Sandvik's (SDVKF) CEO Björn Rosengren on Q3 2018 Results - Earnings Call Transcript

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About: Sandvik AB (SDVKF)
by: SA Transcripts

Sandvik AB (OTCPK:SDVKF) Q3 2018 Earnings Conference Call October 23, 2018 7:30 AM ET

Executives

Ann-Sofie Nordh – Head-Investor Relations

Björn Rosengren – President and Chief Executive Officer

Tomas Eliasson – Executive Vice President and Chief Financial Officer

Analysts

Klas Bergelind – Citi

Guillermo Peigneux – UBS

Matthew Spurr – Exane BNP Paribas

Max Yates – Credit Suisse

Graham Phillips – Jefferies

Markus Almerud – Kepler Cheuvreux

Alexander Virgo – Bank of America

Sébastien Gruter – Redburn

Andreas Koski – Nordea

Ann-Sofie Nordh

Greetings, and welcome to the presentation of Sandvik’s results for the Third Quarter 2018. I’m Ann-Sofie Nordh, Head of Investor Relations at Sandvik. And today as you may notice we have a new setting for this presentation, but the format remains the same. Our CEO, Björn Rosengren and our CFO, Tomas Eliasson, will run through the presentation in due course after which we’ll open up for Q&A, both from the conference call, but also there’s an opportunity to put questions through online.

And with that said, I’ll hand over to Björn and Tomas for the presentation.

Björn Rosengren

Thank you, Ann-Sofie. And also I like to wish you all welcome to this Q3 presentation. Starting up with a little bit of highlights of the quarter, we see strong development in all three business areas with also solid development in more or less all our segments that we are operating in, as well as the three geographical areas, possibility 18.9%, which I think is a good number for the Group and happy with that.

And not least, you who listened to me in the last quarter was a little bit disappointed with the cash flow, now we generated SEK 4.7 billion in cash flow, which is well in line to be able to reach our targets for the full year.

Yes let’s talk a little bit about market development. And we see, as I mentioned, strong growth in all three major geographical areas, Europe up 10%; North America, 14%; if you look at U.S., out of that was 13%; and then in Asia 10%, which is in line with what we will seeing and also in China, which was 10%. The segments are pretty strong all of them. This slide that we can see on the automotive, which is flat, as well as in the mining, sequentially, I think, it’s pretty much in line with previous quarter.

So on orders and revenues, we were up 9% in the quarter and 10% in revenues. We can see that we have a book-to-bill ratio which is just under one. And if we look at the full year, we actually reached 107%, so looks good also for the future.

On the EBIT development, I mentioned I was happy with reaching 18.9% or SEK 4 billion, almost SEK 4.6 billion. And this is a 37% increase. But if you exclude the currency part out of that, as well as the structure and metals, it is a 25% increase, which, I think, is on a good level. Normally as you see here on the chart that the third quarter is seasonally lower than the other quarters during the year.

So if we take a little bit deep guide into our operating units, starting out with SMS and you all know SMS is the best indicator of the market. We saw solid growth, 8% in orders. So when it comes to price volume we saw a good EBIT margin of 25.4%. This has also been a very exciting quarter for SMS. It was the big show in Chicago, the IMTS, where all the two manufactures are gathered every second year. And on this show we received the price also for the most innovative product of the show. Exciting, I find. And that was the Silent Tools. So shows that we are on the frontline when it comes to new product development and technologies.

Then moving over to Mining and Rock Technology, we had an order increase with 8% and revenue increased with 14% and a profit margin of 18.1%. And I’m happy with this 18.1%. Give you a little bit more in-depth in that number is that if you would take the FX out of that number, it’s actually 18.6%. And if you instead lift out the Varel of that business, as you know, is up for sales at the moment it is actually 19.3%. And I think here we start seeing this business now coming up to the levels where, I think, it really deserves.

On the order side, 8% might be seen as a little bit shy. I think I still like to say that the momentum in the market is good. And I’ve been traveling around pretty much in this quarter and visited a lot of customers. I think with the metal price levels that we have both on gold, as well as copper and, I think, nickel, we feel that this is a good level for continuous strong demand.

Then to SMT, or material technology, I think, it goes from clarity to clarity. I’m extremely happy to see orders continue to go at the high level 22%. And if we take out the large order for umbilicus during the quarter, it’s still 70% up so actually good numbers. We are also seeing improvements in the performance in the EBIT levels where we are underlining is 5.7%, which of course is significantly better than the previous year and the reporting a 6.9%. I think this is in line with what we do expect to be able to reach the 10% next year for the full year. So, I think, it’s doing well. I think management and the whole team are delivering great according to the plan.

Also I like to mention there a little bit on the oil and gas market that the underlying investment climate in the oil and gas market is actually showing good indications and we are pretty optimistic moving forward.

Tomas, by that I like to hand over to you. And a little bit in depth in the numbers please.

Tomas Eliasson

Thank you very much Björn. So let’s jump into the numbers. And let’s start with the financial summary as usual.

Orders were up 9% organically, and revenues 10%. Currency was plus 6% on both orders and revenues, and structure was -5%. And structure here was the divestments of Process Systems, and Hyperion and both of the wire business and also the acquisitions of Metrologic and Inrock, net-net -5%. So all in all, plus 11% for orders and 12% for revenues.

