Good morning, and welcome to Alfa Laval's Earnings Call for the Third Quarter. Fredrik and I, we will go through our normal presentation, and after that, we will open up for Q&A. Let me start with a few introductory comments, as always. Let me remind you first that in 2022, we had several imbalances in the portfolio, both in the energy division and in the marine division. It triggered a restructuring program in the fourth quarter last year, which now is completed according to plan, supporting the margin improvement in the quarter. The imbalances from 2022 are now corrected. Additionally, the strong order intake continued for marine pumping system, with a healthy order backlog for 2023 and 2024. The marine division margin started to recover in the third quarter, as previously guided.
Global supply chains continued to stabilize, with customer service and lead times gradually returning to normal levels. The resulting improvement in the operating cash flow to almost 3 billion SEK was expected and welcome. And with that, let me move on to the key figures. Order intake remained on a good level in the quarter and grew 12% compared to last year, and sequentially, seasonally, somewhat lower, as indicated before. Invoicing grew 20% and provided a good volume support to the margin improvement, which ended on 16.7%. Note that the book-to-bill remained positive in the quarter. In all, it was a clean and stable quarter, a welcome change after years of turbulence. And with that, let's move to the divisional reviews, starting with the Energy Division.
The clear weakness in the construction market for HVAC applications was compensated from applications related to the energy transition and natural gas. The temporary slowdown in the heat pump market had limited effects in the quarter, but may have a moderate impact on the next two quarters. Margin remained on an elevated level, above 20%, supported by tailwinds in almost all areas, while the fundamentals are expected to remain positive in the coming quarters. The cost related to both R&D expansion and the capacity program is expected to have some margin impact going forward. In the marine division, order intake continued on a high level with good demand in almost all areas. Contracting levels in the yards, service demands from an aging fleet, and the strong offshore market provided a solid base for the quarter. As guided, the margin recovery started in the third quarter.
A completed restructuring program, a rebuilding of the order backlog, and the replacement of old pre-inflation order book to a new adjusted price level for boilers all went according to plan and earlier guidance. The basics are now in place for Q4 and 2024. In the food and water division, on aggregate, order intake remained firm with variations in the portfolio. Projects and service continued to grow, with transactional business remaining on a lower volume compared to last year. The weakness in the transactional business started in mid-2022, and normally, the cyclicality is somewhat limited in the food and water area. We may be at the bottom of the cycle for the transactional business at this point in the food and water division. Some actions have been initiated to ensure margin stability, nevertheless.
Regarding service, the growth continued on a high level of 12%, 14% last year, compared to last year, with strong performance in all three divisions. The growth has exceeded normal service growth targets for a couple of years now. Ongoing initiatives and market conditions may support the higher-than-normal growth rates for some time to come, still. In terms of the regional performance, this quarter had a somewhat more mixed picture than in recent time, reflecting some softness in the global macro. Most notably is the growth in China versus last year, supported by a strong marine business. Despite geopolitical concerns, China remains a strategic market for Alfa Laval in terms of technology, production, sales, and service. Otherwise, Asia, Middle East, and the Americas were strong in the quarter, with Europe clearly lagging behind in the third quarter.
That summarizes the quarter from my point of view, and I hand over to Fredrik for some further financial comments.
Thank you, Tom. So on a twelve-month rolling basis, order intake is at an all-time high, just shy of SEK 70 billion, with an order intake in the quarter just above SEK 17 billion, which is well in line with our guidance in quarter two. This represents a 12% increase from last year, however, sequentially lower than the record Q2. Organic growth accounted for some 3.7% of the total 12. Acquisitions contributed with 5.1%, leaving the balance 3.2 related to currency. Service continues to grow, with 14% in the quarter, reflecting a high utilization rate of our equipment. Transactional sales remained at the same level as last year, and project business grew some 48%....
Q3 book-to-bill was 1.08, increasing the backlog to SEK 46 billion, of which SEK 13 billion is for delivery in 2023, and the remaining SEK 33 billion will be delivered in 2024 or later. SEK 46 billion in backlog at current pace represents 8 months' worth of sales. Delivery to our customers continues to increase as capacity expansion programs and normalized supply chains allow for an improved output. The 20% growth compared to last year comes primarily from these initiatives and more service sales, giving a combined total of 13%, 13% contribution in the quarter. Acquisitions, 3%, and currency rounding off at 4%. As a side note, accounts receivable have increased in parallel, impacting operating working capital. However, we have not seen an unproportional increase in overdue receivables, a number we keep a close eye on.
