Thank you, Alessandro. Good morning, and welcome to Sulzer's H1 conference call. Today, with me is our CEO, Greg Poux-Guillaume, and our CFO, Jill Lee. This conference call is also being webcasted, as said before. The link to the webcast can be found on our website. During the conference call, we'll refer to the presentation that can be downloaded from our website. I would like to draw your attention to our safe harbor statement, which is shown on slide number two of the presentation. Please note that this statement applies to any statement in the webcast and on the call. This is enough from my side, I hand now over to Greg.
Thanks, Christoph. Good morning, everyone. Before we start with the business review, let me highlight what we've changed in our reporting, we've introduced IFRS 16 standard. What has changed, in very simple terms, is the following. Instead of just recognizing the payments of an operating lease in the income statement, we now have to capitalize the lease and then to write it down. For Sulzer, this has two effects. First, it increases the assets and liabilities in our balance sheet. Second, in the P&L, you see that the impact at this point is positive as the write-downs are smaller than the actual payments, and the interest effect from discounting the liability, at least for H1 2019. On a long-term basis, the new accounting standard will not have an impact on our net income.
In the presentation, we refer to the old accounting method as we want to compare apples with apples. In the mid-year report, you have an additional column with the results under IFRS 16. This will be the basis for next year's half-year report. Please also note that the basis for the 2018 figures are those according to IFRS 15, a standard that we introduced last year. Let's start with the highlights for H1 2018. Our order intake has increased by 8.7%, including acquisitions, and 7.5% organically. We had strong commercial successes in the water market, gaining two large projects for water transportation and desalination in the Middle East. Petrochemicals and oil and gas in general continued to grow in H1 and also in Q2.
Our sales were up by 13.1% adjusted for currencies, thanks to the high order backlog at the start of the year and also due to healthy market conditions. If you compare our order intake to our sales, you see that the book-to-bill ratio is still above one, 1.09 precisely, and therefore, our order backlog continues to grow, giving us good visibility for H2 and beyond. Our operating EBITDA was up by 15.4% currency adjusted, and the operating EBITDA margin or operating ROSA increased from 8.8% to 9%. Now, you might think that this is a small increase, but please remember that we are still converting orders taken at low margins last year, and therefore, each additional Swiss franc in sales has a dilutive effect on our margins.
As our margins on orders in oil and gas have moved up sequentially every quarter starting with Q1 last year, we would expect this impact to diminish over time. I will come back to this effect when talking about pumps equipment. Due to the positive development in H1, we are increasing our guidance for order intake and sales. The guidance for operating EBITDA margin remains unchanged as benefits of growth this year will mainly be felt next year. We continue to make bolt-on acquisitions. We bought two businesses this year, GTC on May 1st, closed on May 1st for Chemtech, and then just after the half year on July 1st, we closed Alba Power for Rotating Equipment Services. Our cash flow follows exactly the same seasonality than last year, and our balance sheet continues to be solid. Let's go to the business review of our divisions.
Starting with our pumps equipment division. Our order intake increased by 5.9%, including acquisitions, and 5.5% organically. As mentioned before, we won orders for two large water projects, one for water transportation and the other one for desalination. Taken together, these projects are worth CHF 42 million. With that, you see that the water market was actually our biggest market in pumps, contributing to a third of the division's order intake. Water was growing by 22%, 22%, and was also up excluding the two large orders. We had continued good momentum in upstream, midstream, and downstream in oil and gas and were deliberately not taking certain orders in power where margins were too low. As you recall, pumps for oil and gas or pumps for water or engineered pumps, they come from the same factories and therefore we can arbitrate one versus the other.
Other markets like pulp and paper continue to be healthy. Sales in Pumps Equipment increased by 17.3% organically on the strong order intake last year, which led to a high order backlog at the beginning of the year. The order backlog of slightly above CHF 1 billion secures the continuation of this positive trend in H2 and carries into 2020. Although we are still converting to sales orders that were taken at low margins at the market trough, higher volumes as well as SFP savings resulted in an improvement of our operational EBITDA margin, and we're able to offset the negative mix. Now, let me share some additional insights on how the market develops for us on the next slide. What you see on this slide is how we are arbitrating our margins up.
This is pumps for oil and gas. On the top left chart, the dark blue bars are the monthly tender volume that we win in new pumps for oil and gas. The light blue is the tender volume that we lose. The red line is our hit rate. You could also call it a success rate, essentially. It fluctuates somewhere between 30% and 50%. In the first phase of the downturn, our hit rate went down as competitors fought tooth and nail for the little business that was available. We then brought down our cost base in order to gain competitiveness. Our hit rate consequentially picked up, and so did our volumes. In early 2018, we started to arbitrate, sacrificing growth for margin.
This led to a decrease in hit rate, but as you see on the chart to the right, it also led to an increase in our gross margin on order intake, which was the objective in the first place. All in all, we have recaptured about 700 basis points in profitability on order intake since the trough in margins in Q1 2018. There's still a gap to the pre-downturn level, but we believe that with continued good market momentum and our competitors also refocusing on margins, this gap will become smaller over time. We wanted to essentially illustrate what we've been doing in terms of arbitrating and to also illustrate the margin improvement sequentially since Q1 2018. Now let's turn to Rotating Equipment Services. Order intake in Rotating Equipment Services grew 7.3%, or 6.2% organically. We've seen increasing volumes in all product lines.
