Ladies and gentlemen, welcome to the SGS 2019 half-year results conference call and live webcast. I'm Sherry, the conference call operator. I would like to remind you that all participants will be listen-only mode, and the conference is being recorded. The presentation will be followed by a Q&A session. You can register for questions at any time by pressing star and one on your telephone. Webcast viewers may submit their questions in writing via the relevant field. Please limit yourself to two questions. Kindly note that no follow-up will be taken. For operator assistance, please press star and zero. The conference must not be recorded for publication or broadcast. At this time, it's my pleasure to hand over to Mr. Toby Reeks, Senior Vice President of Investor Relations at SGS auditorium in Geneva. Please go ahead.
Good afternoon and welcome to SGS first half 2019 result. I'm Toby Reeks, Head of IR. Some of you hopefully know me. I have to say a couple of things on health and safety. We're not expecting a drill. If you hear a bell, a fire alarm, there are some signs at the back of the room. If you follow those fire exits out, we've got a muster point just in front of the building. Okay? With that, I'll hand over to Frankie, who'll open up on our results presentation.
Ladies and gentlemen, good afternoon. Again, welcome to the presentation of our 2019 first half results. Before we start, I would like to introduce you to our new Group CFO, Dominik de Daniel, who has joined us in February.
Correct.
I got it right now.
15th.
15th of February. Great. As usual, I will give you a highlight on our first half performances, and Dominik will provide you a more detailed financial review, and I will come back with a business outlook on the second half guidance for the full year as well. Sorry. If you look at the result, I am pleased to report that our results are in line with the guidance given in January. Total revenue grew by 3.9% at constant currency, of which 3.5% was organic. Our adjusted operating income stands at CHF 489, a 5.4% increase compared to H1 2018. Free cash flow from operation amount to CHF 216 million compared to the CHF 176 that were achieved last year, and our ROIC stands at 23.9% for the last 12 months. During the first half, we also hit three strategic milestones.
The first one was mentioned during our Investors Day in November last year, when I highlighted that following our dashboard review, we were all ready to dispose of around CHF 350 million of asset, and that we will accelerate our acquisition in selected sectors. Both actions having the effect of enhancing our capital allocation in line with our long-term objectives. I am pleased to say that we have executed on this first pillar with the disposal of Petroleum Service Corporation, called internally PSC, and the acquisition of Maine Pointe, both located in the U.S. SGS owned PSC for the past 15 years, and it grew significantly under our leadership, and this thanks to the dedication of our PSC colleagues. Considering the market evolution and our core focus, we decided that PSC will have a better future under new leadership.
As for Maine Pointe, I also highlighted last year the importance for the SGS group to expand our services across the value chain, and Maine Pointe will bring a wealth of competence in operational consulting to support our client addressing the operational improvement needs. We made some acquisitions during the first half, and two further announcements were made on Tuesday to complement our portfolio. Of the seven acquisitions, four of them have an element of technical or operational consulting expertise, which again, is fully in line with the focus of moving more upstream the value chain. Both Lynxis and Maine Pointe are in the operational consulting space. Floriaan is specialized in the area of fire, but also have an aspect of technical consulting. Testing, Engineering and Consulting, under its name indicates, is in the construction sector, but has also an element of consulting in its portfolio.
Subsequent to our media closing, we have also announced a 20% participation in Vircon, a BIM, building information modeling company in Hong Kong, which will complement our portfolio for the infrastructure and construction sectors in the Greater Bay Area in the South China Sea. We have also announced the acquisition of Forensic Analytical Laboratories based in the U.S., and active in the domain of industrial hygiene. The acquisition will expand our portfolio of services in the growing U.S. environmental health and safety market, which is growing strongly for us as well. It is not in the slide, the second milestone that we have achieved is our continuous investment into new sectors for the long-term development of the group.
As an example, our recent investment in the very promising cybersecurity sectors with new facilities in Graz, Austria and Madrid in Spain, and the planned expansion of these activities in North America and Asia. Just to reemphasize here that we in the SGS Group, when we talk about cybersecurity, it is not to compete with the software sectors. Where we're focusing on testing, inspection, certification of chipset and product that would need some kind of competence and expertise in term of cybersecurity baseline assessment. This is also a strong complement to our commitment to the Charter of Trust on Cybersecurity, where SGS is a founding member. Regarding the third milestone in our press release of this morning, we announced a strategic optimization plan of our network with the objective of simplifying our structures and rationalizing our overlapping activities.
Our matrix organization, our decentralized structure, are key strengths for the SGS Group, but at the same time, some elements of complexity and duplication have built over time. Over the past few years, a lot of work has been done and achieved to reach the stage where we can have a closer look at the structure of the network in order to remove waste. On this particular milestone, Dominik will have a slide, and will present that in more details. On that one, I will hand over the presentation to Dominik, who will go through the more financial part of the presentation.
Thank you, Frankie. Good afternoon, ladies and gentlemen. This is my first set of results at SGS. It's nice to see some familiar faces in the audience, and I suspect familiar voices on the call. I look forward to spending some time with many of you over the coming weeks and months. I will start with the overview of the financial highlights for the first half of 2019. Frankie already mentioned the operating highlights in his introduction, with revenues of CHF 3.3 billion and adjusted operating income margin of 14.6%. Constant currency revenue increased by 3.9%. The majority of our business performed well, with the exception of transportation and GIS. Adjusted operating income increased by 5.4% in constant currency to CHF 489 million. At constant currency, the adjusted operating income margin increased by 20 basis points to 14.6%.
