Earnings Call Transcript
LINDE PLC (LIN)
Earnings Call Transcript - LIN Q1 2020
Operator, Operator
Ladies and gentlemen, thank you for standing by and welcome to the Q1 2020 Linde Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Juan Pelaez, Head of Investor Relations. Please go ahead, sir.
Juan Pelaez, Head of Investor Relations
Thank you, Rachel. Good morning, everyone and thank you for attending our first quarter 2020 earnings call and webcast. I am Juan Pelaez, Head of Investor Relations, and I'm joined this morning by Steve Angel, Chief Executive Officer; and Matt White, Chief Financial Officer. Today's presentation materials are available on our website at linde.com in the Investors section. Please read the forward-looking statement disclosure on slide 2 of the presentation and note that it applies to all statements made during this teleconference. The reconciliations of the adjusted numbers are in the appendix to this presentation. Steve and Matt will now give an update on Linde's first quarter performance and we'll then be available to answer questions. Let me turn the call over to Steve.
Steve Angel, CEO
Thanks, Juan. I am very proud of how our employees all over the world have responded during this crisis. Through our business continuity plans, including our remote operating capability, we have been able to continuously serve our customers while keeping our employees safe. We ramped up supply of vital medical oxygen to help our community hospitals fight this virus. We installed oxygen equipment for emergency and temporary care facilities practically overnight. Our employees performed heroic acts to get critical respiratory equipment like ventilators to people in need. We commissioned air separation plants for Samsung in the middle of this crisis in South Korea. And throughout all of this, we maintained best-in-class safety performance. Our respiratory home care business in the U.S., Lincare has become an important second line of defense to fight COVID-19, providing ventilators to hospitals, transitioning thousands of patients from hospital to home care and maintaining continuous respiratory care for their base of 1.6 million home care patients. Some of you are aware that Linde has entered the market to provide inhaled nitric oxide therapy to patients in the U.S. Inhaled nitric oxide is most widely known as a treatment for infants in respiratory distress, commonly known as blue baby syndrome. But more recently, nitric oxide has been used as a treatment for COVID-19 by doctors around the world. This is just a few examples of what we are doing in health care to fight COVID and other respiratory illnesses. I might add that the government does recognize the critical role a world-class respiratory home care company like Lincare provides during a crisis like this. Please turn to slide 3. We have talked about the resiliency of our business for years. Our Q1 results and full-year outlook should give you further proof of that resiliency. What is it that makes us so resilient? First of all, our commercial terms and conditions guarantee us a steady stream of cash flow. We serve diversified end markets including healthcare, food, beverage and electronics. These markets are more defensive, but also offer nice opportunities for growth. Our business is local. We source, produce and sell our products locally. We are not directly impacted by supply chain disruptions. And because we operate our businesses locally, we know exactly how to align our cost structure with the market realities on the ground. The $9.5 billion of projects in our backlog are all under contract and protected by terms and conditions that lock in a significant portion of our expected return. For example, our date-certain provision guarantees that we will receive our take-or-pay when we are ready to supply our product as opposed to when the customer is ready to take the product. Do we expect to see some slippage of scheduled? Yes, but no cancellations. That would be way too expensive for our customers. Who are the customers of these projects, you may ask? They are blue chip companies you know well like Samsung, TSMC, ExxonMobil, Shell, BASF and Phillips 66. Obviously, no one really knows what this recovery will look like, but what I do know is we have a very resilient business model operated by a highly capable, experienced and dedicated global team. If the financial crisis of 2009 is any guide, we held EPS flat excluding the effects of currency. And we doubled our free cash flow. And though volumes were down double-digits, pricing was positive. We also raised our dividend just as we have done now for 27 straight years. And we have no intention of ending that streak now. We do have growth opportunities both during and on the other side of this crisis. I have already mentioned a few in the healthcare space. I expect electronics to remain strong, particularly semiconductors driven by the demand for IT infrastructure, as our economy shifts more towards virtual work, the growth of artificial intelligence and the rollout of 5G communications. We will be starting up our project backlog over the next several years. And we expect to see continued growth from merger synergies. I talked about this in our last call. It is leveraging the joint capabilities of our two companies across a larger global footprint. That includes applications, particularly in more resilient end markets and a comprehensive portfolio of product line plants and the opportunity to further optimize each plant size from a total cost of ownership standpoint. I also expect to see more acquisition opportunities like decaps, but we have to be selective here. I have no interest in being the lender of last resort. But the most exciting opportunities will come as the world drives towards a lower carbon future, especially green hydrogen for mobility. I expect this alone to become a multibillion-dollar business for Linde. I have said before that I wouldn't trade places with anybody. That has never been more true than it is today. It's a privilege to lead this company and this team. I will now turn it over to Matt to discuss Q1 results and outlook.
