Greetings to you all, welcome to the presentation of Sandvik's results for the second quarter of 2018. We will run through the presentation, after which we'll open up for questions. The presentations will be, of course, carried through by our CEO, Björn Rosengren, and CFO Tomas Eliasson. Without further ado, I'll just let you rip.
Thank you, Ann-Sofie. Also, I would like to welcome you all to a sunny summer Stockholm. Beautiful day here. I'm going to present our half-year result for 2018, I'm very pleased to see that Sandvik is moving in the direction that we want. We are seeing strong demand in all markets as well as in all the segments that we operate in. Also, each of our business area is developing in a good way. During this quarter, we have seen record orders, record sales, and record profit as well as profit margin. It's Sandvik that is in good condition at the moment. We are also been working with the portfolio management, we have been, as you're aware of, been able to close a number of deals during the last quarter or just after the quarter.
Hyperion is now closed, as well as welding wires, as well as the Fagersta divestment. Also, the stainless wire is coming to an end. We are moving into the direction that we want to move to grow Sandvik and to expand our core businesses. We are happy to present during this quarter two acquisitions, Metrologic as well as Inrock. Metrologic, you are well aware of. We have had press conferences regarding that. Inrock is a consumable company within directional drilling, which is adding aftermarket business to SMRT. That's great. We have also taken the decision to evaluate strategic options for the Varel business. This is nothing new for you guys. I've been mentioning that before. We have in our strategy to be number 1 or number 2 in the businesses that we operate in.
Varel was bought earlier in a direction when Sandvik was supposed to move more into the oil and gas industry, which we have said that that's not the direction we like to move the company at the moment. The company has developed fantastically well during the last year, we are actually up at levels when it comes to profitability where we were when we acquired the business. It's still a little bit smaller, but it's moving in a nice direction. There are still some parts within that business that we consider core. That is the mining rock tools. That is what we call tricone bits where we, together with the Sandvik range, are market leader when it comes to these products. We'll come back to that later. As I mentioned, the market continues to be strong. We see strength in all segments as well as in all regions.
We see in Europe up 16%. North America looks 8%. It looks a little weak. That is the area which is developing best also sequentially. We see as high as 19% if we take away one-time orders during last year and this year. Good development there. U.S. is around 10% there. When it comes to Asia, it's up 17%, and China there is around 7%. Good development within all these regions. I mentioned before, it is a record order and record revenues. They are up 12% in profit volume. We have a book-to-bill ratio of 1.04. That means that our orders are larger than our revenues. That is, of course, good news for the future. That means that these products will be delivered during the next half year. That looks positive. Both the profit is growing, but also the margin.
We are at the record profit of SEK 5.067 billion. This is equivalent to a 19.4% margin. There is some currency in this part. It varies a little bit between our businesses. If we look at SMT as well as SMS, there is a positive currency effect. When we look at the mining business, there's quite a significant negative currency effect. If we look at the total here, and we include the positive metal effects as well as the FX, and some structural from the divestments that we have done, we are actually 28% up compared to last year. That's great to see. If we dive into each of the businesses and see what's happening there. When it comes to SMS Machining Solutions, also here we have record revenues as well as order intake. Good numbers.
We see continuous good growth here, 8% on orders and 10% on revenues. Very good overall. If you put in the positive FX, I mentioned there was a little bit positive FX there, you take it by approximately 1%. It's moving well. The demand is there, and we've done somewhat increase in inventory on that part, which is very much in line with our expectation. That is for the deliveries, which is normally during the Q3. The effects on SMS there on that part is about 1%. Mining and Rock Technology, strong growth, 15% on orders and 16% on revenues, coming up to good levels. We're also seeing here improvements in the profit during the quarter, reaching 17.1%. I think it's important to understand here we have a very much negative currency effect.
As you all know that the major building market is actually Finland, where we have a EUR. The most of the market that we deliver is the U.S. dollar, where you have a negative influence. If you actually compensate for that negative currency effect there, you actually come up to as high as 18.2%. If you also take out the Varel business, you are as high as 18.9%. We are getting closer to where we are. I still think that there are more to wish for, but, I think we are moving definitely in the right direction. It's also good to see that all the product areas and business units there are starting to perform quite well. That's of course very positive.
SMT, the problem child that we presented one year ago, that we will go into a restructuring program. We said that during the next two years, we are going to reach 10% EBIT level. We have also new management since the second half of the year, where I think it's moving according to plan. I think we also see that in the quarter, reaching an underlying profit of 9%. It is, of course, the quarter where we have best result normally. There is a little bit of building up also inventory for being delivered during the rest of the year. Still, we see good growth. We say 17% here, but if you actually remove the two big orders, we had a large order last year in this quarter, and a big order, but a little bit smaller this year.
