Volvo AB (OTCPK:VOLVY) Q3 2016 Earnings Conference Call October 21, 2016 3:00 AM ET
Joachim Rosenberg - Executive Vice President
Martin Lundstedt - President and Chief Executive Officer
Jan Gurander - Deputy Chief Executive Officer and Chief Financial Officer
Hampus Engellau - Handelsbanken
Erik Golrang - Nordea
Graham Phillips - Jefferies
Klas Bergelind - Citi
Björn Enarson - Danske Bank
Alasdair Leslie - Societe Generale
José Asumendi - JPMorgan
First of all, I would like to welcome you to this press conference where Volvo will present the report for Third Quarter 2016. We will start with the presentation with the President and CEO, Mr. Martin Lundstedt and Deputy CEO and CFO, Mr. Jan Gurander. After the presentation, there will be possibilities for questions and we will mix those questions between the auditorium and the ones who are looking at the webcast. So please welcome, Mr. Lundstedt and Mr. Gurander.
Thank you, Joachim. And also from my side, most welcome to this presentation for the quarter three results for the Volvo Group and to start with some of the highlights from the third quarter. As you have already seen, we saw a quarter more in line with our own expectations with continuous underlying improvement in performance, not at least also coping with the slowing North American market as well as coping with the continuous low levels in many of the emerging markets.
The Group managed to maintain profitability despite lower volumes and adjusted operating margin improved somewhat to 7.0%. In particular, the trucks business managed to improve margins to 8.2% from 7.2% despite a volume drop of 13% and also just to remember everyone, we consider bigger swings between the different regions. When it comes to the volume development in general, for trucks, volumes were down 13% as I said mainly related than to North America, which is seen in the figures both for Volvo Trucks as well as for Mack trucks. For Volvo Trucks, the North American downturn was somewhat offset by stronger European markets as well as market share gains in Europe. Renewals negative figure relates mainly to non-European markets, where we see political turmoil in the areas where we are always operating as well as relative to high deliveries in quarter three last year for the heavy duty, but we had specific campaigns.
For Volvo construction equipment, volumes were flat, but with considerable and unfavorable changes in product mix. Both between the brands, Volvo down with approximately 300 units and SDLG up with almost 300 units and the difference by the way is [indiscernible] plus 20 units also if you see the difference between the minus 23 and the figures on the right side here. But we also saw a shift in the product mix for the Volvo brand as such more pronounced volumes when it comes to compact. And as a matter of fact also in the heavy segment, more volumes when it comes to the light machines in the heavy segment, so it was overall a movement to more light machines for the Volvo brand.
When it comes to service sales in the group, it continued to develop somewhat positively with 2% overall and 1% FX adjusted with gains for – pretty big gains for Volvo Penta and also for Volvo Bus, but with slight decreases both in the trucks and construction equipment business both with approximately 1% FX adjusted. For trucks, the decrease is mainly related to somewhat lower activity in North America also in the service business as well as a decrease in renewal to some extent as a result of a decreased rolling fleet. Volvo Trucks Europe saw improvements.
Service will continue to be in focus to gain shares in the rolling fleet, where we see big potential. When it comes to trucks, some of the highlights that we have seen during the quarter, Volvo’s fully autonomous mining truck is the first in the world to be tested in real operational environment, deep underground in the Kristineberg mine up in Northern Sweden operated by the Swedish mining house, Boliden. And this is the cooperation between the customers and Volvo together with other stakeholders to improve safety, productivity and transport flows. The route is 7 kilometers reaching 1,300 meters underground in narrow mine tunnels. With different sensors, both fixed and moving objects all monitored and avoided. The onboard transport system continuously also optimizes routes and energy efficiency in this specific application and fuel consumption. The product demonstrates our group’s strong position in automation also going forward.
Another highlight of course was the IAA Show in Hanover in September, the biggest truck show in the world. Volvo FH Euro VI was declared the overall number one in very prestigious test, the Fehrenkötter test. And the reason why its prestigious is that it’s lifecycle test with over 300,000 kilometers in operation and 2.5 years in operations and Fehrenkötter tested the different European truck makers and Volvo FH Euro VI came out in top position both when it comes to total cost of operation, fuel consumption and overall figures. And this is also showing a leading position for our offerings and also serves us an important boost in the whole organization internally, so that was great news for us.
We also presented a number of new features at the IAA. Some of them we have already showed to you, but in particular, I would like to mention if you are interested the liftable tandem for our construction segment, where you have a decoupling of one of them rear axle is giving considerable savings and it’s a real innovation. When it comes to market environment, for North America, we are remaining with our forecast of 2016 of 240,000 units and continue to see a slowing down, so our full cost down for 2017 is 215,000. Keeping in mind also that for our production levels, you have seen that already that we have taken down production more than, well, the retail sales are heading for 2016. So from that perspective, we will have less delta as we see it between the retail level of 215,000 and our own production. Just I think a couple of quarters ago we said that when the market was down 15%, we are taking down production with almost 30%. And if you take the figures right now, market is down just south of 20% and we have so far, taken down production with 37%, so that is more or less the same relations.
For Europe, the activity is still high. We see that in different figures coming in also when it comes to the rolling fleet. When it comes to our connected vehicles, but also official figures such as amount in September, it was up 8% and that is following the same pattern as we have seen during the years of 8% to 9% actually when it comes to mount, but also other similar measurement is showing that. And it’s interesting to see actually the mount figures that it’s compounded by the Eastern European flows. I think you got it on also the other day here. And also what we see, you can see that we are keeping the level 295,000 for this year and somewhat down cooling off of 280,000 mainly related to the fact that the replacement need little bit of the overswing when it comes to replacement is softening, but otherwise, the activity level is high. So, we think 280,000 will still be a good level for the coming year. In our calculations, we have also a little bit considered slowing down in UK also following the Brexit effects, not at least when it comes to necessary corrections giving the pretty weak sterling.