Matt White, CFO
Thanks, Steve, and good morning, everyone. The consolidated first quarter results can be found on slide 4. Sales of $6.7 billion decreased 5% sequentially and 3% from the prior year quarter. Excluding foreign currency translation and cost pass-through, underlying sales fell 3% sequentially, but increased 1% over the prior year. Volumes fell 4% sequentially, which includes 2% from engineering timing and 1% from COVID impact. The remaining sequential volume decrease of 1% is mostly seasonal from Chinese New Year and Australian LPG sales. Year-over-year volumes declined 1% due to the impact from COVID. Excluding that, higher growth from project start-ups and resilient end markets were mostly offset by engineering timing and prior year sales of equipment. We achieved pricing improvements across both periods and anticipate continued positive momentum from a combination of past and future actions. Operating profit of $1.4 billion was flat with the fourth quarter, but increased 11% over the prior year. Even with multiple headwinds of COVID, foreign currency translation and economic weakness we managed to grow operating profit double-digit percent from the prior year. Furthermore, we held this profit equal to the fourth quarter despite these issues and significant seasonal factors especially in the APAC segment. Operating margins of 20.1% improved 240 basis points from the prior year and 110 basis points from the fourth quarter. Price and productivity efforts continue to support improvements in business quality despite weaker volumes. As Steve mentioned, we have a very resilient business model, which will serve us well in this uncertain environment. Net income growth was less than operating profit growth, primarily due to lower equity income this quarter. Both equity income and interest expense were unfavorably impacted by foreign currency revaluation of unhedged intercompany loans. While these revaluations had no cash impact, they did affect accounting earnings by approximately $14 million of interest expense and $12 million of lower equity income, or roughly $0.04 less of EPS. Earnings per share of $1.89 is flat with the fourth quarter and 12% above the prior year. Total COVID impact is approximately $0.05 with roughly half from China and the remainder spread across the world. For the first quarter, most countries include a few weeks of COVID impact whereas our Chinese operations have substantially recovered. In addition, first quarter reflects approximately $0.09 of unfavorable non-cash currency impact versus prior year from a combination of earnings translation and the unhedged intercompany loans. Therefore, underlying earnings growth was quite strong, which is further validated by our cash flow trends. Operating cash flow of $1.3 billion was 26% above last year. Recall that first quarter tends to be our weakest due to seasonality. So, the year-over-year performance is more relevant. This improvement was driven by a combination of factors, including earnings growth, improved working capital, and lower restructuring and merger-related costs. Also, it's important to highlight that this figure is true operating cash flow, not an adjusted figure excluding working capital or other cash items. In this environment, it's more important than ever to manage all elements of cash. CapEx of just over $800 million is roughly split between base and project CapEx. As a reminder, project CapEx represents capital spend directly attributed to the sale of gas project backlog. This backlog comprises new growth projects contractually secured by long-term fixed payments and terms and conditions that protect expected returns. Conversely, base CapEx represents all other capital spending including maintenance, cost reduction, and growth initiatives that are either below $5 million or not secured by a fixed payment contract. Base CapEx has declined almost 20% and we anticipate lower spending for the remainder of 2020, which will further support free cash flow. Finally, return on capital continues to improve, now exceeding 12%. Recall this metric was 10.4% a year ago. So this is a substantial improvement in a short period as we continue to find ways to maximize profit and cash growth while prudently managing the capital base. Given the importance of cash and capital structure, I'd like to spend a little more time on the details which you'll find on slide 5. The left side of this slide provides our operating cash flow trends since the merger date in the first quarter of 2019. Recall that the first two quarters of 2019 had more merger-related cash outflows in addition to less impact from cost synergies. Overall, you see a growing trend of improving cash from operations especially when considering the inherent seasonality. Beneath operating cash flow, we are subtracting base CapEx. Base CapEx is the normal day-to-day CapEx for operations and small growth initiatives and thus supports the current earnings base. Project CapEx is excluded because it has more acquisition-like tendencies with defined windows of spending for specific customer contracts. Per the Linde definition of project backlog, all projects support incremental growth from secured fixed-payment contracts. We have a high degree of confidence in project returns and we'll readily invest in them when we can. Therefore, we shouldn't penalize free cash flow with contractually secured growth. So a more relevant metric, it's called available operating cash flow or AOCF. AOCF represents the cash we have left over to spend on specific growth initiatives or to distribute back to shareholders. You can see this is a substantial amount of cash recently around $1 billion to $1.5 billion per quarter. Clearly, available operating cash