If you remove both of those, the underlying growth is 37%. You start realizing that that business is now in a good market for the moment. We're very happy about that. The work will continue, and we are optimistic that we will reach the targets for next year. Tomas, can you help us a little bit with the balance sheet?
I'll do my very best.
Some financials.
Okay, let's dig into the numbers. Take a look at the summary for the second quarter and year-to-date, but I will focus on the second quarter. If we start at the top hand right side, you can see all the top-line numbers, both orders and revenues, as you heard, 12% organically. Currency, +1, both for orders and revenues, and structure, -2. The structure here is process systems and welding wire, which is deconsolidated now, or divested, I should say. If we look at the profit, SEK 5.1 billion almost. That's 36% up, 28% taking out currency, and metal price effects, 19.4% in EBIT margin. We should mention, of course, that as we go into the second quarter, as we always do, we produce a bit more for the summer closing. In Q3, we have a bit of under-absorption.
In Q2, we have a bit of over-absorption. This is, as Björn mentioned, one percentage unit on SMS, one percentage unit on SMT, meaning that it's like 0.5 percentage units on the full group. It is as we normally run the business. Nothing strange about that. The finance net, SEK 266 million, compared to SEK 225 million a year ago, might look a bit strange. The important thing here is to understand the interest net. The interest net was -SEK 173 million in the quarter, SEK 278 million a year ago. The interest net is down 38%, driven by debt reduction and by recapitalization of many of the subsidiaries. The reason why the finance net as such is picking up or going down, is that there are always temporary revaluations of hedges and other derivatives in the finance net, temporary changes.
It was a big plus a year ago, it's a little bit of a minus this year. The interest net is down 38%. Tax rate 26.3%. According to the guidance that we gave after Q4, after the U.S. tax reform, we said that the tax rate would go down in the range. We're not changing the range. The range is 26%-28%, but it would go down and it does. It's 26.3%, which is the run rate that we have and that we expect for the full year. Cash flow, SEK 2.2 billion compared to SEK 2.6 billion a year ago, driven by inventory buildup in the second quarter. Returns, despite this, is going up 24%. We have a higher capital turnover and we have higher profits. Earnings per share up 40% to SEK 282. If we move pages to the bridge.
We start with the organic development, SEK 2.7 billion on the top line, that's 12%. Price volume SEK 1.051 billion in increased EBIT. That's a leverage of 39%, pretty normal. We had basically 50% for SMS, we had 40% for SMT, and a little bit above 30%, 32% for SMRT. So 2.4% in margin accretion or 2.4 percentage units. Currency +SEK 145 million, that's another 30 basis point accretion on the margin. The big driver is net-net. The big driver this time is euros. Even though euro is negative for SMRT, it's very positive for SMS and for SMT. Of the SEK 145 million, about half is transaction, half is translation. Structure one-offs. Here you have the metal prices and the structural changes as well, 0.9 percentage points. All in all, 19.4%. If you take 15.8%, add 2.4%, you come to 18.2%, excluding structure, currency, and metal prices.
Okay, let's leave that one and move over to the balance sheet. Working capital picking up, as we have mentioned, and you can see on the right-hand side, it's going up a bit ahead of the deliveries during the second half of the year. If we look at the cash flow on the right-hand side, you can see that we have a very positive impact on the cash flow from earnings or earnings growth, which as you know, is really the only long-term cash flow driver. Working capital is eating up quite a bit now in this second quarter and CapEx is flat. That's SEK 2.2 billion for the quarter. It's a little bit more than SEK 4 billion for the first six months.
We should say again here that we are confident that we will deliver a free operating cash flow for 2018, which is in line with what we had in 2017, which is somewhere between SEK 14 billion and SEK 15 billion. Q3 and Q4 are the big delivery months for this group. Moving over to the net debt. We had dividend payout in Q2, SEK 4.5 billion. Dividend went up as you might remember. The net debt kicks up, but it's staying at SEK 18 billion, and after this it will continue to go down. Of course, we had the Metrologic acquisition, the Inrock acquisition, but we also had the Hyperion divestment in July. This all washes out, same kind of money in and out. Gearing 0.34 compared to 0.71 a year ago, it's cut in more than half.