If we then continue down the income statement, look at the earnings SEK 4.7 billion, compared to SEK 3.4 billion a year ago, quite an improvement. And SEK 4.7 billion was sort of SEK 4.6 billion is not bad for third quarter, 37% up. And also the margin 18.9%, it’s very, very strong for the third quarter. 18.9% compared to 15.4% year ago and we’ll have a look at that in the bridge in a moment.

The finance net came in at SEK -140 million, an improvement compared to the SEK -193 a year ago. Behind that the most important item is of course the interest net. And the interest net came in at SEK -150 in the quarter, compared to SEK -202 a year ago. That’s a reduction of 25% on the back of reduced debt, as well as recapitalization of the subsidiaries.

Tax rate, 26.1% in the quarter, reported was even lower. And we’ll have an extra look at that also in a little bit.

Working capital was reduced sequentially which had a positive impact on the cash flow. But however, as you can see the percentage was up and we have a little bit of a build-up in inventories in all three business areas. And of course inventory management will be a focus area for us for the coming quarters.

Cash flow SEK 4.7 billion also good improvement recovering very good for the third quarter.

And finally, returns on earning per share showed very good improvement.

So let’s have a look at the bridge on the next slide here. And if you look at the organic part, the 10% improvement on the top line, SEK 2.1 billion, SEK 839 million in EBIT effect that gave us a leverage of 39%. And the leverage was good in all three business areas, 47% for SMS, 35% for SMRT and 45% for SNT. That gave us a margin accretion of 2.2 percentage units, currency added 0.5 and structure of metal prices and one offs and structure add 0.8. So if you strip out currency, you strip out structure, you strip out metal price effect the margin in the quarter was 17.6%. So 15.4 plus 2.2, very strong margin.

Now on the next slide here let’s take a little bit of a dive into the reported tax rate, because we have some things going here now in this quarter. As you can see the reported tax rate was 22.5%, but that includes the capital gain from the Hyperion divestments and that came in with a very low tax rate. So if you strip that out, the underlying tax rate was 26.1%. And the guidance that we have for the year is 26% to 28% it’s been like that for quite a few years now. And we said at the start of the year that the guidance will remain 26% to 28% but in the lower range. And that’s where we are right now. And then we’ll see what happens with the guidance in 2019, but we’ll come back to that early next year.

Okay, so let’s move on to the balance sheet. Working capital, as mentioned, was reduced in the quarter even though the percentage was up. On the right-hand side, you can see the working capital by business area. It’s a bit up for all three business areas, and especially for SMT. But cash flow is improving, and we still have our ambitions, and we’re focusing on it.

On the next slide here, cash flow. You can see that in Q3 the cash flow recovered, nearly SEK5 billion according to plan. If you look at the right-hand side, you can see earnings improved – contributed. Working capital contributed, and CapEx was around SEK 1 billion. So SEK 4.7 billion in cash flow compared to SEK 3.7 billion a year ago.

And that, of course, takes us then to the financial net debt or the net debt really. It’s both financial net debt and pension debt here, reduced down to SEK 15 billion. Gearing is 0.22 – sorry 0.27. And of course, we had some divestments in the quarter, but also some acquisitions. So the net-net was SEK 0.7 billion from divestments and acquisitions. So the bulk of the reduction was operational, and this will continue going forward in Q4 and in 2019. So a very, very strong balance sheet.

So let’s take a look at the guidance. First, Q3, what happened in Q3? We guided SEK 650 million plus in currency effects. We came in at SEK 608 million, so in the neighborhood. The total currency effect though was SEK 381 million. The total currency effect includes revaluation of the working capital and hedges and what have you. There’s no possibility to guide about that. It is what it is. You don’t know what it is until you come to the last day in the quarter.

Metal price effects, we guided SEK 100 million plus, came in at SEK 39 million in the quarter. That’s the in-quarter effect. It’s not a bridge effect.

And for Q4, we guide underlying currency effect of SEK 400 million, and we guide metal prices on minus SEK 100 million.

And then for the full year, CapEx, we keep the SEK 4 billion, as the full year guidance. We’re on SEK 2.7 billion year-to-date right now.

Net the financial items stays on SEK 1 billion, as we’ve been guiding since the start of the year. And the tax rate, as we discussed, will be between 26% and 28%. But as you can see from the year-to-date numbers, it’s more closer to 26% than anything else, but we don’t know until it’s over, until we have the full year.

And with that, I’ll hand back to you Björn for summary and conclusions.

Björn Rosengren

Thank you, Tomas. If we summarize the quarter, we can say that good demand in all three of our businesses, also in the different segments as well as geographical areas. The development of the profit EBIT margin continues in the direction that we are driving the company. We had a good quarter when it comes to innovation. We had a fantastic prize at the IMTS show. But also during this quarter, we were included in the Dow Jones Sustainability Index also this year, where we were actually 92% better than our audited peers. So we are very happy for that. It shows that we are working – going in the right direction.