is more than enough to cover the current dividend. In fact, this is what provides so much confidence in our ability to extend the streak of 27 straight years of annual dividend increases. Even after paying dividends, we have significant cash left over and fully expect that trend going forward. We'll continue to prudently and responsibly allocate that excess cash toward attractive growth opportunities that meet our risk profile including our existing $4 billion sale of gas project backlog. And while we purchased 10 million shares of Linde stock in the first quarter, we have temporarily paused the program to reassess the growth opportunities in light of the current environment. While certain customers are restraining future investments, new growth opportunities are emerging in other areas including customer decaps, tuck-in acquisitions, and hydrogen initiatives. In addition to stable and growing cash generation, we have a high-quality capital structure with some details provided in the upper right section of the slide. At the end of the first quarter, we had $4 billion of cash. Furthermore, our trailing net debt-to-EBITDA ratio stood at 1.5 times. As a single-A-rated company, we continue to have access to low-cost liquidity through Tier one commercial paper which is backstopped by an undrawn credit facility of $5 billion. Therefore, it's clear that Linde has a very high-quality balance sheet which will only strengthen from the growing resilient cash flow. This combination will enable us to quickly seize upon any new growth opportunities that emerge during these turbulent times. I'll wrap things up with the 2020 full year outlook on slide six. It's safe to state that no one knows how the economy will recover from COVID or what a recovery would even look like. However, we remain confident that Linde has a resilient business model in any macroeconomic environment, including today. To address this dichotomy, we felt the best approach was to provide a scenario-based outlook for the full year 2020. The left side shows the prior 2020 full year guidance of 9% to 12% EPS growth from 2019, or 10% to 13% when excluding an assumed 1% currency translation headwind. You can see at the top that we are updating the currency translation impact to a 4% to 5% headwind. This estimate is based on the weighted average exposure of foreign currencies and the forward rates at a certain point in time. As you all know, this is a non-cash impact and will change with the daily rates, but it represents our latest estimate. 2020 EPS growth rates excluding foreign currency will depend on both, the definition and trajectory of a recovery. For simplicity's sake, we are defining recovery as a point when base volumes are down low to mid single-digit percent from 2019 levels. In other words, consistent with our February 2020 guidance, we believe that industrial production levels will experience recessionary conditions even when excluding direct COVID impact. Regarding the COVID effect, we are providing two different scenarios of 2020 recovery. To reiterate, we are not trying to project the timing of a COVID recovery, but rather are providing two different benchmarks of potential underlying earnings impact. Clearly, there are myriad of paths this could take, but the idea is that investors have a baseline to work with and then utilize their own projections to understand sensitivities. Scenario one, assumes base volumes recover by early Q3 and then stabilize for the remainder of the year at levels which are low to mid-single-digit percent below 2019. Under this scenario, we would anticipate full-year EPS excluding currency to increase mid to high single-digit percent from 2019. Scenario two, assumes base volumes don't recover until mid Q4. This essentially means Q2 lockdown effects would carry until the middle of Q4. Here, versus 2019, EPS excluding FX would be flat to negative low single-digit percent. Under all scenarios we are assuming Q2 to be the worst quarter, with the most significant impact from COVID. At this stage we would approximate the sequential EPS decline from Q1 to Q2 could be anywhere from 10% to 15%, depending on the severity of lockdowns and the impact of foreign currency translation. This is our latest estimate based on April results and our current thinking on the remainder of the quarter. Finally, the CapEx outlook has been reduced by $400 million, as we see lower base CapEx spending from merger efficiencies and fewer requirements for small growth investments. These actions further support our confidence in growing free cash flow over 2019. In summary, Linde offers an incredibly defensive model, with significant internal productivity opportunities, a track record of growing free cash flow, a high-quality balance sheet and more than 65% of sales underpinned by fixed fees or resilient end markets. This defensive model is further enhanced with significant profitable growth opportunities from our industry-leading project backlog, unrivaled hydrogen portfolio and world-class technical and engineering capabilities. It's true that we're facing an unprecedented pandemic and subsequent economic retrenchment that could limit global growth for many months or years. However, we remain confident in our ability to provide products and services to make the world more productive and safer, while continuing to drive the organization to higher levels of performance and efficiency. I'd now like to turn the call over to Q&A.
Operator, Operator
Your first question comes from the line of David Begleiter with Deutsche Bank.
David Begleiter, Analyst
Thank you. Good morning, Steve and Matt and Juan. Guys just on decremental margins how should we think about those in Q2 by segment, by region? Thank you.