Last slide, a few words on the guidance or the actuals on the guidance. Underlying currency effect was SEK 140 million, we guided zero. Of course, it's the euro which is driving. The metal prices in the quarter ended at 201, we guided 100. This is in quarter, it's not year-over-year, this is in quarter. For Q3, this is a big number on the currency effect. It's +SEK 650 million, and this is mainly U.S. dollars, with the currency rates to be used by June 30. We will have about half of this money is translation, half of it is transaction. Euro will turn to become a little bit positive, but the really big one is U.S. dollars for Q3 with these currency rates. It's a big number and it will of course have a big impact on the top line as well.
Metal prices in quarter for the third quarter, SEK 100 million. If we look at the full year guidance CapEx SEK 4 billion, year to date is SEK 167. We stick to the guidance of SEK 4 billion. Finance items, SEK 1 billion. Year to date, SEK 520. The important thing here is the interest net, which will now be around SEK 800 million out of that SEK 1 billion. That's more than 50% reduction in two years. The tax rate, as I mentioned, will stay on 26.3%, 26.4% going forward here. We keep the guidance, but in the lower part of it.
That's it, Björn. Over to you.
Thank you. To round off this session, I'd like to just say that besides that Sandvik is developing in a good way, and that we have very strong markets where we are operating in, I'm also very pleased to see that the Sandvik new structure has landed well and is in place. The decentralization process has been a tough journey for the company during the last two years. I think with the present setup and structure, Sandvik actually consists of 34 business units and product areas where the business actually is driven from. That's where the management is, and that's where the important business and the right decisions are being taken. This is extremely important for the way Sandvik is going to work in the future.
Besides this, we have built up a business governance system, the scorecard systems, which is a fantastic tool for the businesses to very quickly analyze where we are in the development, and make the units take the right decisions. It's also an excellent tool for the business area heads who are driving their product areas, but also for us in the group management to actually follow the development of these 34 units and make sure that the right decisions are taken. It makes them actually really agile. While some businesses are developing extremely well, focusing on growth and growing the businesses, other businesses in the group have strong focus on getting the cost structure right, adopting the sales and the resources in line with the demand in the market.
I think that really helps the group to be agile, but also to develop in the right direction going forward. By that, I think we can end this session, we can move in the direction of question and answers.
Yes. Thank you. I think we'll start with opening up to see if we have some questions here on the floor. Yes, we do. Peder, please go ahead.
Thank you. Peder Trygging, Handelsbanken. Normally in SMS, orders is typically a bit higher than revenues in the second quarter, given summer deliveries and so forth. Given the pattern we saw right now, orders growing organically by 8% and revenues by 10%, and given what you see in the books so far in this quarter, how would you see demand is trending if you try to take out the seasonality here? That's my first question.
First, when you talk about SMS today and maybe the SMS that you are referring to back in time, that was without PBT. PBT is actually our Wolfram business, which is both the mine, but also the recycling of old inserts, and it's also making Wolfram for a lot of businesses. Only 50% of that business is coming to our business and 50% are being sold externally. That business has had, when you look between the quarters, quite significantly different. If you look at this quarter, that was less than it was during the previous quarter. We had in the beginning of the year enormous, and that is how the orders are coming in. You book up orders in the beginning of the year, and then you deliver out there.
I think the difference between 8% and 10%, you should not see that, because when the orders come in, it's a delivery out immediately. You should see that the orders and the revenues is between 8% and 10%, and with that. I don't think you should make any conclusions that one is less than the other one, that part. What I can mention on that part is that this is probably the best indicator of the industry that you can use, because this represents the activity in the production facilities around the world. You can see this is how it is, and how the future will be, we don't know. The difference here a little bit from SMRT, for instance, where you have long order books, we don't have any order books.
I mean, they are very short, except for the Wolfram, which has been extremely high in the beginning of the year. I mean, it's booming up in that part. It's a little bit like that, but I normally give a little bit of feeling of how has next month started. We have come half of that, I think what we have seen so far, there's no change in the pattern that we saw during the previous quarter.
Thank you very much. Just my short follow-up, sorry. You mentioned that the inventory build in SMS was sort of normal due to seasonality, but at the same time, it was mentioned that it helped the margin by one percentage point year-on-year. It's more than at least last year. Could you please repeat what you did last year? How much is normal this year? How much is abnormal last year?
Exactly. You can answer that.
Yeah, I can take
If you can please turn myself. Am I on? Okay, good. Yeah, sure. Last year, we were in a situation where demand was picking up enormously quickly. It was a high demand drive in SMS. We tried to build up, we didn't manage. We just didn't manage to build up stocks. This year it's quite normal. That's why you have a year-over-year bridge effect, which is maybe then a little bit higher than normal.