Pump services and spares were up 8% following the rebound in new equipment. Turbo services was up 8% also from a low level in a still very challenging market environment. Finally, electromechanical services were up 4%. Sales were flat in turbo services, as it takes some time to convert the order intake to sales, but the other two business lines were growing. Operational EBITDA increased by 9.5%. Not exactly to the same extent as sales, resulting in margins which were slightly below last year's H1 margins. Reasons were mainly timing impact from some lower margin contracts that we had to recognize at point in time in our revenues, according to IFRS 15 standard. We acquired Alba Power just after the half year on July 1st. Alba Power, based in Aberdeen in the U.K., is a leading independent service provider for aeroderivative gas turbines.
In 2018, Alba made revenues of GBP 34 million and a profit margin of above 20%. Through this acquisition, we diversify our gas turbine service business into distributed power and offshore as well as marine applications, where there are sizable and active markets and numerous cross-selling opportunities with our existing pump, motor generator, and turbo service customers. Moving on to Chemtech on the next slide. Chemtech grew again very fast. Orders increased by 25.9%, or 23.3% organically, driven by very active petrochemical markets in North America and China. Order intake from both separation technology and tower field services grew double digit. For the latter, on a relatively low basis in the previous year, sales increased double digit in separation technology but were flat in tower field services.
Profitability continues to go up with EBITDA margin going from 8.3% to 8.9%, mainly due to higher volumes and also a favorable business mix. Historically, the lower margin tower field service business was about 30% of Chemtech's business. It's now about 20%. As you may recall, we decided to refocus that business on its core, and therefore, we aim to keep it around 20% of Chemtech. On May 1st, we acquired GTC. GTC is a U.S.-based technology company offering proprietary processes and systems for the production of aromatics and other petrochemicals. This acquisition strengthens Chemtech's leadership in petrochem and expands its revenue base to process licensing and associated proprietary equipment and chemicals. The annual revenues of GTC is around $50 million, and it generates a high single-digit EBITDA margin. For GTC, we paid an enterprise value of $39 million.
We get a lot of questions from investors on where we are in the cycle and how long this growth in Chemtech can continue. Let me give you some insights on the next slide. We look at different leading indicators, such as inquiries, non-binding offers, etc. Anything that gives us a window on the pipeline of projects at our customers. Tendering activity is one of those indicators. Between the submission of a tender and the booking of an order in Chemtech, there can be many months. What you see here is that tender activities in Separation Technology have increased year-on-year since the low in 2016, a trend that shows no signs of slowing down. By the way, this is a good proxy for the chemical, and to some extent, also the refinery market.
This gives us confidence in our order intake for the rest of the year and into 2020. You also see that we've refocused our tower field services business, a decision that we took in 2017. After a year of consolidation, tower field services start to be more active again, but stays focused on its core capabilities, hence the drop in tendering volume that you see around 2018, a slight pickup in 2019. Moving on to our Applicator Systems division. Applicator Systems is currently a two-part story. On one hand, we have dental adhesives and healthcare, which together grew 6.1% in H1, 2.5% organically on an already high base from last year. All of this is at robust margins. On the other hand, our beauty segment declined by 9%, on two effects, essentially. The first is an effect that we've mentioned already many times last year.
The one customer that we talked about on previous calls that stopped production of its generation 1 product and is now launching a generation 2 product. By the way, that generation 2 product has not generated to date any sales for us. If I extrapolate for the rest of the year, in 2019, that could be a negative volume impact of CHF 8 million for us if we compare to 2018. It's a baseline impact on that one customer. Secondly, the lower growth at our large beauty customers, in a market being disrupted by smaller independents. That's a big effect. These independents use social media influencers and viral marketing to disrupt the market. As this virtual world is extremely fast-moving, they ask for short lead times and smaller batch sizes, as well as additional services, which is a positive for us over time.
Today, our production processes are largely geared towards the slower-moving traditional beauty companies with large batch sizes. To adapt to this market change, we are investing in our industrial base. We are consolidating two factories that we have in Germany, in-sourcing decoration skills, and changing our industrial processes to make production much more flexible. Our Bechhofen factory will be state-of-the-art. Work will only be complete in the second part of the year. As you know, Bechhofen is our largest beauty factory. We're expanding it to adapt our processes to these faster-moving independent customers.
We're also closing our Bamberg factory, which is a smaller, older factory that we have in Germany. That closure has been announced. We see in our numbers that we've taken overall about a CHF 20 million impact that we've taken in the first half of the year. CHF 14 million of that is restructuring, CHF 6 million of that is non-op. That's the impact that you see on our net income, if you look at the numbers that we've disclosed. We've engaged with our social partners in Germany. It's progressing quite well. It's a difficult decision, but it's a decision that we had to take for the competitiveness of the business down the road. Keep in mind, we remain the market leader in brush-based beauty applicators, and these changes will benefit us over time.
Back to the figures, lower sales in H1 2019 were also driven by beauty on the same reason as for orders. APS was more profitable on mix given the lower beauty with op EBITDA margins going up in applicator systems from 21.2% last year to 21.5%. EBITDA itself was slightly down despite the higher profitability on lower volume. I now hand over to Jill for the financial review. Jill?
Thank you. Thank you, Greg. Ladies and gentlemen, welcome as well from my side. Greg already mentioned the most important points on this slide. Let me go over it swiftly, focusing on the items that have not been discussed, and then going into the details. Now, despite a negative mix effect, our order intake gross margin has stabilized. Remember, last time we showed this margin, it was at our annual results presentation, and there the decline was still 110 basis points. Compared to the level of 33.3% achieved for full year 2018, we are up by 50 basis points in the first half of 2019. Our order backlog continues to grow, giving us good visibility for H2 2019 and also into 2020. EBIT and core net income also increased significantly due to the higher op EBITDA.
EBIT was impacted by the restructuring provision of CHF 14 million in APS for the upcoming closure of our Bamberg beauty factory in Germany, as well as a related CHF 6 million of non-operational costs for the consolidation of the Bamberg production into Bechhofen. As Greg mentioned, all in all, it's about CHF 20 million. Free cash flow was on last year's level, showing the usual seasonality. Like last year, we expect cash to come in in the second half of the year. Let me now turn to the next slide with the quarterly order development.