Steve Angel, CEO
If we consider the volume perspective, there is a low double-digit decrease in volumes from Q1 to Q2. This forms the basis for Matt's forecast indicating a drop of around 10% to 15% in Q2. As for operating margins, there will likely be some decline in Q2 due to the rapid drop in volumes, and we won't be able to reduce costs that quickly. However, I am confident that we will achieve growth in operating margins for the year, as we will manage to eliminate enough fixed costs to ensure this outcome.
Matt White, CFO
Yes. And I'll just add David to Steve's exact point. As you could imagine with the local markets, we have a lot of costs and flexibility. So as we adjust those markets to the realities, the second quarter may not reflect the full cost benefit, but you may see some volume reduction, but then we'll get the benefit of adjusting those markets for the remainder of the year in terms of the cost structure.
David Begleiter, Analyst
And Matt just on those FX impacts impacting equity income earnings and interest expense in Q1 will they continue into Q2 as well?
Matt White, CFO
I do not expect that the unhedged intercompany loan will have a significant impact moving forward. This is based on our balance sheet date, which is the end of March, and we have already seen those currencies begin to appreciate against the dollar. If this trend continues, it could even be slightly beneficial in the second quarter. However, this is a noncash item and primarily relates to how we finance our various companies when the functional currency differs from the one used for financing. Therefore, I do not anticipate anything of that magnitude going ahead, and it may turn out to be a bit positive depending on currency fluctuations.
David Begleiter, Analyst
Thank you.
Operator, Operator
Your next question comes from the line of Peter Clark with SocGen.
Peter Clark, Analyst
Thank you. I have two questions. First, I'm curious about the electronics segment that you mentioned as being resilient. I believe there are some developments in the initial phase, possibly something in China and regarding GTA. Can you clarify what percentage of your electronics business is made up of carrier gases?
Steve Angel, CEO
Peter?
Peter Clark, Analyst
Yes? Can you hear me?
Steve Angel, CEO
Peter, sorry. We can't hear you. You are cutting off.
Peter Clark, Analyst
I'm curious about the percentage of carrier gases in the electronics sector, especially with Samsung and GTA now operational. I've observed the resilience in this area. My second question pertains to the productivity projections for the full year, which was a significant highlight in the February presentation, indicating a potential increase of over 6% in EPS. I assume that despite any challenges in executing planned reductions for 2020, we still expect a substantial number. Those are my two questions. Thank you.
Steve Angel, CEO
Electronics accounted for 9% of our sales in 2019, and we expect this percentage to increase as we begin to address our backlog, which was approximately $900 million at the start of the year. This growth will largely come from on-site projects as we work through these initiatives. In terms of total cash fixed costs, which exclude depreciation and focus on controllable expenses, I am confident that our total cash fixed costs in 2020 will be lower than in 2019 by a high single-digit percentage. This is an improvement over our initial projections. Given the impact of the pandemic, which led to significant economic shutdowns in the U.S. and Europe for much of March and April, we found it necessary to adjust our plans. Based on Matt's forecast, we anticipate recovery in 2020 to remain below pre-COVID levels. We expect this recovery to be in the low to mid-single-digit range. However, if the recovery surpasses these expectations, we will take advantage of that opportunity.
Peter Clark, Analyst
Understood. Thank you.
Operator, Operator
Your next question comes from the line of Bob Koort with Goldman Sachs.
Bob Koort, Analyst
Thank you very much. Can you discuss the potential for decaps? Are you noticing increased interest from your customers or potential customers in light of the challenging economic conditions or perhaps due to crack spreads, or has there been little change and companies haven't had the opportunity to explore or express interest in that?
Steve Angel, CEO
It's a good question Bob. That was something we commented on. The answer is yes. We are seeing more interest. I think more will come as they think through their financial condition. We're working on something as we speak. But I do expect that one of the opportunities that's going to emerge from this is the opportunity to do some of these decaps. Now, obviously, we have to be careful, we have to be selective we have to make sure that these are world-class assets that we're going to be supplying operated by blue-chip companies. But I certainly expect to see more opportunities than we had in prior years.
Bob Koort, Analyst
And one other thing I note Steve across sort of the large-cap more defensive chemical names we look at, at least, you guys have probably had the most resilient earnings stream even in light of your scenario analysis but maybe haven't been reported as much from an equity standpoint. I'm curious on two things. One you guys have daily sales runs across your network. Years ago you used to provide us monthly updates. Is there any scope that maybe you could give us some interim quarter updates on whether scenario one or two might be occurring or your expectations for it? And then two, I'm wondering is there any chance as that progresses you could become more ambitious on getting back into the share repurchase activity?