Besides that, also, it's true that the inventory was SEK 200 million higher than the expectations, both from us and from themselves, and that was related to scrap buying. They buy these inserts in the market, and they bought for SEK 200 million more into that part. We will buy less during that part. That's part of the recycling of inserts when we make parts. That has no influence whatsoever on the improving our profitability.
Yeah, that's in the supply unit.
I think we have an additional question here. Olof, please.
Yep. Olof Larshammar from Danske Bank. One question on SMRT. You mentioned in the presentation that you see potential for further structural improve the business. Could you please elaborate on which areas you see a potential during the coming years?
Absolutely. You who have been following the SMRT development during the last three years have seen, of course, an astonishing development during this period. That comes to the aftermarket, which has improved significantly, both grown dramatically as well as improved profitability, as well as the equipment part of the business. When we improve our businesses, we work with continuous improvement. Each of these businesses, they have their action plans to become a little bit better. It's everything from launching the right product, making sure that the production is becoming lead times that are shorter and more efficient. At the moment, the business is, I say, hampered by enormous pressure from orders, especially the part which is the underground business that is load and haul, as well as an underground drilling part where we see huge growth numbers.
They are struggling with suppliers, with components, not being able to complete all the equipment before they deliver out. There are still inefficiency in these units, which is related to very high growth numbers in the business. Comes what I think is probably the most exciting business for Sandvik and for the mining industry. That is actually the automation part of the business. I would say today that every serious mine in the world today is looking to autonomize mining. We have numerous projects. That drives our automation solution, but that also drives demand for equipment, because you cannot use old equipment for that. You need the latest. That's probably the most exciting. The other part is that we're seeing the aftermarket now quarter after quarter, where we grow over 10%. That is important.
That is important for the profitability totally, but it's also for the stability in the downturn. From my perspective today, Sandvik SMRT is a very stable and strong business, but we can do better. It is an exciting business, but we can do a little bit better.
Thank you.
Thank you very much. Operator, can we move to the conference call, please, to see if we have any questions there. Just like the previous two gentlemen very kindly did, I ask you to limit yourself to two questions, because I know there's quite a few people wanting to ask questions. Operator, can we please have the first question put through, please?
Yes, of course. We go to the line of Markus Almerud of Kepler Cheuvreux. Please go ahead, Markus. Your line is now open.
Yeah, thank you. Hi, Markus Almerud here from Kepler Cheuvreux. Starting with SMS, can you just talk a little bit about the trends again, coming back to Peder's questions, asking maybe about talking a little bit about daily sales rates, both throughout the quarter and also sequentially compared to Q1, both by region and also end markets, particularly in the automotive. That's my first question.
Okay. A little bit short in SMS. We've seen the growth level. It is up around 8%-10%, which is good. We're seeing growth in all segments. We're seeing growth in all regions. Where we've seen the best sequentially development during this period is actually in North America, that is positive. That also includes the automotive, which you probably remember that during the last quarter, we also saw a little bit of flatten out. Year-over-year, we put it still on flat, it has had a good development in that market. When you look at growth levels, it's easy to get a little bit spoiled with big numbers when you come to SMS. Normally for SMS, a good growth numbers is 3%. That is the part. We're talking about 10%.
When you're looking at the whole market, what is actually happening in the market, that is production units all over the part that are ramping up their activities. It's a good part. It's a good demand out there. When it comes to the daily rates, we are maybe not seeing a growth in the daily rates, but we're seeing them on a very high level, and still growth numbers.
Just to follow up on that, because there's lots of concerns and worries out there, especially about the PMI falling and decelerating growth. You talk about production units across the board are ramping up. Are there any worries out there among your customers about this, about the economy is about to slow down? Is it a pretty steady rate in how they are conducting the business?
We know that market goes up and down. At a certain stage, that will be going down. How it will go down and how it will be affected is difficult. So far, I knew that this question would come today, so I went on yesterday and asked our guys within SMS, "Are you seeing any slowdowns? Are you seeing anything that would affect this part?" They say, "No, we're not seeing it at the moment." This is of course now. Tomorrow, we cannot answer, of course. The important thing is that we are preparing ourself for able to handle both ups as well as taking care of flattening out or if we'll see softening off.
