme. It's mostly on-site, and those on-site contracts, we feel very good about. So from that perspective, we absolutely expect they would be withheld -- or upheld, I should say. A lot of them are based on English law and things like that. So from that perspective, we feel good. The merchant and packaged has been tough for a while. I would say more than just the last 6 months, we had a period of stagflation there for a bit of time. And so from that perspective -- which is very small for us, by the way, the packaged and merchant. So Russia has not been easy for a while but the on-sites have been be very good, and anything related to, I think, exports of natural resources continues to be good. So we'll have to see. It is one of our geographies, and at this point, we haven't made a lot of incremental investments, though, and we'll just have to see what opportunities present themselves in the future.

[Operator]

Our next question comes from the line of Mike Sison from KeyBanc.

[Michael Sison, analyst]

It looks like the backlog continues to improve here at $1.7 billion. Can you maybe remind us where that backlog peaked historically? And given the industrial backdrop has been pretty positive here, do you see that backlog continue to improve over the next couple of years?

[Matthew White, executive]

Mike, I think from us, our backlog peaked probably in the mid 2s. One thing you'd want to take into consideration on that, we had a large steam methane reformer project that was in there for quite some time, probably 7 or 8 years when you go back in time on that. We did resolve that. That actually became a sale of equipment when all the dust settles. So if you pull that one out, I'd say low 2s is probably the more normalized, where we peaked on that. The nice thing I like about this current cycle, to your point, it is a good cycle. And what we're seeing, and I'd say the quality of our contracts and customers, is a nice rhythm of start-ups and replacements, start-ups and replacements. From my perspective, the best thing about a backlog is a backlog that's constantly churning. A growing backlog can be good but we need to make sure we're starting them up. So right now we're having large start-ups. As you know, we had a very large start-up in the first quarter but we're replacing it with new projects. And as long as we can keep replenishing and actually taking something that's a use of cash and turning it into a source of cash, I think that's quite successful. So we feel very good. To your point, it's gotten up to 1.2. When I look out the rest of the year and we kind of probability adjust, it's possible we could have a 2 handle on the backlog again. And so I think the backdrop is pretty strong, and we feel good about our prospects and where we are on some of these pre-backlog opportunities.

[Michael Sison, analyst]

Great. And then in terms of pricing, I think you mentioned inflation. Your pricing is in excess of inflation to quite some degree. How much of that is just driven by what you're able to do and then, to some degree, maybe industry pricing and everybody's working their way to get that pricing action?

[Matthew White, executive]

Well, a portion of it is just how you contract, Mike. There are several contracts out there that have inflationary aspects, either escalations or ability to surcharge through for power escalation. I mean one thing that's very clear is you are seeing power escalate in many geographies in the world. For various reasons. So having the right contracting to be able to recover that, I think, is quite important. But aside from that, it's just a matter of just having at the very low levels to have to grind it out and work through it. But it's, as you know, a very local industry and inflation is a big, big driver behind the pricing in this industry.

[Operator]

Our next question comes from the line of Jeff Zekauskas from JPMorgan.

[Jeffrey Zekauskas, analyst]

I don't have a question on developments in your deal but I have a question on the structure of the deal. Do you -- could you close the deal without Chinese approval, that is if there were regulatory delays in China and you didn't hear from them?

[Matthew White, executive]

Well, Jeff, I figured you'd be the one that would try and find a way around it. I would say this much, and I don't want to get into any depth on any of these discussions, but in our BCA, we list 9 regulatory agencies that are required to close the deal, and that is a public document. So you can go pull that information and see the 9 required to actually close. Obviously, we have to file with others that are very important. But of those others they are not required to close the deal for the BCA.

[Jeffrey Zekauskas, analyst]

Okay. And if you received regulatory approval from China on, I don't know, October 23, could the deal still be closed on the 24th?

[Matthew White, executive]

Yes. I don't want to get into any specifics, Jeff, on either hypothetical situations or views of regulatory decisions. So at this stage, unfortunately, it's something we're working very constructively and we're having good dialogues across all global regulators, and we will continue to update you guys on events as they are warranted and relevant. But at this point, I don't want to get into any specifics -- especially with any specific regulators.