But maybe the most important of all is that Sandvik is a very strong company today. We have an enormously strong balance sheet, which we have been working. We have a strong cash flow, which we expect to continue in the near term – future, which will put us in a situation where we are close to being debt-free. This gives us a lot of muscles and opportunity when it comes to the growth, which we are focusing on, and opportunity when the valuation of some of the targeted assets are going down the right level, we have a good striking power. So with a lot of optimism and courage, we are looking forward to an exciting future.

Thank you very much. By that, I actually want to give over to Ann-Sofie for the question-and-answer part.

Ann-Sofie Nordh

Yes thank you. And what that we’ll open up for questions both from the conference call, but also please feel free to use the online option. And operator would you please put through the first call from the conference call please?

Question-and-Answer Session

Operator

Of course. [Operator Instructions] And the first question is from Klas Bergelind from Citi. Please go ahead your line is open.

Klas Bergelind

Yes hi, Björn, Tomas, it’s Klas from Citi. A couple of questions from me. First on SMS and automotive. You’re seeing stable demand in Europe and Asia slow down versus last quarter, but not as dramatic as, I think, many would have thought. European light vehicle production is down 3% in the quarter. China is down 5%. So first of all, are you taking any market share? Or is it just simply that we should expect that lag effect where you expect incremental weakness into the fourth quarter as it takes some time to get the inventories in the channel out? I think you alluded here on my screen that there’s a weakness in China towards the end of the quarter. So what have you seen at the start of the fourth quarter in automotive, please?

Björn Rosengren

I think the fourth quarter if you look at, I mean, we have had a couple of weeks here, it continues approximately at the same level as we saw in September in the third quarter. So it’s on a good level. Normally, the Q4 is on a higher level than we see in Q3, which we are following pretty much for the business.

As you mentioned there that we saw some weakness during the end of Q3 when it comes to automotive in China. If we’re looking at the quarter, I mean, what we’ve seen – SMS I think it’s a good indicator, of course, for the automotive industry, but also for the whole industry. And what we saw during the quarter, which was somewhat softer in China, was actually compensated in North America when it comes to demand. It’s, of course, difficult for us to predict the future.

And I think, from our perspective, we read the newspapers, and we read the same as you doing about the automotive industry. So of course, we are preparing ourselves in a good way to be able to handle that when it will affect us.

Klas Bergelind

So – but obviously, the fourth quarter will always be higher than the third because of seasonality. But on daily sales in automotive, there’s nothing that you’ve seen in terms of weakness across Europe and China? I mean, obviously, China a little bit, but…

Björn Rosengren

I mean, I can see, of course, for the whole part, not just for the different part, but it continues on the same level on the daily rates as we’ve seen in the previous quarter.

Klas Bergelind

Okay. My second one is on mining. The weakness in the copper price thus far seems to be driven by currency. We understand that most projects are going ahead, even the green fields that have been announced. At the same time, we see these results isn’t some earlier signs of that discretionary spend or large orders now being pushed to the right owing to the increased uncertainty around macro and tariffs. When you look at your project pipeline, Björn, in mining, do you see any hesitation from the miners now? I know when I met you in September that wasn’t the case. I wonder if that has changed.

Björn Rosengren

I’ve been actually spending quite a lot of time out in the market visiting customers in the regions. You know that I spent quite some time also in South America, where we see the copper in Chile with El Teinte [ph] and Codelco, and so on. I think it’s quite a good mood in the market. A lot of big decisions has been taken within copper. We all know that most of the copper mine is going underground at the moment, which means big investments. We know that the copper rates are actually getting less, which means that you have to dig out more rocks.

So I think it’s a pretty good sentiment among copper today. The price is not so bad, to be honest, that it’s around $6,200, $6,300, which is quite good number. Historically, we say when it stays over six we say that the market gets pretty good. And of course, it’s driven also by the higher dollar in many of these countries where you do in the mining, some of these where currencies are significantly weaker than the dollar. So of course, they make quite good money on there.

So I mean, if you go out and listen to the market, it’s pretty good. They are pretty optimistic out there. I agree that I think maybe 8% was a little bit shy from what I expected maybe I would have hoped 10% for the part. But I would say that September was better than summer. It was more quiet during July and August. And then we saw a good pickup in September. To be honest, I mean, I’m pretty optimistic for the next quarter. It’s difficult, of course, to see moving too long forward, but the sentiment in the market is quite good on mining.

Klas Bergelind

Okay, good, good. My final one is on the moving parts in SMRT. Am I right that Varel is a 13% margin on EBITDA, midstream mining construction perhaps 10%, and therefore drilling and holding slightly above 20%? And in that light, if that is the case, what is the upside to the SMRT margin when you look into 2019? Because those margins across the three verticals are in line or near others in the sector with solid market shares. Just want to see the opportunity. I mean, how can SMRT be the number one on profitability across drilling, holding, Varel and in crushing and screening?

Björn Rosengren

I’m – my heart is in there, and I’m pretty optimistic about the SMRT future. Let me give you a little bit an insight. I cannot, of course, not comment on all the margins that you said but I will give you Varel. It was not that strong actually quarter for Varel. It was down in 7% underlying, which is quite significantly lower than we saw during the second quarter there. So if you look at SMRT without Varel, I said we actually did 19.3%. So good.