This includes approx 20 basis points from IFRS 16. This was more than offset by collection delays, primarily in our GIS business, which we expect to improve in the second half of 2019. Operating income increased by 61% in constant currency, largely due to the CHF 264 million gain of the disposal of the PSC business. This was partly offset by a number of factors, including provisions for indirect taxes, remeasurement of the defined obligation of the Swiss pension fund, and goodwill impairment of CHF 21 million, and restructuring costs of CHF 16 million, which was CHF 11 million higher than in the prior year. Last year's operating profit was negatively impacted by CHF 47 million in relation of the overstatement of revenues in Brazil. The tax rate increased from 24% in the prior year to 34% in H1 2019.
The increase in tax rate is due to the valuation allowance on DTAs considered in the first half of 2019. Going forward, we would expect it to be in the higher 20s. Subsequently, the net profit after minority interest increased 38% to CHF 377 million in the period under review. We posted a solid organic growth of 3.5%, while acquisitions added 4.5% and disposals had a negative impact of 10 basis points, leading to a constant currency growth of 3.9%. The currency impact was negative by 2.8% as the Swiss franc strengthened against all major currencies, with the exception of the US dollar. Moving on to the revenue growth by business. You have all had the chance to read the release by now. We'll just focus on a few of them.
Consumer and retail had a pleasing performance given the geopolitical backdrop. It continued to grow strongly with 5.5% organic growth in the first half. This is a strong performance given the slow start, which we talked about at the start of this year. Electrical and electronics saw the strongest growth. Softlines started slowly, but growth improved gradually throughout H1 and is now posting solid growth driven by the new sourcing countries such as Vietnam, Indonesia, Cambodia, and Turkey, while China was stable. Industrial also performed very well, growing strongly with organic revenue growth of 6.8%. Within this, oil and gas posted double-digit growth. Growth in manufacturing and infrastructure was solid, while power and utilities was broadly stable. We talked about transportation having a difficult year. It declined organically 4.5%.
Weaker demand in field services and some price pressure and increased competition in regulated service more than offset the strong growth in testing. Finally, government and institutions had a challenging first half as revenue declined organically by 4.4%. This was driven by the gap between signing and implementation, as well as the enforcement of certain client contracts, particularly in the e-waste monitoring solution, Renovo. From a regional point of view, the strongest growth was in the Americas, which was up 5.1% organically. We grew strongly in South Central America, especially in Peru, Colombia, and Brazil. Whereas growth in North America was modest. Asia Pacific also grew well by 4.4%. Growth continued to be driven by strong growth in China, Korea, and India. While growth in Australia was solid, in Taiwan modest, and Hong Kong, Japan, as well as Thailand, slightly declined.
Organic growth in Europe, Africa, Middle East was a modest 2%. Double-digit growth in Eastern Europe and Middle East was offset by Africa and Western Europe, which were held back by the weakness in our GIS and transportation business. The development of the headcount is well controlled. Period end FTEs increased 1.5% organically year-on-year, which compares to 3.5% organic revenue growth. Acquisitions added 0.3%, while disposal and the optimization of the network combined resulted in a 4.8% reduction. Overall, total headcount fell by 3% at the end of the period, which is, of course, also impacted by the disposal of the PSC business in the U.S. Regionally, productivity improved most in the Americas due to the structural changes implemented in North America as well as South America. South and Central America benefited on top from a higher operational leverage. The adjusted operating income increased in constant currency by 5.4%.
This comprises 4.8% organic growth and 0.7% added through acquisitions. Operational leverage was held back by collection delays, largely in GIS, for which we expect a clear improvement in the second half of 2019. Currency had an adverse impact of 3.7%, leading to an increase in actual currency of 1.7% in the period under review. Moving on to the margin development. You have seen the numbers, so I will focus on a couple of highlights. Margins in Minerals increased strongly by 110 basis points, which is primarily due to good operational leverage in energy minerals and an improvement in the trade business. Oil, Gas and Chemical showed a nice increase of 100 basis points as it benefits from the improvement in the upstream business, combined with the cost control measures implemented in the trade-related services. CBE increases margin by 10 basis points.
While a modest improvement, it's a strong performance given the lower auditor utilization rate due to the 2018 transition period. While there was a small benefit from the acquisition of Linsys, there was also good cost control and good performance from higher margin services in the performance assessment. The largest improvement in margin was in Industrial, up 240 basis points. This is the result of our active contract portfolio management, where we are exiting value-destroying contracts and successfully reprice some of the existing contracts. There was also good contribution from restructuring measures taken in the first half. The margin decline in Transportation reflects the impact of the revenue factors covered earlier and some related mix effects. There was a material margin decline in GIS.
This is the result of strong collections in H1 2018, collection delays in the first half 2019, which led to a significant increase in bad debt charges, contract and enforcement delays. As I already mentioned, we expect these factors to improve in the second half. Moving on to the balance sheet. The balance sheet for the end of June compared to the balance sheet at the end of 2018 considers the changes in relation to IFRS 16 lease accounting standard and IFRIC 23, which addresses the interpretation of uncertainty over income taxes. Both accounting standards are effective as of January 1st, 2019. The increase in property, plant, and equipment of CHF 588 million is explained by the recognition of right of use assets of CHF 686 million on January 1st, 2019, following the introduction of IFRS 16 minus the subsequent depreciation.
Out of the lease liability of CHF 714 million as of January 1st, 2019, CHF 161 million are considered as current, while the remaining amount is considered as long-term lease liability. As a result of the introduction of IFRIC 23, a tax provision of CHF 40 million has been recorded against equity. PSC was deconsolidated as at the end of June 2019, and the proceeds of CHF 320 million to be received is reported under other current assets.