[Operator]

And our next question comes from Laurence Alexander from Jefferies.

[Laurence Alexander, analyst]

A couple -- a few, hopefully, short ones. About a decade ago, you guys used to talk about having about a 1% tailwind for organic growth just from energy efficiency investments. Are you seeing the industrial appetite for those come back? And then related to that, a couple of years ago, you were talking about how over, say, a 3- or 4-year period, you might have line of sight to about a 3% annual tailwind from on-sites starting up on average, not each year. Is the current backlog and the trends you're seeing in line with that or better than you would have expected when you were making those comments?

[Matthew White, executive]

I'll start, Lawrence, with your second question and then go to your first. So you're absolutely right. We had laid out back on our strategy probably 4 years ago, that based on our backlog, we anticipated a 3% EPS. And we stuck with EPS because, as you know, each contract can be a little bit different on how the revenue is reported, but we said a 3% EPS growth rate that we see extending out 3-plus years. And as you may recall earlier this year, we extended that another year based on the wins. So we still believe that we can see a 3% EPS plus or minus neighborhood of improvement over the next 3 to 4 years based on this current backlog. Now if our backlog starts to increase, we can reassess that, but this was based on a roughly $1.5 billion continually replenishing backlog, which is where we still are right now give or take. So I'd say yes, those dynamics we still see valid over the next 3 to 4 years. And if we continue to maintain this level of backlog, that should continue out more years. From your first question, as you may recall, a lot of the energy efficiency I'd say we were seeing many years ago, were for natural -- reducing natural gas consumption. So for instance, if someone had a natural gas-fired burner, any type of combustion operation you do, you want to eliminate inert gas, meaning nitrogen primarily. So by displacing and burning in an oxygen environment, you would accomplish that. Given that natural gas at least in the U.S. is much cheaper, those applications are less than what they were probably a decade ago. But I would still say in emerging markets anyone using higher-cost hydrocarbons, especially oil, that application is still very, very valid. But more what I would say we're seeing displace that is environmental reasons for NOx and SOx reduction. By burning in a better environment, you can reduce that, and you see that a lot also in the glass industry where it gets into, even more so with throughput improvements in addition to environmental. So I would say the original main drivers have shifted, but they're still relevant in certain markets and in certain end markets and we're still seeing some improvements with that energy efficiency.

[Laurence Alexander, analyst]

And have you received any clarification from the managers of the different equity indexes as to whether or not you'll be -- belong in the -- which ones you'll belong in? Or is -- will there be a technical period post the deal closing where it will be ambiguous?

[Matthew White, executive]

Yes. They can't tell us until post close, as you probably know. So they're not able to make the decision. You could probably look at other deals, as you know, like DowDuPont and some other relevant situations, and they're not able to make any announcements until the deal is consummated and they review that and then they make their decision for index inclusion. But obviously, we're pursuing both the New York Stock Exchange, S&P 500, as you can imagine, and the DAX and the Frankfurt Exchange.

[Operator]

The next question is from David Begleiter from Deutsche Bank.

[David Begleiter, analyst]

Matt, just on the U.S. packaged gas strength, can you get a little more detail as to where and what's driving that and how long do you think this is -- I think you said low double digits right now -- is sustainable.

[Matthew White, executive]

Hi, David. High single digit actually all in. What we're probably seeing is mid-single-digit plus on gas and then we're still double-digit on hard goods right now. And it's funny I asked the same question internally here, and the answer is it still is pretty broad based. Clearly manufacturing, you look at industrial production and you look at some of the subcategories of industrial production like metal fabrication, construction, equipment, they're doing quite well. So they drive a lot of welding, shielding gases. So think argon is a big driver in that area. That continues to do well. Construction does well, but we're also seeing a variety across many other end markets. Some resilient markets, health care, some of the packaged gases we deliver into hospitals. But also aerospace, as Juan had mentioned, even refining, things for gas analytics. So it still is pretty broad-based, and packaged gas, as we've always said, tends to be a very good proxy with industrial production especially the subcategories and the manufacturing categories. So at this point, there's no one market I could point to that I would say is more strong or weaker than the other, but it's fairly broad based.