Looking at the quarterly order development, we continued to grow in Q2 by 7.8% on a currency-adjusted basis and 6.6% organically. The biggest growth driver in Q2 from a division perspective was Chemtech with + 37%, followed by RES with 7%, and PE was flat mainly due to the lower new equipment orders in power. As you know, we consciously arbitrate on that front. APS was slightly down on the beauty market. From a market perspective, oil and gas and chemicals continue to be strong. Power was up for RES, and water also increased. We had also quite a significant impact from foreign exchange, which shaved off about CHF 23 million or 2.5%.
The acquired businesses, Brithinee and GTC, contributed a combined CHF 11 million to our Q2 order intake. Let me now go into the next slide to give you some more insights into our operational EBITA. Whereas volume contributed strongly, we had a negative impact from mix because we proportionately converted more lower margin orders to sales than in the previous year. Savings from SFP in a magnitude of CHF 11 million help us to make up for some of the other costs in OpEx that increased with higher volumes.
Acquisition had only a marginally positive contribution of CHF 1 million to opEBITA, so the entire results actually really improved because of the organic performance. As you can see on the right-hand side of the slide, IFRS 16 had a positive impact on opEBITA of CHF 3 million and has also led to an opEBITA margin of 9.1% when considered.
Moving to the next slide, showing the steps from opEBITA to EBIT. Here you see we incurred restructuring costs of CHF 16 million, mostly in APS for the upcoming factory closure in Bamberg that Greg already mentioned. The additional CHF 6 million of other non-operational costs related to that are not included in the SFP related costs. SFP related non-operational costs amounted to CHF 8 million. Our EBIT stood at CHF 96 million, resulting in an EBIT margin of 5.4%, which compares to 5.2% in first half 2018.
Moving further down from EBIT to net income on the next slide. Looking at items between EBIT and net income, you see that our negative financial results has increased to CHF 10.5 million from CHF -4.9 million a year earlier. The biggest driver is not increase interest expenses on our bond, but rather it's the translation effects on cash we hold outside Switzerland, mainly in U.S. dollar and in euro. Here, the exchange rates on the last day of the month were not to our favor. Our effective tax rate stood at 22.8%, basically the same level as in previous year. For the full year, we are also targeting something around 23%. Now turning to the balance sheet. This continues to be a bit unusual as we now hold CHF 226 million of cash that is owed to Renova, but not due.
We have split this out so that you can make your own calculations. Why is this cash and not debt? It's because it doesn't bear interest and it has no maturity, both necessary for this to be considered as debt. It is therefore a payable which will be paid someday. The CHF 226 million comprises the 2018 and 2019 dividend that we have not paid out, totaling around CHF 118 million and another CHF 109 million related to the share repurchase and sale. Depending on how you look at it, our net debt to EBITDA ratio has increased to 1.1x or 1.8x . This is calculated with the reported 12-month trailing EBITDA, which is CHF 340 million. Net debt for us is seasonally high in the first half of the year and then comes down in the second half, as you can see from the chart on the slide.
It's driven by the seasonality of our free cash flow, which tends to be low in H1 and higher in H2. If you put our net debt to EBITDA ratio into perspective, you'll find that even excluding the cash owed to Renova, we are exactly at the same level as mid-year of 2018. With that, let me hand you back to Greg for the outlook.
All right. Thanks, Jill. On the back of the good first half of the year that we've had, we update our guidance for 2019 as follows. We now expect our order intake to increase by 6%-9%, up from the previous 2%-5%. On sales, we expect to be up in the range of 7%-9%, up from the previous guided 3%-5%. The initial guidance was mainly organic for both given GTC and Alba, we now include acquisitions, which should contribute about 2% on order intake and sales. We expect our opEBITA margin or operational ROSA to be around 10%, which is unchanged from previous statements. As you know, most of the impact of order intake this year will be felt in sales and therefore in profit next year.
Note that this guidance adjusts for currency effects and includes the acquisitions announced today, mainly GTC and Alba. Let me summarize on the last slide before we take your questions. Our markets remain healthy. We look at them in a very thoughtful manner. What we could tell you today is power and beauty are in transition. Power has been down for a few years. Today it has more upside than downside at this point. Beauty, as I explained, APS is in flux as the growth is being captured by independents. That's moving our focus from the historical larger beauty customers. That's being corrected by our investment in Bechhofen. We look forward to rebounding in 2020. In industry, which we serve in various businesses, applicators, but also pumps and service, in industry we see growth rates coming down a little bit.
Nothing dramatic, there is a softening in areas like construction and in areas like electronics in China. We know we serve the electronics market in China with adhesive systems, for example, the manufacturing of phones. We do see some element of softening of growth. Industry is still a really good market for us, but we see growth softening. In oil and gas, we see the rebound continuing this year and in 2020. We believe that we're still in early phase of the CapEx replacement cycle, and that's also what our indicators are telling us at this point. All of that, of course, is based on a world where we avoid heading into depression or a recession because of increasing trade wars.
All in all things continuing as they are today, we believe that the investment cycle in oil and gas will continue to be supportive for Sulzer for the rest of the year and for 2020. We also start seeing better pricing. We've seen a price upswing in North America. We don't see that in other parts of the world in oil and gas yet, but we have started to see a price increase in oil and gas in North America. In areas like water, aftermarket in general or dental taken together, these three areas, water, aftermarket, and dental, taken together, they represent more than 50% of Sulzer. We continue to enjoy solid markets. We had, again, a strong order intake in the first half of the year. In general, at higher margins. This higher order intake will drive our future sales growth.
