Volvo's (VOLVY) CEO Olof Persson on Q2 2014 Results - Earnings Call Transcript

Jul.18.14 | About: Volvo AB (VOLVY)

Volvo AB ADR B (OTCPK:VOLVY) Q2 2014 Results Earnings Conference Call July 18, 2014 8:30 AM ET

Executives

Olof Persson - President, Chief Executive Officer, Director, Member of the Group Executive Team

Analysts

Alex Whight - JPMorgan

Martin Viecha - Redburn

Alex Potter - Piper Jaffray

Ashik Kurian - Goldman Sachs

Andreas Brock - Nordea

Operator

Ladies and gentlemen, welcome to the Volvo Group report on first six months 2014. Today, I am pleased to present Olof Persson, CEO. For the first part of this call, all the participants will be in a listen-only mode and afterwards there will be a question-and-answer session.

Speaker, please begin.

Olof Persson

Thank you very much, and most welcome to this telephone conference. We will do as we have done in previous quarters here now that we will have just a very short introduction and then we will open up directly for the questions and answers, since the material has been available to you, both on the web and also here in press conference and discussions.

But before starting, I would just like to because there have been some discussions around the profit improvement program, the SEK9 billion up until 2015. And just let me to recap the situation and what we have been saying and trying to say all the time. We have, as a general target, to over time improve our performance with 3% margin. That is a non-ending target, meaning that over time we would work through so we can regardless of the different factors we are in, having a 3% higher margin than we previously have had. Now there a target that is a long-term target that we are going to work towards over time.

Then we have the SEK9 billion program, which is then a strategic program running from 2013 to 2015 where I have, together with the management team, identified, quantified and also set up a number of targets for the organization to be achieved by end of 2015. This is relating to profitability, but it's also we have targets around HR, we have targets around technology and that has also been communicated and presented to you that is the 20 targets strategic plan that we do have.

The first quarter, those SEK9 billion saving and improvements that we want to see is coming from a number of different things. One is of course cost savings and there we talk about our efficiency program, for instance, but it also regarding increasing our gross margin and profit improvement that we have talked about in the press conference earlier today and the margin improvement that we have seen. That is also part of the program going forward.

Those SEK9 billion will then be materialized over time at a certain base. That base will be presented in a curve to the capital markets today in December where you can see then how much per year that adds up to, for instance, this year which will see improvements in the range of SEK4 billion and then leading up to end of 2015 to the SEK9 billion. And that is where we refer to the program and where we refer to the SEK9 billion and if we are ahead or behind, that is the reference curve that we do have. That curve, as you can see, if you have seen it, but if you see it, that curve starts to January 1, 2013. So that means that the SEK9 billion improvement is done based on the 2012. That's the base and how we measure it.

Then we have also have a baseline, and that is the SEK300 billion. So basically, we have the SEK9 billion and we have the SEK300 billion in turnover in That relates then to an improvement of 3%. So and then, I am sorry if there has been some misunderstanding about that, but I hope that opening will clarify the program and how we are measuring.

So with that, I was not planning to have an opening as I said, but I think the key issue with the second quarter and the way the second quarter have developed is very much related to construction equipment in China and related to trucks in Brazil. These two items has had a considerably negative effect on the result during the quarter and the improvements we have seen in other parts of the organization from the efficiency improvement program and the SEK9 billion program has not been enough to offset that.

And as I said, I think you have read the material. So I suggest that we move into questions, as we can have a dialogue on the issues that you find important, and the questions that you want to have asked.

So operator, by that, please open for questions.

Question-and-Answer Session

Operator

(Operator Instructions). We have a first question from Mr. Alex Whight from JPMorgan. Please go ahead, sir.

Alex Whight - JPMorgan

Thanks. I have got a few questions. I would like to have it one at a time. The first question is actually just on your opening comments there, you talked about a 3% improvement over time. If I look at the average group margins since 2000, it's been around 4.4%. Should we take that as meaning that you are seeking a 7% to 7.5% group margin average through the cycle, if you take a, like an extended period of time and then when we have fluctuations and the cycle is high and when the cycle is low?

Olof Persson

The way we are looking at this, and I also said, there is no time or deadline on this one. The way I look at it is, that if you go back historically and see, in a high cycle we have a certain percentage at that point, which should be 3% higher than that point. You have another margin at the low of the cycle and if you look at that, we should over time now be able to be 3% higher than that. So that's the way we are looking at it. So if you have, we are basically moving the profitability curve in the entire highs and lows in the market upwards on a parallel movement of 3% units, but again, this is done over time and we don't have any deadline on it.

Alex Whight - JPMorgan

Okay, and then just on the call this morning, I think you talked about SEK500 million year-on-year savings benefit from the program in Q2 at the group level. I guess the question is how much of that would have affected the truck division? And then as the second part of the question is how much should we expect to see in Q3 and Q4 year-on-year?