[David Begleiter, analyst]

Very good. And Matt, can you just go through the merchant operating rates by region?

[Matthew White, executive]

Sure. When you look at the U.S., right now we're still probably high 70s in base merchant in the LIN and LOX, but argon continues to remain tight. As you know, it's more based on oxygen base loads. And as I mentioned, demand is high in met fab, so argon is still tight across most of North America. Brazil is still probably mid-70s and that's just as much a function of, we still have some on-site customers under take or pay that we do over. So it's probably the base molecules are constricting even as much, if not more, than the liquefaction capacity there. When I look at Europe, we continue to see some improvements. We're getting up to, say, mid-70s now for LIN and LOX. Argon a little bit less than that. So Europe is running well. Asia is one that -- it's a little tighter in some areas, but it's kind of overall probably in the 80s as we're seeing good demand. That continues to be strong across several countries in Asia. So I'd say trends are going well but we're able to get good utilization out of our asset base globally, but clearly, we have room to expand if needed in all of our markets.

[Operator]

The next question is from P.J. Juvekar from Citi.

[P.J. Juvekar, analyst]

I had a question on pricing related to your earlier question. Pricing was up in packaged gases in both North America and Europe. And do you think that packaged gases pricing leads merchant pricing in that sense that you see it first in packaged gases, which are shorter than contracts compared to merchant?

[Matthew White, executive]

Well, I could say this much on Europe, just to add to that, part of that pricing is not only recovering inflation in the packaged gas side, but also we do have a refrigerant business there in Italy. And as you can imagine, part of that pass-through is both power and fluorine and refrigerants and also some of that price. So it's a combination of packaged gases in our refrigerant business in Southern Europe. But I would say that I don't know I could call it a leader, but I would say packaged gases tend to be much tighter correlated with inflation. As you know, in packaged, the contracts are not very long. They could be 1, 2, 3 years or they might just be purchase orders. So they are the most sensitive and probably the most elastic as far as pricing but they also tend to be repriced more to inflation faster. And in some cases, especially hard goods, where you know we operate primarily as a distributor in hard goods, these hard goods can be sourced from various countries, from various locations. And so as you may get cost creep, whether it's through tariffs or other various raw material items like metals, then that has to be recaptured in the pricing to recover that inflation. So you're seeing some of that as well in packaged gases to recover those hard goods' higher costs. So it's a combination, I'd say, of all that. But -- so I don't know if I'd say it's a leader, but I would definitely say it's probably most closely tied, timing-wise, to inflation, given the short duration of contracts and given their exposure to a variety of both hard goods and gases.

[P.J. Juvekar, analyst]

Great. And then you won 2 on-site projects in Asia and 1 in North America. Can you talk about those? And as you look forward to second half of '18 and then in '19, can you size the impact of new projects starting up?

[Matthew White, executive]

So I'll start with the starting up. It is not a number we've disclosed, as you can imagine. Generally, we've been, on average, probably 1/3, 1/3, 1/3, just on the average, build cycle is 3 years. I don't see next year drastically different than that. Could be a little bit lower because, as you know, this year, we had a couple of large start-ups including our largest project ever. So I think the start-up next year we still believe will overall reach that 3% number in that range I talked about before for EPS growth, but the backlog reduction somewhere in that neighborhood of 1/3 or maybe a little less. As far as the ones we've won, chemicals and electronics primarily, as we had mentioned, when you look at the U.S., still seeing strong chemicals activity across the spectrum, and so investments continue to be made and this was an asset related to that investment. And in Asia, one in chemicals and one in electronics. So as we had mentioned in prior calls these continue to be kind of the strongest growth end markets, primarily in Asia and North America, as you know, and we continue to see good opportunities. And if I look at our pre-backlog, the major 3 markets related to that are still electronics, chemicals and energy, to an extent. Those are, right now, I would say, probably in the best build cycle. But hopefully, we'll start seeing things in manufacturing and some of the other end markets soon.

[Operator]

And the next question is from Steve Byrne from Bank of America Merrill Lynch.

[Steve Byrne, analyst]

Matt, just continuing on that commentary, how would you characterize that pre-backlog geographically?