In Brazil, the market is expected to recover somewhat. We have seen signs of that lately that we have reached the bottom, so we expect to reach out very old still from very low levels up to 35,000 next year and we are keeping the full cost of 30,000 for this year and in Asia, well, actually, increasing the full cost for this year from 820,000 to 870,000 units, and all for costing a stable level than for medium and heavy duty. Also, India is expected to continue in the growth momentum from some 330,000 this year to 390,000 whereas Japan expected to be stable on relatively high levels of 90,000.
When it comes to market shares, we would like to start with North America. Obviously, the pressure from the declining market is mainly coming in into the – on-highway segment as you are all aware of. And that is in our case, hitting Volvo that has the strong presence in the on-highway segment than Mack. Also, we had a slow start in the beginning of the year. We have been also focusing on the quality in the business, prioritizing that higher than volume in itself. And as you remember, we also had a hiccup when it comes to deliveries in quarter one due to a quality deviation that we were losing some volumes. We have had good feedback, by the way, from the customers on that activity. But when it comes to volumes, that has been also one of the explanations here. For Mack, given much stronger presence in the vocational segments, where we don’t see the same decline, we are seeing also a slight increase in market share of 0.5 percentage points.
In Europe, Volvo is moving ahead in a good pace, improvement of 0.7 percentage points. And it’s pretty much across the board. Actually, we are seeing improvements in the majority of the markets, whereas Renault is flat on 8%. But it has also been one of the priority for us to remain with the quality in the business, not at least when it comes to the balance between price and residual values for Renault given introduction also of the relatively new Renault T range where also, the first truck is now starting to come back here. And in Brazil, market share is down slightly, but with those low levels that we see is more about sticking to your strategy when it comes to pricing and to be consistent vis-à-vis our customers.
Japan market share is also as you can see down. It started actually with internal transition of production systems beginning of the year where we were losing out some volumes. And during the year, given the relatively high level, we have been losing out some bodybuilder slots. And as you know, the majority of the trucks shift into Japan are with redid executions and bodybuilder. And we are the only – we are not having captive bodybuilding operations. That has been following us during the year, but we are seeing better opportunities for that in the coming quarters here. And as you can see also, we are glad to see that other important markets that like South Africa, Australia and also, as a matter of fact Korea, that we don’t get any official market share figures here are developing well.
When it comes to – yes, there is small comment on [indiscernible], in China with a strong market, we have for our joint venture, DFCV seen a slight decrease in the market share. But also in that case, given the increase in the market, priority has not been to follow that directly, but to also get the right type of pricing into the market that we also have seen coming into the improvement of the result. And in India, the main achievement has been actually improvement in the heavy-duty segment from 3.5% to 5.1% and still continues with the strong level of 33.4% in medium-duty, that is also a slight improvement actually.
Maybe coming to Russia, even that we are hovering on very low levels, some improvements in the total market but still on very low levels and also, in our internal market shares or in the market shares for Volvo. Last year at this period in time, we were just north of 10%. And now we are just below 20% actually. So that is important for the future and has helped us also to restart in a good way, also where we have just increased production a little bit. I will come back to that in a minute.
Order and deliveries, yes, North America again, orders and deliveries was down considerably due to the current correction of the market, mainly in on-highway, but also that the dealers are focusing on continuous to decrease the inventory levels. We have seen inventories coming down, but there are still a number on your own place more optimistic when it comes to the speed. But we are very firm to balance actually orders, deliveries, inventories and we will not produce anything more than we need here and not be tempted doing so.
In Europe, orders increased by 6% with Volvo up with 12% and Renault overall flat. But I think it’s important to mention also that in the heavy-duty range, Renault was up with 7%. And production in Europe mainly for Volvo has been adjusted upwards to meet two factors; the increased demand and also to take down lead times and to have a reasonable order backlog. But we feel now that with increases we have done and we have in pipeline that the second reason correcting, so to speak, the lead times is gradually going away and we will see some slight adjustment in the fourth quarter when it comes to our production level for the European system.
In South America, orders increased by 36% from as you know, low levels. It was mainly resulting from a better export to neighboring markets out from Brazil. But also actually now we see dealers starting to place orders after an extensive period of de-stocking in the Brazilian market. In Asia, both orders and deliveries decreased slightly, mainly due to decreases for Volvo trucks and Renault not down at least in the areas where the big political turmoil in the Middle East. But we also saw increases for UD Trucks. And as I said, the slight recovery in Russia and market share gains have resulted in increases from low levels in Kaluga operations in Russia where we are running now with at least what you can call, an industrial flow which is good for us.
Moving then into construction equipment and also start on the innovation side of the business, we had what we call the exploration forum. I don’t know if anyone of you had a chance to be there where Volvo construction equipment showcased a number of, actually leading technologies, aiming of obviously for CO2 reduction, but also very important other factors like CO2 noise and safety, not at least and also productivity. First of all, the LX1 hybrid wheel loader on the left here, potential to save up to 50% of fuel and also featuring a new type of design. Because when you really start to use the new technology, when it comes to electromobility, you can use the mass centers in a different way, which makes them design much easier actually. When you see the lifting on, for example, it’s only one, if you are interested in technology, but also when it comes to the length and thereby, also improving turning radius for example. So there are a lot of opportunities coming up now and shared ideas also with other parts of our group.