The increase in goodwill is due to the consolidation of the balance sheet of Maine Pointe and a couple of other smaller acquisitions. Net debt at the end of the period is CHF 2.1 billion, or CHF 1.4 billion excluding IFRS 16, compared with CHF 0.7 billion at year-end, reflecting the dividend payment of CHF 589 million, seasonality, so the need for working capital in the first half, and the increase in our M&A activity.
The operating cash flow increased from CHF 316 million last year to CHF 341 million this year. However, given the introduction of IFRS 16, the payment of lease liabilities of CHF 87 million is now reported under financing activities. On a like-for-like basis, the operating cash flow would have been CHF 252 million versus CHF 360 million last year. The decrease is a function of a higher increase in working capital.
The higher outflow compared to year-end is solely due to timing of payments. You surely recall the very strong net working capital at the end of last year, which was significantly driven by payments occurring in 2019 instead at the end of 2018. Capital investment in fixed assets were slightly lower than last year, covered in the next slide. While investment in acquisition increased by approximately CHF 100 million, mainly related to the Maine Pointe acquisition consolidated as of June 30th.
Dividends of CHF 589 million were paid in the first half, and we paid back the CHF bond, which was due in the first half, for a total cash consideration of CHF 375 million. CapEx in the first half 2019 was at 3.9%, somewhat lower than the historic trend of 4.4%. However, we believe this is just a timing issue, and CapEx will increase in the second half, leading to a CapEx in percentage of revenues more in line with historic trends. Our focus areas in terms of CapEx are related to investments in cyber, strong investments in E&E in Asia, as well as investments in 5G wireless. Lab additions in the food business. Addition of primarily outsourced labs in the mineral business.
The following slide shows the evolution of the operating net working capital as of June 30th in percentage of revenues in the last 12 months. Just a couple of remarks to this one. First of all, in the last couple of years, SGS did a fantastic job to optimize net working capital. From a seasonal point of view, net working capital is always higher in the first half than at year-end. Net working capital in percentage of revenues as of the end of June was further improved by 20 basis points to 2.9%. While we don't expect any further improvement on the liability payment side, we still believe there are some further improvement opportunities on the AR side, especially when it comes to time to bill as well as to the collection process.
We announced this morning a structural optimization program, which is needed in order to run our business more efficiently going forward. The program is focusing on simplifying the business by eliminating duplications and reducing layers within our organization. The cost for this program, of CHF 75 million, will occur in the second half of 2019 and expected to deliver savings that will exceed the initial investment in 2020. The full benefit should be achieved in 2020. As we're primarily targeting overheads and indirect costs, the risk to revenue is minimal. With these measures, we will steer our business in a leaner and more efficient way going forward. Before I hand back to Frankie, our key points in the first half financial performance are solid organic revenue growth of 3.5%, or 3.9% in constant currency.
Our adjusted operating income increased by 5.4% in constant currency, resulting in a margin increase of 20 basis points. Profit for the period was up 34.8% to CHF 399 million, driven by the gain from the divestment of PSC. We spent CHF 268 million in CapEx and acquisitions and achieved a free cash flow of CHF 216 million. With this, I hand back to you, Frankie.
Thank you, Dominik. Let me give you a quick review on each of the business lines for the second half of this year. Let me start with Agricultural, Food, and Life. It is still too early to have a clear prediction on the new crop conditions, but the early information indicates some improvement in the export condition, and this should be favorable to our trade activities for the second half. Testing and auditing activities for food are expected to remain good during the second half with a positive development across the network. Life sciences laboratory testing and clinical research are also expected to achieve good growth in the second half of this year. Overall, I expect similar organic growth as H1, and we should see a further improvement of margin.
If I look at Minerals now, growth for Minerals will come under pressure moving to the second half of this year with the expected softer market conditions for the energy minerals, planet operations, and geochemistry. The startup of new on-site laboratories, a strong metallurgical pipeline, and trade portfolio will balance overall growth, which should be slightly lower than H1. The margin improvement should continue into H2, as we have already taken measures to rightsize the business in anticipation of the softer market conditions. Oil, Gas and Chemicals. If we exclude the impact of disposal of the PSC activities in the U.S. and in the Netherlands, the remaining of the OGC portfolio will achieve a moderate growth in H2. We expect strong growth in both upstream activities under all condition monitoring and a stable outlook for the trade and testing activities.
Margins should improve due to the mix of business growth and disposals. Consumer Retail. H1 performance in China was relatively stable despite the trade tension between the U.S. and China. Volume in Hong Kong has decreased significantly due to the higher exposure to the U.S. trade, while the rest of the network has performed solidly, particularly in Turkey, Vietnam, and India. Assuming no further tariffs escalation between the U.S. and China, we expect consumer goods to achieve similar growth in H2 as in H1, and the full-year margin should be similar to the one of last year. Certification and Business Enhancement. The negative growth seen in H1 should moderate in Q3 as the comparator rule from the ISO transition period last year ease, and we expect to return to growth from Q4 of this year.
The addition of Lynxeye and Maine Pointe to our performance assessment portfolio brings a strong competence operational consulting and will create new growth opportunities for CBE. The acquisition will also support overall growth and help build on the H1 margin improvement into H2. Industrial. As we mentioned at the end of last year, the focus of the Industrial Services in 2019 is to rebuild its portfolio and improve profitability. During H1, we have discontinued several maintenance contracts and closed our pipeline and non-destructive testing activities in the U.S. This will have a short-term revenue impact in H2 but will also support further margin improvement. Growth in H2 should moderate, reflecting the discontinued contract offset by continuous growth of other activities, including material testing, supply chain services in the manufacturing sector. The lower growth should be combined with a strong margin improvement. EHS, Environmental Health and Safety.
The solid growth across the entire portfolio in H1 is expected to continue in H2. This business should continue to benefit from a continuation of same market drivers from previous years, including increased regulations and increased demand for marine and industrial hygiene services. The margin should improve further in the seasonally stronger H2 as a benefit from efficiency measures taken in H1. For Transportations. I noted at our full-year result 2018 presentations that Transportation would be under pressure in 2019 due to the end of several contracts. As expected, both our regulated services and field services were significantly down in H1, as already indicated by Dominik. We expect the trend to improve slightly moving into H2 as the negative impact from regulated and field services moderates and growth continued in the laboratory testing network, in particular, our new EV battery testing activities in Germany will gain momentum.
Overall, H2 growth should be stable compared to H2 of last year, and the margin should improve slightly compared to H1. To conclude with GIS, Government Institutional Services, the trading conditions should improve in H2, supported by the expected volume increase in our scanner activities in Cameroon. Our new valuation program in Mozambique and the stricter enforcement of our renewable project in Ghana should also support growth momentum. Also, PCA volume in H1 were impacted by the temporary suspension in our Kenya program, sorry. This has been lifted now, and we should be seeing the volume back to normal. For the full year, we expect to get back to positive and stable growth compared to last year. The margin will also be closer to the 2018 level as we resolve the bad debt situation of H1.
In term of guidance for the rest of the year and moving toward the end of 2019. Based on the different business line outlook I just gave, and subject to assumptions that no further escalation of the U.S.-China trade disputes, I'm expecting our second half organic growth to be similar to H1. In term of margins, the second half is traditionally the busiest semester. This together with solid outlook for many of our business line, we should expect a stronger uptake of the adjusted operating income for the end of this year. Income margin for the end of this year. Our guidance for 2019 remains unchanged and our solid organic revenue growth, higher adjusted operating income, and robust cash flow.
To conclude, I would like to thank my colleagues of the Operations Council, most of them present in this room, and the entire SGS group for the achievement of this set of solid results. Their efforts were also instrumental for us achieving the three milestones I mentioned earlier. Our capital allocation to enhance value, investment in new sectors for the long term, and the optimization of our network. This milestone will position us to ensure SGS' leading position in testing, inspection, and certification industry, and create long-term value for the SGS employees, customers, shareholders, and for society. The last slide that you see on the screen is our Outlook 2020.
Just to reemphasize on them is deliver mid-single-digit organic growth, accelerated M&A, adjusted operating margin of above 17%, strong cash conversion, robust return on invested capital, and maintain the dividend or grow it in line with the improvement of adjusted net earnings. On that, we can go for the Q&A session.
Q&A, right. If we start with the Q&A in the room, hands up. Sure. Ladies first.
Thank you.
Two questions. Can I limit it to two questions as well?
Sure. Suhasini from Goldman Sachs. Two, please. Oil and gas, the upstream has been quite strong in first half. Has the strength in this division actually surprised you? Has pricing actually come back? How's the pipeline looking going into second half and 2020? The second one is more of an accounting one. IFRS 16. Was the benefit on the margins particularly strong in some divisions, or was it spread out across the group divisions? Is the full year benefit also 20 basis points? Thank you.
Marco, do you want to take that?
I'll take the IFRS 16 first. It's approximately 20 basis points, and there is no big difference around the different business units because it's basically a function of the average duration of your lease portfolio, and there are no significant difference around the group.
For the first question, for upstream, the result was not surprising because we had the dip for the past couple of years, and we've worked really hard in securing new contract in the Middle East and in Asian regions where we're more focused on upstream but production part of the process. This is really the result of all those efficiency improvement, contract securing over the last couple of years is now creating the stream of revenue. We're expecting the kind of growth that we are looking at, first one into a second half. Some of those contracts are long-term contracts, so we should see some momentum into 2020 as well.
Thank you. Theresa, on that side of the room. Aymeric.
Yes, it's Aymeric Poulain from Kepler Cheuvreux. I just wanted to come back on this CHF 75 million cost saving program, I'm just wondering why you did not raise your margin to 2020 target on the back of that, given the fact it should be quite an important uplift. If not, what is actually eating into your margin? Should we conclude that the organic growth is essentially an inflationary pass-through, there's no real profit growth or even negative potentially pressures on the margin that we should be aware of? Also, bearing in mind that there is this operational margin pressure underlying, why is the group continuing to shrink capital investment and instead of redeploying capital in a more aggressive way? Thank you.
Do you want to take on the-
If you look to the program, our goal is 17% plus, right? Obviously, it's getting more challenging. Of course, the CHF 75 million is a key enabler to get there. There's also a plus, right? The goal is not 17.0, it's 17+ . This program is very helpful for the 17%+ , but it's meant to be a program also for the future, as we think we achieve efficiency gains, which are helping also beyond 2020. It should not meant to be that we now therefore increase the target up, because it's a target 17% plus, and we are confident to get there.
In terms of capital spend, the objective is not to increase capital. In fact, as Dominik mentioned just earlier, that the lower numbers in terms of revenue is just a question of timing. We have a new investment coming around in the second half of the year, we should be back more or less to the same level that you see on a yearly basis. It's also taking a more disciplined approach toward the newer field and newer areas that we're looking at. It's just that the question of timing. There's no intention to increase the spend on the capital of this company. Not in the CapEx, I would say.
Okay, should we move on to Ed?
Ed Steele from Citi. Hi. Following on from that last question on restructuring. Obviously, SGS been through several years of efficiency savings, procurement savings, lots of restructuring costs going through the business. This is not the first program. Could you give us some specific examples of the things that you are doing that are incremental beyond what's been previously announced, give us an update also on the shared service center benefits that are supposed to be coming through at the moment, procurement savings, et cetera, that didn't seem to get featured. Then second question, maybe you could just talk a little bit around the decision to dispose of the OGC asset, PSC. Obviously, it's performed very well in the last few years, been one of the highlights of that division, really, against some pressures elsewhere.
Given it's got some characteristics of asset light, et cetera, which you may not like, are there some other assets in, say, industrial that you might want to dispose of as well on the same basis, please?
Maybe I address the second part of the questions. The process for PSC is really clearly linked to the dashboard that we have put in place now almost three and a half years ago, where we're looking at the specific gauge in term of growth and in term of margins that we are looking at. The PSC activities are quite unique in the sense that when we bought it 15 years ago, it was the tankerman business and a lot of transporting of chemicals all over Mississippi River. You look at the growth of the last few years, couple of years, it was more focused or linked to the petrochemical industry, where they were supporting the petrochemical industry in term of expansion of their manufacturing bases, which is a totally different businesses that we had at the beginning of the process.
While the initial businesses was fitting into our core strategy, the later part of the growth was getting further and further away from the actual core value of the PSC that we got. It doesn't mean that this part of the business is not valuable for someone else, but in our long-term evolution of our own strategy, it was not the part of activities we want to focus on. We see more potential in growing this part of the activities, which is much more lower margins than the ones that we had initially. So this was part of the reason why we have decided with Alain, Head of OGCs, to decide that we need to walk away from these activities and we're still in a good pattern in term of disposal of such activities.
You're absolutely right, it's a good asset, but it's just a different focus on what we are looking at in the longer term. As for the rest of the portfolio, as I said, the dashboard will carry on. Now 350 last year, we've done about three. You can debate, I may have another 50 that will go around. We are looking at more assets, but the plan is really to ensure that those assets fit the strategic logic for us. If it doesn't, then we'll have no issues to make further disposal. At the same time, we also need to look at area where we can grow.
I think the Maine Pointe acquisition was a good example where while we're disposing of one part of our portfolio, we are acquiring something else that is complementary to what we want to achieve in term of value chain and the enhancement of our portfolio.
An asset-light business, by the way.
Yeah. This, which is our satellite consulting business, so. You want to address the first?
Yeah. If we look to the restructuring, and of course, you're absolutely right, every year a kind of restructuring, and if you add this over several years up, it's a certain amount. I think this program is different in two ways. First of all, it's itself, CHF 75 million, this is not what we usually spend as restructuring in a half year. If I look to restructuring programs historically, of course, based on my limited experience in SGS, it's often related much more to the direct costs changing in a certain local market, price changes or changes in a certain business, which were always rightfully, actively addressed. While this one I would call is more a structural change, where we basically look to opportunities to eliminate duplication. Maybe I have to go a little bit back, and Frankie said this already in his introduction.
If you look to our structure, we have a matrix structure, which is very successful, where we have nine business units with strong leadership who have a detailed understanding about this business and the strategic responsibility. Then on the other hand, we have the operations, the CEOs, who are running the daily business, who are making sure that the service is delivered with great quality and run this in an efficient and very productive and profitable way. It is a good combination because as I see also as a newcomer, it led to better organic growth than the peers with the same portfolio, basically the last five years every year. That being said, often in companies with such structures, over time, duplication is building up.
Duplications between the business and the countries, duplications between the functions and the business, this is just how things happen, and I see this also in other companies. It basically means that we, to give an example, in one business unit, we have IT people. The IT people should be in the function of IT. These kind of duplications, we are addressing. We also think that in certain jurisdictions, we have business unit managers for very small businesses where the question is: Is this sufficient? Can you really act in the right way on the market if your direct overhead is too high? This program is basically focusing to eliminate this duplication in the second half of the year. Therefore, what I also said, the impact on sales should be rather limited.
A couple of closures are part of it, but it is really minor, because it really addresses more the overhead and the indirect cost base. There should be sustainable cost savings, and it should also help, if you have duplications, sometimes the decision-making takes a bit longer.
Thank you. Do we have any further questions in the room? Yeah, please, Paul.
Thank you. It is Paul Sullivan from Barclays. Sorry to come back to the restructuring point, but I am just interested to know what really changed since November when you reiterated the targets? Now you need to take a CHF 75 million restructuring charge to achieve the target. I am not clear what is really changed. Do you see it as additive, or was the basis of the target effectively flawed when you set it?
No, not at all. In fact, in November, when we discussed about the target of 2017. There was also on a plan, an element of what needs to be done within organizations. While we set the target, we do not explain in details exactly what is going to happen, and we were already in the working process of this plan.
It shows that Dominik has joined us in February, which just accelerated the plan to make sure that we have able to deliver that now as to the full plan. We put it in the first half of this year. The idea of the plan already existed. We knew there was a efficiency in there that we needed to take some extra measures to ensure that this waste was going to be picking up. You look at all the different steps we've done over the past few years. Besides the shared service center, we also introduced the World Class Services, which is more focused on the optimization of the processes of laboratories and the field activities itself. It's an internal, longer-term evolution of the process that we want to optimize.
This additional piece of the optimization is really looking at the duplications of the network to reset the orientation of the network, because the matrix organization over time has created a very successful model, but as Dominik just mentioned, also created this duplication, this waste across the network. The idea was to have one program, the World Class Services, to optimize the laboratories operations and other programs to optimize the network itself in terms of duplication, overhead on some of those clustering of function within a smaller country, smaller business line. This was part of the rationale behind the plan anyway.
Could you, just to be clear, could you give us the exact impact from disposals on the second half margin and on next year?
If you look on disposals on second half, so it's basically selling this U.S. business is approximately 20 basis points because this business itself had not a bad margin, but it was lower than the group margin because the margin itself is a higher single digit. Maine Pointe on the annualized basis is rounding to 10 basis points positive.