[Matthew White, executive]

Well, right now, Steve, as you look at our current backlog, it's about half Asia, half North America in terms of where we stand. And when I look at the pre backlog, it's probably not too distant from that. We were more heavily North America for a period of time. Asia had built up. If anything now, we could be a little bit higher North America. But again, these are projects that have been actively worked on for the last anywhere from a year to 2 years. And we'll have to see which ones ultimately come to fruition. But it changes based on where we are in, I'll say, the starting gate in contract negotiations. But again, U.S. Gulf Coast and Asia are the 2 primaries.

[Steve Byrne, analyst]

And just a question about the disruption in Brazil from the trucking impasse. Is it fair to say that some of your customers down in Brazil are still impacted by the lack of a settled trucking freight rate? And maybe the -- conversely to that, do you compete with anyone in the merchant business down there that is struggling in that they have some outsourcing of that merchant trucking?

[Matthew White, executive]

Well, I would just say high level, everybody was affected by the trucking. It was not discriminatory in any way, and the industrial production number for the month, as I mentioned, at minus 7% pretty much characterized and validated that effect. So from that perspective, we were all affected. If I look at now, things seem to have gotten back to normal. I mean, clearly, for a smaller company, it may be more difficult. But when I look at the broad scheme of things, I think we're all pretty much back to normal there. We haven't heard of any additional issues, but normal is still a challenging situation, as we know, given the political uncertainty. So I don't think there's any residual issues right now, large or small customers, but we'll have to see what happens over the next several months.

[Operator]

The next question is from Mike Harrison from Seaport Global Securities.

[Michael Harrison, analyst]

Speaking of trucking issues, we're hearing a lot about rising freight and logistics costs, particularly in the U.S. Can you just remind us as you think about your merchant and packaged gas suite in the U.S., I guess in North America overall, how much of that is in-house versus outsourced? How much inflation have you seen from either rising labor or fuel costs? And how confident do you feel you are in your ability to pass that through to customers?

[Matthew White, executive]

Okay, Mike. So I'll start with just the diesel kind of. That's a structure of a pass-through surcharge that is a contractual component. As I mentioned earlier, passing through inflation can be very contractual, and diesel is a classic example of that. So these are aspects that you contract to recover. And so from that perspective, there is a lag. It's usually 2, 3 months, but that's something that will go up and down with the diesel cost. As far as truckers, you're absolutely right. The costs are going up. It is tight to get truckers, but this is not, I would say, anything new. We go through this in cycles, as you know, with how the economy, especially in the United States, is going. When the economy is going strong, there tends to be more shortages of truckers. And when the economy is softer, you're able to get some. And then things like Amazon and FedEx and UPS will continue to absorb more drivers just in general. So when I look at Praxair, this is something that we've had to manage since our inception, and we always keep a balance, as you mentioned, of in-house drivers versus outsourced of both contract and common carriers. We'll use both. And that percentage of in-house can range anywhere from 50% to 75%. It flexes up and down just based on conditions. And then we will use outside truckers for surge capacity and also ongoing variable. Clearly, they've got to meet our safety standards and that's a big part of getting them trained, getting them as part of our culture. So it takes some time for us to get them to be the right drivers, but it's something we're used to. We've got a great team that does this day in, day out. And from my perspective, while it's challenging, while it's tough, there's nothing I've seen overly concerning about this current trend versus any prior trends.

[Michael Harrison, analyst]

All right. Appreciate the detail there. And just in terms of the U.S. on-site business, it looks like U.S. refinery utilization is running very strong. Just wondering if you can comment in a little more detail on the strength you're seeing in hydrogen. And did you see any planned outages that were pushed out as refiners look to run harder?

[Matthew White, executive]

As you may recall, in the first quarter, we had some significant turnarounds that we mentioned and that occurred, and those were ones that we believe were pushed out from '17. We had a combination, as you know, of strong refining margins coupled with the hurricane toward the back end of the year. So that pushed a lot of turnarounds into Q1. The vast majority of our customers were back end running hard like you said, although this quarter we did have 2 large customers that were having some outages, they are back running now. So that -- from that perspective I'd say right now, we're seeing pretty strong demand and strong volumes. And the refiners, from my perspective, want to run. And so hydrogen is doing well. So is oxygen and nitrogen, which both go to refineries as well. So at this stage, things are running well, and then we'll just have to see how things go forward.