The good thing with the SMS business, that is not like many other businesses where you can see, for instance, for equipment within mining, where you can see in a downturn, when volumes go down very much. When you see in a downturn in SMS, and you see negative numbers, they are normally a couple percent. If it's a lot, it could be 5%, 6%. Maybe you remember from previous downturn. It's a little bit different from some of other businesses in the market. It's an aftermarket business. It's consumables, which are being used all the time.
Important, of course, is that we and our customers are not building too much inventory.
Okay. If I can just quickly talk about crushing and screening, where you see a very rapid growth, which is kind of new. You haven't really seen that before. What part of crushing and screening? Is it both the portable and then the fixed? Is there any special big orders there which is impacting?
I don't know. Have we said specially that we have-
No
more significant in crushing and screening?
Yes, we did see in relative terms, we see a good support in drilling equipment and also crushing and screening. It's generally in crushing and screening.
Crushing and screening is, of course, both construction as well as mining. When you look at the mobile crushers, they are more related to the construction industry, and some of the stationary crushers are more to mining, but you can also find them in a lot of quarries. One development which I like to talk about here, because I was a little bit rough on them when I was new here, that is the mobile crushers. The mobile crusher have now reached the margin numbers. That was a little bit magic at that time. Remember, I said there might be a question of divestment in the future. Now they have, during two years, improved their performance fantastically, are doing good numbers. On the stationary crushers has been this much more stable business moving on, both in the mining and big crushing.
That has had good development quite some long time, it continues to be on a good level.
Okay.
It represent both quarry as well as mining.
Okay. Thank you very much.
Thank you very much, Markus. Operator, can we have the next question, please?
Yes, of course. We'll open the line of Max Yates at Credit Suisse. Please go ahead.
Thank you. I just wanted to ask a question on mining and rock. I think you've talked a lot in the past about we should be looking at commodity prices and how they move as the key driver. I just wanted to check, given we have seen some declines in the copper prices recently, are you seeing that reflected in customer conversations and negotiations and activity, or is there nothing really to report there in terms of activity levels?
I think copper is one of the strong areas at the moment. They are investing well. You know how the industry, they waited a little bit longer than you saw some of the other industries to get going. During this year, the last 12 months, we've seen good demand in copper. A lot of orders is actually coming from copper today. There is no signals that this would slow down. If you follow the mineral prices, they went up, and now they're moving sideways on a high level. At the moment, we don't see any big changes there.
Okay.
We follow it carefully, yeah.
Just to brief follow-up, could you give us an idea on your balance sheets at, I think, given cash generation, you should be nearly have no net debt at the end of 2019. Could you just remind us how you think about your balance sheet? What the level of debt you feel comfortable carrying on the balance sheet? When you look at capital allocation and the pipeline, is there enough out there to fulfill that level of debt on the balance sheet, or could we start thinking about any shareholder returns?
Well, okay. On the balance sheet, the net debt right now, just to give some background, is SEK 18 billion. Given what we said about the free cash flow generation for the rest of the year, could most likely end up below SEK 10 billion, before the end of the year, which would mean then if we don't do anything major, would lead to a net debt-free situation during 2019. That's not a target as such.
We have a capital allocation strategy, let's say from an operational point of view, which is one-third for dividends, one-third for M&A, and one-third for CapEx, really. The target is not really to live with a total net debt-free company. The target is to release resources in the balance sheet so that we can invest in assets, in new companies, acquisitions, so that we can develop our business, which are profitable and stable. Björn?
I think it's correct. We started our acquisition journey in our core businesses, and we have, as I mentioned, proud with these two, but there are, of course, a lot of things going on, and we would be happy to talk more about that when they are coming in coming quarters.
Okay. Thank you.
Thank you, Max. Can we have the next question please, operator?
We are now open the line of Alexander Virgo of Bank of America Merrill Lynch. Please go ahead. Your line is now open.
Thanks very much. Good afternoon, everyone. Just a quick one. Sorry, is that better?
Yes, that's better. Thank you.
Just a quick one, I guess, on SMS. If you look at the report last year, Tomas, I think you built a little bit less, as you said, in terms of inventory, but I think if you look at the incremental margins of SMS over the last three or four quarters, clearly they've come down as the production system aligns with demand. Given the concerns that we have seen in the market, and the fact that you have built a little bit of inventory into the summer shutdowns, can you give us a little bit of help around what we should expect in terms of incremental margins over the next couple of quarters? Are you going to look to reverse that inventory build in Q3, perhaps a little bit harder than you did last year?
Perhaps in terms of follow-up, Björn, I wonder if you could talk a little bit about the development of China over the last couple of quarters in SMS. I think you called 7% to China, but I think that's for the group overall. Thank you.
Okay. Tomas, do you start?
I can start. When it comes to inventory and inventory buildup, we must not forget that we come from a situation where we were understocked, and we have talked about this over the last two, three quarters because the demand has been so strong for SMS. We started to get challenges for some of the brands, some of the core brands within SMS. Now we have built back to the levels where we should be so that we can deliver according to our promises to our customers. Of course, we don't want to leave that situation. We're back in balance now, plus a little bit of overstocking for the Q3 shutdown. Incremental margins, we are not changing anything. 35, 40, around 40% or something like that. That's what we see going forward.
Good. When it comes to China, yes, it's correct. China is the higher growth for SMS than it is for the group. That's correct. We normally don't talk about those numbers individually, but it's a little bit higher. China is very strong. It's strong in all the segments there in the market, and it's developing well. When you see in the group being high between 20% and 30% on that high side, SMS has never been on that level. They've been lower on that part. It's more when it comes to equipment sales within the mining part, which is more affected on that part. I saw numbers today in the papers, China is growing 6.7% GNP. That is the part we know that when we're looking at our market, it is GNP plus that we should be in a different market. China feels very strong.
It's a lot of exciting projects that are going there. Automotive is only one there, but it is the general industry, it is the aviation industry, it is the tech industry. There's a lot of things happening in that part. We feel very comfortable about the development in China. No indication for a slowdown there.
If I could just follow on that, Björn, the fact that you saw SMS Asia grow 10% in Q2 versus 14% in Q1 against, I guess, a tougher comp, is that comp driven, not China slowing down?
I think Asia, what we have is 17%. We not talk so much, but one of the markets where we are growing faster than anyone else is today Japan. We have a super team there, and it's doing amazing at the moment. That's a little bit part, but that varies a little bit between the different regions. I think we were in Asia 17% and China 7% during this quarter. I don't think there is any reason for any worry from that. At least, I don't see it that way. I think we are experiencing well. We are close to the customers, we are close to the market, and it looks quite good. It is, of course, very high numbers, and we know the automotive industry is making close to 30 million cars every year. It's a big market.
Thanks very much.
Thank you, Alex. We move on to the next question please, operator.
That is open line of Guillermo Pena of UBS. Please go ahead, your line is now open.
Guillermo Pena or Guillermo Pena. Thank you for taking my question. From UBS here, asking kind of a relative question to the one that we heard from Virgo. It's more detail in a way. I think, Tomas, you mentioned that you were expecting the free cash flow from operations to be aligned with last year. If my memory doesn't serve me well or does serve me well, you recorded round about SEK 15 billion cash flow, which means that you have additional anything between SEK 11 billion to SEK 12 billion cash flow. Given the state of the cycle we are in, which is still growing, right? You still take away the seasonal adjustment that you need to do in Q3. Would it be possible for you to meet demand from customers in Q4 without inventory buildup or actually being able to meet that cash flow number easily?
Would you need basically to be a lot more constrained on receivables as well, as well as inventories?
I think on the cash flow unit, we saw a very strong growth during last year. During that year, we managed to deliver actually a cash conversion that was over 100%, more than just the profit. SMS is enormous. It's amazing. They are running on a really high cash conversion numbers, we do expect that to be down during the year. They will be all the way up there, even though that they are growing. They are doing a fantastic job there. SMRT, it's correct that traditionally in this industry, of course, that that business drives more because you buy from sub-suppliers, you have more products being built, and then you have deliveries. If you are, for instance, delivering a mining truck to Australia, it's actually three months before it leaves the factory until it being invoiced to the customer. Yes, it takes more inventory.
At the same time, they are working with a lot of activities to improve their performance. The deliveries has gone up. From the beginning, we saw high orders and we saw low deliveries. Now, the deliveries are actually coming up on quite good levels, we should continue to see an improvement in deliveries, which will also generate cash going forward. I think we feel comfortable to say that to reach the numbers that we gave before, those are our projection, those are coming from the businesses, and those that we support. Yes, we think we can, even this year, and that will be the third year in the row where we have cash flow on this level. I can assure you their businesses, they're being incentivized on this as well as rest of the performance of the businesses.
They're putting quite a lot of efforts to make sure that we reach these targets.
I'm a bit concerned because it's almost a doubling. It's not a doubling, but it's just basically last year, second half, you did SEK 7 billion cash flow. Sorry, it was a bit higher than that, in fact.
It's actually SEK 11 billion.
SEK 9 billion, yes. We're talking now about SEK 11 billion-SEK 12 billion. Finally, it is reachable, and I guess you need to focus.