So where do we see the upside? We see continuous strong development in the aftermarket. And you know from before that the aftermarket is key to the success in the SMRT. It gives stability. It gives profitability and also agility in a downturn. So that continues to develop in a fantastic good way for Sandvik. And I think this is not only driven by that the market is growing, but also that we – I think we are doing a better job when it comes to the aftermarket. But the most important – and I said it before, and underline it here again, that is the automation. It is so exciting. More or less every mine around the world – I mean, maybe you visit a number of them, are today looking into automation.

So I think that is going to drive the business going forward, but it’s also going to get Sandvik closer to the customers. And when you’re closer to the customers, you can develop your aftermarket and your support business, but also drive equipment. So that’s where I’m the most optimistic, and there are so many exciting projects on the automation side going forward. And the technology is there, so it’s a quite a unique opportunity we have at the moment.

Klas Bergelind

Thank you.

Ann-Sofie Nordh

Thank you, Klas. Operator can we have the next question please put through?

Operator

Of course. Next question is from the line of Guillermo Peigneux from UBS. Please go ahead, your line is open.

Guillermo Peigneux

Hi, good afternoon Guillermo Peigneux from UBS. I actually wanted to ask about ground tools in Machining Solutions. How much revenues in Q3, I mean, we could have basically that as well for 2018 so far? And also what was the growth relative to the other part of SMS in relative terms?

Björn Rosengren

I don’t think I can give you that split when it comes to round tools, but it’s correct that round tool is actually growing faster than what you’re seeing on the insert market. And that’s, of course, the change in the market. And here, this is the same with the Sandvik, that we managed to grow with this market quicker on the round tools side. And what’s exciting is not because you know we always said that there should be less margin when it comes to round tools, but I think we have been able to prove that we can keep the good margins also on the round tool development even though that is actually growing a little bit faster than the insert market.

Guillermo Peigneux

Thank you. And the follow-up on that, I believe, and correct me if I’m wrong, that part of the round tools franchises manufactured by yourself and part of it is actually round tools that you buy and then you do photovoltaic deposition. And I wonder whether you have also more or less a split or a feeling how much is what. And so how much is produced by you at Sandvik, and how much is just bought and then coated? Thank you.

Björn Rosengren

I think we produce the majority of the round tools. It varies a little bit also between the brands. For instance, if we see Walter has always been the one with highest percentage of round tools in the market, but we see, at the same time, both Seco growing very quickly there but also Coromant very strong development in round tools. So the majority of what is being sold is actually produced in house.

Guillermo Peigneux

Thank you. And my last question is obviously relating again to the SMS division on the inventory levels and the 60 bps, how you get, obviously, on a year-on-year basis. But I was wondering whether it would have been – given all the signals that we do have in car

production and in some of the trends in different cycles, whether in order to preempt or try to anticipate the cycle, some inventory destocking or more aggressive inventory policy was needed? Or are you confident with your inventory levels as we stand right now?

Björn Rosengren

Of course, I’m not happy with building up SEK 250 million in inventory during the quarter. And when we look at SMS, it was actually higher. We’re talking over SEK 400 million there. But the important thing is that half of that is actually coming from buying of powder as well as recycling components for the future. That, I think, will get down pretty fast. We are running our production facilities a little low now because we need to get the inventory in time. We have pretty tough targets when it comes to net working capital going forward.

So I think all our operating entities. And this is not only SMS, it is SMT that need to focus on this. It is SMRT. They all have different reasons for why the inventories are high, but I can assure you that it’s a strong focus in all our operating entities, and we are determined to reach our target when it comes to net working capital as well as the cash flow going forward.

So the focus is absolutely there. We’ll be working hard during this – during the Q4. So I need to prove it for you guys, but that’s the objective.

Tomas Eliasson

And one mustn’t forget that we – I mean, we’re in a situation now where we have growth on growth. I mean, we’ve been growing for like eight quarters now and running the supply chain in strong growth for that long time. I mean, it’s a delicate balance. Now, I mean, the growth number this year is not as big as last year. So yes, it’s a focus area right now.

Guillermo Peigneux

Yes, thank you very much. Maybe I can ask another one. Remind me – I can’t remember now whether your electrified mining equipment is running on mobile batteries or you need basically to stop the machine to recharge and load the battery backup. Therefore, you just basically have more downtime? Thank you.

Björn Rosengren

Let me talk a little bit about electrification because I think this is an exciting area for the future. It’s the same in the mining market. We talk a lot about battery-driven loaders and truck and also drill rigs. On the drill rigs, it’s a pretty simple solution because you have these batteries there where when you’re tramming them really back and forth, you use the battery. And when you drill, you actually connect to the grid, which you always do with a drill rig. So at the same time as you are drilling, you’re actually loading your batteries. So that is a seamless flow. When it comes to loads and tracks, it’s a little bit more difficult. And there, I think we have the same challenges there as every electric car in the market. And that comes to how long you can run on the batteries before they are – they had to be recharged.

So far in the market, this market hasn’t taken off yet. There are a couple of mines who are running test units in the market and trying to get acquainted with it. I’m convinced that to get mining permits in the future, you need to be there with this electric.