Steve Angel, CEO
All right. So, let me take a moment to address that. Yes, I believe we could consider providing an interim outlook based on your accurate assumption that we closely monitor these volumes. I keep an eye on them, trying not to check daily since that could be overwhelming, but I do review them weekly on a global scale. We have a clear sense of our performance. I think we can come up with some insights. Regarding share buybacks, at this stage, due to the opportunities we discussed involving decapitalizations, which can be substantial, we want to ensure we have the capacity to seize those opportunities. Historically, we’ve emphasized that our business priority is to invest in the core operations. We aim to focus on key plants and businesses, whether it's new projects or decapitalizations, as that yields the highest return on capital for our company, and that has consistently been our main focus.
Matt White, CFO
Bob this is Matt. Maybe I could add a little to kind of your question on the outlook. So obviously, we have April under our belt here. I'd say April came in better than what we initially anticipated. But if you look at our 10% to 15% outlook I mean the worst-case side of 15% would probably have to imply April repeats for the remainder of the quarter. Obviously, if there's an improvement from April you could be at the 10% or better layer. But at this point we'll have to see where that goes. But I think that's how we think about the sequential look and it's very fluid. It's something that we have to keep monitoring. But that's how we think about looking forward.
Operator, Operator
Your next question comes from the line of John McNulty with BMO Capital Markets.
John McNulty, Analyst
Yes, good morning. Thanks for taking my questions. When we look at the project CapEx that you laid out is there a way to think about what portion of that's tied to the smaller projects the ones that are sub $5 million? And how should we think about the returns on those whether they're kind of in line with the general return profile of the larger ones or are they above or they below? How should we think about that?
Steve Angel, CEO
I believe, to Matt's point, most of the decline of about $400 million is in the base area. Regarding large projects, those returns are secure. The question is whether we will push back the anticipated start-up by a few months. The base includes everything, such as maintenance, safety, and small projects, but large projects are classified within this base. I don't foresee a complete halt in activity; I've recently approved a few new projects. There are still some small on-site opportunities that we consider very good. The return profile remains unchanged, so we continue to see solid returns. However, it's reasonable to expect that opportunities will be fewer in the current economic climate.
Matt White, CFO
And John, just to add to that, a significant part of the base capital expenditures was related to growth. Within that growth, I would categorize it into two main areas. One includes the smaller standard plants costing under $5 million. As Steve mentioned, we are still seeing opportunities and growth in this area, although it will be slower. The other part of that growth involves tanks, cylinders, trailers, and much of the transportation and storage equipment associated with growing either liquids or cylinders. In this current environment, we expect that area to see a decline because we already possess a substantial asset base that we can utilize. Therefore, I anticipate a more significant decrease in the transportation and storage components of growth compared to some of these smaller on-site projects.
John McNulty, Analyst
Got it. That's helpful. And then maybe just as a follow-up. So, you commented in the beginning remarks around Lincare and the opportunities there and the support that you're giving. And one point that you made was that the government truly appreciates this. I guess can you flush that out a little bit? I know this has been kind of a business that, maybe there were question marks in terms of whether it's fit in the portfolio or not. I guess how might that be evolving at this point?
Steve Angel, CEO
Lincare is a business that reports directly to me, and it has since the beginning of the merger. I monitored it closely as we approached the merger and noted that the trend starting in 2018 was improving. The results in 2019 exceeded those of 2018, and we anticipated that 2020 would outperform 2019 as we developed our plans. Given the current circumstances with COVID, I am confident that we will have a solid year in Lincare. This is important because, as we all know, the healthcare system has been under pressure, and needs like ventilators and ICU beds are critical. Our respiratory home care services allow us to support patients transitioning from hospitals, thereby easing the burden on healthcare facilities. The government and the Center for Medicare & Medicaid Services have recognized this need and have been working with us to streamline the process, including reducing paperwork and face-to-face requirements that are not practical during this time. Our capacity to provide necessary services at such a crucial moment is significant, and while many smaller home care companies may struggle to do so, Lincare has the resources and expertise required. This demonstrates our value to both the company and me this year, and I foresee this continuing positively into the future. With COVID-19 being a respiratory illness, which is our area of expertise, I feel increasingly optimistic about this business. I emphasized the importance of understanding and improving it in the early stages, and my outlook is quite positive today.
Operator, Operator
Your next question comes from the line of Vincent Andrews with Morgan Stanley.
Vincent Andrews, Analyst
Thanks and good morning, everyone. Steve, could you elaborate on the decaps? I'm thinking that, similar to large projects, there will be competition for decap. Could you discuss where you see your competitive advantage? I believe some of it relates to density and engineering, but how do you think the winners in these decaps will be determined? From your perspective, how do you assess hurdle rates and risk profiles compared to a similar investment in a large project?