The HX1, hauler prototype as you can see, is a battery electric load carrier and will take part actually also in the similar type of products that we are running with Boliden that we called the electric site with one of the big construction companies in Sweden, where we are focusing then on obviously improved productivity, but also as we said completely new level of CO2 functionality. The aim in this project now is to reduce carbon footprint for the quarter with 95% and gain productivity with 25%. But also with substantially fixed when it comes to safety and noise emissions. The leading position in autonomous electrical and connected operations demonstrated also how the shared technologies across the Volvo Group is very important for the future, both for hardware, components and modules, but also for software, time to market, volumes and business models.
When it comes to the market environment for our construction equipment business, we are for North America then to start with leaving the full cost for 2016 unchanged drop of between zero and 10%. And we also anticipate a further decrease in that market of somewhat zero to 10% also for 2017. The European market continued to grow through August, with 8%, mainly driven by a recovery in France and also pretty strong markets in Germany and Italy, but as we started to see then slowing markets in the UK and further decline in Russia. Europe is forecasted to be stable for 2017 and we leave again the forecast unchanged for 2016 with a slight increase here.
And in China, there are more signs now that the market has reached the bottom even to start to stabilize and our forecast is that the market will grow between 0% to 10% during 2017 for low levels, we have already started to see that in the excavator segment even if wheel loaders are still on the decline, but at a slower pace here.
In Asia, excluding China, the main decline this year has been related to Japan where we are not present whereas India is growing in a good pace. Volumes for next year in that market area, is expected to be flat. When it comes to order and deliveries, order intake was up with 17% compared with the same quarter last year with contributions, more or less, you can say Europe was flat about from all regions and deliveries for the quarter was flat. And as I already said in the beginning, the product mix has been unfavorable with the movement, both between the brands and lighter equipment in the Volvo brand.
North American specific order intake was plus 6%. Also, partly driven by the fact that we have introduced more products for final execution for the compact segment, but deliveries were down as you can see with minus 24%. And in Europe, order intake was more or less flat with better order intake in France and Germany, but offset by weaker markets again in Russia, but also in Norway. Deliveries were up 9% and we are still having positive momentum in market shares in the heavy segments. South America, the strong order intake, plus 6% to 9% for low levels also related to SDLG machines in Brazil, but still deliveries are somewhat on the decline here.
And in Asia, including China, order intake was plus 24% backed by high order intake for Volvo excavators in China, Volvo general growth in India and SDLG in China and Southeast Asia. Deliveries for Asia, was up somewhat, mainly thanks to SDLG deliveries and export markets in Asia. For buses, the general market development, just to give you a flavor of that, Europe, plus 10% and North America stable, but still both are running on pretty good levels, whereas demand is weakening in important bus markets such as South America and Asia. Asian markets affected by lower export to China and lower domestic demand in many markets. Both orders and deliveries decreased with 7% mainly Asia and South America. In South America, it was more or less everything related so far to Brazil. In addition to a decrease of delivered volumes, the quarter also had negative product and market mix offset by continuous improvements in the services somewhat 1%, so maybe nothing to write on about yet.
During the quarter also, the first order for the series produced Volvo 7900 Electric, we got in from Luxembourg, which is very good, reduces fuel consumption with 80%. And we presented also a number of very innovative solutions at the IAA Fair, not at least when it comes to ergonomics. If you take Volvo Dynamic Steering as an example, it actually reduces the muscular strain for drivers with 20% to 30% in normal conditions and up to 70% in specific conditions. And we know from research that that is one of the main parameters to have drivers to be attentive actually. We also introduced pedestrian and cyclist detection and we had energy and urban transport focus with our different executions from hybrids and all the way through to full electric executions on the city bus side. Some major orders is also important for us, 126 double decks hybrids to the UK, almost 140 buses to San Antonio in the U.S. and 100 units to a big customer in Taiwan to mention some.
When it comes to Volvo Penta, marine, if you start with the market situation, marine leisure segment remains flat. But we see some signs of a slight increase. But the sub-segment, gasoline still declining actually. We are gaining market shares in a declining market, but it’s declining. Interesting enough, also, we were awarded Engine and Propulsion System of the Year by Yachts France Magazine. At the World Yachts trophy 2016 recognizing our IPS innovations also for the new introductions we have done in this segment.
In Marine Professional, it is what we see continuously affected by the oil and gas segment, whereas our industrial oil speed into the off-road showed a scattered picture when it comes to the demand, but we are gaining new customers in a good pace. And in power generation, there is a slight improvement related to Asia, Middle East, Africa and export-oriented European markets whereas Europe, domestic, if I may say so, Europe internally and North America are weaker.
Finally, also while both orders and deliveries were down driven by the slowdown in the marine gasoline segment, sales continue with 5% up, driven by a more heavy product mix. Also positive was the increase of 14% service sales with a strong momentum in marine leisure. In this particular business is very good with a long and good summer as a matter of fact and we saw that as you know. So, all in all, Volvo Penta is showing good progress. And I would in particular like them to highlight the awards of new customers in the off-road segment moving forward.
So with that, I will leave the word to Jan to go through the figures for the quarter.
Thank you very much. So, third quarter is here. I think it’s a quarter that is in line with our own expectations broadly. What is all about right now, as you see, is that the demand, if you take the global demand is downwards a little bit, but to see that the regions are behaving very, very different. This means that our task is very much to manage the upswings and downswings in the different regions and to do that in an efficient way. Also, that – which means that we basically don’t have any help for the markets means also that we have to continue to work with our continuous improvement work with the internal efficiency in the company. Flexibility and inefficiency is – efficiency is very important from that point of view.