For Sandvik, we are in quite a favorable position when it comes to this electrification because we actually started to work with electric cables on loaders long before anyone else, and we offer today a full range of loaders where you actually connect yourself to the grid with long cables that are – so a combination where you need to tram one of these trucks or loaders up for the ramp. You can actually connect yourself to the grid. While you are tramming on a flat surface, you can use the batteries. When you are using the grid, you are also loading the battery. So there is a lot of different tries – different technologies that we are experimenting with at the moment. And I think in a couple of years, you will start seeing some mines buying this equipment. But it’s still an early stage, and it’s a very few units that are really actually operating operationally in the market yet. But I’m convinced there will be – and I can assure you that Sandvik is being part of that development, and we’re going to be in the front line.

Guillermo Peigneux

Thank you so much. Very helpful.

Björn Rosengren

Thank you.

Ann-Sofie Nordh

Thank you, Guillermo. And both you and Klas work as good reminders for me to remind you to limit yourself to two questions each, please, because I know there are a lot of people waiting in the line to put their questions through. And with that said, operator would you please put the next question through?

Operator

The next question is from the line of Matthew Spurr from Exane BNP Paribas. Please go ahead your line is open.

Matthew Spurr

Yes good afternoon everyone. Thanks for taking the question. I had one on mining and consumables. Can you talk a little bit about the consumables development? It’s been sort of up and down. The commentary this quarter on mining and consumables reached quite nicely. But some peers and competitors, it sounds as though it’s still quite a tough area. Is it different for you because of where you’ve got stronger market shares? Or is that still difficult?

Björn Rosengren

When we talk about consumables within the mining industry, I think we have, of course, a strong market share in more or less all the areas where we are operating. The consumables, together with the service business we call the aftermarket, which there represents 60% to 65% actually of the total sales of Sandvik, we had during the quarter a good development, just under 10% development, on the consumable business. So that reflects a little bit of what’s happening operationally in the mine. The service and the consumables, that’s the activity level that we are seeing. So it’s moving quite good at the moment.

Matthew Spurr

Okay. And then can my second one be on back to SMS and sort of the demand profile? So you said that the Q4 started on the same sort of level as September. I didn’t quite catch whether you said September or Q3. Can you say how the exit rate was in September versus the rest of Q3? Just trying to get an idea of whether there was a slowdown towards the end of the quarter or not.

Björn Rosengren

The slowdown we saw, that was within the automotive in China. That’s the part. Otherwise, I think it’s on the – on a flat level.

Matthew Spurr

Okay, thanks.

Ann-Sofie Nordh

Thank you for the two questions. Much appreciated. And we’ll have the next question put through please operator.

Operator

Next question is from line Max Yates from Credit Suisse. Please go ahead your line is open.

Max Yates

Thank you. Just the first question is on mining. So you talked about the timing of large orders, and I just want to try and understand whether that was more a technicality of when you’re booking them, and you perhaps now booked them already in October or whether that was a reflection of seeing sort of some increased hesitancy across customers. Perhaps you have booked them already.

Björn Rosengren

We haven’t booked any large orders during this month until today, even though, of course, a lot of orders is coming in. What I said during the quarter actually is that, yes, I thought maybe 8% was a little bit shy in relation to my feeling of activity in the market or my feeling – our feeling, our girls and boys out in our operating entities is seeing at the market. But you probably saw there was no really large order booked during that quarter, and I think that’s a little bit of timing. I’m pretty convinced that we will see that before the end of the year.

Max Yates

Okay. And may be just one…

Björn Rosengren

Really from you also when that happens.

Max Yates

Okay. Thank you. And may be just one for Tomas on the FX in the quarter. And obviously, I appreciate it’s sort of very difficult to predict how the FX sort of plays out with the working capital revaluations, but I guess the difference between what was guided and reported was more than perhaps we’re used to. So could you maybe explain just what the key differential was between those and if there’s any sort way that we can try and anticipate if the SEK 400 million guidance for Q4 may end up being sort of materially different to that and whether there’s anything we can look out in terms of certain currency moves through the quarter to try and understand that.

Tomas Eliasson

Well, we only guide translation and transaction effects. We guided SEK 650 million for the third quarter. We guide SEK 400 million for the fourth quarter. And we’re pretty sure it will be SEK 400 million if the currency rates don’t change compared to where they were just a few weeks back. We give no guidance on revaluation and the revaluation of hedges, et cetera. So there’s of hedges, et cetera. So there’s no guidance whatsoever on that one because it’s so difficult. Not really. It can be SEK 100 million or SEK 200 million either way, but it’s you never know.

Björn Rosengren

I think one important thing to say that during this quarter, there were a number of activities that happened that made it a little bit bigger. And I think that that could be explained with three major things or four major things.

Tomas Eliasson

Yeah, sure, well, there were some – I mean you had the big currency devaluation in Argentina, for example. We had Turkey. We had Russia. I mean, there were a few currencies like that you had quite an impact. It doesn’t explain the whole thing, but SEK 80 million, SEK 90 million or something like that out of that.

Max Yates

And that’s just revaluation of the hedges for those currencies?

Tomas Eliasson

It is – well, no, it’s not revaluation of hedges. In these countries where you have, let’s say, nonconvertible currencies, you report in U.S. dollars, but you have another currency underlies, which means you run into a big balance sheet revaluation when you have these kind of currency changes, really.

Max Yates

Okay, thank you.