Olof Persson

The majority of that comes through the truck division, because that's the major part of the program. The part of the efficiency program is valid for a bigger part of the group, but the majority comes through trucks. And the second half, we will continue to focus on cost savings. We don't guide exactly how much is quarter-over-quarter, but it is of course a part of this curve that we follow up to what should happen, the SEK9 billion. We could, perhaps, add to that if you look at the curve that was presented at the capital market, we committed to improvements of SEK4 billion this year. If we look at the curve off to be the second quarter, it was like ahead of that curve. We do have, in particular, on the margin improvements on new sales. We then have an improvement, but we also following in the plans when it comes to cost reduction. So, yes, okay.

Alex Whight - JPMorgan

So I guess since you put up the curve in December, you have obviously had your negotiations taking place in Sweden and in France and in Japan. I imagine you have got a better idea now of how much savings you should be expecting to see in the coming couple of quarters. I think there is obviously some concerns today about what's going on behind the scenes and what's really changing at Volvo, given the magnitude of the business as far as consensus expectations. I guess some guidance would or a rough indication would be helpful.

Olof Persson

If you see the reduction of white-collar people, we have done 1,200 people out of the 4,400 the first half of this year. We do have the Swedish VMP program 530 people will leave mainly during the third quarter. There are also other measures in the group that like people leaving in the third quarter then we have France and Japan voluntary leave programs that comes in the fourth quarter mainly and a little bit overhanging to 2015. And as I said earlier today, we are 100% committed to deliver on this 4,400 and we have done 1,200 and it will be done in the first quarter of 2015 with the majority leaving this year.

Alex Whight - JPMorgan

And how many are the France and Japan? Is that the balance or is it --?

Olof Persson

We have 4,400 we are taking out. We are going to make the majority of 4,400 this year with a little bit of an overhang. So what does it mean? We have taking out less than half so far, which means that we have to do more in the rest of the year and have a little bit overhang into 2015.

Alex Whight - JPMorgan

Okay, and then the last question I had around the savings target. That's an absolute savings target. Is that the way we should think about it? And we should have cost inflations to consider as well?

Olof Persson

That is in terms of number of employees and of course you have a normal salary increase as well underlying in all countries. But the absolute is the number of employees.

Alex Whight - JPMorgan

And the SEK9 billion is an absolute number as well or is that net of inflation number?

Olof Persson

The SEK9 billion is a net number. So that is the number that we have committed to be achieved by end of 2015. It is a composition, as you know, of targets we have set and a so-called headwind factor to take care of different aspects of the business that we have going forward. So that's how we come to the SEK9 billion.

There is a final add to that and you have expanded very well but there are two parts. We have regular employee which we are talking about the VMP programs and all of that, but then of course we also consultants that we are addressing and in this new structure, we are actually changing the organization as well to get more efficiency. If you look at that and support functions, we are now implementing a completely new more efficient structure and that is also something that you need to, in the Swedish legislation, in the France legislation and in the Japanese also to negotiate.

So it is not only the reduction per se, we also need to negotiate the structure and that is exactly what we have been doing now and that's why we will continue not only with VMP fixed employees but we will also reduce the remaining on the consultants side. So it's a total reduction both fixed and consultants.

Alex Whight - JPMorgan

Okay, and then just on the normal wage inflation, is what, 3% to 4% for the group as a whole or?

Unidentified Company Representative

4% is on the high side, I would say.

Alex Whight - JPMorgan

4% is on the high.

Unidentified Company Representative

Yes.

Alex Whight - JPMorgan

So if we have 3.5% by over three years on a SEK36 billion, you are sort of running at nearly SEK4 billion of added cost from wage inflation. So we should be thinking about an absolute level savings of at least SEK13 billion, probably a bit more, if you get out the cost inflation as well. Is that how you think about it?

Olof Persson

How did you come to the SEK13 billion?

Alex Whight - JPMorgan

So if you have salaries out side of SEK36 billion, 3.5% of that is SEK1.25 billion. It's a three year cost program. So we have three years of cost inflation which takes us to SEK3.8 billion. If we add SEK3.8 billion to the SEK9 billion, then we get to shy of SEK13 billion.

Unidentified Company Representative

I think this is a fairly technical calculation that you arrived at. I think as we said before, I think what Olof mentioned before, this is the SEK9 billion is as we have included headwind there. It is the absolute savings that we are going to do net of inflation going forward.

Alex Whight - JPMorgan

Okay. Thank you.

Operator

Next question comes from the Mr. Martin Viecha from Redburn. Please go ahead, sir.