Sales are down 6%, limited currency effects in this quarter. We see then actually the biggest driver of the downturn of the sales is coming from vehicles, down 10%. Service is a little bit, you can say almost flat. Region-wise here that’s what I talked about before. You can see that Europe is coming up for the group, while North America is coming down. There, we can see that of course also South America, talking about region swings, it’s down compared to one year ago. Asia is a little bit up and then Africa and Oceania is a little bit down. So here you see what we really are working with, with our regional value chains to make this in an efficient way.
The operating income, adjusted operating income. Here we, as you know before, we have also disclosed the one-timers. We make it a little bit simple now and talk about adjusted. I can promise you that we will only have the big major things here and it will be perfectly clear on what it is as well. But I think it makes life a little bit easier both for you and for me when we do this, so basically, coming from a $5.1 billion in profit last year to the $4.8 billion this year. And as you can see, when it comes to different business areas, they are all with exceptional buses actually contributing to the improvement. I would come back on the different business areas a little bit later.
Group functions and other, this is actually very a little bit on the low level Q3 last year. This year we see that it is related to IT. As you remember, we had an external IT business with gross profits that we sold that were included in this item. We have also transitioned costs when we do the outsourcing as well and that is going according to plan. So, the business case is still there. So that is what’s explaining the higher figure that you see in group functions and other.
So, then looking into the different parts of the P&L, that explains the difference and of course, it is the gross income that takes down the profit. And as you can see, the gross income margin is more or less on the same level as last year. So, this is to a large extent driven by or is driven basically by volumes. The efficiency programs or the structure programs that we are running actually both are contributing here as you can see when it comes to cash R&D, selling and admin and it actually goes according to plan. Here, in the other which is not compared to the others that we had on the previous slide, here, it’s mainly related actually to the credit losses in China. Last year, we had approximately SEK300 million in credit losses in China. This year, it’s a little bit shorter of SEK100 million and that’s the main reason for this improvement. Apart from that, you can see here that we have actually favorable market mix. The good markets that we have in Europe, actually helps us from that point of view while the lower markets in North America is taking us down. Service business is actually although not from a volume perspective, but actually this quarter from a margin perspective, helping us also on the positive side.
Cash flow in the quarter, SEK2.1 billion. Third quarter is usually from a season point of view, a weak quarter. As you know, it’s the first and the third quarter. I think here what maybe sticks out a little bit is that the payables side is usually is a little bit on the weaker side compared to what we had in this quarter. And as you know the fourth quarter is also then the strongest cash flow quarter. As you saw today as well, we are divesting some or actually more or less of all of our real estate in Gothenburg as well, it’s SEK2.7 billion and that will of course further strengthen our balance sheet. We are currently at a net debt of SEK7 billion and approximately 9% net debt to equity. You should also remember that we have the fine for the EU investigation or EU settlement that we have as well that will come in the fourth quarter.
Looking closer into trucks then, delivery trucks is down 13%. And of course, it comes from almost half of the sales compared to 1 year ago in North America while Europe is up a little bit more than 10%. Sales then, in terms of vehicles down 13% and service 1%, both currency adjusted. And despite that drop then in volumes and sales that we see, we can see here that we go from an operating margin of 7.2% up to 8.2% for our truck operations. And of course, we have some currency effect as opposed to a little bit less than SEK200 million for trucks. You saw on the group level, it was almost flat. You always ask me, so I can say it immediately, what do you think for the year. And with – when it comes to the transaction effect on the P&L for the whole year, we think it will be around SEK1.5 billion with all the other conditions that I always say as well given the flows and so on.
Over here, we have in the truck business for the quarter SEK200 million, and of course, since the truck is such a big part of the group, you will have exactly or more or less the same explanations as we had for the group on the group level. The market mix, the effects of the efficiency programs, service business also and then also of course, on the negative side volumes and how it affects our capacity utilization. CE, flat in terms of machine deliveries, but here as Martin mentioned, I think is quite an important factor. We see now that the product mix is going in, I would say in their own direction with actually Volvo, the Volvo machines coming down. SDLG machines coming up which is not good for the profitability. And within the GPE segment, we are coming from the bigger machines into the slightly smaller machines. And also, compact is growing more than what the big machines are. So there is a lot of movements in the product mix. But you can say that all of them are right now on the negative side, fairly flat and then in terms of machine sales when it comes to both machines and service.
The operating income is slightly better compared to 1 year ago, 5.2% compared to 4.8%, a little bit small improvement, SEK600 million in the quarter. And here you can see that on the positive side, you have the lower credit losses from China, approximately SEK200 million while we are hit here on a product mix and on the currency side. I will say that this might give you a little bit of picture. We are not doing anything ourselves. But you can say that the product mix are actually overshadowing a lot of the good work that we are doing within Volvo Construction Equipment that we basically cannot see because it’s overshadowed by the product mix. So the improvement programs in CE is and they are there and they give result. But when we do this kind of presentations, we take the major factors that’s why it’s gets overshadowed.
On the bus side, flat in terms of weaker sales and service sales as well. The operating income comes down compared to 1 year ago. And here, we have quite a few interesting currency pairs within buses I can tell you. Since you know, we have operations in India, Mexico, Brazil. And it’s not always easy to – so buses, from a currency perspective does not always behave as the group does as a whole. And this quarter was a negative, almost SEK140 million on the currency side. Apart from that, we have also lower volumes. We have to mention that we have also the product and market mix, mainly mix related within Europe with this quarter being a little bit less on the hybrid side compare, which is actually a good for our profitability. We also see some market mixes actually within the Nordic region that’s been unfavorable to us. But also here, you can say that the cost programs are going and it’s not always structural, but it’s also in terms of costs when it comes to our products and so on. EBIT margin wise, 4.3 compared to 6.1, 1 year ago.