[Operator]

The next question is from Jim Sheehan from SunTrust.

[Peter Osterland, analyst]

This is Pete on for Jim. Could you quantify the margin impact in Europe from the CO2 disruption? And given that strong pricing growth of 3%, do you expect that the margin uplift there will accelerate in the back half of the year?

[Matthew White, executive]

Well, we didn't disclose that, but I'd say consolidated, it might have shaved close to anywhere between $0.005 and $0.01 off total results. So you could probably back into what that might have meant from a Europe perspective. And yes, when you look at that price of 3%, as you may recall, inflation's been challenging in Europe but we're starting to see some signs. There are some tightness of certain products and I think that is driving a little bit of the inflation as well. And so our team's done a good job to go out there and get back some of this pent-up inflation, and power has been a big area. You may recall when you look at pass-through, we had 4% this quarter, I think last quarter, we were a similar number, low single digits. So we've started to see power, as I'd say, the initial area of inflation and it's kind of creeping through in other areas. So our team needed to get ahead of it, and they did. So when I look at that, I think that's a good result. Now as you can imagine, this second quarter is the high season for CO2. So we had the outages during the difficult time. As I mentioned in the prepared remarks, most of our sources are back and running to normal rates, but we see a normal seasonal decline at this point just given the seasonality, but we feel we should be able to manage this now given the balance.

[Operator]

Our last question comes from the line of Kevin McCarthy from Vertical Research.

[Matthew DeYoe, analyst]

This is Matt on for Kevin. So merchant price in China has improved and I think company utilization rates, as you had mentioned, in Asia were kind of in the low 80 range. But it seems like industry utilization rates, in China in particular, somewhere in the 50% range. So are we just catching up to a more normalized level of pricing here and then going to expect it to balance out? Or should we expect continued price traction as utilization rates kind of continue to tighten?

[Matthew White, executive]

For my perspective, Matt, I think it's, I guess your former, of trying to catch up. You go back the last several years, it's no secret that there was a large excess supply of merchant product in the China market. A lot of that was driven by both capacity in the -- what I'll call industrial gas but also capacity in the nonindustrial gas, meaning steel mills that had byproduct coming off of their captive plants. So this drove both -- not just low utilization rates but just more supply than demand. And pricing in China was one of the lower pricings around the world given this. So while China throughout the years has had inflation, you could debate it but anywhere from mid- to high single digits. The pricing, and you just look back at our history, was not reflected of that. So I would say at this point now, you've had some structural supply impacts that have been favorable where capacity, especially related to the steel mills has come out as steel mills have been shuttered. Remains to be seen how much more of that will happen. I think that seems to have slowed but you also have demand improving, and the combination of that has allowed us to capture some of this pent-up inflation from several years to get pricing that is closer to what we would expect. I mean because you got to remember, in China, it has some of the highest mill rates in the world. So you've got to take that in consideration when you look at merchant pricing because power, as you know, is one of our biggest inputs. So from that perspective, we need to get pricing more in line with what the recent inflation has been and what the costs are to serve that business. And I think that's what's been happening as we've seen some both structural improvements and demand improvements.

[Matthew DeYoe, analyst]

And if I may, just slide one more in. Can you remind us your stance as it relates to pursuing Chinese coal gasification projects? Your competitors' comments make it sound like competition for those has picked up.

[Matthew White, executive]

Well, I could say this, our stand has been the same for the last decade-plus. We've been quite clear that whether it's China coal gasification projects or other projects, we will pursue ones that meet our density strategy, that meet our return criteria, not just financial return but also who we partner with in our technology and matching that up. So that's something we participated in, in South part of China, Eastern part of China in integrated industrial parks. And we have had long-standing strong relationships with customers over a decade on that front. We have not pursued moving upstream or we have not pursued going into regions where we're not able to achieve the density model. So we've been quite consistent as far back as I've been here, and we feel good about how we're doing that.

[Juan Pelaez, executive]

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

[Operator]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a nice day.