The increased sales and mix of sales booked in quarter three have resulted in a good gross profit level above 33% and better than the equivalent in 2022. Margin on sales remained stable in the third quarter across the divisions for the transactional sales and for service sales. Pricing activities have matched inflationary pressures, while commodity prices have stabilized on a high level. The price effect of backlog, the effect of price in the backlog for project business starts to diminish as the backlog moves into invoicing and delivery. Capacity utilization impacts are actively addressed to match demand. Sales and administration costs have increased with 10%, driven primarily by inflation, but also by acquisition and added resources in growth areas. However, in proportion to sales, it is a favorable development to 14% of sales.
R&D increases beyond inflation, and we invest more in product development. Operating income increases 41% with a strong drop-through from increased sales, a favorable product mix, and completed restructuring initiatives in marine, and the ongoing restructuring in welded heat exchangers. EPS increases from 2.92 SEK in Q3 2022 to 4.29 SEK in Q3 2023. Adjusted EBITDA margin for Q3 was 16.7%. The 2% improvement in margin is mainly driven by increased sales, product mix, and the yield of restructuring programs. The adjusted EBITDA margin for the marine division improved to 15.1%, compared to the 12.1% in Q3 2022.
The energy division and the food and water division also contributed with strong margins, 21.6% and 15.5%, respectively. Cash flow from operating activities increased to SEK 2.9 billion, compared to SEK 670 million in the same quarter last year. Free cash flow increased to SEK 2.4 billion, compared to SEK 315 million last year, despite the higher CapEx level of SEK 527 million in the quarter. We have noted three acquisitions in the quarter, equaling some SEK 232 million. Finance activities burdened the cash flow with another SEK 804 million. This continues to reflect our current strategy to deleverage our debt position. Some more detail on this in the next slide, but all in all, a cash flow of SEK 1.4 billion.
Our current cash flow generation has allowed us to deleverage SEK 1 billion and eliminate the short debt position incurred by the dividend payment. The euro exchange rate impacts negatively, increasing our debt position, bringing the final balance to SEK 15.4 billion, of which is equivalent to 1.42 times EBITDA. Net debt on the same level as last year, but in relation to LTM EBITDA drops substantially to 0.95. Adding lease liabilities, the ratio increases to 1.2. Average funding rate on our debt is 1.92. And then finally, for some guidance, we reiterate our guidance around investments in 2024, between SEK 2.5 billion and SEK 3 billion.
However, we lower our guidance in 2023 to SEK 2.5 billion, as we delay some of the investments, and some of the investments take longer to take effect on the cash flow. Currency impact is calculated according to the consensus of currency given by banks at some 11.5 euros per crown, or rather 11.5 crowns per euro, and the PPA amortization decreases to SEK 710 million in 2024 as some of the marine acquisitions fall out. With that, I go back to Tom.
Okay. Thank you, Fredrik, and, let us then, finally conclude on the outlook. As we have indicated in the report, the market conditions overall are expected to remain unchanged in the fourth quarter, with a weakness in some end markets compensated by positive tailwinds in, sustainability-related applications. With a record order book of SEK 46 billion and a positive book-to-bill in Q3, the load and invoicing for 2024 has been secured in many parts of the portfolio. And with that, let's move to questions.
Ladies and gentlemen, at this time, we will begin the question and answer session. Anyone who wishes to ask a question may press star, followed by one on the touchtone telephone. If you wish to remove yourself from the question queue, you may press star, followed by two. If you are using speaker equipment today, please leave the handset before making your selections. Anyone who has a question may press star, followed by one at this time. One moment for the first question, please. The first question comes from the line of Klas Bergelind with Citi. Please go ahead.
Thank you. Hi, hi, Tom and Fredrik. Klas at Citi. So first on food and water, when I back out Desmet, orders were quite a bit weaker than I thought for the rest of the business. Is this China continued destocking that you talked about before or something else? And if you could comment here on Desmet, when we look at edible oil supplies, the data here are quite a bit above long-term averages, which suggest that capacity additions might start to level off soon. Do you think we're peaking here on Desmet? There has been remarkable growth since you acquired the company. Thank you.