Remember, once again, that from order intake to sales, it takes us 9- 12 months for engineered products in areas like pumps, equipment and Chemtech. Which these engineered products are the main beneficiaries of these higher margins that I've been talking about. Our profitability in terms of operational EBITDA margin has increased by 20 basis points on the back of the already improved sales volume and cost savings. Finally, the good H1 results and the positive trends in most of the underlying markets lead us to increase our guidance for order intake and for sales for 2019. With that, I close the presentation, and Jill and I will be happy to take any questions that you may have.
The first question comes from Pascal Furger with Vontobel. Please go ahead.
Good morning. The first question on APS here, you closed this factory in Bamberg. Do you expect any additional costs in the second half? If you could share with us, what did you exactly produce there? By combining the two factories in Germany, any indication on what will be the positive impact on profitability of APS next year? The second question, free cash flow. Reported flattish in H1. You're considering your increased CapEx and net working capital requirements. What can we expect you for the full year? Any sort of indication in terms of free cash flow yield you aim to achieve? Maybe last question, oil and gas. Could you give us, please, some more granularity on the performance by segment upstream, midstream, downstream? Just an additional one on downstream. The recent profit warning of BASF, so does this anyhow impact your petrochemical business? Thank you.
All right. Thanks, Pascal. Let me take your questions one by one, and Jill will jump in, too. Bamberg and Bechhofen are two beauty factories in Germany. Bechhofen is a much larger factory. It's about 3x the size of Bamberg. Bamberg is an older factory in the center of a city. We have to retool to serve these independent customers that want more decoration, much shorter lead times.
We're doing that in Bechhofen, and we're closing Bamberg. We shift the production that we had in Bamberg into Bechhofen, and we also make a CapEx investment in Bechhofen in terms of changing some of the production lines to adapt to these customers. That'll make us much more competitive for these independent customers that require a lot more services and much faster pace from us. In terms of the cost we've taken, as we said, CHF 20 million, CHF 14 million + CHF 6 million. Additional cost in the second half of the year, Jill?
It would be around CHF 5 million.
All right. There'll be an additional CHF 5 million in the second half of the year. We don't expect further cost beyond that.
Yes.
I think in total, it'll be the CHF 25 million for the first half of the year, another five coming in the second half of the year. We're not giving guidance on what that means in terms of cost savings and profitability for APS once implemented. I'm sure you understand that we're still in the consultation process. It's gone well, out of respect for the people involved and what we're trying to achieve, we'll hold off on giving indications on this at this point.
We'll communicate on that in the future. Free cash flow, same pattern as previous years. Free cash flow on the same level as last year, which actually is a decent performance if you account for the fact that we are growing significantly and that growth generates working capital for us. We've improved the working capital efficiency somewhat. What that means in terms of free cash flow yield, Jill, you want to step in?
I think beginning this year, when we had our annual release, we said that it would be around 4%- 5%. Despite the increased volume and with our improvement on the net working capital, we see ourselves still keeping within that range. It would be around 4%- 4.5%, I would say.
All right. Thanks, Jill. Oil and gas upstream, midstream, downstream. Upstream rebounded later than everything else. Upstream started rebounding in early 2018, so we're still pretty early in the upstream CapEx rebound. Midstream has been very active in North America. We think that midstream is going to be very active for another couple of years, and we think there's a possibility that midstream, in two years, will slow down somewhat as the North American market finishes with this investment cycle of pipelines, which is mostly related to bringing shale oil to the coast, which has been an issue because there hasn't been enough pipelines in North America. Midstream going strong, where we've got very significant load in midstream. We think that slows down in two years, probably. Downstream's been very good. As we said, the main indicator of downstream for us is our Chemtech business.
So Chemtech business is almost exclusively downstream. A lot of the Chemtech business is actually petrochem. 60% of the business in Chemtech is petrochemicals. We don't see a sign of a slowdown in petrochemicals at this point. We still see capacity additions in North America, in Asia, and in the Middle East. I can't comment on the BASF, but we continue to see sustained demand in the part of petrochemicals that we serve. Did I answer your questions, Pascal?
Perfectly clear. Thank you.
Thanks, Pascal.
The next question comes from Fabian Haecki with UBS. Please go ahead.
Yes, good morning. A question again. On the topic of pricing and operational leverage, you already elaborated on that, but honestly, I'm still struggling to understand that. Sales organically went up by 12%. That's hardly any margin impact. You say the mix impact was CHF - 29 million in H1, which was still significant. If I remind correctly, prices for new orders were already stable throughout the whole last year. How can it be that this impact is still so significant? When we talk about mix, is it really all pricing or is it some of it product-related and market-related? Also, the other question, that is how do you expect that to evolve in the second half? That would be my first question.
Okay. I'll take the first question, and then we'll ask you for a follow-on question. The first question, the slide God, my eyesight is not what it used to be. I think it's slide six, the one where we see the arbitration and the rebounding market for pumps for oil and gas, is really where the answer to your question is. In pumps for oil and gas, the lag time between orders and sales is 8- 12 months, and it's probably closer to 12 than it is to eight. Essentially, our volume's gone up, but a big part of our volume increase is the trading of these orders that were booked at the trough. Essentially, we're trading sales that come from orders that were taken at the trough of the market last year.
We've got the volume upswing, which leads to better absorption for us, coverage of our fixed costs. That volume at this point is still the volume from 12 months ago, which is at lower margins. Hence, the fact that the volume upswing is not corresponding to a margin upswing of similar nature. You just have to account for the lag time, essentially. This is why I'm indicating that we believe that our margins will continue to go up into next year, because we will be trading volume that was booked at much better margins.