Steve Angel, CEO
I'm not going to change how I view hurdle rates or risk moving forward. There will be instances of competition, and we may act as a supplier in a complex scenario. We could be the preferred partner to take over an existing asset, and this will simply involve negotiations between two parties. I believe the same will apply to our competitors. This is where opportunities will arise. Linde Engineering has established many plants globally, including ASUs and HyCO plants. We have a comprehensive list and know their locations, and we will evaluate them to decide which ones we are interested in and which ones we are not.
Vincent Andrews, Analyst
And maybe just as a follow-up on your leverage level. I know we've been having this conversation in prior quarters but obviously the world is a bit different now. So has anything changed about your willingness to lever up the company? And does it matter whether it does decaps to cash flow right away versus large projects with buybacks?
Matt White, CFO
Hi, Vince, it’s Matt. Yeah, I start with the standard basic part of our capital allocation policies which we're going to maintain an A rating right? We're absolutely committed to that. And the nice thing I think about the capital policy, we've laid out is, it's going to be the same throughout any environment. And this is no different. So as you may recall, our approach is maintain the A rating. We want to raise the dividend every year. And our priority always is good growth projects that meet our criteria. Whatever is left over goes to buybacks. And to the points we made in the prepared remarks and Steve's points, we are seeing a different landscape of growth opportunities now in light of this environment. We want to understand that and assess that. Hence we've paused the buyback program. Now that the potential growth opportunities are changed and some especially things like decaps will have more different cash profiles than you would on normal projects, we just want to assess it and understand it. So our capital allocation policy has not changed at all. Our view on the desired credit rating and appropriate debt levels has not changed at all. But this environment has created opportunities where that did not exist prior and we want to make sure we assess that and understand that.
Vincent Andrews, Analyst
Thanks very much guys.
Operator, Operator
Your next question comes from the line of Mike Sison with Wells Fargo.
Mike Sison, Analyst
Good morning everyone. It's good to hear that you all sound well. Regarding Q1, I'm curious about the numbers. The adjusted EBIT increased by 11%, and operating income also rose by 11%, but EBITDA only grew by 4%. Can you explain the difference and how this will progress for the rest of the year?
Matt White, CFO
Yeah, Mike, this is Matt. I’d be happy to address that. You might remember during our second quarter call in 2019, I talked about the sequential EBITDA change from Q1 to Q2 and mentioned a presentation format change. As you recall, we didn’t officially merge until March of 2019, which means this change was oriented towards the future, but it is also affecting year-over-year comparisons. In simple terms, there’s probably around a 4% impact from other reclassifications. It was just a shift between fixed costs and EBIT and DA, resulting in a net zero effect on operating income, but it accounts for another 4%. Additionally, I mentioned the effect of equity income from noncash unhedged loans. As you know, EBITDA calculations include equity income, which means that’s likely another percentage point impact; again, this is noncash but still significant. So, it seems like EBITDA might be affected by around 9%. The only difference from the 11% growth is that depreciation is slightly lower. However, I believe it’s better to focus on cash rather than solely on EBITDA as a proxy. Operating cash flow increased by 26%, which is what I find most relevant. Moving forward, you won’t encounter this effect again as it was a one-time occurrence at the merger adoption in Q1. I have no concerns looking ahead.
Mike Sison, Analyst
Great. And as a quick follow-up, last quarter you had a nice EPS waterfall chart. When you think about the positive, the savings like 6% or so then pricing was a couple percent. Stock buyback was couple percent. Maybe that's a little bit lower and then project backlog was couple percent. Are those positives still intact? And I guess that implies something like mid-single-digit declines in your base case for demand and then maybe 10, 11, 12 who knows in the bear case. Is that kind of the way to think about it? Thank you.
Steve Angel, CEO
I believe that focusing on the key elements is the right approach. Our project backlog indicates approximately 2% growth in both revenue and profit for this year, next year, and the year after. That seems reasonable. If you review the previous data, we refer to as the Christmas tree chart, it shows around 2%. I don't foresee anything that might change my perspective on that. Historically, even during times of significant volume drops, we've managed to maintain positive pricing, and I don't anticipate that changing. On the cost side, expenses will increase, and we'll cut more costs this year in response to the current environment, which is necessary. The two main factors affecting us are foreign exchange, which Matt mentioned, and volume. Everything depends on volume. We've outlined two scenarios, but you can create your own. What we've presented may not accurately predict outcomes because our understanding of the situation has changed in the past month. This will continue to develop, and if volumes rebound quickly, we could perform exceptionally well next year.