From an underlying basis, you would expect the underlying improvement of 20 ex the IFRS changes to accelerate in the second half.
Correct. Yeah.
Thank you. I think we have one more in the room.
Thank you. William Haggard from Rothschild & Co. Two questions, one on tax rates. Could you elaborate a little bit on the detail behind drivers and changes to tax rates from 2019 forward, and that impact on earnings? The second question is to do with negotiation of contracts with clients, particularly in terms of pricing, whether there are any changes at the moment.
The tax rate in the first half is 34%, 10% higher than the prior year. This is related to deferred valuation allowance on deferred tax assets in some jurisdictions. It's a non-cash item, but it's increasing actually to 34% in the first half. This will lead to a full year tax rate of 31%. Going forward, the tax rate will be in the higher twenties, which is higher than the tax rate which we had the last couple of years. That's a function on the one hand, obviously we see in certain jurisdictions, taxes are slightly increasing, but it's also a function of IFRIC 23.
IFRIC 23 is a new interpretation about uncertainty around taxes, where you basically, in your own assessment about the potential tax case, have to assume that any tax authorities have exactly the same knowledge as you. This is an interpretation which was before not there. This leads in general to tiny higher tax rates. We believe the tax rate going forward 2020, as far as we can say, because there, of course, could be always changes in tax rules, it will lead to a tax rate more in the higher twenties.
Sorry. The second question was, it will depend on the business sectors. I would say you look at in terms of price pressure, the extreme is currently the Oil & Gas Chemical unit in terms of the trade business. We have quite a lot of new competitors. We mentioned about a few of the second-tier players in the past that has put pressure on the pricing strategy. We've also seen a couple of new players from the Asian countries is also putting pressure on the margins, is on the cutting some of those mid-tier players already. This is a typical example where pricing pressure is putting an issue on us. We try to optimize the network to defend our margins. We are not in the game of just dropping our price or sake of competing with those passive companies.
There's a lot of internal optimization we're going through. On the other side of the spectrum, I would say in your businesses like licenses and food activities, where the pricing power is still good. We still maintain our momentum. Some of the consumer goods in terms of chemical testing and so on, we still maintain some of our good pricing momentum. It always broad aspect from one spectrum to the other one. It's difficult to give you an exact answer.
If we've exhausted the questions in the room, should we move over to the call, please?
The first question from the phone comes from Chirag Vadhia, HSBC. Please go ahead.
Thank you. Two questions. Do you think the uniformity of price discipline across players and the business lines, which is once historically dependable, is starting to erode again? Secondly, is there too much focus on margins where focus should really be instead on sales and delivering sales growth? Thank you.
I'm sorry, what did you call the first question?
The first one was price discipline, whether the price discipline in the TIC industry, whether it would erode again.
Not really. In fact, you look at that, I think it's again, the price discipline is really by market segment. There are changing conditions. There are market specific, market dynamic that forces different players to take specific actions. As the sector is quite diversified, we see a really broad variety of pressure. As I said, on the oil and gas side, it's more extreme for the time being, while for some of the other licensing orders, it is more stable, and we have a better pricing power. On some of the newer product in, among with our health and safety, for example, we have a lot of pricing power. You talk about micropollutant, these PFOS kind of activity, high-risk activities. We have a much more stronger pricing power than the traditional salt water kind of testing. I don't think it's a lack of discipline from the TIC sector.
I think it's more a question of maturity of the product cycles, that we just have to keep looking at the new regulation and newer items to put on the market. As we do for the consulting, to reinforce our value chain to our customers and trying to bundle the services that protect us better against some of the more mature product that we hold in terms of pricing.
The second one was, is there too much focus on margin at the expense of growth?
I don't believe so, because we are really clear that growth drive margins and this one aspect, without growth on top line, you can debate on your margins. While we focus on the growth as well, it's just that while we're working on the growth strategy on some of the segment that the transformation of portfolio is part of this growth driving strategy we're putting in place, and we have to go through this process. We're also trying to focus on our margins because whatever waste we're taking out now is waste that we don't need to take out for the future. The two parts goes in parallel. Sorry. Therefore, it's not a specific reason why we're focusing more on one than the others.
Thank you. Could we move to the next question on the call, please?
Next question from the phone is from Patrick Jousseaume, Société Générale . Please go ahead.
Yes, good afternoon. Two question on my side. First question is on free cash flow. You mentioned effectively that after a settlement of payment of these liabilities, cash flow from operating activity is EUR 254 million. When I calculate the free cash flow, that is to say after net purchase of six assets, I found CHF 129 compared to CHF 176 last year in the first half and CHF 210 in first half of 2017, so it's a 40% reduction in two years. Could you elaborate a bit on that? The second question is about exceptional items, i.e., the difference between adjusted operating income and operating income. We have CHF 147 million in the first half. Should we expect something around CHF 70 million for the full year, given the CHF 75 million that you have mentioned for the optimization program? Are there other moving parts?
Thank you.
If we first have a look to the cash flow, I pointed this out that basically, if you look to the cash flow statement and you look to the payment of lease liabilities, this is obviously an outflow, which was historically shown as a rent payment. Now it's in the P&L depreciation, that the cash flow is basically down if we adjust for this, like I said in my speech. What are the reason for this is basically that we had much more increase in working capital in the first half of this year compared to the first half of last year. We had CHF 205 million more need of working capital in the first half this year versus CHF 124 last year, which is basically explaining much more than the difference in the cash flow. The reason for this is the following.
The main reason is basically the timing of payments, because you recall it was a very strong cash flow, operational cash flow, and reported cash flow, very strong cash flow driven by very strong working capital at the end of last year, operationally, and even more so reported. This was, on the one hand, clearly driven by the fact that payments occurred in the first quarter 2019, which were related to Q4 2018. Furthermore, if you look now half year to half year, you need to consider that at the first half last year, where the provision or the write-down was booked in terms of Brazil of CHF 47 million. It had a negative impact on the earnings, but it helped basically in the first half last year on the working capital. These two items explaining basically the difference.