You see the delta on page six, the 700 basis points from the trough to where we are today for oil and gas pumps, as an example. Essentially, the prices for new orders have not really stabilized already last year. They still went down. This is what we are seeing now with 8-12 months delay. I understand this impact of 8-12 months delay. I have expected the pricing to have already stabilized last year.
No, it has stabilized. What you see on that slide six is you see that the trough for marginal order intake was in Q1 2018, and then Q2 was up, and then Q3 was further up. Sequentially, we've been up ever since. In Q1 2019, essentially, we traded the margin from these Q1 2018 projects, which were at the trough. In Q2, we traded something a little bit better, but that was still much lower versus the margin on order intake that we take today.
The trough, in terms of the margins, also in terms of the pricing, was Q1 2018. That means that the trough, in terms of margin on sales, is essentially Q1 2019, if you want to think about it in those terms. Essentially, as it relates to margin on sales, we are in the early phase of that rebound because you take essentially what happened to the order intake and you have the chart on slide six, and then you slide that by 12 months, and you get the answer to your question, essentially. Hopefully, I'm clear. I hope I am.
Okay. Yeah, thank you. Next one on APS. Beauty was down 9%, you say the shift in your customer base more towards this kind of small, agile, fast, social media companies. Missing out on those companies, how easy or how difficult is it to get them back? They have certain suppliers at the moment.
Yeah.
How can you win those back? How easy is that, or how difficult?
It's not too hard, actually. It's not too hard because it's a market that is churning continuously. The independents that are setting the world on fire today are not necessarily the guys that will be setting the world on fire in two years. It's the beauty of viral marketing and these companies that have a very small surface and that launch products that are hit or miss, is that when you hit, then you're very successful. If you look at the history of these independents as they've started emerging a few years back, there's been a lot of churn. The guys that are emerging today are not the guys that were successful two years ago. We serve that market today already, we just don't serve it as efficiently as we'd like to.
As we adapt our industrial tools, we can start taking orders from those guys increasingly because our factory will be ready in the second half of next year. For example, if you take the traditional customers, if you have an issue with L'Oréal and you're shut out of L'Oréal, it's really hard to win a company like that back because, for reasons that I'm sure you understand. The independents, once again, the guys of today are not necessarily the guys of tomorrow. We are present in that market. We're still a market leader. We're just not as present as we'd like. We are suffering from the effect of where the growth is coming from. Essentially, the traditional beauty customers, I think there's six companies that together capture 70% of the market worldwide.
These six customers today are capturing a much smaller proportion of the growth of the market. The independents are capturing a much higher proportion of the growth of the market. That's what's impacting us today. I don't think it's a problem, and winning those guys back, some of it is winning some of those guys back, but a lot of it is winning the new guys, because the new guys will not necessarily be the same as the guys today.
Okay, that's clear. Thank you. The last one. As your Sulzer Full Potential and cost savings program is coming to completion this year.
Yep.
Wouldn't this be time also to provide us midterm targets, or what is your view on that framework?
We don't intend at this point to provide midterm targets. The feedback we get from you guys is that you're still very focused on what's happening in the markets and what are the long-term trends and what's the volatility and where is the economy heading. I'm not sure in this environment it's the right timing to start introducing longer term targets. I think where Sulzer stands out maybe a little bit versus some of the other stuff we've been hearing is that we are increasingly telling you about our leading indicators, and I am trying to give you perspectives into 2020. I think at this point, we'll do that informally as part of these exchanges that we have, but there's no plan at this point to introduce midterm targets, at least to disclose midterm targets to the market.
Okay. Thank you very much.
Thanks, Fabian.
The next question comes from Jörg Schirmacher, from Baader Helvea. Please go ahead.
Yes. Good morning, everyone. Majority of my questions have already been answered. I have just two smaller ones. Maybe on your guidance, at least to me, it seems the increase seems rather substantial. Generally, again, I would like to understand how are your discussions with customers, for example, in oil and gas going? Do you get the feeling from them, given the uncertain environment, that there's confidence regarding the remainder of this year and also 2020? That's my first question, and the second one on the gross margin improvement and management becoming more selective in which projects to take on. What are your criteria here? How selective are you, and how can you avoid the risk of being too selective and maybe also trade too much growth in return for higher profitability? Thanks, Greg.
Okay. Thanks, Jörg. Good questions. The oil and gas customers are confident about the future at this point. We're very present in the market. As you know, we're the market leader in pumps for oil and gas. We are also one of the two companies leading the market for separation equipment, Chemtech. Essentially, we've got a good view of upstream, midstream, and downstream. We're probably today the market leader for pumps for pipelines also. We talk to customers across the globe. The only market that we don't cover very well, as you know, is the shale market, because we don't do fracking pumps. Therefore, our exposure to shale, to non-conventional oil, which is 5% of the market worldwide, is mostly through the pipeline pumps that we sell to connect the shale patch to the export centers.
If I comment about the 95% of the market that Sulzer covers, conventional oil. The conventional oil customers at this point are comfortable with the corridor in which oil prices are evolving. That sort of, if I take Brent prices, that sort of $55-$70 range that we've been in for the last, God, I don't know, year and a half. Most observers see prices continuing in that range in the midterm. It's a range at which oil companies make money. These guys are in the early part of their CapEx replacement cycle, certainly for upstream. Downstream, as you see in Chemtech, the level of inquiries has continued to be high. That's why I'm guiding you guys in terms of our view that the markets in those areas will continue to be healthy in 2019 and in 2020.
What gets lost in the fray a little bit at times is that there's been an underinvestment overall in the market for something like three years, and all of that has happened while demand has continued to go up. Now, people forecast that the demand growth will slow down and level off potentially. You have to keep in mind that the investments in replacement capacity has not followed pace. Worldwide depletion is something like 6%. Essentially, there is a need for investments to replace that production that is falling off progressively, and this is what our customers are doing. We see that continuing to be healthy in 2019 and 2020.