Matt White, CFO
I would like to add to Steve's point that many people use the term recovery, but it's important to clarify what that means, as it varies from person to person. No one really knows what recovery will look like, but we have made an effort to define it. We see it as reflecting some recessionary conditions. Therefore, it's essential to consider what recovery means and when we can expect it.
Mike Sison, Analyst
Thank you.
Operator, Operator
Your next question comes from the line of Nicola Tang with Exane BNP.
Nicola Tang, Analyst
Hi, everyone. Thanks for taking my question. Actually it ties on quite nicely to that point you just made on recovery. I think in your opening remarks, you mentioned that actually you had seen a decent recovery in China. So I was just wondering if you could talk about how China today is tracking versus more normal conditions. And then just on the engineering business. In the slides you mentioned that the sales decline was driven by project timing. I was wondering to what extent that was due to disruptions related to coronavirus not being able to get on-site versus like longer-term project delays? Thanks.
Steve Angel, CEO
Okay. Let's start with China. The current volumes are showing that merchant liquids are in the high 80s, likely close to 90% now. Although we haven’t returned to 100% of pre-COVID levels yet, the trend is improving. The issue in Asia is that the challenges we faced in Q1 in China are now being seen in Q2 in places like India, to a lesser extent Southeast Asia, and Australia. The on-site business from Tier 1 steel suppliers took a significant hit during the downturn, the Lunar New Year, and COVID. Moving forward this year, we need to ensure that we’re not accumulating excess inventory that won't be absorbed. It's a favorable time to collaborate with Tier 1 suppliers in China. On the chemical side, activities vary, showing figures between 70% to 90% of pre-COVID levels, depending on how fast China’s economic recovery progresses. The export order book will influence this sector. Clearly, companies are emerging from the COVID period, as noted in other reports, and that trend is ongoing. Regarding Linde Engineering, there are some challenges in executing projects, but nothing significant at this time. Their transition to virtual management, similar to ours and many other companies, has been effective. So far, I haven't noticed any project delays, and everything appears to be on track. While sales may potentially decline slightly, the order backlog remains solid, which is the most crucial aspect right now.
Nicola Tang, Analyst
Okay. Thank you.
Operator, Operator
Your next question comes from the line of Duffy Fischer with Barclays.
Duffy Fischer, Analyst
Yes. Good morning guys. Steve you had referenced kind of the recession of 2008, 2009 and how well the business did through that both EPS and pricing. Looking back at that versus what we're seeing today what are the pros and cons of using that as a template as a guide as we go through? So for the merchant business what might that mean? And then because you didn't have the engineering business back then maybe walk us through what that business could look like in a recession in your mind?
Steve Angel, CEO
I didn't have the Linde Engineering business back then, and I may have still had a small home care business in the U.S., but it was nothing like Lincare. There were some opposing dynamics at play. I believe U.S. volumes dropped about 12% during that time, while worldwide we were down approximately 10% in 2009 compared to 2008. Pricing was still positive and reactions were quite similar. Pipeline volumes in the U.S. fell sharply during the financial crisis, and we experienced a similar decline with COVID. When the industrial base in the United States shuts down, pipeline volumes also start to decrease dramatically. Merchant liquid volumes suffered significantly in 2009 and are looking quite low as of April this year as well. Though the crises are different, the effects on volumes are comparable. I am confident that Lincare will have a great year. Looking at Linde Engineering, they are in a fortunate position, having closed a large order coming into this year. Their third-party backlog is $5.5 billion, which equates to two full years of sales. Additionally, they are working on the engineering for an extra $4 billion in gas sales. They are in a much stronger position than they have been historically, with a large backlog and gas sales that can help cover their engineering costs. I am not concerned about Linde Engineering this year, and we would need to see a significant drop in orders into next year before we would face any pressure there, at which point we would consider adjusting costs more aggressively. For now, they have a substantial backlog to work through, which will sustain them for a while.
Duffy Fischer, Analyst
Great. Thanks. And then just on your comments around decaps the opportunity set SMRs versus ASU versus others. What does that look like in your mind over the next year or so?
Steve Angel, CEO
I think that's an interesting question. I would say that we will see both opportunities, possibly with a heavier focus on the ASU side. When discussing SMRs, we're looking at hydrogen, syngas, or CO for refining in the U.S. and other parts of the world. Additionally, ASU opportunities will also arise. I'll just leave it at that.
Duffy Fischer, Analyst
Thanks, guys. Be safe.
Steve Angel, CEO
Thank you.
Operator, Operator
Your next question comes from the line of Laurence Alexander with Jefferies.