Regarding the one-off items, if I understand your question right, one-off items for the second half of the year, it's basically when you look on Where do we have this? We have basically in the first half, we have the gain in other non-recurring items of CHF 201 million. For the time being, what would I expect in this one-off items in the second half of the year is basically the restructuring cost of CHF 75 million. Other items for the time being, we would not expect, obviously, the normal amortization of the existing acquisition and the newly acquired businesses.
Thank you very much. I would like to remind people on the call they can submit questions by typing as well, if they would like to. Shall we move on to the next question on the call, please?
Next question comes from the line of Alexander Mees, JPMorgan Please go ahead.
Good afternoon. Thanks for taking my call and questions. Two, please. Firstly, just on transportation. Obviously, it's been a difficult time for you in transportation. I wonder if remedial action is required in that business, or is it just a question of working off a few unfavorable contracts and then things will get better, and if so, when will that be? Secondly, you've obviously been very busy in M&A. I just wonder if you see any changes at the moment in the competition for the assets that you're looking at and the multiples you're being asked to pay. Thank you.
For the transportations, the key activities that we're doing currently is to wait to expand our portfolio into a newer field in the testing environment. As is concerned, the regulated activities is very difficult for us to take extra steps because these are concessions is terminating, and we have to wait for the cycle of these concessions to restart in terms of bidding. There's not much we can do besides to optimize our cost base and to ensure that we can bid for the next project that comes on the tender that comes on the market. On the regulated side, difficult to mitigate the risk. On the field activities, on the testing, yes, we are looking actively at new contract, expanding our portfolio. The launch of our electrical battery testing labs in Germany is a good example.
We also are setting up an onboard electronics activity testing in India and in China. This is way to expand and to diversify our portfolio to accelerate the growth, because these sectors are growing at a high single-digit. Which is a good activities versus the more softer regulated businesses that we have those contract on. As the cycle flush out, we should come back in a more stable growth in terms of those two activities.
The second one was on M&A multiples in the market. Are we seeing any changes? Is there any change in competition for those multiples, for those companies?
We focus a lot on those mid-size to small-size asset. I think the run of those larger asset in the past couple of years has subdued it a bit. I would say that in terms of multiple we pay is not different than the strategy that we presented last year in terms of the bracket we've been paying. I think during the Investor Day, we showed a little bit the kind of bracket we're paying. I would say that you look at the different assets that we have acquired up to now, they're not far off from what we traditionally pay. With some differences, obviously. Some of them are in a segment is slightly higher than the others, but I would say on the overall, we are quite disciplined on our approach. We are not paying more than what we historically did.
Should we move on to the next question on the call, please?
Next question comes from the line of Jean-Philippe Bertschy from Vontobel. Please go ahead.
Good afternoon, gentlemen, and welcome to Dominik. The first one would be to follow up on my colleagues and with this margin. When you exclude restructuring, shared service centers, procurement, the dashboard, IFRS 16, it looks that you are under massive pressure, and you have a pricing pressure from the market. If you can explain that into more details. The second one, to add to Chirag, focusing on margin. I think maybe on that standpoint, maybe more focusing on the returns, because it looks like the PSC divestments was damn good in terms of returns, maybe not in terms of margin, and the one you acquired with very high margin is not so good in terms of returns. Maybe the strategic rationale behind that. Thanks.
Should I start, first one? If we look to it, the IFRS 16, yes, it has, of course, a positive impact, approximately 20 basis points, right? It's positive, but it's also somewhat limited, and this is how IFRS 16 works, that you basically take the rent and separate it into rent payment and a financing cost on a EPS level is actually negative in always the next year because the finance charge is front-loaded, right? But it's limited. Now, on the other activities, we're working intensively in procurement, and I also think there are areas which we so far didn't focus on. I think there are also some more opportunities which we have to tackle. It's also the case, you can make procurement savings, but it still means that your remaining cost will inflate, right?
We have to look this in a combined way and not say this is the saving and this is then more the profit because we have inflation for other costs. They are not massive, but they are there. On shared services, I think it's a good setup. We're moving more and more countries to the shared services, to Katowice and to Manila. There's still some more work needs to be done in terms of harmonization and optimizing the process, because if the processes are not standardized, you will not achieve the full productivity. There we are currently focusing on to further optimize and basically standardize first the processes, and if the process is standardized, you get also higher efficiency gains. These are all very important things, and they are not there to stop in 2020. They are really going on beyond it.
In terms of returns, honestly, if we look to the acquisition Maine Pointe, I'm convinced they earn more than clearly earn more in the first year than their cost of capital. If you deploy money, which in the first year earns more than your cost of capital, then it's a good investment, right?
Yeah. Maybe I can add on the PSC versus Maine Pointe. I don't understand your comment when you look at in isolation the PSC activities, but I also mentioned that we're looking at that two or three years ahead in a dynamic manner, which will evaluate the market evolutions and where this asset is heading to. I mentioned earlier to the earlier question that in our view, this asset is a good asset, but it's not heading in the right direction in terms of the focus of the portfolio. This part of our core focus. The strategic significance, the evolution of the market, what we believe we need to focus on versus what some of those assets, because of the market alignment and so on, goes to, has also an incidence on the way we are evaluating our asset.
It's not really much just a static or historical view, it's also a projection into future is important to us. Likewise for Maine Pointe, it's not just about the asset itself, it's the projection of what they can do for our CBE activities. When we talk about the pain point of our customers, how we can bundle these kind of activities into a more value enhancing portfolio services. This also a little bit a dynamic process we're looking at, not just purely static or historical factors of those assets as well.