Tomas Eliasson

And I mean, I wish we could guide on that, but can’t really. So that’s why we have decided not to guide anything around that. You never know.

Max Yates

Yeah, excellent. Thank you.

Ann-Sofie Nordh

Thank you. We will have the next question put through please operator.

Operator

Next question is from the line of Graham Phillips from Jefferies. Please go ahead. Your line is open.

Graham Phillips

Thank you, Björn. Thank you, Tomas. My two questions, one is on CapEx. You’ve obviously retained the guidance of SEK 4 billion, but it does imply quite a pickup in the fourth quarter. What is this being spent on? Where could that actually begin generating some extra growth? What would be the outlook for 2019? Thank you.

Björn Rosengren

If we look at the CapEx a little bit is that I think we guided for the full year just over SEK 4 billion, and we are a little bit lower. So I think many of – this is actually being summarized from our operations from below. We don’t go in and question these at the moment. But when they come, we actually – they need to be, of course, approved in the group management as well as if they’re bigger even up in the board. So even if we see – if we guide that it be might be SEK 1.4 billion, I’m still pretty convinced that will be under SEK 4 billion for the full year.

Graham Phillips

Just as a follow-up. I mean, intrinsically, I mean, where are you investing to add to additional growth from underlying markets? I mean clearly that’s where you can get some leverage?

Björn Rosengren

I mean, it varies a lot. I mean, in some places, we are investing in new IT system structure. That’s driving a little bit of capital. We are not building any new factories. In some cases, we are maybe moving two distribution centers into one and that creates some capital investment that you need some return on. So there are small things that we are doing, but of course everything needs good return on investment. And we like to see the investment in these areas where you can see growth in the future.

Tomas Eliasson

Yeah, and if I may just add to that. As I mean we have not invested in any capacity expansion really at all, with maybe some exception. But it’s product development and as Björn says its IT systems. It’s efficiency and productivity, and those kind of investments. Maintenance is going down quite dramatically. We don’t have any numbers for you, but the trend is very clear.

Graham Phillips

Okay, thank you. Well, perhaps related to that. And I mean you’ve obviously get some good growth figures coming through, let’s say, SMS is growing 11% organically in North America, Europe 7%, the aftermarket growth in metals and mining that looks like – and my math’s trying to look at maybe what it was last year. I know you have restated things up maybe 15% or 16% and you are clearly outperforming. I know you gave some indication of why that may be, but do you think also in any of these areas that customers maybe stocking up a little bit in anticipation. I don’t know if price rises or is something else that you are outperforming underlying sort of indicators. I mean mining production is only growing a few percent and the IP numbers and GDP number is substantially lower than what you were reporting from SMS growth in those two regions.

Björn Rosengren

I agree with you. And I think we’re seeing this during the two last years, very strong growth in the aftermarket business and that’s related to significantly more activities from our side. And when we are talking market share, and the aftermarket is how much of the service of our equipment is done and how much we can deliver both when it comes to spare parts, wear parts as well as service hours on these units. We look at that carefully. We make sure in each of the regions that the focus is there and that is driving.

I mean when it comes to SMS from the hand into the mouth as we say, the customers have deliveries within 24 hours. So there is no reason for anyone to stock up in any parts. If a distributor does that, of course that can happen, but that the majority of our business is actually sold direct into the market. And I think everybody is very careful today in stocking up. And I think this is a big difference from historically you saw. I think SMS is pretty much showing the activity level that is taking place in the segments that we operate.

Graham Phillips

And no price increases influencing those numbers of significance?

Björn Rosengren

The price increases are good. I mean we are high up and we are reporting 1 2% price increases in the market, which is – should be there absolutely and I think it’s on the healthy level.

Graham Phillips

Okay, thanks very much.

Ann-Sofie Nordh

Thank you, Graham. We’ll have the next question please operator.

Operator

Next question is from Markus Almerud from Kepler Cheuvreux. Please go ahead. Your line is now open.

Markus Almerud

Hi, Markus here from Kepler Cheuvreux. I would like to start up with the mining and rock if I can just. So what part of your installed fleet is now replaced? And I’m talking about drilling and load and haul in particular. And is it also possible to say anything on the average age at the moment of that fleet? And related to that how do you think this automation electrification will pan out? So will it be when – when you have upgrades of machinery or will it be new projects mainly? Or who do you think will be the main buyer? Will it be across the board?

Björn Rosengren

Okay, let me start with the last one. I think it’s an important question because when it comes to automation sometimes these are being done when you are going to a new level. You’re making a certain change in the mine. That’s when you see the big investments where you see a fully automated mine level. When it comes to small automation, I mean a lot of customers are trying out.

And today if you’re looking our portfolio, the AutoMine you, it’s everything from have one loader to have a couple of them or have a full fleet. So you can actually start with a smaller and then you can add on to it. And a lot of customers are trying this and experimenting and seeing what kind of effects they get by these investments. So I think it varies, but the big investment is normally when you take a more quantum leap step in the mine. And you have also the possibility also to design the mine, which is perfectly suited for an AutoMine.

When we look at the CapEx on the equipment, I’ve been very clear on this for a long time that it’s difficult to call our loaders and trucks and drill rigs as capital equipment. It is wear equipment. They have a life time of five to ten years depending on how rough they are being treated in the difference. When you exceed five years, you actually need to either replace them or you have to actually upgrade them in a way, which of course generates a lot of revenues.

We don’t have any numbers exactly how much that has been replaced, but you know that the number of equipment we have in the market is between 15,000 and 20,000 units operating in full speed today out in the end of market. So there is always a big demand for equipment. What determines buying of equipment or not buying equipment that is normally not the actually the mine manager or the individual mines, that normally comes from the cash being generated from the boards. So more or less all the mines they want to buy equipment all the time to be able to deliver good productivity there, but sometimes when the profit levels of the mining industries are lower, they can actually cut the cash flow into the operation. At that time, they run them a little bit longer, so that that varies.

But at the moment with the metal prices that we have today, it was quite healthy level especially when you have the dollar so high compared to many other of the – so most of the mining companies are actually making good, good profit levels today. So that should continue to roll and there is always a demand from it. So it will never be a time when they have replaced the oil fleet. This is happening all the time.

Markus Almerud

Okay and then just one other quick one on just a general wording of your release. So you’re right that you see demand intensifying in all three major geographical regions and improving all customer segments except automotive and mining. Is that compared to second quarter? So you are seeing as intensifying and accelerating or is it…

Björn Rosengren

That is…

Markus Almerud

Compared to last year?

Björn Rosengren

That is compared to last year. We also show in the paper sequentially, and all of those are flat if you look at…

Markus Almerud

I just want to make sure. Okay, perfect. Thank you very much.

Björn Rosengren

Thank you.

Ann-Sofie Nordh

Thank you, Markus. We go to the next question please.

Operator

Next question is from the line of Alexander Virgo from Bank of America. Please go ahead. Your line is open.

Alexander Virgo

Thanks, very much. Good afternoon Björn and Tomas. Just a quick follow up I guess I suppose. I’m trying to quantify the impact on margins for Q4 of your inventory management. If you obviously have a bit of a benefit tailwind in Q3 of 60 bps, I’m wondering if you can give us any indication what you think the headwind might be for reversing or managing that down a little bit in Q4.

Björn Rosengren

I can’t give you any numbers there, but I think it’s the right observation that when we take down the inventory not in old parts – I mean, when it comes to the mining industry, it looks a little bit different because that’s a lot of equipment that is being under production, and some of them are already ready. So they have to be sold out to the market. When it comes to SMS, yes, of course, when you take down the inventory, yes, it affects – it will have effects on the margin. I can’t quantify it at this moment. I think that depends on a little bit how successful they are to take down the inventory during the fourth quarter.

Alexander Virgo

Okay. But I suppose if we start off with the 400 basis points, SEK 400 million or so you mentioned earlier on as the – and so if we take that as our starting point, is it a fair assumption? Is that right?

Björn Rosengren

No, I don’t want to go into any details on that part. I can assure you that we are – they’re fighting hard to continue with good margins in that business. But yes, it can have small effects on the margin when we take down the inventory. I think that’s about what I can say.

Alexander Virgo

Okay, that’s helpful. Thanks very much.

Björn Rosengren

Thank you.

Tomas Eliasson

Thank you. We can just clarify that 60 bps, that was Machining Solutions and not the total group. The total group’s was 20 bps.

Björn Rosengren

Yeah, that’s correct.

Alexander Virgo

Thank you.

Ann-Sofie Nordh

Thank you. Can we have the next question please?

Operator

Next question is from Sébastien Gruter from Redburn. Please go ahead. Your line is open.

Sébastien Gruter

Good afternoon. My first question is on the balance sheet revaluation of SEK 230 million in the quarter. I mean, could you split this impact by division? And related to this issue, would you say we should add back this impact to the EBIT to get a clearer picture of your underlying margin performance? Or should we speak with this impact to better forecast following quarters?

Tomas Eliasson

I mean the hedging and balance sheet revaluation part of the balance sheet?

Sébastien Gruter

Yeah.

Tomas Eliasson

Can we give that by division?

Ann-Sofie Nordh

No, we haven’t.

Tomas Eliasson

No. No, we don’t disclose that by division as such. And I mean that can be seen around next quarter, can be a plus next quarter or a minus. I mean, we don’t know. We don’t have any specific guidance on that.

Sébastien Gruter

In terms of how you treat that, would you say we should exclude this impact from your EBIT performance in Q3 to get a clearer picture of your underlying margin performance? Or you don’t do that?

Tomas Eliasson

No, no, no.

Björn Rosengren

I think the underlying FX is SEK 381 million actually. And…

Tomas Eliasson

For the group…

Björn Rosengren

For the group and that is what you have to look. Yes, it was just from the translation and transaction. It was higher, the SEK 600 million, but the effect that – the underlying running is SEK 381. So this time, it was negative. But it could – next months, if you see some of these currencies in a certain market get strengthening against the dollar, for instance, that would – the fact that some of the hedges are placed in a different way that would also affect – it could affect positively. So it’s extremely difficult to – actually to forecast in a quarter going forward, and that’s why we don’t do it.

Tomas Eliasson

I mean I am not sure if I understood the question fully, but, I mean, the effect of all the currency – all the various currency effects for the group and for the business areas are immaterial. So you can see how much it is and how much it impacted the margin and the accretion or the dilution or whatever it is, so that we report.

Sébastien Gruter

Okay, the – on your – toward the end of your three-year plan and 7% CAGR in EBIT, you will probably exceed the – I mean, you will exceed the target so far. When can we expect a net debt on this – on the next of a three-year plan or if you – if it’s three or five? And should we assume the focus would be more on costs and less on profitability in the next plan?

Björn Rosengren

I cannot go into the details there, but we’re planning to do that on – during the Capital Market Day and just before – during the springtime. I think that’s the time – that’s when we had the three years that’s we promised and what we’ve been delivering on. We will put the right targets, which is adequate to the situation where we are and how we see we want to drive the company in the future.

But I agree with you. I think when I came into the company I was not satisfied with the margin of how we drive the group. And we were at the 12% EBIT level. Today, we are running at 19% for the group. So that is, of course, a different situation. I still see upside, of course, because we work with continuous improvements in all operations, and we’re going to push that, of course, hard. But it’s true going forward that I believe the value in this group is going to be generated by growth going forward and that is important.

Tomas Eliasson

And if you go back to 2015, we had 17 of our businesses loss-making at that point in time. Today, none. So it’s more units who are in growth mode than stability, profitability. But there are still some where we have work to do.

Björn Rosengren

The other part, which I think is important for the future to drive value in Sandvik is also to show that the group is resilient to downturns. I think that’s extremely important, and that’s what we’ve been working on the last three years to make sure that we do not go back in margins where we once were but that we can protect our margin also in a downturn. I think that’s the big focus in Sandvik today.

Sébastien Gruter

Björn, thank you.

Ann-Sofie Nordh

Thank you. I think we will have time for one more question if you put that through please, operator.

Operator

Of course, next question is from Andreas Koski from Nordea. Please go ahead. Your line is open.

Andreas Koski

Thank you very much. Good afternoon. I would like to ask about the inventory buildup in Sandvik Machining Solutions as well. Did you say that you built inventory by more than SEK 400 million for Sandvik Machining Solutions impacting the EBIT in the quarter?

Tomas Eliasson

No, no, absolutely not. It’s half of that, I would say, approximately.

Andreas Koski

Okay, and how does that compare to the buildup in Q3 last year? How much did you build back then?

Björn Rosengren

Good question. Do you have that number?

Tomas Eliasson

Not me. Do you have that number?

Ann-Sofie Nordh

I don’t remember on the top of my head right now.

Andreas Koski

Okay, no. But may I ask you about Q4, do you have those numbers because now you plan to reduce inventories in the fourth quarter, and I think you built inventory in Q4 last year. I understand you don’t want to give any guidance of how much you will decrease inventories in the fourth quarter this year. Do you remember or do you know by how much you build inventories in Sandvik Machining Solutions in Q4?

Björn Rosengren

I don’t actually remember how that was.

Tomas Eliasson

In Q4, we had issues with…

Ann-Sofie Nordh

Andreas, I can come back to you. We can do that after the call and I can – we can come back to you with the details then.

Tomas Eliasson

But it was completely, I mean, we can say right now we have a very completely different situation. The demand was so strong. It was stronger and stronger and stronger. We actually had problems with delivery to our customers. We don’t have that problem today.

Björn Rosengren

We had some issues within SMRT…

Tomas Eliasson

Yeah.

Björn Rosengren

To get the equipment out to the customers. But I am sure it was of course on the upturn when it comes to drive up the market. And of course, we are now on a very high level, and we are seeing sequentially the numbers being pretty much in line there. So the focus is to getting down the inventory. On SMS, yes, I told you about half of that SEK 250 million, which is related to SEK 200 million approximately, which is related to EBIT effect. The other part of that part is actually powder and scrap that was bought into the group, so no effect on that. It’s correct. We will focus on getting the inventory down. And I think, yes, in SMS, it can have some effect of the margin, but don’t make it too dramatic as we are pretty confident about the fourth quarter.

Andreas Koski

Yeah, okay. And maybe you can help me with the dynamics here because I don’t have all the details. But if demand for Sandvik Machining Solutions, again, on a daily, say, sales rate stays more or less unchanged in Q4 compared to Q3, what would that imply in terms of year-over-year growth? I come to a number of maybe 4% or 5% year-over-year organic growth. Is that the number you recognize if you just look at the daily sales rates going into Q4?

Tomas Eliasson

I would not guide you in that direction, yes. We’ll wait and see when it comes, and we’ll make sure that we take care of the volumes. If it’s that level or if it’s somewhere else level, we’ll be adjusting our production and our deliveries in accordance with that. But if we start getting into guidance forward, it becomes a little bit wrong.

Andreas Koski

Okay, thank you very much.

Tomas Eliasson

Thank you.

Ann-Sofie Nordh

Thank you. And with that we will end this presentation and update. Before we finish, I’d like to remind you that we have announced the date for our Capital Markets Day, which will take place on the 21st and 22nd of May next year. And then you’ll have the opportunity to visit our test mine in Tampere in Finland. So of course, we hope to see you there then. But before that, we’ll see you in about a quarter’s time. Thank you very much.

Björn Rosengren

Thank you very much. Bye-bye.