Martin Viecha - Redburn

Hi, this is Martin Viecha from Redburn. I have a just a bit of clarification of the restructuring program. Does this means that the 30 basis point margin improvement plan is different to the SEK9 billion profit improvement plan? And am I understanding this correctly that by 2015, the total profit achieved will be 2012 profit plus SEK9 billion?

Olof Persson

What I have said a number of times is that what we are committing to is based on 2012. We will have, on those areas which we have specified and then you can see that yourself, it's in the sales and admin and it's in the gross margin, its in the R&D, it's in the IS/IT cost, and so on and so forth. In those items, we will improve based on 2012 with SEK9 billion. So compare those items by items, we would have an improvement by 2015 of SEK9 billion based on a SEK300 billion turnover. So that is, and then I have said also, because I have got this question a lot, and I have been clear and we don't know the margin in 2015, because that is, we don't know the currencies and other things as well there. But we are committed to that by end of that year on those items, we should see an improvement by SEK9 billion. So on those items, it would be SEK9 billion better. Is that clear?

Martin Viecha - Redburn

Yes. That's perfectly clear. Secondly, are we talking about two different plans here as in the 300 basis points plan and the SEK9 billion plan? Or are we talking about the same thing?

Olof Persson

The SEK9 billion plan is a very important piece of puzzle to achieve that over time 3% margin improvement. So it is a very important piece of doing that. Then of course we will continue up to 2015 to continue to improve and do the necessary things we are doing. But in general, you can say that the SEK9 billion strategic plan is a plan up to 2015. The 3% over time and regardless of the cycle is something that will come over time, but the SEK9 billion plan is a very important piece in achieving that.

Martin Viecha - Redburn

Okay. Thank you very much.

Operator

The next question comes from Mr. Alex Potter from Piper Jaffray. Please go ahead, sir.

Alex Potter - Piper Jaffray

Hi, guys. I wanted to switch over to China, if we can. I was wondering if you think the market wide difficulties that China is facing right now might for some of the Chinese competitors out of the market, do you think over the next year or so when you see these increased competitive problems, inventory, things of that nature, will that drive those companies out of the market?

Olof Persson

Well, it's difficult to say, but if you look at, historically we have -- it depends on the market size to start with. We don't know exactly what the market would pan out being a sustainable market for the Chinese market and that will also how many players, but if we go back in China and look at what has happened over the many years and if you look at the wheel loader business and there you can see that there has been a consolidation, a substantial consolidation over the last 10, 15 years. It was a huge number and I really mean a huge number of small local players doing wheel loaders in China up until, I would say up to 2005. And there we have seen a reconsolidation. Would that happen again? Might be so. And again, it depends on the market size and so on and so forth. But if it happens, it will take some time. I don't think it would happen overnight. That will not happen presently now but we are definitely committed to the Chinese market and we will make sure that we do what we can in order to stay in our place and then it might be as we see a more consolidation in the market going forward. Little bit based on historic experience as well.

Alex Potter - Piper Jaffray

Okay, very good, and then I had two questions on North America truck. The first one is on cyclicality. Obviously we have seen very strong orders here. Do you think there is any risk that we are pulling demand forward into 2014 and we potentially see the cycle peak out earlier than we originally expected? So that's question number one.

Ad then question number two is, earlier on the call you mentioned that you are working on trying to improve the profitability in the North America truck market. If you could just boil down to maybe the one, two, three types of things that you are doing in the near term to increase margins in North America truck, that would be very helpful. Thanks.

Olof Persson

Sure. I think one important fact with the North American market right now is that up until now or up until recently that's been a replacement markets. So we haven't seen any growth in the market. But now we do see a sort of an expansion also into new and expansion of fleets and so on and so forth. And that is of course much driven by the economy development in the market and therefore, it will have a lot to do with the GDP going forward in the North American and U.S. in particular, how that is developing and I think that will be a correlation back to as it normally is between GDP freight volumes and also expansion or contraction in the North America market and we will see how that develops.

When it comes to the profitability in North America, there are two areas where we focus mainly on. And one is to really making sure that we capture all the market business, based on our higher penetration on I-Shift and engines, but also and I think it's important to remember is to provide a better service totally. We have moved a lot in the North American market to work with Telematics in order to improve service offers to the customers and the whole area around the maintainability, service and business around that is something that we focus a lot around in order to improve an increased profitability in North America.

The second one is, of course also that we need to work on. If you look at the brand and the brand position that we have, both with Volvo and the Mack. We are addressing the Mack brand with a relaunch of the brand now. A rebranding. That is also important in order to connect that to the product features and that is also something we do. So I would say, there are the two major areas that that we are working on. And the second area, you could put on to having or actually having a rightly positioned product in the brand position, but also very competitive product in order to increase the profitability.

Alex Potter - Piper Jaffray

Okay. Thanks very much, guys.