I always benchmark what we say with what the other guys are saying. I was reading the transcripts from the Schlumberger results call and the Halliburton results call. These guys are saying exactly the same thing. They're saying that shale is slowing down because the economics for shale are problematic and the cash flow in shale is problematic, and the offtake, which is the pipelines to the coast, is also problematic. They're saying, if you look at Halliburton and Schlumberger, they're saying shale is slowing down, but they're saying that they're seeing 8% organic growth in upstream across the globe in conventional oil. These guys are actually, when I read what Schlumberger and Halliburton is doing, they're actually giving guidance in terms of their view of that growth continuing further than 2020. I think these guys are talking 2021.
We're not trying to get ahead of ourselves. We don't have to look into 2021. The indicators that we have, the customer inquiries that we continue to have, the discussions that we have with our customers, and the benchmarks that we get with guys who are much bigger than we are and also have very good market coverage, all of that converges to the same thing, which is that the recovery in oil and gas still has legs, and that CapEx spending should continue to be pretty good for the, certainly in Sulzer's view, for the 18 months to come. Hopefully, I've answered your question. Before I take the selectivity question, Jörg, is there anything else you want to ask on oil and gas, or did I give you what you needed?
That was very extensive. Thank you very much. That's good.
Thank you. In terms of selectivity, you're right that it's kind of like running an airline. It's yield management. It's yield management in the sense that you're running an airline and you've got your flight that's scheduled, and you have to figure out at which price you market the tickets. The pricing is at a certain level a long time out, then it goes up or down again, depending on how full the plane is. What you don't want is to have this spare capacity, which is costing you money, and that is not bringing contribution income. What we try to do is today there's enough growth in the market, there's enough volume that we can afford to be somewhat selective. I don't want to overplay this.
It's not like Sulzer is sitting there with a wealth of orders and sitting on our throne deciding which orders we take and we don't take. What we've done mostly is we've cut out the bottom, which is that we've raised the threshold at which we don't let our guys commercially engage, because we think it's wasted time. We continue to keep a close eye on that, because there is the risk that we'll sacrifice too much growth, and that can have negative impact in other ways. At the end of the day, there is a level of contribution margin that we're trying to maintain, even from the lower margin orders. At the end of the day, if I take oil and gas, Sulzer is the market leader in pumps for oil and gas. It's essentially Sulzer and Flowserve.
I think if the market leaders are not signaling to the market that we expect that what we provide will be compensated fairly. If the market leaders are not signaling that they believe that now is the time, then there's very little chance that pricing will improve in the market. As a market leader, we're taking our responsibilities, and we are clearly signaling that we believe that pricing has to go up because demand has gone up, and factories have been filling up. Now is the time when we should get more compensation for what we do.
That's what we're saying. We're not falling asleep at the wheel. We're continuously looking at volumes and growth, and we're making sure that we don't shoot ourselves in the foot and sacrifice too much growth. It is a concern. We think that we're managing it correctly today, we think it's important to show the market that we're leading the way on pricing, at least we're trying to. Anything else, Jörg?
Thank you very much. That's it. Thank you.
The next question comes from Charlie Fehrenbach with A WP. Please go ahead.
Good morning to you. Good morning, gentlemen. I'd like to come back to your outlook. The perspectives for the second half of the year are worsening worldwide. You obviously raised your guidance on back of the good figures in the first half. You still see a slowdown, I guess, in sales in the second half. Could you maybe give us a bit more light? What are your expectations for the second semester? Which markets are more resilient, which a bit less, and where do you see the sales slow down? Thank you.
Thanks, Charlie. It's mostly the reflection of how we trade our backlog. The sales for the second half of the year, a large part of the sales of the second half of the year are already in our backlog. There's also the short lead time stuff, which mostly comes from aftermarkets and also from some elements of the turnaround services market in Chemtech. I would say also applicators as mature lead times. Let me try and answer the question. We're not seeing a slowdown in the shorter lead time business, so that's not where it's coming from. It's really mostly a reflection of our forecast of the trading of our backlog. Jill, you want to add anything to that?
No, I think, it's essentially that because for the project business, we have the backlog to project what's coming up in the second half. We continue to grow on the top line in orders as we have given you in our guidance. This is just a reflection of the trading on our backlog into sales.
As you know, your question was mostly about sales, but the world's slowing down and the order intake, there is a slowdown worldwide of various segments. I think automotive is slowing down. Some parts of electronics are slowing down. Construction is slowing down. We're not blind to these effects, and we are to various extents in these markets, or we have connections into these markets. We're quite observant of what's going on around us. I commented on our markets one by one, and once again, water is wastewater. It's mostly linked to population growth and urbanization. Oil and gas, as I told you, we think we're still early in the recovery, CapEx cycle. Power, we're already at the bottom. We don't see a further drop.
We said there's a bit of a slowdown in growth in industrials, but industrials has continued to be a good market for us. It's just, it's composed of various businesses, and we see some areas of slowdown, like electronics, as I said. I tried to give you a mixed bag, but on the stuff that a lot of people worry about as it relates to Sulzer, oil and gas. The leading indicators that we've included in these presentations are level of tendering volume. The tendering volume is essentially a good indicator of what's going to happen for order intake in the second half of the year, unless our hit rate collapses, and there's no reason our hit rate should collapse, because we have a pretty good handle on our pricing.