Thank you. I think we've got time for another couple of questions. If we take the next question on the call, please.
The next question comes from the line of Tom Sykes, Deutsche Bank. Please go ahead.
Yeah. Thank you. Good afternoon, everybody. First of all, just on the minerals business, could you maybe go through the degree to which you're seeing demand soften? The degree to which you can actually still grow the on-site business, because you're going to face quite tough comparators on that, particularly in the beginning of next year. What's the scale or pipeline of on-site opportunity to offset any weakness in, say, samples demand? Just on the evolution of the CHF 75 million, at what point did you get to CHF 75 million, i.e., is this a response to slightly slower growth? How much of this is structural, and how much of this is just that growth seems to be a bit slower, therefore you're taking out more cost in maybe more economically sensitive areas, please?
On the first question for the mineral sectors, the slowing down of the businesses is mainly on the geochem activities. We're looking at that in terms of the commercial lab. The on-site activities is still good. As we said in the past, it's the more stable activities because we have multi-year contract is exclusive to us. We're still having a few more new labs coming online in terms of pipeline in the second half of the year. We're also having quite a lot of tenders trying to bid for new labs that if we win them, will come into the pipeline in the first half of next year. I would say we're not concerned about the significant decrease. It's more the stable to increase is still on these kind of activities.
The other equation of second half of this year is more the price of the coal, which is rather soft in Europe for the time being. We see a slowdown of the trade between Russia and the European countries. We're also seeing a strong pickup in terms of the trade in the eastern part of Russia on some of those shipping market because the Pakistan and the Chinese are actually buying coal because of the rather reasonable price. We see the two effect offsetting each other, but we're still being prudent by saying that compared to what we've seen in the first half, the growth will slow down in the second half. This decision can change getting into the first half of next year. Will change because their trading conditions there, that is quite dynamic.
Okay. Thank you.
Second one was on at what point did we get to the CHF 75 million of cost savings?
In terms of savings?
Yeah. How do we get to that number, I guess?
Maybe I can start. In term of evolution, we've been looking at it for quite some months, and certainly is an element of what we think could be taken out and what things the market evolution is, because the dynamic situations where as we evolve into our plan, we see the area of softness versus others, and we see that in term of structural, we can also take little bit bigger hit into that. I would say is a bottom-up process. We gone through for quite some month through the organizations, the network with all our executive VPs and the Chief Operating Officers across network and ask them, If we were to optimize the network and these are the rules of the game, how will you do it and how we can extract the best value, best optimization possible?
They come up with this plan, and we just basically help to consolidate that into a more structured way. It is a dynamic process and certainly over the course of the assessment of this plan, some area where we started to push a little bit harder versus other area when we see growth picking up where we're a little bit softer on that as well.
Okay.
Okay. Let's move on to the next question, and then that'll be it. I think that we've hit an hour and 10 minutes roughly. Final question, please, from the call.
Next question comes from the line of Edward Stanley, Morgan Stanley. Please go ahead.
Sorry, I may have missed it. I was keen to find out a little bit more about China. I know we're all a bit bored about it, but given all the industrial warnings that are going on at the moment, you say that China is broadly stable, but there are either emerging problems in Hong Kong or Hong Kong is getting worse. Are you seeing any particularly aggressive swings in any of your divisions or segments going through Hong Kong? What should we be watching out for that consumer might get worse rather than stay stable in the second half?
For China, certainly, we see the impact of the economic evolutions and the dispute between the U.S. and China. At the same time, we're also seeing an expansion of the local Chinese market. We are seeing a softness onto the international trade. We have been very strong in terms of getting to the local market. I think a couple of years back when you asked me the question, or one of you asked me the question about the percentage of our domestic market, I said was just short of 50% or close to 50/50. I can say that now we're well in excess of 50%. A big chunk of what we do, and not a big chunk, I would say more than 50% of what we do is linked to the domestic market. Our portfolio has also evolved.
The good news is, the expansion into domestic market has managed to offset the slowdown of the international market, plus creating some growth in terms of the total growth in China. Hong Kong is a slightly different problematic in the sense that Hong Kong traditionally is the big trading hub for the retail sectors. If you don't do consumer goods, there's less variety of services that you can offer in the difference of China, which is much bigger. Hong Kong is rather a captive territory. We have strategy. You look at the expansions, the 20% investment into Vircon is part of our expansion strategy in terms of diversification strategy, sorry, in terms of our industrial portfolio.
If you recall, we also made a 50/50 joint venture with a company called the RPS Asia a couple of years ago, which is now active into the third runway of the Hong Kong airport and is quite active into the Greater Bay strategy of the South China Sea there. We are actually expanding our activities into the industrial sectors in Hong Kong. The consumer goods sector will follow the natural evolution of the retail sectors. As I mentioned earlier, the drop is more significant for them. You will stabilize because Hong Kong will have trading needs in terms of for the consumer goods. It's just for us to take into consideration those dynamics and start to expand the portfolio into something else. Certifications, industrial is the two next sectors that we're looking at for Hong Kong.
China, we are pretty good because the growth in China is all about nutrition, health, around with the health and safety, and some of the industrial activities which compensate largely the international decline.
Okay, thank you. I think we'll draw it to an end there. If there's people still on the call who'd like to ask questions, they're more than welcome to email those to me, and I'll reply to them as soon as I can. Maybe not this evening, but certainly tomorrow. Thank you very much, Frankie. Thank you very much, Dominik. Welcome to SGS. I'd like to invite everyone in this room to come and join us at the atrium for a cocktail after this meeting. Thank you.