Operator

We have next question from Mr. Ashik Kurian from Goldman Sachs. Please go ahead, sir.

Ashik Kurian - Goldman Sachs

Hi, it's Ashik from Goldman Sachs. I just have a follow-up question on your clarification on the SEK9 billion cost savings. Now that you have clarified that you are using 2012 as a base for that, if I recollect correctly, in 2012 you also said that your margins were hampered by around SEK1.5 billion or so of launch cost. Now, is the reversal of this also part of the SEK9 billion cost improvement by 2015? Or should we see a normalization of the launch cost on top of the cost savings coming through?

Olof Persson

The launch cost was primarily, I would say, in 2013 where we have that, it is also the launch cost in 2012, of course, but mainly in 2013. And when it comes to the selling and that is particularly on the selling side. The targets we have set as you can see now, is actually a percentage of the sales. And that means that we are already using the whole sale which is the back office point of view, and therefore the launch cost are very much also on the retail side. So generally, you can say that we have taken a hike for that in the SEK9 billion in order to accommodate into the SEK9 billion. So the answer to your question is that the savings you see is the savings that is part of the SEK9 billion which also includes savings coming from the launch cost.

Ashik Kurian - Goldman Sachs

Thank you. Very clear.

Operator

We have next question from Mr. Fredric Stahl, UBS. Please go ahead, sir.

Olof Persson

Fredric? We are there operator?

Operator

Yes, we take the next question from Mr. Andreas Brock from Nordea. Please go ahead, sir.

Andreas Brock - Nordea

Thank you. So two questions, if I may. First of all, on China VC, the market was down, you were down more than market. You were down 30, the market was down around 19, if I recall correctly. Could you help us understand what happens in such a massive downturn both in terms of how the local customers think about brand, how they think about price, how they think about financing? And what are the main challenges now for your sales in China?

Two, also on the gross margin improvement which is happening in Europe, how is the increase in price on the Renault side? Is that doing just as well as on the Volvo side?

Olof Persson

If you look at the challenges on the sales side in China of course one of the reason that the market is down less than our deliveries is the fact that we have stopped delivering into our dealers and that means that in fact we have in Brazil, the sales that goes down faster from the dealers out to the market which means that our sales goes down. And again there is the right of addressing it but it is a correction that is costly but has to be done.

If you then look how the customers react, well it is of course a difficult situation for the industry as a total, all the way out to the end customers and I think what is very important now is to look that we have a good control that we measure and see the machine utilizations. We have a good sort of sight or an idea when the market is coming back and how it is coming back and where it is coming back and what kind of models are starting to move again.

We also have to make sure that we are monitoring the whole flow of system when it comes to the dealer inventory to make sure that that is actually coming down. So it is a market which is of course down and by that also affecting the whole of the industry. But the key here, I truly believe is to have a lot of people on the ground to really feel and be there to react quickly and making sure that we do the right decision when we start to see things moving again when that will come.

When it comes to the gross margin improvement on the Renault side, it's still early days, but the pricing on the Renault side has been accepted. We have seen that, going forward now. When it comes to our offer to the customers, we look of course at the price and the margin but it is also on the service agreements and financing and that creates a package. But so far so good when it comes to pricing on the Renault side as well even though it's early days.

Andreas Brock - Nordea

Thank you. Just one final, my follow up there on VC in China. I know that you have some off-balance-sheet guarantees made to the, I believe the banks in China that are financing the construction equipment sales. Have any of those off-balance-sheet items or are any of them impaired? Are the banks forcing you to start paying them for i.e., some dealers et cetera have gone bankrupt?

Unidentified Company Representative

So far there has been no call on guarantees on Volvo.

Andreas Brock - Nordea

Fair enough. Thank you so much.

Operator

(Operator Instructions).

Olof Persson

Okay, operator. If there are no more questions then I would like to --

Operator

There are no further questions at this time. So please go ahead, speakers.

Olof Persson

Okay. Then I would like to thank you for joining the call and I hope by the introduction, as I clarified some of the issues that was discussed during today regarding our certain programs. At the end of the day, I just want to reemphasize first, we are totally committed to making sure that this program is executed. We are on plan. It is a fundamental part in our commitment to increase the structural profitability of the Volvo Group. It is something that's not done from one quarter to the other. But I hope that you can see now that we start to see the positive impact. In this quarter, those positive impacts, which start to get quite sizeable was not enough to offset the negative that we had in China and the trucks in Brazil, but it shows to me and the rest of the organization the importance of this program in order for us in the future to be much better prepared to be able to cope with those kind of swings. That we will continue to see in the market going forward. We are in a volatile business. So with that I thank you much for calling in. I wish you all a good summer and talk to you again on the third quarter release. Thank you very much. Bye.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!