Penta continues to deliver 14.5% compared to 13.5% last year. Here, we see that flat on the product side on the earnings side, 14% up. And it’s actually so that we got almost one more month of service sales in the third quarter, a big part of the regions actually had a very good outcome for us. So of course, especially noted that in the Nordic region, but it is actually what gives us a good development on the service side. Here also from the profitability point, good product mix as well related to bigger engines, 16-liter engines, gensets and these kind of things while gasoline leisure is lower. So that’s also helped the profitability in Penta.
Financial services on a good level, not much to talk about. We see that the profitability is actually improving compared to 1 year ago. In terms of credit risks, Europe is right now very good. We come from a situation, you can say where we have been an extremely good low level in terms of credit risk in Americas while on North America, when it now starts to come back to you can say normal level, which is no worrying signs of what they see United States. We managed the downturn in Brazil in a way that we still actually make money in Brazil on the financial services operations, which I think is good. So by that, you want to summarize, Martin?
Thank you, Jan. I think when it comes to the three points we have already discussed that maintained profitability on lower volumes than in particular the improvements that we have seen in trucks. And also just to come back to what we have talked about during the last quarter, we reported also that we are continuing to drive organization, brand and business area centered, clear and also regionally centered which would be even more important now for the coming periods also with a strength of the regional value chains, not at least when it comes to flexibility and following the different demands, but also when it comes to continuous improvement and connecting more customer centric organization. And we think we feel that we have good momentum and that changed as well actually for the ten business areas of the group. So a clear direction, steady deliveries for this quarter and just moving ahead as a group, I think that’s the summary.
Okay, thank you very much. With now, we open up for questions. Let’s start.
Q - Hampus Engellau
Hampus Engellau, Handelsbanken. I have three questions. Starting off on the cash flow, I think you had a negative working capital effect last year minus SEK8 billion, so it’s a significant step up, maybe you can talk a little bit about that and also if it’s result of cutting production in North America. Second question is on North America, if I do my numbers, it’s easy numbers though, your production was down around 42%, given your guidance for next year, what kind of a delta in terms of production change do you need to do. And then last on Europe, summarizing Hanover exhibition people are still talking about tough pricing and also Daimler coming back, but you continue to grow your business. Maybe you could talk a little bit about that? Thanks.
Yes, if it’s all done with – if we start with North America when it comes to inventories. As we already say, I mean, the 240,000 that we all forecasting for 2016 is, I mean, less than the production cuts we have done both in the calculations and also what we have announced so to speak. We are seeing around 40%. And that means that the delta between the two – I mean partly, we have also lost market shares in all fairness. I mean to calculate I mean, call it spade for a spade. And the second part is obviously that we are seeing also decreases in the inventories, but I mean when – so from that perspective, the 215, I mean, from a production delta, it will be less, so to speak than we have seen this year. But we are all extremely firm that we will continue to have the right balance between what orders we are getting in, deliveries and the inventories and not – I mean, have a strategy of hoping for the best so to speak. So therefore, we are working very close. We are – we will have a number of stop days and adding up to maybe a couple of weeks during the fourth quarter, but I think that is the main message about that is that the balance and the discipline regarding as I said deliveries, order intake and inventory is the main priority and also balance that with the right quality in the business, because with a down pressure. I will not guide more than that when it comes to the production level, but that is the thinking behind what we are doing. And then when it comes to Europe and pricing, etcetera, I think as I have said, we have had a good momentum, not at least for Volvo, when it comes to market share and development and order intake, etcetera. Price wise, it is still a tough market in Europe. And an obvious reason is that there are so many rainy days out there in the other regions. And a lot of the OEMs are using obviously Europe for supplies to other parts of the world as well. So, in a market that is on high levels, Europe, everyone wants to be there. But I should say, it’s stable, it’s something pricing, stable pricing in Europe so to speak. And I don’t know for...
Working capital, if anything, if you look North America with the down is actually negative more than it is positive. I would rather put it on the fact that we, I think also it’s a bit surprising to pay that side, because that we also ramped after the summer holidays to high levels in Europe and we maybe did that a little bit quicker and bigger than what we did after the summer holidays last year. So, I think that’s more of, I would think, it might be as always be this kind of the payment days that we have in the quarter as well. I think we were also little bit surprised, but it’s not related to North America, if anything, that’s a negative.
Erik Golrang, Nordea. Also three questions. The first one on services, particularly for trucks which was down by 1%, I think currency adjusted if you could elaborate a bit of the drivers there and in that context particularly North America where you have been optimistic about the prospects for improving roads and services and when we might see that? Second question is on this production reduction you are planning for Europe, if you can quantify that in anyway? And then the third question is on construction equipment, you made a few comments talking about the shared knowledges across the group. But then, we are also seeing that there are a number of construction equipment assets up for sale out there. We have done by heavy exiting their CE business. We do some as well, doing something with Bobcat. No opportunity to join forces with anyone of this?
Take the second question, I was right, I cannot do two things at the same time.
Okay, sorry. Yes, European production, yes if we start with then services, what we saw in the quarter and obviously, as you know services is a long-term gain so to speak. And for good and for bad both when it comes to the increases, but also when it comes to decreases. And that’s the reason why we really are all focusing on an increased share of wallet when it comes to the customers, because that is serving us the cash and also in – when it comes to – in relation to units. But in North America, we saw a small decline. I mean, more or less trucks, was on you can say steady levels, minus 1%. We saw somewhat decrease. I mean we think that is related to – we are sure that it’s related to a somewhat lower activity on highway segment. At the same time, one should know that our share, market share in North America when it comes to the services is very low. So, the real things that we are driving now, is, for example that we disclosed or that we discussed last quarter uptime focus base the connectivity. And where we are doing it, but I mean, we have a big network. We see improvements in the services.
So, from an activity level, we know what to do. We have a lot of discussions. I was over in the U.S. last week discussing with our dealers how to execute it together, because this is really teamwork and the plan is there. But from quarter-to-quarter, so to speak, I am not worried more than I think it’s an activity level in the short run here, but opportunity in the rolling fleet exists. Then in Europe, we saw improvements for Volvo, but – in Renault, that is again as for North America very important to continue to work on what we have in the rolling fleet since we have been shipping lower volumes the last year. So, we need to capture what is out there so to speak. Production level is seen in Europe. As I said, we have increased for two reasons during quarter three. And we will keep that, to a large extent, in quarter four. But then, somewhere during the quarter four, we will slightly adjust that downwards. And the main reason is that we see that the lead times, is coming back to a reasonable level because one of the other deteriorating points is we have two long lead times. And once they owe to a normal level, we will adjust with the same strategy as we are running in North America or South America. We will not produce to stop basically for as low as possible. And then when it comes to Volvo construction equipment, the reason why I wanted to mention that is interesting to see when you start to see the backbone on new technologies and the importance of sharing the modules and the software around that actually. And then when it comes to opportunities in market, we will continue to overlook that, but we will work on it before we are having working groups on the quarter three reporting, so to speak.
We will have a question from the telephone also.
[Operator Instructions] Our first question comes from the line of Graham Phillips from Jefferies. Please go ahead. Your line is open.
Yes, good morning. Graham Phillips from Jefferies. Two questions, please. First one, Europe and looking at Renault Trucks, can you talk a little bit about what’s happening there in terms of the – if I just have the new T truck on the heavy side, but it looks like things have cooled off a little bit. And what is the impact from the capitalization of R&D? Would that start to reverse in the fourth quarter?
Sorry when it comes down to Renault and Europe, I think in all fairness for quarter three, as we said we had a flat quarter. And in relation to the total deliveries in the heavy segment that is of course weak than – but we have still remained with the market share of 8%. And we are prioritizing the quality of the business for Renault and the good news was actually that we were up with 7% in order intake. So, I think we have the right focus. Also the brand-based organization with Renault will actually also support that strategy that we are convinced and we have a good team in place. And then, when it comes to the capitalization….
When it comes to R&D, for the first two quarters this year, we capitalized more than we amortized. We have said that it will turn in the second half of this year that we will amortize more than what we capitalized. If I remember correct, it was SEK41 million, actually that we had more in amortization than capitalization in the third quarter and that trend will continue into the fourth quarter. We were probably net for the whole year be a little bit more capitalized and amortized though.
Okay, thank you. And my second question is around the financial service activities, I see that the penetration rate has ticked up slightly, but it’s still lower than what your competitors are getting. When you think about the credit rating that you have, is it much more that you can do and what are the credit rating agencies saying about potentially upgrading your credit rating, which I think is two notches above junk?
I think the – when it comes to financial services, I think talking about penetration I think we have the penetration. Of course, there are some markets that we want to improve the penetration, but that’s more out of a business perspective and it’s not at all related to how we look upon rating. There are a few important markets for where we should become better. I think I can mention France is not on a level where we want to see it. Japan is on a low level. We have new also market entries for financial services where we are building up our market presence and the best example of that is India actually. And we are currently on very low penetration levels. And that of course affects the global figures. We have room to continue to develop a good profitable business with good credit control in our financial services without having any kind of effect from the rating agencies. I don’t think it’s at all connected as long as you run it in a good way.
So you don’t think that the business would benefit from a very high credit rating?
That’s another thing. I mean the cheaper we can borrow money, the better it is for our business, absolutely. That I agree with you.
Exactly, so what sort of thing do you need to do to improve that credit rating?
To improve the credit rating is to improve the profitability in the long run, take down the swings in our profitability that we have had historically, i.e. to take care of global upturns, downturns and regional upturns, downturns.
Increase services. That’s what we can do.
And be disciplined when it comes to the balance sheet and capital allocations. And in that respect also, we announced this morning that we are also maybe that we will go to also that we are divesting real estate in Gothenburg, in line with our strategy to concentrate our activities in Gothenburg to [indiscernible]. And that is also in the short run. But I mean this is to simplify the portfolio to really I mean concentrate around the items that Jan said here.
Now I understand that. I mean obviously, selling those assets helps, but of course in the fourth quarter, you have now indicated that the EU truck fine will be going out the door and I think you also got China credit losses that have to be reimbursed to bank, so I think it’s SEK6 billion or SEK7 billion that goes out the door on those two items?
We have another question from the telephone before we turn back [indiscernible].
Our next question comes from the line Klas Bergelind from Citi. Please go ahead. Your line is open.
Yes. Hi Martin. Hi Jan. It’s Klas from Citi. I have three questions, please. Firstly, on Europe again, I understand that you are quite flexible looking at the workforce, I think you can cope with a low double-digit decline in volumes without seeing much margin impact, but what about price versus cost, so we see input costs increasing sharply and we know that pricing is not great in Europe, you have Scania with the new truck range and Daimler wants to take market share again, so do you believe price versus cost will get worse from here?