I think that our guidance in terms of order intake is pretty safe for the second half of the year. We've given a range. We've made the range a little bit wider than we usually do. It's 300 basis points when we have a tendency to guide 200 basis points. We think we're pretty confident that we'll be in that range at the end of the year as guided. As for sales, as I said, it's a transformation of the backlog. That's in a way, I don't want to say that's even safer, but it's more under control. That's how I would comment on the second half of the year. Anything else, Charlie?
Okay. Thanks. Maybe an add-on. No worries at all about the trade tensions?
Trade sanctions, it's become the new normal. I hate to say that, but it is, and it's costing us money. We don't disclose how much it costs us because it's mostly non-material for Sulzer. First, I say we don't disclose, and I'll ask Jill, what's the cost impact of trade sanctions in the first half of the year for us?
If you are referring to, say, the tariff, then it's a very low single digit CHF 2 million.
Yeah, CHF 2 million, 3 million for the first half of the year. I had to pull it out of Jill, you see? You see how much work I have to do for you guys. We said last year it was about CHF 5 million for the whole year. Jill is saying it's somewhere between CHF two and three for the first half of the year. It complicates our life. It forces us to juggle where our supply chain comes from. It forces us to juggle which factory deliver to which markets. There's a cost associated. It's manageable and unless the rhetoric steps up, it will stay within those levels.
Thank you very much.
Thanks.
The next question comes from Christian Arnold with MainFirst. Please go ahead.
Yes, good morning. I would like to come back on the operating leverage. Not so much of pumps equipment business, but more on the Rotating Equipment Services and Chemtech. Looking at Rotating Equipment Services, with organic sales growth of around 14%, the margin decline is a surprise. However, you were saying that it's mainly coming from timing impact.
Does that include or imply that already if this timing impact is falling apart, already in H2 we will have higher margins compared to last year, assuming that we have a similar growth pattern also in the second half for Rotating Equipment Services. Into the same direction also in terms of Chemtech, also here. Here we did see a margin increase on the back of volume growth and also on the back of positive business mix. Nevertheless, one could argue this operating leverage should be higher. Could you elaborate a little bit on that? Thank you.
All right. Sure, Christian. We'll take those questions. Well, let's see. Jill will take RES, and I'll take Chemtech. The short answer to your question on RES is yes. Jill will give you the long answer.
Yes. The long answer confirms the short answer. Essentially, we have in the first half, as we've mentioned, the timing impact of a lower margin project, and therefore, it's IFRS due to the introduction of IFRS 15, point-in-time type approach that we have to adopt under the IFRS 15 implementation rules. We now expect them, therefore, in line with the higher volume and away from this timing impact, we will see H2 better than H1.
Okay. What I would add on the RES business is, the RES business is three businesses, essentially, three segments. You've got pump service, which is about 60% of the business, and most of it is service on our pumps. Not all of it, most of it. You've got turbo service, which is on turbines and compressors, and it's all of it is on other people's gear. You've got electromechanical, which is motors and drives and stuff. This is all third party also. Electromechanical is a lower growth business. It's exposed to various industries, so it's kind of a basket of different things. It'll continue to be growing, but at, I'd say, lower single digits.
The pump service business will continue to pick up, because when we sell a new pump, we start having service and parts revenue anywhere between two to three years after we sell the pump. Call it three years. If you take the rebound in engineered pumps for oil and gas, that rebound started in downstream two and a half years ago, and it started in upstream a year and a half ago. Therefore, we're right in the middle of that rebound in service and parts volume for pumps. We think that we'll continue to be supported by an improvement of our pump service business. The turbo service business, as we said, it's a lot of turbine and compressor service, but a lot of it is turbine.
That market has been depressed, that market has kind of settled down at a low level. As long as we don't erode in turbo service and we continue to grow slightly in electromechanical, the growth that we will get from pump service as the mechanical lag time impact of selling new pumps two to three years ago, that will carry the RES business to better results progressively. A better second half of the year, we believe that RES will continue to perform well into 2020. As I go to Chemtech, the operational leverage on Chemtech. Chemtech's doing really well. There's not as much price uplift to be expected in Chemtech because prices were not as impacted in Chemtech and the recovery happened earlier. Right now, the improvement of Chemtech, the leverage, it's mostly volume driven. In separation technology, it's quite significant.
The only thing that held the margin back a little bit in the first half of the year is Tower Field Services. We refocused the business. Refocusing the business, we made it smaller. That has an impact. We're still trading things that we took that we were maybe a bit less happy about than the stuff that we're booking today. I would say that as an indication, Tower Field Services is lagging behind a little bit in terms of profitability, and Separation Technology is doing really well. As Tower Field Services stabilizes, recovers, then the operational leverage will be more apparent. Did we answer your question, Christian?
Yes. Thank you very much.
Thanks so much. Your answer was actually longer than Jill's.
I know. Jill is concise, and I need to work on it.
Thank you.
Thanks.
The next question comes from Armin Rechberger, from ZKB. Please go ahead.
Yes. It goes into the direction as everybody else is pointing. We see a downturn all over and you are saying your markets are healthy, not all of them, but mostly. If you look at Q1, we had a positive trend, and a strong order intake growth of 9.3% for the whole group. Now it went back to 5.3% and the order intake is CHF 35 million lower in Q2 than it was in Q1, which is not a seasonal pattern as it was not the same in the years before. Everybody is suspicious now and you are happy and confident. Well, it's just a point I want to point at and not maybe a question. Yeah.
Well, Armin, it's a fair comment and I said I'd work on being concise, and the concise version of your question is, am I delusional? It's totally fair to ask that question. I don't think we are for the reasons that we've explained, but let me try to give substance to some of the numbers that you brought up. In the first quarter, we had these two orders in order for CHF 42 million larger orders, didn't have those in Q2. If you start looking at deltas between Q1 and Q2, the bigger stuff, it falls whenever it falls, and it's not linear and it's not the same every quarter, so you'll have some give and take.