Klas, your reflections are generally correct. Desmet has had an order intake since we acquired them well above our expectations and well above the acquisition plan, and probably somewhat above what is long-term to be expected. There's a substantial order book now with Desmet, and consequently, lead times will go up. So, I think we don't necessarily expect to continue on exactly that level going forward. As for the rest of food and water, it's a mixed picture. The service business continues to grow very strongly. We were relatively low in large projects on our own food systems business, so that affects the remaining part of food and water somewhat, and that's normal variations, I would say.
So not a cause for any big alarm. But what we also see is the transactional part of the business, starting in China last year, is affecting several parts of our business, the equipment business in the Food and Water Division. We are a bit lower in biotech after the huge growth during the COVID period and the vaccination programs. We've been a bit lower on the dairy side, and we've been a bit lower in a few other end markets.
So all in all, I think our guidance has been that we may, after being stable on a lower level for a couple of quarters, our sense is that we potentially are about on the low point in our transactional business, whereas project business has remained fairly good and service business has been super strong.
Thank you. Then on the energy division, obviously, HVAC down linked to construction, and which is something we've heard from others this reporting season, and also heat pump is a bit softer, which shouldn't be a big surprise either. But I'm sort of curious to hear, Tom, you know, what are you seeing here the next couple of quarters, the discussions, particularly around sort of the heat pump business with your customers? Obviously, we've all seen share prices from some of your peers derating heavily here on concerns, but obviously it seems to be more of a temporary weakness. If you could elaborate a bit on what you see, that would be very helpful.
Yeah. Let me start with the HVAC applications, excluding the heat pump, and I'll take that as a second point.
Okay.
On the general HVAC side, related to construction, we have a clear impact. So we see the transactional; it's normally a short-cycle business, mainly for GPHE heat exchangers.
So, we see the short cycle business coming down as a result of less construction business. For us, it's not necessarily a big problem. The supply chain is the same when we do larger project orders in a lot of areas. So, we are quite flexible in our manufacturing infrastructure when it comes to the end applications for Gasketed Plate Heat Exchangers. And consequently, it goes down in some areas, up in other areas. So all in all, we don't necessarily expect a negative impact from a weaker construction market outside of heat pumps.
Now, related to heat pumps, I remind you that our heat pump business is about half of the unit that is supporting them, so we're also delivering to gas boilers and a whole range of other applications. So, for one of our four business units in the Energy Division, about half of that volume is affected by the development on the heat pump side. Now, we expect a clear weakening of that market in Q4 and Q1. The implications for us remains a little bit to be seen. On the one hand, we've been chasing. In one sense, I would say it's a bit of a welcome break. We've been having a hard time to keep pace with customer demands for the last two years, and so our capacity buildup continues.
We are a firm believer that the market will come back relatively shortly. The regulatory environment is in place for 2024, so after a weaker period, we think we are gonna be back to a normal, growth trajectory in that business. We have, over a period of time, had to prioritize very heavily as to which customers we could, at all deliver to. So we also have an opportunity to open some other sales channels, as the market is softening. So let's see what the net, net impact is, but we, we consider it likely that we will have a moderate impact on the energy division over, the next few quarters, and after that, we would expect to be back on, on, normal track again.
Okay, great caller. Very, very quick final one, maybe for you, Fredrik, on, on the margin in marine. It's moving obviously in the right direction, which is good to see. Can we talk a little bit about how the savings are kicking in on the boiler side? How the sort of the backlog conversion on, on, on the pumping system side is sort of moving through, the fourth quarter and into the first half next year? And sort of what I'm trying to get to is obviously margin trajectory here, over the next couple of quarters from the current 15. Thank you.
Yep. Well, I mean, the margin recovery we see in marine is really driven by a couple of elements. It's not one single element that's driving it. It is a mix effect that we see, of course, with a high service business and a high utilization of the fleet. It is the restructuring programs that we announced last year, that we have concluded with this year, and it is, of course, the improved factory load that we see, particularly then for pumping systems, but also boilers. It is also, as you quite well indicate here, the clearing out of pre-inflation backlog and the restitution of that backlog with new, fresh orders that are then priced in at a higher level of commodity prices and of course, with inflation in mind.