I can show you there is no inventory buildup in the mining business, which are not products which are placed an order, built to customer, and then you have a little bit of lead time, and then it goes to the customer. The inventory that you are building up is actually no risk. It's out there.
Yeah.
We even let the customer prepay a little bit before the part, so they cannot cancel the orders in the part. That's a big difference from before, 2007, when we had the big crash. I think the market is much healthier in this part. If in the future, the volumes would go down, then the cash flow comes like a cannon, and then you have a number of years where you are just getting a huge cash flow out of those businesses. That's how the business works.
Thank you.
I think for us, the financial situation is good. We have a good cash flow position, and I don't think this is a big worry. I think people are making a little bit too big thing out of this.
Okay.
We'll reach the cash flow in the end, and we will be reaching those financial targets based on that.
Maybe I could just add, Guillermo, yeah, we know it's SEK 11 billion. It was SEK 9 billion second half of last year. It was SEK 8 billion the second half of 2016. The company's growing.
The profitability is much higher today.
Yeah, exactly. It's a lot of money, but we feel quite confident.
Yeah. Maybe out of curiosity, a question on Sandvik Machining Solutions. How much of the recycling business is recycled in China?
Recycling in China?
Yeah. How much of your recycling operation or what is the dependence, let's say, from the business %, from a cost perspective to China in one way or another, especially on the recycling part?
The recycling business works that in the factories where we sell a lot of inserts and round tools, afterwards, we collect them and we buy back them when they are used. We deliver them to Austria where we have our big recycling plant. They actually grind them down and they actually take out the tungsten out of that, and that are being used. In a new insert, approximately 50% of the tungsten, which is the main contaminant, is actually coming from recycling that part. We are buying, and of course these prices also varies between how much is available in the market. That's the business. PBT is a product area. We follow them as we do with Coromant or Seco or mining part.
They run their business in a way, they sell 50% of the business goes to Sandvik, 50% of the business go externally. They even have a mine there where they take out their own tungsten. It's a business where they run it, and from my perspective, they're doing a hell of a job. They are performing fantastic. It's not easy when you have your brothers and sisters that are stars, and you'd have to get up to over 20% to even be looked at. This is the environment where they are working, and I think they're doing a great job.
I see. Thank you very much.
Thanks.
Thank you. Operator, we'll have the next question, please. Hello? There seem to be a little bit of a technical issue here.
Sorry, we go to the line of Klas Bergelind at Citi. Please go ahead, Klas. Your line is now open.
Thank you. Yes. Hi, Björn and Tomas. It's Klas from Citi. I have two questions. First on the moving parts within SMRT, it seems like the aftermarket is growing at a similar strong pace as in the last quarter at around 10% in parts and service and consumables, running at high single digit. Can I just ask, was there any increased price cost pressure on the consumable side? I wonder if this had changed versus the last quarter? If you could help us with the margin ex PPA and including PPA for Varel in the quarter.
First, I think service and spare parts is over 10%, and not just a little bit over, it's good 10%. I am not allowed to say more, but that's developing fantastic well. When we talk about aftermarket, it's correct that the consumables is a part, but actually the service and spare parts grows a little bit faster than the consumable business. That is doing well. Prices, it's a good market. We're seeing good prices, and a part we are seeing prices around 2%, some of the business even a little bit higher than that. We're not going to go into detail, but we are on a pricing-wise, a stronger performance now than we did in previous quarters. We're following that, and that's an important part of course, driving profitability in good terms.
I meant, sorry, Björn, I meant on the consumable side. Some of your peers have highlighted price cost pressure, at least last quarter. I was just wondering on the consumable side, whether that has changed anything quarter-on-quarter?
For us, we see positive price development in consumables. From our part, that is developing well. I hope our competitors are not lowering their prices too much.
Okay. Thank you. My second one is on coming back to SMS, you said that China was very strong in the quarter. I thought orders in SMS were growing only 5% in China in the quarter, which is obviously a sharp slowdown from the 15%-30% we've had over the last two years. If Asia is 8% and Japan is much stronger, China must be slower than eight, I would've thought.
No, China is higher than eight.
For SMS?
For SMS.
In orders? Okay.
Yes.
Thank you.
The next question is from the line of Lars Brorsson at Barclays. Please go ahead, Lars, your line is open.