I mean when it comes to the marketplace when introductions are happening. And normally that is changing a little bit of the dynamics. So that we had to look what is happening. But as we have said also, in this pretty harsh environment, not at least when it comes to the export markets out from Europe, I think we have maintained a good discipline on that. And that is what we are working on. And obviously, we need to continue to offset different type of input costs with productivity gains and simplifications and taking out of the type of cost. And that is the basis that we are working now with a brand based organization, P&L responsibility taking out so the speak via efficiency and the quality improvements, etcetera.
Okay. My second question is on Europe, I am looking a little bit about how you look at the different countries, they are down 5% next year. How much of this is driven by UK market that already was near peak before Brexit versus other countries, I assume that UK will be down quite a lot and then may be Northern Europe softens and Southern Europe perhaps flattish, if you could just help us a little bit your thinking on the country level, please?
First of all, I mean as I said, we see two main factors and obviously then you have a little bit mix in the different forecasts for the regions, so to speak. But still obviously, Southern Europe has a potential upwards. You have so to speak, an unrealized replacement need to some extent in Southern Europe. But the two main factors that we have been looking into is not big, really big swings in the normal marketplace. Its one effect is softening UK following Brexit and also as you said, peak. And also that we see that average vehicle age is coming down, so a little bit over-swing that we had in replacement will come down, but still market on good levels. That is what we are forecasting. And then we see good activity as we said also in Eastern Europe also and not at least when you follow the flow activities, both I mean our connected vehicles and also when it comes to mount and other indicators.
Thank you. Finally, you think in that construction equipment and looking at the margins, so again perhaps more relevant for CE than for trucks, I mean if steel prices are up quite a lot then the impact on COGS, typically lags to your prices a couple of quarters, the fourth quarter is always seasonally weaker on demand, how concerned should we about the margin for construction equipment going into the fourth quarter, I mean you have the negative mix headwinds from brands now and potentially you could have this price cost getting weaker?
I think first of all, when it comes to the raw material prices, as you correctly said, they usually kick in with the lag, both when it goes in the right direction and when it goes in the wrong directions fortunately. So I think that will probably take a little bit time before it kicks in. Then when it comes to the – as you correctly said, the fourth quarter is a weak quarter and that from a seasonal point of view and I think you guys should be cognizant of that and of course looking to what we, in terms of the product mix as well sort of order intake for steel and so on. And I think that’s what you have to watch out for.
Thank you. [Indiscernible] from Colliers Asset Management. A question on the service network and the strategy, you have opened up the Volvo service network and allowing Renault Trucks to be serviced as well, could you elaborate on how that strategy is going, for example we heard that in Norway it’s doing very well, Sweden is not really opening up its service network to Renault trucks, but how is that strategy going overall in Germany and other countries?
First of all, if we take the sales and service network, the strategy generally speaking, we – our main strategy is to have that separated as much as possible when it’s possible from a critical mass point of view. When it comes to sales it’s given, so that’s we are all working hard on to really have that to all the way to the dealers, etcetera. And then when it comes a service network, obviously we use the force of the group. So where we don’t have the right critical mass for, one brand or for the two brands combined, we should obviously use the fact that we can combine, so we have the right presence, because presence is everything. And when it comes to work of using the different networks, it can also be I mean vice versa. I think that is running according to plan. In some areas, we did go too long and that we are correcting now and in some areas, we still have work to do to have the right presence, but it’s an ongoing work. And it’s a good to both coordination and understanding between the two brands. And then it might be in some places where it’s not executed well and then we need to correct that obviously.
Excellent. Thank you.
Björn, Danske Bank, a short question on JVs and specifically then in China, Dongfeng, the results that we see in the P&L, is that a reflection of where you are in terms of where the market demand which is very much burdened by ongoing investments?
I think when it comes to our join venture in China, last year was as you remember, 2015 truck markets went down quite a bit. If I remember, it’s approximately 25%. For the whole last year it was making losses, including the third quarter. This year, with volumes coming back, the joint venture is turning into black figures again. So it actually performs better compared to 1 year ago. I think if anything, the focus in it is a little bit we would try to focus on the quality in the business we are doing and that’s why we see a little bit of loss in market share. Also the market, there are some pretty aggressive players in the market as well for the time being. And we rather focused on actually keeping a good and sound business there. But year-over-year it’s actually improving if you look upon the entity. Then you can get into the Noble Auto Group reporting and then can talk to Christer afterwards, why it’s not shown more in this line that you have in the P&L. But Christer will be more than happy to take you through that.
One more question from the telephone.
Our next question comes from the line of Alasdair Leslie from Societe Generale. Please go ahead. Your line is open.
Yes, hi. Good morning. Couple of questions please. Firstly, just in trucks, obviously, service down 1% adjusted overall, but North America down only 1% as well. So, can you call out what your service growth was in Europe perhaps in the quarter, because I guess we really should be expecting that to be improving quite nicely given obviously rising activity utilization rates, etcetera? And obviously, you have a sort of strong focus on service as well. And sorry I missed part of the call earlier and really is a follow-up to a couple of questions before. But why is there a decrease of service in Renault? You mentioned a decrease in the rolling fleet, but shouldn’t that installed base be relatively stable. So, is it perhaps something more structural there? And the second question just on South American trucks, obviously, orders were up very strongly in Q3, 36%. You said you are starting to see dealers place orders again in Brazil, which is very encouraging, and yet you are still calling for fundamentally a flat market next year. So, maybe if you give some color there on what’s happening and what you think we need to see from here to make it a bit more confident of a sort of stronger rebound in the Brazilian market next year? Thank you.