So we have a strong backlog or a revitalized backlog, I would say, and of course, that's what we start to see now as we come through with the improvements of the backlog in marine.
Thank you.
The next question comes from the line of John Kim with Deutsche Bank. Please go ahead.
Hi. Morning, everybody. A couple, if I may. If we look at your order intake, large orders are increasingly a component or a percentage component of your intake for 2023. How much of this is Desmet, and can you characterize the other contributing factors to the large orders? Is this something we should expect going forward, i.e., a bit of lumpiness? Second question, unrelated: Given trend investment and growth you see in your end markets, when should we expect the company to generally not be capacity constrained? Maybe another way to ask it is: When do you expect your intake and your revenue or your invoicing to, quote, unquote, normalize, generally speaking? Thank you.
Let me start with your last. I think, our main... Given that we are now, as you can see, growing invoicing quite substantially with 20%, I think we are catching up the, the backlog that was late for delivery in most areas. So the real capacity constraints areas that we see now has been related to the heat pump market, and that is self-correcting itself as we speak. So I think for getting into balance, I think we are pretty much getting there now into the fourth quarter. And so, let's see where we go from here.
I think what one may reflect on is related to the large orders, that in several areas now, we are fully booked in 2024, so we're looking for project bookings into 2025, 2026. So I think it's, you know, the pipeline on the product side is getting relatively full, and so that's a difference from before when we were in the manufacturing side constraints. I think the manufacturing side now starts to look in good balance, and with the capacity programs, I expect it to remain that way moving into 2024 and 2025. On the large projects, you're correct. I would contribute it to a couple of things.
Number one, the marine division by nature is a relatively sort of large project type of business. So, with high order intake in that division specifically, it's not a change in the business nature, it's just a mix shift towards a large share of marine orders that are booked that way. So that's business as usual. In the energy division, we have a bit of an effect on the oil and gas sector, which tends to be larger projects. So in terms of mix, that is slightly higher, but otherwise, projects and equipment sales tend to go through the same manufacturing line. So I'm not too concerned on sort of any shifts between equipment and large orders on that division either.
When it comes to large product in food and water, there, as you indicate, we have the biggest effect. I don't have in my head exactly the number for Desmet in the quarter. Maybe you do. It was 3.7%. Sorry, well, the structural effect was 5.1% in the quarter. Yeah, but the share of Desmet was?
SEK 1.2 billion. Okay, so there, there you have the numbers. It's a meaningful contribution. What I would... As you know, there we do have a bit of a dilution effect on the margin. We've, we've stated before that we're looking at about 10%+ on margin on our project business, including food systems and Desmet. So consequently, when that share is growing, it's putting some pressure on our margin. Let's see where we go on that. What I, what I would say on that issue is that already in Q3, we have a bigger effect on project invoicing than before. And as you can see, the dilution effect is not as, as big as you perhaps would have anticipated.
And in reality, I think our product business at the moment looks quite healthy in several parts of our business. We're on all-time high margins across the board in project business, in the energy division, and in the food and water division. So while we're not changing the guidance as to our objective, and there's always some uncertainty when it comes to project execution, it actually looks healthy in Q3. And in terms of the order backlog, the gross margins look relatively promising for the coming quarters as well.
... Okay, very helpful. Thank you.
The next question comes from the line of Max Yates with Morgan Stanley. Please go ahead.
Thank you very much. Good morning. I just wanted to touch on the Q4 guidance, and could you just give us any maybe color across the divisions of what you're expecting by division? Is there any sort of meaningful deviation to that flat guidance when you look across the divisions for the fourth quarter?
It's a good question, and there was a reason why we're a little bit moved past it in the, in this guidance comments. I think in reality, what's gonna make it to break it for the three divisions is how the large orders are coming in, and they are, by nature, a little bit unpredictable. So we felt, you know, the more we go in granularity, the bigger the chances that we are wrong on the details and right on the, on the, holistic picture. So that's, that's what's a little bit the background. We don't see, you know, any... You know, if we take the marine business climate, both for the marine side, for the service side, and for the offshore side, the market outlook is stable on a high level.
So we don't see a change there, regardless of where the bookings will come in next quarter. But of course, after a very elevated couple of quarters in the marine business, the backlog is now at EUR 1.7 billion, I think. So, you know, we gotta have to catch up with invoicing there before we load ourselves too heavy, but the market outlook as such is stable. On the energy side, there is a bit swings between the short cycle and the long cycle. All in all, we judge the conditions for the energy transition coupled with a strong gas market as a stable platform for the fourth quarter. And in the food and water side, we are growing in service.
We are on a low but probably stable level on the short cycle business, so, you know, some of the large projects will decide whether we remain stable at current level or a bit higher or a bit lower. So that's the reason why we were a little bit cautious in detail guiding on the divisional level, but there you have the color.
Okay, that's very helpful. Just second question was on Desmet, and I mean, I think you called out kind of SEK 1.2 billion of large orders that we can see. I guess what I'm curious about is when I look back at Alfa Laval's large orders, they've historically been kind of SEK 500-600 million a quarter at group level, obviously before Desmet. I guess what I'm trying to understand is Desmet is about SEK 1 billion revenue business per quarter, about SEK 4 billion annually. We've just had kind of SEK 1.2 billion of announced large orders. So how big is the actual Desmet order intake? Is it the case that almost all of the Desmet orders are, by definition, large orders, or is there also another kind of SEK 800 million base business?
So I mean, basically, what was the Desmet book-to-bill in this quarter?
Well, the book to bill is clearly positive. You know, we prefer not to be, you know, specifically detailed on every number, on every granularity in the company. But you are correct in assuming that the underlying order intake is somewhat bigger than the announced projects. So I think we're sort of up and running at around SEK 5 billion at the moment, in that order of magnitude. And that is way above where our long-term expectations were as we acquired the business. So we are very happy on the fact that we are performing well, both in margin and in volume at the moment. We don't expect that it's a level that will stay and grow from this.
We will probably have some volatility in the Desmet business over the coming years without any particular cause of alarm. It's just the nature of the product business we acquired.
Okay, and just a very quick final one. I mean, obviously another kind of very good, very strong energy margin. What I'm curious about is, you've obviously talked about the investments that you're making in that business capacity crunch, and I think you've identified that eventually we were going to have a kind of SEK 100 million investment cost, per quarter, totaling about SEK 400 million. I guess, did we have that full SEK 100 million this quarter, or was that kind of investment in the, in the EBIT line or the EBIT margin impact, was that delayed, as well? So what was the impact this quarter?
No, quite correctly, it is somewhat delayed. There is a cost coming into the quarter for the execution of the investment projects, but it is also as we're delaying some of the investments or rather facing some of the demand we see here. Then, of course, the OpEx part of it is somewhat lower, and that is reflected in the margin. However, we expect quarter four to be a little bit heavier on the OpEx side as we increase again the investment pace on some of the investments that we hope to have activated for capacity towards the end of next year.
Okay. Would it be fair to assume a 20% margin is maybe normal for this business once we have those investments in half?
Yeah. You know full well you're not gonna get a guidance on that.
I thought I'd try.
Yeah.
Thank you very much.
Very good.
The next question comes from the line of Sebastian Kuenne with RBC Capital Markets. Please go ahead.
Hi, gentlemen. Just a few follow-up on the heat pump situation. Klas already addressed that. Can you just clarify how much of the CapEx program that you had initially-
... announced back in February was related to the heat pump market, and what your current view is on the heat pump portion of that CapEx? And the second question is on pricing and raw material costs. You already mentioned that you think gross margin should or that you're confident on gross margin development, but do you now expect also like incremental tailwinds from falling raw mat prices and from increased pricing inside your order intake? Thank you.
Well, regarding the CapEx programs, we have a lot of reasons for why we don't wanna be all precise about how the millions fall between different areas. That belongs a bit to business intelligence that we need to keep tight. But, with that said, we've been clear that it's been in a significant share of the program that is directed, not towards heat pumps, mind you, it's directed towards brazed and fusion bonded heat exchangers. Those are used in a host of air condition applications and other applications, including into the hydrogen side, and potentially into the data center side. So this is a product platform that will be needed in a host of applications as we grow.
The second point that I just want to remind you on is that I think when we launched the program, we already guided that we would have been serviced well by a 20% capacity increase, even at the levels we had last year, due to the fact that we are running seven days, 24/7, which is not a very cost-efficient way of running industrial operations. And so we needed a substantial increase to get back into an operating structure that was cost efficient. And secondly, we are looking at a host of applications beside the heat pump side that is built on the same product technology. So that's why we are you know, we are not-- we are obviously concerned that the main driver of the growth going forward in the 2024, 2025 comes back on track.
But we don't wanna, you know, overstate the short-term consequences of a weaker heat pump market. On the pricing and raw material side, you know, there may be some, you know, but we hedge raw materials, so we are not necessarily immediately impacted in a large way from changes in commodity prices. There are some areas where we've seen cost reductions, but I also remind you that we do have cost inflations in several areas, not least in wages and salaries, which are, in this year, probably the highest we ever had globally, in our history.
So, the challenge of managing the cost base and the pricing continues, but it's clearly a more benign environment now than we had for the last couple of years.
That's very helpful. Thank you very much.
The next question comes from the line of Johan Eliason with Kepler Cheuvreux. Please go ahead.
Yeah, good morning, Tom and Fredrik. Johan at Kepler Cheuvreux here. Just some minor details here, a follow-up at the end. If you look at your maturity profile of your net debt, I mean, you have a big chunk coming up in 2024. Obviously, your average funding rate is still quite attractive, 1.92, then dependent on if you will replace the debt due next year or not. But what would you say your average rate would sort of trend towards if you are replacing all of the 2024 debt? Would it go above 3% at current market rates, you think?
Well, it's kind of hard to speculate exactly where the interest rates will be in 2024, and particularly towards the mid of 2024. I think there's a lot of moving elements that may, you know, move the interest rates both up and down. But if we take the current level as an indicator, then yes, we would probably land somewhere around the 3% level. Now, our intention is, as much as we are capable with the cash flow that we have, to service debt as much as possible in order to strengthen the balance sheet, and of course, then to allow us freedom to do other activities, perhaps on the M&A side.
Okay, good. And then on marine, obviously, offshore seem to be doing well. Tankers is also performing well, which are all sort of good segments for you, going forward. Do you think this trend will continue, or how do you see specifically the developments in the tanker and offshore segment for you?
Yeah, we think there is stability in the market. The issue in the market is yard capacity. The lead times are what they are. We see some changes of slots at the yards where there are conversions from one class to another that sometimes plays in our favor. But otherwise, we are beyond 2 years in terms of delivery times at the yards, generally speaking. And so, short term, we think that I think if there were more yard capacity, we would see a bigger increase in contracting and potentially in orders.
We are where we are right now, so stable at this level is the outlook that we provide at the moment.
Okay, thank you very much.
The next question comes from the line of Weier with UBS. Please go ahead.
Yeah, good morning. It's Sven from UBS. The first question I have was just on the Q4 order outlook. I mean, for Q3, you explicitly said you're expecting seasonality back after four years of no seasonality, probably. Was just wondering how you see seasonality for Q4. It sounds like you see stable orders, of course, the uncertainty around the big ticket awards, but you know, if you had negative seasonality in Q3, shouldn't there be positive seasonality in Q4?
I think that that observation and question is to some degree correct. I would, you know, Q4 is typically a stronger quarter than Q3. I think we are a little bit cautious in our order intake outlook, just from the fact that if you compare this year with any prior year in history, we've been booking SEK 18 billion, SEK 18 billion, SEK 17 billion, and a stable outlook. It takes us to a number which is just so much higher than anything we ever invoiced or booked. We start to book orders into 2025 by now in certain areas for projects.
So I think we are a little bit just, you know, not just related to what is the market conditions, but we just have to recognize that we've been on a very, very high level, and that makes us, you know, a bit cautious as to whether it's a repeat on the 18 level. We have not been there historically, as you well know, and so, that's our best estimate for Q4. I think what we wanted to say with outlook is that in the marine side, in the food and water side, and in the energy side, we don't really see, you know, large changes other than the weaknesses we've already been carrying for about four quarters on the transactional side.
That's fair. Thank you. The other question I had was just following up on the energy margin once more, because when I look at the quarter, revenues were relatively similar to what you had in Q2. And you already said, you know, there was no really, the investment cost wasn't there yet, fully. And yet the margin was 200 basis points higher than in Q2. So what has caused that? Is there also a mix issue inside, or what has generally, surprised you maybe also positively? Because I thought the guidance for the second half was clearly that the energy margins should maybe have a similar trajectory as they had in the second half of last year.
Yeah, it's... We are, as we indicate in the report, we are in a bit of an elevated level there. There is an element of mixing that. But I would say what is important to us, and one important factor is the restructuring program that we executed end last year. We carried some significant burdens and load issues, as you know, in the welded side after cancellation of Russia and a number of bad years in the oil and gas sector. And those have been corrected both from a cost point of view and from a load point of view, and that's a big part.
We have a project business in the Energy Division called Energy Separation that is now, historically, has been burdening us in terms of margin at the single-digit level, which is now performing very well in the quarter, even exceptionally well. So, there are some parts in the portfolio which we have addressed just as we have in the Marine Division, which is very helpful and used to be a burden on the margin, and now is getting more into perhaps not a positive contributor, but at least doesn't weigh down as much as it has historically.
And from today's point of view, for Q4, is the additional investment cost the only major swing factor that you see? Because last year we had like a 300 basis points decline in Q4 sequentially, obviously quite big.
We normally have some phasing issues-
Yeah
... between Q4 and Q1, and we normally have a fair share of project invoicing in Q4. So I think, Fredrik, we expect a reasonably high invoicing and perhaps a bit of a dilution effect just due to the mix, whereas the underlying margin in the business is from a gross margin point of view most likely rather stable. A bit weighing on the cost side, a bit weighing on the mix and project side. That's- is that too much of a guidance?
It's not too much of a guidance. That's what we expect.
The final question I had was just on the food transactional side, where you clearly said we should be at the low here. I mean, do you have any visibility on your end when there should be an improvement? Are you expecting this during the course of next year, or is it just impossible to say from today's point of view?
Well, well, it is a guess, I have to say. So we're not basing this on a lot of expectations from customers at this point in time. But if we look at normal swings in the business cycles and where we've been now, and if we look at some of the end markets, including biotech and others, which we feel have an underlying growth rate, we have reasons to believe that we will see a gradual improvement in 2024 on the food and water side.
I think I also want to recognize here, for those of you who've been with us for a number of years, we had exceptionally good growth in the food and water division over a whole range of years, from when we founded the division until two years ago. And so, growth rates were a bit higher than we expected. We may have had sort of a number of good years when it comes to segment exposures and end market exposures that played in our favor, above and beyond the normal market growth. And maybe we've seen some of those swings edging back a little bit of the growth potential for a couple of years. So I think we are...
Our sense is we are stable at the lower level at this moment, and indications are that we might see a gradual improvement into 2024. So that's where we are in our judgment.
Thank you, Tom.
The next question is from the line of Moyo with Goldman Sachs. Please go ahead.
Morning, all. Thank you for taking my question. It's Moyo Adebayo here from Goldman Sachs. I just wanted to follow up on the capital allocation question, and given, obviously, the improvements made in the leverage, I was wondering if restarting the buyback was a consideration?
No, at this point in time, we have sufficient capital allocation towards investments and towards organic growth, and also we expect there to be some opportunities around M&A. So a share buyback at this point in time is not something we're discussing.
Very clear. Thank you.
The next question comes from the line of Gustaf Schwerin with Handelsbanken. Please go ahead.
Yeah, so thank you. Two questions. Firstly, on the comment on showing the capacity expansions a little bit, can you in any way indicate the magnitude of the delays, either in, I guess, percentage of capacity expansion available in 2024, or timing of the additions or whatever, really? And then, secondly, on the topic of shipyard capacity, what are you hearing there right now? Are you seeing any signs of it being ramped up to any degree? I think on the last call, you were quite optimistic on the contracting cycle in general for the coming years. Is that still the case? Thank you.
Yeah, the contracting outlook remains the same, and probably a bit more positive this year than previously thought. There are some minor addition to yard capacity in China. We are unlikely to see it in Korea. We are probably unlikely to see it in Japan in any meaningful way. So the question is primarily related to restarting some Chinese shipyards. It's not gonna make a huge difference into next year, but on the margin it may be helpful. On capacity expansion, we... You know, typically, it goes a little bit slower than we assume, so our guidance for CapEx for this year is probably a little bit too high.
You know, we are mainly following the energy transition trend when it comes to our CapEx program. So I would say there is no, you know, change in directions or scope at this moment in time. We are facing maybe marginally slower in some areas, but we are well in balance at the moment, and there's a lot of critical areas. Let's say the commissioning of new equipment at this moment, as we speak, is higher than I ever experienced in my industrial career, so don't get the feeling that we're not moving on it. It's we are getting well in balance in a lot of areas for the expected growth in years to come.
Thank you.
The next question comes from the line of Andreas Koski with BNP Paribas Exane. Please go ahead.
Thank you, and good morning. Can you hear me?
Yep.
Yes.
Oh, perfect, because I didn't get the notification that my line was unmuted. A couple of questions, please. You've mentioned several times during the call that you are now booking project-related orders for 2025 and maybe even for 2026. I wonder if you could give an indication how large part of your backlog is for delivery in 2024?
In 2024, where we'd expect, a major part of the SEK 3.3 billion, the, the, thirty-three billion, sorry, excuse me. I would say that some, you know, perhaps, I don't have the exact number in my head, so I'd rather not say, but, it's some percentage, and we can get back to you on that, what that is for 2025.
Okay. Most of that should be delivered in-
Yep. Yep.
Okay. And then, just a comment on the outlook. I understand that you are a bit cautious now for the fourth quarter, and we should not see the normal seasonality. But is that, and that is mainly because you expect a lower number in terms of large orders, because the project-related orders will not come through because the order book is so strong. Is that how I should read it, or do you expect underlying weakness also in the transaction business?
No, I think that's a correct description. We agree to that.
Yeah, and then on the marine margin, sorry if I missed this, but are you still confident that you will reach the 15% EBIT margin, 18% EBITA margin at some point in 2024?
We have never given a clear statement as to exactly where we gonna end up. So two comments to that. The first one is we've said we expected to start a gradual improvement in Q3. That happened, and consequently, the guidance was that there may be further steps, and we haven't changed our opinion on that. And the second comment is that, you know, the improvements that we see coming through now, they are actually secured into next year. So with that, you're gonna have to make some percentage assumptions on your own, but the direction is clear.
Understood. Thank you very much.
The next question comes from a line of Vlad Sergievskiy with Barclays. Please go ahead.
Yes, good morning, and thank you for taking my questions. I'll start with the outlook for demand trends in traditional energy or oil and gas, and here we can include offshore tankers and LNG carriers, potentially. Do you see any signs of a potential slowdown in this segment, which is obviously performing very well right now? And how margin accretive is this product mix for Alfa Laval?
We don't see weaknesses for the short term. We feel the market conditions are stable and remain stable, at least for the rest of this year. The margin question is a little bit difficult to answer in the context that we span over tankers and platforms and offshore and refinery and gas transportation, so it's a pretty wide span. So I cannot give you a real relevant guidance on it. I think what we made clear, though, a couple of times was in the last boom in the, you know, 2014, 2015, the oil and gas business was exceptionally profitable due to the high demand trends. We are not there at this point in time. We are more in the sense of normality of it.
So I don't think we have, you know, an important guidance to say that it's gonna make a difference, either positive or negative. The one positive thing that we have with us, though, in Q3 already, is the fact that we got rid of some of the load imbalances in units that were largely engaged with oil and gas side. So the imbalances or utilization improvement has been one cornerstone of the margin improvement in Q3 compared to last year.
That's perfect. Thanks very much for that. And also, you mentioned heat pumps slow down several times. Is it possible to contextualize within the broader Alfa Laval how big heat pumps as a percentage of the revenue, let's say, right now? Is it... Are we talking low single-digit %?
Yeah, that would be correct.
Got it. Final question, obviously, big improvement in free cash flow this quarter. Is it fair to assume that cash conversion will remain sound in the near future, given working capital is less of a headwind?
Yes, absolutely. That's our expectation. We expect that the profitability that we're generating in or the cash flow we're generating from operating activities will remain on a high level, and we expect operating working capital to stabilize on the current level in relation to a higher turnover.
Excellent. Thank you very much.
As a final reminder, if you would like to ask a question, please press the star followed by one on your telephone. There are no further questions at this time. I hand back to Tom Erixon for closing comments.
Okay, so, thank you very much for a good session, and may I remind you all, when we're here, that we have a digital capital markets day next week. We will more share the long-term perspective on where we see demand trends and transition trends affecting us and the way we'd intend to develop our business up towards 2030. So I hope we see the majority of you there. Thank you very much.
Thank you.