Hi. Thanks. Hey, Björn, Tomas, Ann-Sofie. Just following up on that question, I'm sorry to belabor the point, Björn, on the trends in SMS, particularly in China. It does look like quite a meaningful slowdown. If you go from 20% in Q1 to what I think is 9% in Q2, that's obviously a very rapid deceleration through the quarter. With the risk of trying to pin you down on some numbers here in China for the quarter as we exited, could you help us a little bit with the run rate in Q2 or in early parts of July, maybe to be specific, did China actually grow in June, July for you in SMS?
To be honest, I think we pinpointed that down pretty much. If you compare to the previous quarter, it's pretty flat, I think. Sequentially part, what you saw in orders during Q1 is the same level for SMS in Q2. That I know. It's not a slowing down. You're always comparison with the previous year. It also depends a little bit what happened during that period. It is not a softening, it's a flat development quarter-over-quarter in actual terms.
Understood. Can I turn to your European automotive segment in SMS? You obviously had a very good Q2. A little bit beyond normal seasonality. Do you think you benefited from some pre-WLTP ramp in Q2 among some of your European automotive OEM customers, i.e., these new test procedures that seem to be impacting both the quarter that we've been through positively, but potentially negatively going forward the next couple of quarters?
Of course, that question we were expecting. Our SMS people, the Coromant, they are putting their ear to the market actually to listen what is going to happen, and talking with the customers. There are no indications from the market that there is going to be a slowdown during the part which is related to this going forward. Right or wrong, I don't think we will know. I think the future will tell in that part. Of course, we are being very careful and listening to, will there be an impact? I read, I think, in the numbers here that during Q2, automotive was up in sales, dramatic during end of the second quarter, which of course means that a lot of cars will be produced during the next half year. We'll see.
So far, we have no indications that they come to us and say that now we are going to slow down with 10% or 5% or anything like that. There's no signals whatsoever from the market in that direction.
Understood. Finally, if I can you help us with the year-over-year impact on your EBIT bridge for SMS with regards to production levels? I appreciate now you're producing in line with demand, if you like. Obviously, last year you had a 50 basis point tailwind in Q3 last year. It sounds like we are producing in line now, which means it should be something similar negatively impacting your EBIT bridge in Q3 2018 versus last year. Is that fair?
I think it was during this quarter, it was about 1%, which gave an extra. Difficult to say.
For Q3?
For Q3.
We don't have any guidance for that, no.
It depends on, of course, where the demand. I can assure you, we are not building any more inventory during this period. If the level will stay like this or go down a little bit, that depends on also, they have a number of closures of factories during this period, and that's why we're doing it.
The EBIT margin is always seasonally down in Q3.
I think you also know, you can look back in Sandvik that you see that Q3 is weaker when it comes to profit levels than Q2. This is the strongest one.
Sure. Talking year-over-year, thank you very much.
Sure.
Thank you. We can squeeze in one more question, operator, if it's going to be a quick one. Please, whoever's next.
Okay. We go to the line of Sebastian Kuenne at . Please go ahead. Your line is now open.
Hi, good afternoon. I will be quick. We haven't touched on the U.S.-China trade disputes. Do you export from China into the U.S. in any of the business units? Maybe if you can give us some breakdown of the cost of goods sold of your U.S. subsidiary by region, or how much of their COGS are domestic or derived from China, Mexico, and Europe. That would be good to assess.
It's very little. We have about, I think we had a number of SEK 35 million or something like that's coming from our big factory for mining equipment, some of them. That is not a big thing because we are doing the same things in Tampere, that is just a little bit of a capacity reason why we're doing it. If you see, there is no impact whatsoever when it comes to these customs. I think that's part of it. We have looked over for the businesses, the one which we all know, that is the SMT. We are, of course, always curious to see how that is affecting our performance of the SMT.
When we talked to Göran, he said that it's quite interesting today because we are so local there, we are doing more than our competitors, which means that everyone that is asking for an exception becomes official. There comes up a lot of interesting deals where competitors say that there is no production locally, while we can say, "Yes, we can." There is an opportunity coming up. The cost increases, they're already being compensated above with prices. So far it has not had any negative effect on our profit margins so far. Probably a little bit positive at the moment.
The sourcing for SMRT, do you have any sourcing from China for the U.S.?
No. There is no sourcing. What we are producing mining equipment in the U.S. is the Alachua, where we're making the surface mining equipment, they are not buying anything from China, what I know. I think there are probably more local supplies there. No effect whatsoever there.
Okay, thank you.
Thank you very much. On that note, I end this session, and we bid you all a continued good summer, and we'll see you again in October, I assume.
Have a great summer.
Thank you.
Thank you. Bye-bye.