Yes. As we said, when it comes to the service business for trucks down, we are down a little bit more than the average in North America excluding FX is approximately 2% actually and that is really the lower activity in the short run that we see on highway. But we also have as I said activities going on, because there is a big pent up demand. And through our uptime centers, specific activities, the dealers that are executing all this strategy we see positive momentum. So here, it’s about. And also, I mean, continuous penetration also of the captive powertrain, not at least now when it comes to M drive for Mack Trucks. There are a number of good parameters. But in the short run in this quarter, we are down 2% excluding FX. And then – and in Europe then, coming back to what I said about the rolling fleet, I mean, we have had lower shipments. I mean, we have come down from a level of north of 10% market share, not at least then in the heavy segment. And that is in the long run affecting. And even if you have a rolling fleet that is pretty stable. We know also the market shares are declining over time. So, we have a higher market share when the trucks are so to speak young and that is something that we are working on, but that is the fact. So, I don’t think you should look at it at structural more than the fact that we need to work on the volume. And as we have said also, the share of wallet, I mean, what we can do for the customers to have the high penetration and in some of the markets, where Renault big – it has been a traditional of customer workshops, for example. But I think, in many cases, we have good discussions. And again, with the brand-based organization, you get the right focus or the full P&L. And what you need to do for that specific brand so to speak. So, I think that is more or less the main comment.
When it comes to South America, as we said two reasons for, so to speak, the production levels and deliveries, I mean, the export markets are okay, it’s actually both Chile and Peru and also Argentina moving in the right direction. And we see that signs of that the extensive destocking has made stocks coming down to right level also in Brazil and started to place orders. But as we said in the forecast, we don’t believe in a quick uptick. And therefore, we need to continue to focus on efficiency in the regional value chain that we have in Latin America or in South America. They have done a very good job so far and further adjustments will be done also during fourth quarter to fine tune that. So that is….
Sorry, just as a follow on to that, sorry and again I did miss part of the call. So, you might have commented on this early. But if you could just comment on probability down in sort of Latin America, Brazil at present, that would be great as well?
I mean, we don’t comment on that one, but it is – if you take Latin America as a whole, it’s actually working in profitability. And then, of course, we utilized the fact that we have a good – the fact is that we have a good production right now in Brazil with low cost value to the currencies, while the other markets in Latin America is more dollar related. So, actually, as a whole, South America is pretty good and Brazil is not that bad either to be quite honest.
But I think this is exactly also one of the main messages from us. I mean and also not at least internally how we are operating now. We cannot hide behind average. This is where we have swings in the different regions, markets close by, but we have the strength in the group that we have the regional value chain. So, the more link they are the better we can operate. And I think the uptick on 7.2 to 8.2 given averagely minus 13, but all the movements you have between markets, regions, etcetera is showing an underlying strength and performance at closeness and that is what we will continue to focus on.
Anymore questions from the auditorium? Okay, we continue with one more then from the telephone. Last one.
Our last question comes from the line of José Asumendi from JPMorgan. Please go ahead. Your line is open.
Many thanks. José at JPMorgan. Couple of items please. The first one, I wonder if you could help me have a little bit on deliveries, trucks, North America, Q4. We are looking for a step-down versus Q3 or was your business sense, are we looking for flat maybe versus Q3? Also coming back to LatAm, I used looking also to see sequentially orders up in Q4 versus Q3? And then final item will be which I think about the business into 2017, particularly in the truck business regardless of the end markets, what kind of efficiency gains can you get of the system to continue to offset incremental R&D, incremental depreciation charges if you could maybe put a number to that? That will be very helpful. Thank you.
I think when it comes to North America, I mean, we have been guiding on, on the total market. And also a little bit what we expect when it comes to market share as I said. And I think it’s possible to have maybe an idea about what deliveries, etcetera should look like. I mean, you have to consider a little bit when it comes to the stock reduction that has to continue to take place. When it comes to overall industry stocks, it peaked actually and if I remember correctly now in October last year with some more than 70,000 units, 73,000, 74,000 units, I think now we are down to around 55,000. And for the whole industry and in that regard, we have been better off and we will continue to make sure that we have strong discipline on that and the industry needs to take down the level to somewhere around 40 or just north of 40 we think. So, they are all the parameters really to think about when it comes to the fourth quarter. And then when it comes to South America, as we said, we have seen some signs lately on stabilization, etcetera, but it’s very early days also to say what is what and we feel a little bit now when we have executed the destocking, but again we stick to the guidance of 30,000 and 35,000 next year when it comes to the market in Brazil and with knowing also that the stock levels are more normalized again.
And in terms of efficiencies and so on, I mean, we are – while we leave this here, we are leaving, you can say, the SEK10 billion structured cost reduction programs, we have already before that, of course and what we just talked about, how we want to become much more efficiency along our value chain working with continuous improvements and get that flow to work in the company. Connect the different parts of the company much better to what they have been before in extremely functional organization and work along the value chain. There are huge gains to take out of that when we do that in a good way, everything from the sales and service person all the way through the organization to R&D. There has been too many gaps there and that’s been extremely inefficient. So, that is the thing that we are focused on going forward. And of course, there is a potential in that, but we have not quantified that to the external work.
And when are you going to quantify that?
I have quantified it, but if we are going to tell it to the external, that’s another thing.
Yes. But I mean, also just as a reminder, what we said also during our capital market update in London regarding capital expenditures we said also that the level that we have had historically is not what we will see in the future. I mean, as a factor of 1.3 or 1.4 over depreciation so to speak.
Okay. By that, I think we say thank you for this press conference and thank you very much for attending.
Thank you very much.
Have a nice day. Thank you.
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