I'll give you another example the other way around, which is Chemtech. Chemtech grew, what? 26% in the first half of the year. I think we grew 26% in the first half of the year without a single order in Chemtech of more than CHF 10 million. What's exceptional about the growth in Chemtech is that it's not that there aren't any larger projects on the horizon. There's a bunch of larger things out there, but none of them were awarded in the first half of the year. You can also hold out for some level of hope that we'll get some larger stuff in Chemtech in the second half of the year. There's a little bit of a give and take.
You have to look at the underlying business of small to medium-sized orders, and then you have to factor in for the bigger stuff that falls whenever it falls. We didn't see a slowdown in the second quarter. If it reads like a slowdown, it's because of how these orders fell. As we look forward, as I said, our leading indicators, it's a pretty safe indication of order intake for the second half of the year. I don't sit here thinking that we've given the guidance that we're at risk of not meeting for order intake in the second half of the year.
I wouldn't give that guidance otherwise. Nobody was putting a gun to our head in terms of raising the guidance. We're doing it because that's what we see for the second half of the year. Beyond that, we're giving you circumstantial evidence for continued healthy level of performance into 2020, but we'll reassess together at the end of the year as we see markets developing.
Okay. Well, I'm not so concerned about your lifting up the guidance. I was concerned about Q1 to Q2, but you explained it with these big new orders you had in Q1 and which didn't fell into Q2. That's a good point, yes. I have some minor questions, two more of them. You mentioned at APS, this second generation product with your big customer. When I got it right, you mentioned that you got no sales so far for this second generation product. Is that the case, and why? The last question, very fast to answer, CapEx 2019, which level do you expect?
Okay. Jill will take the CapEx question and I'll take the APS question. The APS question, yeah, you're correct. You heard it right. Second generation, we haven't gotten any sales yet. I think our customers have been a bit slow launching, and also generation 1, we were sole source. We were the only provider. Generation 2, there's two suppliers and we're one of the two. It's probably a combination of these two reasons. I'm not exactly sure what kind of volume the other supplier is getting, but my view is probably not a whole lot either. It's just a question of timing of launch more than anything else.
As I said, I think that that one customer that we've been talking about cryptically for a year and a half now, it was a negative baseline impact last year because we had a strong year with that customer in 2017. Actually, it's going to be a negative baseline impact this year because we still had CHF 8 million of revenue with that customer in 2018. This year it's looking like it could be, I don't want to say it could be zero, but we're still waiting for that to start. All the contracts are signed, the machine are in place. The customer actually owns some of these machines, but I can't control when they launch and how they launch. Jill, you want to talk about CapEx?
Yes. On the CapEx part, you've seen that in 2018, our CapEx was about CHF 95 million, CHF 96 million. This year with the addition of, for example, our Bechhofen plant, the expansion, that will bring another CHF 30 million. Essentially you can plan with around CHF 125 million.
For 2019.
For 2019.
I think, the question was about 2020.
2020-
No, it was just 2019?
Yes, but--
You want 2020 too? I can make her talk if you want.
Sure.
Jill? In 2020, our normal level of CapEx, we think are normative, if you want to call it that way, is that CHF 90 million, CHF 95 million level that we had in 2018. That’s a reasonable level for us given the acquisitions that we’ve made and where we are. We’ll be closer to what number did you say for 2019?
I think closer to CHF 100 million. Yeah.
2019?
2019, 125.
125, 2019. 2020, we'll go back to somewhere between the CHF 95 million and the CHF 125 million. I'm sure we'll still have some of the CapEx for Bechhofen. Right now we're factoring that a lot of it is going to happen in 2019, but these things have a tendency to slip when you're doing construction. It might be a bit less in 2019, a bit more in 2020. I can think of at least one other exceptional investment that we have to make in the range of CHF 10 million- CHF 15 million, I think, in 2020. I'd say give or take. We're a bit early to talk about this. We haven't even done a budget yet, obviously, for 2020. If you take the CHF 95 million from 2018 and the CHF 125 million that Jill talked about for 2019, and you kind of split the difference, you probably get the 2020 number, and you're not far off.
Thank you.
There is a question from the webcast, because there's no more question from the queue as I understand. From the webcast, Eugen Perger of Research Partners is asking, c ould you please elaborate on the engineered water projects? What kind of projects were they? Desalination for agricultural and/or urban purposes? Do you expect further project of this kind?
Desalination, I think it was urban. I don't think it was agricultural, but I'll check. Yeah, the desalination order pipeline is quite active. It's Middle East, mostly. Some Asia, a lot of Middle East. We're constantly being solicited for projects like that. They're big, you don't always control when they happen. It remains an active market. The other one was a water pipeline. It was just water transport, also in the Middle East.
There are no more questions.
Other questions before we wrap up?
There are no more questions from the phone.
What I'll do is, I'll conclude. And what I would say is, it's been a pretty good first half of the year. We think the second half of the year will continue along the same trend, hence, the uplift in our guidance. We continue to keep a very close eye on all our markets, and we're not oblivious to the economic uncertainties around us. As it translates into Sulzer and the markets that Sulzer serves for the second half of the year and into 2020, we feel confident at this point that the signs of a slowdown are not visible yet. Therefore, our business should be operating at a pretty good level for the second half of the year. We'll update you on what we see in the second half, and we'll see whether we stick to our guns for 2020
At this point, we're feeling pretty good about what we see from our customers. Once again, with areas of slowdowns as we mentioned, but overall a positive picture and it will continue to translate into the numbers. On those words, I thank you for your time and your thoughtful questions, and wish you all the best for I think what will be a busy few days for you guys. Thank you.