Laurence Alexander, Analyst
Good morning. So one of the debates after the merger was the cultural integration and the resilience of the two cultures and how well they would work in a crisis. Now that we're in one, can you give some perspective on both positives and also maybe just specifically addressed have you – needed to replace staff in the senior levels in any regions or product lines as part of the – over the last six months? But also can you address sort of just what you've been pleasantly surprised by or what's worked what hasn't?
Steve Angel, CEO
Well, I think that's a good question. Obviously we've been in the middle of this for a couple of months and even a year plus going back to the beginning of the merger. But I've been quite pleased, very satisfied with the response I've seen from everyone around the world not to differentiate between legacy Linde or legacy Praxair or legacy BOC or legacy whatever, because we have various groups in the new Linde plc. But – because this isn't my first rodeo, as soon as we started to see things unfolding the way they did, I basically went back and pulled the playbook out of 2009, took a good look at that, refreshed that, got that out to everybody. I think it's important that we all get grounded early in terms of what needs to be done, what pace it needs to be done. And I'm very pleased with the response that I have seen really from everybody around the world.
Operator, Operator
Your next question comes from the line of Steve Byrne with Bank of America.
Steve Byrne, Analyst
Yes, than you. A couple of months ago, Matt you were talking about – at the beginning of this pandemic, as it was unfolding you expected to learn how to be more productive, something to that extent. And I just wanted to see whether you were able to pull forward any of these productivity initiatives that we feel like maybe have been set at – to relatively modest levels. Are you able to pull forward because of any disruption going on at the governments or workforce? Anything along those lines that we could expect greater cost synergies going forward?
Matt White, CFO
Yes. And maybe to learn more productive, I'd maybe just say there's probably more productivity opportunities. I agree with that absolutely and I think the prior conversation we had. And I think it's to an extent what Steve had said in his earlier remarks that we're a very, very local business. And obviously, we have a set of opportunity of some efficiencies that we were already undertaking with the merger. In conjunction with that as the dynamics change in our local businesses, we need to adjust and adapt with our cost structure. On top of that when you get in an environment like this, there's just a bit more of a burning platform. And I think that burning platform helps – even to Laurence's question earlier, it actually brings the culture together faster in my opinion. And we're seeing that. And so I think you find more opportunities, people become more creative and the local markets require maybe cost structures that might be a little different. So you add all that together, yes absolutely, there's greater productivity now than what we originally anticipated in the beginning of the year. And we just need to act on it in all capacities. And it's across all fronts. And it's not just people, it's lots of different things. And so I think this is what we are actively working on. And we feel there's a lot more opportunity that we're going to continue to work towards and we should be seeing the benefits in our results throughout the year and into future years.
Steve Angel, CEO
So I'm going to add one thing then we'll take one more question I think, Juan, right? So everybody is going to go through what are the implications of COVID strategically speaking going forward? And what are the implications to your company what are you going to do different? We've already alluded to a couple of things throughout this. Being a local business, not directly impacted by supply chain is good thing for our business. We've talked about the importance of health care being in resilient end markets. We've talked about decarbonization opportunities, hydrogen. We're going to see that going forward. But another implication that I think relates to your question is digitalization and the ability to operate plants remotely, the ability to monitor plants remotely, the ability to diagnose what's taking place, preventative diagnostics, predictive maintenance. All of those capabilities are going to be even more important, not just for us but for other companies going forward. And that – I've always viewed that as mainly a productivity opportunity for our company.
Operator, Operator
Your final question comes from the line of PJ Juvekar with Citigroup.
Kara Enomoto, Analyst
Good morning. This is Kara Enomoto on for PJ. I was just hoping you could possibly compare and contrast what you saw in China in Q1 with maybe the cadence of declines and a recovery in the Americas, EMEA and other parts of Asia. And while I know you can't get too granular I was wondering if you're starting to see any positive or stabilizing signs in any of those regions?
Steve Angel, CEO
Yes. I think China, obviously hard stop and then reopening instant stimulus from the government. And clearly, they're coming out of this fairly quickly. I think for Europe when I look at the merchant liquid volumes for Europe in April just to give you that number, it's off 15%. But as I look at the industrial volumes it looks to me like maybe the last week or two in April we're starting to see a little improvement from that. If I were to look at the United States merchant liquid volumes are off like 20%. Sitting here today, I haven't seen any change week-to-week in that number. And if you think about it China went first coming out followed by Europe maybe starting to emerge from that and then the U.S. is still kind of behind and more at the bottom of the curve at this point. So we'll see.
Kara Enomoto, Analyst
Okay.
Operator, Operator
Management, the floor is yours for any closing remarks.
Steve Angel, CEO
Yes. Just thank you again, for everyone participating in today's call. Like always, if you have any further questions, feel free to reach out to me directly. Have a great day and stay safe.
Operator, Operator
Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect.