This is the presentation of the third quarter results 2014 for Sandvik. Very welcome. As normal, you will have a presentation first, followed by the Q&A session, and that's how this hour is going to run. As of today, you have the option to ask questions either from the floor, via the telephone, or through the internet as well. Firstly, the presentation.
Thank you, Magnus, and once again, welcome everybody who's here physically in Stockholm and everybody who's watching us over the web. Firstly, maybe to summarize our third quarter for 2014. We continue on our strategic journey and have taken several steps forward on the path that we have drawn up for the company. We closed one further production unit in the quarter of the initial 11 that we have ongoing closures for and expect a further three closures during the fourth quarter of this year. That program is developing according to plan. We also made a divestment of a non-core asset, our distribution business in Australia and New Zealand, which belonged to the Sandvik Materials Technology business area. The market has been relatively stable for the company during this quarter. North America and Asia stick out in the positive direction, where we're seeing continued good, strong business conditions.
In Europe, we see more of a mixed picture, where obviously the conflict between Russia and Ukraine and the following consequences and the tension between the EU and Russia is having effects on the economic sentiment directly in Russia, but also indirectly in markets like, for example, Germany. On the positive side in Europe, we also have some areas where we've actually seen very good and strong market situations. Like, for example, the U.K., a lot driven by the aerospace industry. The cash flow in the quarter was strong. We have a SEK 3.3 billion cash flow, and this was driven by, obviously, the underlying results, but also a continued reduction of our inventories in the group. This resulted in the net debt to equity ratio being reduced to 0.87.
The EBIT for the quarter came in just short of SEK 2.5 billion and was affected positively by both currency and metal prices. This slide we've used many times before, and it sort of outlines the strategic direction that we have in the Sandvik Group. What we're trying to do is really to drive a strategy in Sandvik that shifts us more to higher growing markets, helps us to yield higher returns, and also creates a business which is better at dealing with the very significant volatility we see in many of our market segments. Some highlights and steps that we've taken in this quarter is the closure of one production unit within Sandvik Mining. An exit of a non-core business within Sandvik Materials Technology, our distribution business in Australia and New Zealand.
We inaugurated an investment in Sandvik Process Systems, which increases our capacity significantly in what, for Sandvik, is a highly profitable area where we think we can grow a lot more from where we stand today. We also are very glad to announce an addition to our group executive management. Tomas Nordahl, who has been running Sandvik Venture, he has been offered a very good job within Boston Consulting Group, a global partnership role, so he will leave Sandvik at the end of this year. The new person taking over his role is Jim Nixon, the CEO of Varel International. Jim brings with him a number of strengths which are very important for Sandvik's future developments. He knows the oil and gas industry extremely well.
He spent his whole life in that industry and brings a lot of competence and knowledge around this segment to us, which is a very important segment for Sandvik directly in Venture, but also in areas like, for example, Sandvik Materials Technology. Jim is also a very successful entrepreneur. He's built Varel from being a small business into a quite sizable operation today. That experience makes him, I think, a very suitable leader also for the other business units within Sandvik Venture, and he will be a good coach and support for the leaders we have for businesses like Sandvik Hyperion and Sandvik Process Systems. Looking more specifically at our various markets. You can see Europe, year-over-year, more or less a neutral picture, -1%, That characterizes the weaker market developments that we see in the European markets.
Asia actually grew quite significantly, up +11% compared to the preceding year. We also see good growth in North America, up +6% compared to the preceding year. In the southern hemisphere, we see a bit of a mixed picture. In general, we see continued weakness based on the negative trends that we've seen over a long period of time within the mining industry. South America is up this quarter due to very strong invoicing in a number of mining systems projects. In general, also, we see quite a weak mining market in South America. Looking at our segments. First, the year-on-year invoicing, we actually now have two segments this quarter, which are in positive territory, both the energy sector and the aerospace sector, which was in positive territory the preceding quarter already.
Mining continues to be down year-on-year in terms of its invoicing compared to the preceding year, though. Looking at the arrows and the developments in the various segments, the picture of a stable market condition really prevails. It's only really aerospace where we see a continued ongoing positive trends compared to where we were the preceding quarter here, though. Looking more specifically at our invoicing and order intake. Order intake was down -5% in price volume terms compared to the preceding year. The main driver for this is not a weakening of really the market conditions. The main driver is that we hardly had any large orders when it comes to mining systems in the quarter. This is actually quite normal. These large projects can fall into a quarter or into the next quarter.
In the underlying rest of the mining business, we did have a book-to-bill of around one. For the equipment sales, the rock tools, and aftermarket business. The mining market does display a stable market condition. Looking at the invoicing, it was up 2% compared to the preceding year. Our EBIT came in just short of SEK 2.5 billion. We had some positive effects from currency, +SEK 80 million, and we do start to see continued currency tailwinds for the Sandvik Group right now. Our expectation, given the currency exchange rates that we had at the end of the quarter, is that we will have a positive effect of even as much as SEK 200 million in the fourth quarter of this year. Metal price effects were also positive during the quarter and boosted results by SEK 171 million.
This trend is, however, changing, and we do expect where we stand here in October that we might have or are likely to have a slight negative effect for metal prices coming into the fourth quarter. Our cash flow was very strong. This is due to continued somewhat more restrictive approach to capital expenditures. We now expect CapEx in the group to come in just shy of SEK 5 billion for 2014. We also did a good reduction of our net working capital, which enhanced the cash flow in the quarter. Looking then compared to our financial targets, while we saw very good growth in the quarter, in part helped by currency, but also structural effects driven by the Varel acquisition and the underlying 2% price volume change that we saw in the company.
Our ROCE is still below our targets, was actually annualized in the quarter somewhat higher than what we saw for the rolling 12 months. We continue to work with improving our profit margins in especially, I would say, Mining and Construction to move towards our target of 25%. Our net debt to equity ratio improved significantly during the quarter and is now 0.87, which is not far off from our long-term target to be below 0.8. That was my brief initial summary. With that, I'd like to hand over to Mats Backman to talk a bit more about some of the other aspects in the quarter.
Okay, I'm starting with a brief summary of the supply chain optimization program, where we have initiated closures of 11 units. We are targeting cost savings of about SEK 800 million with full run rate in 2015. In the third quarter, we closed one additional unit, and that was a smaller production unit for mining down in South Africa. Going forward, this is the phasing you can expect for the remaining closures. We will take another three in the fourth quarter and then the remaining six in 2015. All in all, this program is running according to plan. We are now detailing the plans for the next step of the program. We'll get back with more information related to that in early 2015. Looking at the net working capital, we are quite pleased with the development in the quarter.
We managed to reduce the value with some SEK 900 million. More importantly, we had destocking across all business areas. We reduced volumes with some SEK 1.2 billion in the quarter. We managed to keep the relative net working capital flat comparing with the second quarter. That is from a seasonal point of view, really good, because normally we have a seasonal effect of 2%-3% units higher net working capital in the third quarter comparing to second quarter. Looking on the development for the different business areas, we have continued to be on target level for Machining Solutions. We have actually managed to reduce the volatility in net working capital for Machining Solutions, which is important also from a profitability point of view with that.
For Mining and Construction, we delivered according to plan. The only disappointment looking on the net working capital in the third quarter was actually related to Materials Technology, where we need to speed up the destocking now going into the fourth quarter. Looking into the fourth quarter, what you can expect is destocking in four out of five business areas, with Machining Solutions being the only one where we are planning to produce according to demand. Net debt, as you probably remember, we increased the net debt with close to SEK 10 billion in the second quarter due to the closure of the Varel acquisition. Also due to the payout dividend, we ended up with a net debt to equity ratio 0.96 in the second quarter.
We managed to decrease this to 0.87 in the third quarter. That was due to a strong cash flow, definitely driven by inventory reductions. That will continue now in the fourth quarter as well. We are selective when it comes to investments. Like Olof said, we are changing the guidance for the full year to be below SEK 5 billion. All in all, we are working on reducing the net debt further in the fourth quarter. We are aiming for our target of 0.8 net debt to equity by the end of 2014. I'm leaving for you, Olof, to summarize.
Okay. Just briefly to summarize before we open up for the question and answers. We continue our journey, the strategic execution of our strategy in the company. I think we're well on track with the programs that we've drawn up in the Sandvik Group. As Mats mentioned, we're on track with our program to optimize our supply chain. The closures are running according to plan within that initiative. We saw strong cash flow in the quarter. We continued to reduce net working capital. Also that was helped by underlying earnings. We have a tight approach on capital expenditures also in the group. Overall in the market, we do see a stable demand picture. With that, I suggest we open up for your questions. Magnus, could you lead that?
Yes, we will. As we mentioned in the beginning of the call, we have questions either coming from the floor, through the telephone, or via the internet as well that you can write in your questions. Please limit your questions to one at a time as well. That is of convenience for all. Operator, do we have any questions at this point in time?
Yes, we have a question from Mr. Lars Brorson at Barclays. Please go ahead.
Thank you very much. I had a few, but I'll restrict myself to one, please. Just on the CapEx guidance, Olof and Mats, when you say, Mats, that you're being selective with regards to investments, can you talk to us about where specifically you're being selective or whether rather this is perhaps a matter of either canceling certain investment projects or pushing investment into 2015? Also to the SEK 5 billion level that we're running at in 2014, should we expect that level to continue over the next couple of years, particularly in relation to the manufacturing footprint realignment that has seen a step-up in CapEx levels? Thanks.
I think the SEK 5 billion CapEx level is a reasonable number to assume going forward for Sandvik. We should, in a steady state situation, obviously be able to be somewhat lower than that, but we do need to do certain investments when it comes to moving production onto new manufacturing locations. We're looking in general at all the capital expenditures we're doing. I would say the changes we've seen have not necessarily related to larger strategic projects, but a tighter view on the continuous underlying maintenance capital expenditure that goes on in the group.
Thanks.
Thank you very much. Operator, may we have the next question?
We have a question from Mr. Andre Helfenstein at Credit Suisse. Please go ahead.
Good morning. Thanks for taking my question. I just have a broad one on machining reinvestment cycle that we have talked about before. Could you tell us where we are right now, sort of as a run rate over the last couple of quarters? Are we at the required level in terms of things like R&D to sales or investment in presence of brand? Do you need to ramp it up further as a run rate from the current levels? If you do, then could you give us an idea of order of magnitude?
That's a very good question, we have been investing during this year quite significantly, actually, in these kind of activities within Sandvik Machining Solutions, that has led to certain cost increases. For example, in the third quarter, we had a very large share of IMTS fair in the U.S. where we had a strong presence from the Sandvik Group. My view is that we are at the correct level as we see it right now. We're not planning to see further cost increases in these areas, but that the current level of investment that we're doing into sales and marketing activities and so is adequate to take us forward for the foreseeable future.
Thank you.
Thank you very much. May we have the next question from the floor, please?
Yes. Peder Frölén, Handelsbanken Capital Markets. A follow-up on that, the leverage question for Machining Solutions, put it a bit differently. Once again, we have organic growth, but sort of negative leverage on that. With reasonable levels of front-end investments, what type of organic growth do you need to have a positive leverage next year? Obviously, 4 is not enough as we speak today. I think that looking on the third quarter is a little bit special considering the results we had in the third quarter last year. Because we were helped to some extent by some provision releases last year related to incentive programs within Machining Solutions, and I would say that was probably between 1%-1.5% on the margin. That is one aspect that we will not see that in the comparison going forward.
Secondly, I would say that, comparatively to last year, we have the investment in R&D and in front-end related to Machining Solutions. As Olof said, we are all probably on the right level there. It sounds like, yeah, with a 4% organic growth next year, we should be able to expand EBIT.
Yes, absolutely. As Mats said, I'd like to stress that this leverage that we see Q3 last year to this year is not really a representative comparison because we have certain issues like, for example, this dissolution of provisions that we had in Q3 last year that distort the comparability. You should expect normal leverages for us. We've also, as I said in the previous question, now reached the point that we feel we have adequate levels in terms of sales and marketing activities to drive future growth in the business.
That's very clear. The price mix on MS this quarter?
The price improvement, development. Overall for the group, we're talking about around 1% price improvement, mainly driven by Sandvik Machining Solutions.
Thanks.
Very good. I could tie into that one with a question from the internet as well, from Eric Carlson. What do you see in pricing sequentially in the mining division for equipment and for aftermarket, respectively?
Well, we see roughly a stable pricing development when it comes to the mining side of the business. We don't see deteriorating prices, but we also don't see the historic positive prices evolution that we saw. That's, of course, due to the much tougher market conditions that we see today than a few years back.
Thank you very much. May we have the next question from the floor, please?
Yes. Anders Sundström, Swedbank. Some more questions regarding Sandvik Machining Solutions. How do the outlook or production rates at the beginning of this quarter, you mentioned that this was the only division where you're not taking down production, where you lift production, a little bit about market share development in this segment.
Well, starting with how the sales have looked so far into October, we see stable development compared to the levels that we saw in September. We don't see any negative trends also due to recent uncertainties in the sales. Then market share development, well, I think we are holding our market share well. We are trying to address when it comes to the mid-markets, how we can actually increase our share in that area where we haven't historically had a presence. In my mind, we see good growth rates in brands like Pramet and Carboloy that we're using to address the mid-market business.
Production levels?
Yeah, production. Sorry, yes. That should be on normal levels, as Mats showed. We have, I think, succeeded very well in Sandvik Machining Solutions to have a much more stable inventory development than we've had historically in the business, therefore, production levels should be in line with sales also in the fourth quarter. We're happy with the net working capital ratio that we have in Sandvik Machining Solutions.
Okay, thanks.
Thank you very much. Operator, may we have the next question, please?
We have a question from Alexander White at JP Morgan. Please go ahead.
Yeah, morning, everybody. It's Alex at JP Morgan. Just got a question around the mining division, if I could. Just trying to better understand the Q3 results there. The sales look strangely strong given the order trends that you've had. I guess FX helps a bit, but was there a large project completions? Did that have any impact on the mix, positively or negatively?
We did have quite a good invoicing for mining systems in the third quarter. They are below the average 9% EBIT margin rate that we saw in the third quarter. That has a somewhat diluting effect with this large amount of mining systems that we have in the business.
Within that 9% EBIT margin, was there a portion of the provision reversals that you talk about at the group level on page three of the release? Was some of that within the mining division?
For the whole group, we had about SEK 80 million of provision releases in the third quarter. About half of that relates to Sandvik Mining having a positive effect on results.
Okay. If we're just looking ahead in Sandvik Mining, can you help us understand how much in sort of incremental savings we should be thinking about over the coming 12 months? Also, I mean, the drop-through was very high, which I guess was partly impacted by the project completion. When should we start to see that drop-through getting back down to more normal levels?
Well, looking into the fourth quarter in a positive direction, we have continued savings. As you see, Sandvik Mining numbers are coming down in the business there, both for the group as a whole and very specifically for Sandvik Mining. That will work in a positive direction for Sandvik Mining margins going into the fourth quarter. We won't have things like, for example, these provision releases that we saw in the third quarter. I would say they're roughly on a similar level in magnitude, those two effects when looking at the fourth quarter.
Okay. That's helpful. One last question, if I could, on Sandvik Mining, and then I'll get off the line. Can we just consider the business excluding the large orders? Around SEK 5.5 billion of orders this quarter, SEK 5.8 billion or so last quarter, excluding the large orders. It's clearly a deterioration sequentially when FX, I imagine, was a tailwind. I understand you'd sort of describe the underlying market as stable. Can you help us understand within sort of services or within equipment, which of those two areas saw the decline in orders sequentially?
No, we actually for both of those two areas see, I would say, a stable market condition compared to the preceding quarter. We see somewhat, we have a bit of a seasonal effect in Q3, but no material changes in terms of how the market is performing. Both of them are close to one when it comes to book-to-bill, both the equipment side and aftermarket and consumables part of the business.
Okay. I thought given customer services is strongest in the back half of the year, I would've thought that the seasonality in the orders should've been positive. I'm just trying to reconcile the decline in orders with the stable market.
Well, as said, we do see stable market condition and nothing out of the normal. You should expect that we are stable when it comes to these underlying parts of the business, when it comes to our rock tools, aftermarket service business, and also the equipment side. What has affected the numbers this year or this quarter is both the high invoicing that we had with mining systems and a very low order intake.
Okay. Thanks for your answers.
Yep. Thank you very much. Operator, may we have the next question, please?
We have a question from Mr. James Moore at Redburn. Please go ahead.
Yeah. If I could just follow up on the mining business. I see that your orders have been quite low, but the invoicing high as we just talked about, and I guess that's had some help to the margin. On the other side, I think you say in the statement that there was something like SEK 600 million of destocking in the quarter in mining. Is that the case? Could you say what sort of impact that destocking had on the mining margin?
I would say a rather low impact because the major part of destocking within mining was actually related to parts. We don't kind of struggle with under absorption in that respect. A rather low impact from destocking in mining in the quarter, despite the high volume reduction.
Just switching topics onto restructuring. Your picture for 2015, could you help us a bit there? You obviously took quite a lot of charges about a year ago, and you gave a range for what restructuring could look like, and that would leave us with something between SEK 1 billion of restructuring charge coming in 2015 or SEK 2.1 billion of restructuring charge in 2015. It's quite a big range. I wondered if you could help us where we will be in that range, and will it all be booked in the first quarter of 2015? I think there was some suggestion in the past it would come in the first quarter.
We are still kind of detailing the plans for the second step. We will come back with more information early 2015. I guess that's what we can say right now. That does not mean that's the final step. This is a three to four-year program that we're talking about. It's not necessarily so that the announcements in the beginning of next year will take us all the way to the completion of the program.
Okay. Sorry, just stepping back to mining. If we've got the positive from the higher invoicing, and we've got a small negative here from the destocking, and you talk about the savings coming through. In simple terms, because there's a lot of moving parts that are hard to understand on the outside, what sort of clean margin should we think about for mining next quarter?
We're not that specific and don't give forward-looking guidance, but we have a number of things that we're working in a positive direction this quarter, which won't come in the fourth quarter, and other things like cost savings coming through in the fourth quarter. Net-net, those are roughly of the same magnitude.
Okay. Thank you.
Thank you very much. May we have the next question from the floor, please? Please remember to limit your question at one at a time. No questions from the floor at this time. Operator, may we have the next question?
We have a question from Mr. Ben Maslen at Bank of America. Please go ahead.
Yeah. Morning, Olof. Morning, Mats. two on SMT, please. I think you raised some of the prices in SMT over the summer following the rise that we saw in the nickel price. I just wondered if that was having any negative impact on demand for standard products now that nickel is coming back again, and that the people wait for prices to come down to buy new inventory. That's the first question. Then on oil and gas, are you seeing Sorry, do the first one.
Yes. Well, obviously, in the standard products, there's a larger element of distributor-related sales and inventory speculation than what we have on our niche products. If there will be a sharp continued decline on nickel price, that could potentially have a negative impact on standard products within Sandvik Materials Technology. We see a general fairly stable but weak market in Europe, and that's what we've seen really during the third quarter as well. How that will develop into the fourth quarter now, we'll have to see. Right now, nickel has been declining a bit going into October.
Got it. Thank you. Then the follow-up was within SMT, we've obviously seen weaker oil and gas prices, more uncertainty in those markets. Has that had any impact on demand for your umbilical products? Thank you.
It has not to date had any impact whatsoever. I think one should remember that when the oil companies are looking at these kind of large investments, they have, of course, a very long-term perspective. A short-term drop in oil price does not necessarily have any impact on completion of projects. We are also into technical areas, which are more and more needed within the oil and gas industry. The type of products that SMT are developing and producing are in areas that are growing faster than the overall underlying demand in the oil and gas sector here. Part of them are also related to getting a longer life out of the existing wells, like certain umbilical installations and so can be.
That can be more related to this sort of smaller ongoing CapEx and not necessarily only demand these large new projects to create demand.
Got it. Thank you, Olof.
Yeah.
Thank you very much. We will switch to a question from the floor in Stockholm.
Yes. Peder again. On construction, you mentioned no expected restructuring or adjustments in the fourth quarter. This is the second or third quarter with pretty weak numbers out of construction. How should we think of this? Are you still getting your head together what to do with this, or what are you waiting for in terms of trying to
Cut costs. We shall have ongoing very significant cost-cutting programs within construction. Manning was down quite significantly in the third quarter, and we have a big site closure, which is still ongoing, Swadlincote in the U.K. related to our mobile crusher business. That site is one of the three that we expect to close during the fourth quarter of this year. So that's not yet completed that step. That's quite a material impact. That individual site is quite a large one from construction perspective.
Demand is still struggling or still tough out there when it comes to construction, mainly due to China and so forth.
Yeah.
Should we expect sort of adjustments to current demand situation on top of the, how do you call it, supply chain optimization for that specific division?
We're seeing a fairly stable market environment for construction where we stand right now. What we're doing is more related to actually adapting the longer term cost structure of the business and short term adaptations to a weak market. Structural long term improvements of the underlying margin of the business.
Okay. Thank you.
Thank you very much. We have another question from the floor in Stockholm.
Yes, Anders Sundström again. Coming to Venture, it seems that excluding Varel, the result was relatively poor, some SEK 160 million versus some SEK 218 million Q2. What is the normal level there?
Well, Venture does see some varying results. We right now have seen some drops on APT prices, for example, or tungsten prices and so, which do affect results negatively there. You're right in that underlying, excluding Varel business, there has been a certain drop in profitability compared to the preceding year. Sequentially, on the other hand, Varel did see a very good profitability development Q3 compared to where they've been earlier this year. That I think was a very positive development anyway.
What about the fourth quarter for the remaining Venture business other than Varel?
Well, we actually see a fairly good market situation for both Process Systems and Sandvik Venture and so.
Thank you very much. Operator, please provide us with the next question.
We have a question from Mr. Fredrik Stall at UBS. Please go ahead.
Yeah. Hi, good morning, guys. It's Fredrik here from UBS. On SMS, we've talked a bit about your investments and the impact on margins there, I'm more curious about the revenues. Have you seen the impact from your efforts in your growth and your market shares? If you haven't yet seen the full impact, when should we expect that to come through? Thank you.
We have gradually been putting in efforts during this year. We also have had a number of very significant new product launches, which have been gradually rolling out during this year. We continue to have a high ambition with these efforts, which should help us to have good growth rates going forward. As I said, we're not increasing the investment levels beyond where we stand today. For example, Europe is, I would say, a bit more uncertain today than where we stood nine or 12 months ago.
We should start seeing the benefits hopefully then over the next few quarters?
Absolutely. That's our expectation, yes.
Thank you.
Thank you very much. Operator, the next question, please.
We have a question from Mr. Colin Gibson at HSBC. Please go ahead.
Thanks very much. Good morning, everybody. Two questions, if I can, and I'll ask them one by one. First of all, I wanted to ask you about your worldwide market share in cemented carbide tooling. I think the new strategy at Sandvik Machining Solutions very much designed to try to win back share. Do you feel yourselves that you have any evidence so far that you're actually starting to achieve that yet?
Not in any big way. We talk about something like if you look at the whole market, a 20% global market share roughly for the Sandvik Group. We do have efforts both in terms of entering into the mid-market, which has been a fast-growing segment of the market, where we have not really had an offering in the past. We're driving organic growth into that area. We're also negotiating a potential joint venture into that area to support our growth when it comes to the mid-market. When it comes to the premium market, we have a very strong focus on our research and development right now, and that is absolutely key when it comes to moving forward our positions in that market. For example, GC4325 insert within Sandvik Coromant is a very important step in terms of creating a product that puts us ahead of competition.
These kind of steps are laying a foundation for us, which will make it easier for us to grow and take market shares going forward. I'd also like to add in the premium area that we are doing certain selective investments into technology areas where we see very good growth potential. Last year, we bought out the remaining share of a company called Precorp. They make diamond-tipped drills for the aircraft industry mainly. This business is growing very fast. We're talking something 30%, 40% growth rates in what is today a small business, but has potential actually to support Sandvik's position in this fast-growing, very attractive area going forward in a very good way.
Thanks very much indeed. One follow-up question, if I could. Just looking at the return on capital employed performance, notwithstanding some pretty good performances on the margin and some pretty good performances on working capital, you still have a huge hill to climb in terms of reaching your return on capital employed target. Would you agree that to reach that target, it will depend on restructuring you haven't yet announced? Or would you, on the contrary, argue that you can achieve that ROCE target within the frame of everything you've already announced?
Well, with the mining where it currently is in terms of its own market situation, that's of course, quite a big gap, and mining is one of the big profit drivers in the Sandvik Group. Obviously we need to continue to build margins in our existing businesses, but probably need some tailwinds in the market to achieve something like 25% ROCE in the group.
Okay, thank you.
Yeah.
Thank you very much. We have another question coming from the internet. It's from Eric Carlson again. What do you think we need to see in the environment to see an uptick in mining demand? Where in the division would you look for an improvement first? Equipment orders, services, consumables, or mining systems?
That is, I think, a very good question. Mining is a market with several different dynamics. It is clear, I think, that the expansion related large CapEx projects, they're going to take several years until they come back. The mining industry is not looking for big ground scale investments right now. From where we are today, there is a good potential that you will see the OpEx related spend increase over the coming one, two years in the mining industry because production rates at the mines are still very high and actually have been increasing. At the same time, one has cut even in the OpEx related areas, trying to destock, trying to maybe use machines a bit longer than one have used them in the past. In longer run, that becomes a productivity problem.
The miners, I believe, will actually need to increase their OpEx spend going forward to maintain these very high production rates that they have. The likely development that you will see going forward is that you will first see a pickup in OpEx related spend and then maybe a bit longer into the future, you will see the more expansion related CapEx coming back in the industry. It will be more related to spare parts and equipment sales actually starting to move in the positive direction, which are the first signs that we start to see this OpEx related improvement in the mining industry. The CapEx related, well, you need to look at when there are big new mines being announced, which I think will still take a few years until we start to see that development.
Thank you very much. Operator, may we have the next question?
Our next question comes from Mr. Lars Brorson from Barclays. Please go ahead.
Yes. Thanks. I just had a quick follow-up question, sorry to belabor the questions around mining demand. When you talk about normal fluctuations in the demand pattern, again, iron ore price is down some 20% since your Q2 results, down 40% year-to-date. I'm surprised that given we're at close to sort of $80 a ton, that incremental drop in iron ore price, not a catalyst for lower spending among your customers, particularly for your systems business, where iron ore, from memory, is about 60%, 70%. I guess the question arises for me is what kind of visibility do you have here in terms of what really is normal business conditions for your system segment? Thanks.
It's a very good question, as you say, iron ore is a big driver of our mining systems business. Our main exposure is with the large mining companies like BHP Billiton, Rio Tinto, more when it comes to mining systems projects. I actually just visited Australia the other week, and they are completing these large projects. Rio, for example, has been very clear on that they view themselves as the lowest cost producer. If anyone's going to have to give in the market, it's going to be the higher cost margin al iron ore producers. We've seen some effects, for example, in Sweden, of these small miner investments that are actually going bankrupt now in iron ore, Dannemora, Northland, have big financial troubles. Sandvik's exposure to these higher cost iron ore producers is actually very limited.
As long as BHP and Rio Tinto, as examples, continue their strategy of being market leaders and having a cost base which widely is lower than even the current prices and most of its competitors, I think there's good room for at least continued seeing that they will replace equipment and continue to make certain selective investments into the Pilbara, for example, in Australia.
Thanks.
Thank you very much. There are no further questions from Stockholm at this time. Operator, may we therefore have the next one from you?
Our next question comes from Andreas Koski from Deutsche Bank. Please go ahead.
Yes, good morning. Thank you. A quick question on group activities. It was a negative impact on EBIT by SEK 264 million in the quarter compared to SEK 342 million in previous quarter. I think you've earlier guided for a level of SEK 300 million-SEK 400 million per quarter. Is this still the guidance, or should we expect a lower level going forward?
Around SEK 300 million. We have a high volatility in between quarters when looking on group common or group activities. Somewhere around SEK 300, I think is the fair number.
Perfect, thanks. On mining, did you have any major orders at all in the quarter, or was it zero?
No, we didn't have any major orders within mining this quarter. We had only one larger order that we've highlighted, that was into the nuclear segment, where, and that you can take actually as quite a positive sign. We booked a SEK 200 million order within Sandvik Materials Technology.
Good. Lastly, if you could clarify, should we expect the second phase of the Chain Optimization Program to be announced in the first quarter, or can it come later in 2015?
You should expect it definitely in the first half of next year.
Okay. Maybe in Q2?
That would present into the second half of the year, actually. I would say probably earlier than that.
Okay. Thanks.
Thank you very much. Operator, the next one, please.
Our next question is from Mr. Andreas Koski from Credit Suisse. Please go ahead.
Yes. Hi, it's Andre again from Credit Suisse. Just a couple of follow-ups. One, again, a broader one on Asia. Your message is very solid there. Could you just help us with breaking it up a bit between countries, how that mix is looking and maybe between your business segments as well? If you could comment on kind of longevity of that strength, because some of your peers have been obviously talking a bit more conservatively on the region. Any color would be much appreciated.
Well, when we look at Asia for us in the third quarter, it's I would say especially Japan and China that have shown some better strength for us, that we can talk about the automotive sector, general engineering as well as positive markets in Asia. Year-on-year, we had a quite good increase, as I showed earlier, in terms of our sales in Asia. It's especially, I would say, these two markets who have been the positive drivers.
Got it. Thank you. Maybe one for Mats as well. The guidance you gave on where you'd want the net debt to equity to be at the end of the year implies another SEK 3 billion odd cash generation quarter in Q4. Would that be correct, Mats, or are there any other moving parts within that equation?
No, we are aiming for the 0.8 level by end 2014. Definitely, we need to have a high contribution of cash flow coming in for that number.
We also have SEK 400 million coming in from the divestment of Sandvik Materials Technology distribution business in the fourth quarter.
Got it. That's helpful. Thank you very much.
Thank you.
Thank you very much. Operator, please help us with the next one.
The next question is from Mr. James Moore from Redburn. Please go ahead.
Thanks. I've got a follow-up on the SMS margin. It looks like sales were largely unchanged in the third quarter against the second, but the clean EBIT margin is down about 1% if we adjust for the small share of provision release in the business. I think last quarter you talked about a 50 to 100 basis points of negative margin impact from underproduction, which would suggest that the sequential clean margin has dropped more like 1.5%, 2%. I know that there's been a bit of seasonal production decline, and you talked about some sales ex and R&D. Equally, I see your headcount's down in the business. Is there anything else that's affecting the margin on the downside in the MS division? Is this a mix there? Is there something else?
Do you see this as more reflective of a sustained clean margin deterioration going on?
No, I would say, looking on the margin development in the third quarter for Machining Solutions, it's pretty much according to what we said after the first quarter or after the second quarter. We have a seasonality going into the third quarter, but we talked about maybe 50% of enormous seasonality going into third quarter this year due to kind of the net working capital situation. That's really what we see. No surprises from that point of view, I would say.
Okay. In terms of your Construction business, you talked about exiting the non-core business. Can you just clarify that it isn't possible to sell the whole of Construction because it's very interlinked with Mining, and that what we're really talking about here is mobile crushing and screening?
Construction is very difficult to just chop a block sale as a whole business area within Sandvik, because many parts of the business, the crusher business, the tunneling, drill rigs, and so on, have quite strong ties to the other parts of Sandvik. That's correct.
Is it in particular mobile and crushing and screening, which is an industry suffering at the moment, where you think you can separate that piece?
I don't want to comment specifically on any potential exits within construction, but mobiles is one of the lesser integrated parts of our construction business compared to others. Breakers is also such an example in that business area.
Just one follow-up there. Just on the mobiles, is that a heavy loss maker at the moment, or is it in the black?
It is a challenging financial performance in mobiles, and yes, we have been losing money in that business.
Thank you very much.
Thank you very much. The next question comes from Peter Lindmark through the internet, and it runs: How was auto production during last Christmas holidays versus normal amount of stop dates, et cetera, especially in Europe? It is not announced yet for this year, but what is your best guess today, given auto sales momentum, auto inventory levels, et cetera? I think this question relates to our customers' production.
Yes. When we look at automotive from Sandvik's perspective, what we see right now, we see fairly good markets in North America and in Asia. We, as several other companies have talked about, have seen certain weakness in terms of production and plant production within the European automotive industry. That gives roughly the picture that we see. Any potential weakness related to auto right now is mainly centered around the European producers.
Very good. I think the question also was related of if we have an opinion today where automotive manufacturers' Christmas plans look like.
That's a question I don't want to go out and comment, but I think should be directed directly to the automotive producers.
Thank you very much. Operator, the next question, please.
Our next question comes from Mr. Alexander Leske from Societe Generale. Please go ahead.
Hi, good morning. Couple of follow-up questions on mining, please. One shorter term and another longer term. Shorter term, just provisions for stock obsolescence in mining. Sorry, I might have missed some comments here, but it sounds like it's relatively small in the quarter. Can we assume a similar level going forward, i.e., we're pretty much done with that now? I guess also just on that side, if you have any more color around the de-stocking in the spare parts in mining that you referred to, was that any particular area?
First, when it comes to obsolescence, I think you can expect the level we saw in the third quarter. No major impact from obsolescence. We are continuing to address the inventory within mining, I think that's the best way to deal with obsolescence going forward, getting down the inventories. When it comes to the de-stocking, yes, we are expecting a de-stocking going into fourth quarter as well, to some extent related to parts in the fourth quarter. We don't expect any kind of major P&L impact coming from de-stocking in mining in the fourth quarter.
Okay, great. Just a longer-term question. Mining, traditionally very conservative industry in terms of embracing technology change. Given the persistence of a weak demand environment, just whether you feel we could now see an acceleration in the adoption of new, more productive technologies, particularly around mechanical rock excavation. Just wondering if you've seen any changes in customer interest there in terms of pushing that forward, how you see yourself positioned for that change, or do you ultimately think it's going to be a bit of a slow burn still? Thanks.
I think it's a very good question. In the period we saw with very strong growth in mining that we saw up to 2012, there was very little or quite limited interest in trying new technologies. The core thing was to get new capacity as quickly as possible and normally taking very low risks. Today, in this environment, all miners are looking at productivity, cost savings, more than actually increased production. I think we will see an acceleration in technology development. I think things like automation are going to rise a lot faster. The mines want to get people out of the mines to create a safer environment, and of course, reduce costs. We see increasing interest into electric vehicles, and Sandvik is developing several new products into this area for economic reasons and also for environmental reasons, which are driving many of the mining houses.
I think it's likely over the coming years that you'll see an acceleration in technology developments within the mining industry.
Okay, great. Thanks.
Thank you very much. Operator, may we have the next question, please?
Our next question comes from Mr. Nick Wilson from BS&I. Please go ahead.
Hello, good morning. It's just a quick one on SMT. I know your strategy talks about exiting non-core businesses, and obviously we've seen the disposal of the Australia-New Zealand distribution business. Can we expect further disposals from this business going forwards, or was that mainly the business that you had earmarked for disposal? Thanks.
No, we put it up on our list with our strategic agenda, as I showed earlier here, and we will continue to look within SMT, but also in other areas of Sandvik at non-core assets, which we feel the company will be strengthened and more focused by divesting. Over the years to come, we will continue to have that focus here within the group.
Thank you.
Thank you very much. We have no further questions at this time, which means that we conclude this session. I thank you for your attention. Have a good day. Thank you.