Ladies and gentlemen, very welcome to this presentation on Sandvik's second quarter earnings and results. My name is Magnus Larsson, Head of Investor Relations. This coming hour will look the way it normally does. We will have a presentation by the Chief Executive Officer, followed by the Chief Financial Officer, after which we will have the normal question and answer session. With that said, Olof Faxander, please carry on.
Thank you very much, Magnus, and welcome everybody who is here in Stockholm with us and, of course, all of you joining us over the web here. I will do a brief presentation here together with Mats, and then, of course, we'll have our usual question and answer session. To start with summarizing our quarter, I think the most important events that happened during the second quarter for the Sandvik Group was that we took several steps forward along our strategic agenda. We initiated a further closure of four production units and actually completed the closure of one. We also closed the deal with the acquisition of Varel, which lays a foundation for us to continue to build future profitable growth. The market conditions in the quarter were stable and overall, largely unchanged compared with the end of the first quarter.
Overall for the Sandvik Group, a fairly stable development. I think what is also important, that in mining, where we've for many quarters seen an actual declining trend, we've now seen, I would say, quite firm stability in the market at the levels where we're at right now. Our EBIT came in at just below SEK 2.6 billion for the group, and we had a number of items affecting the EBIT in the quarter. Acquisition related costs related to that closure of the acquisition of Varel International. We had certain currency effects of about minus SEK 200 million for the group. In a positive direction, we had effects from positive metal price effects amounting to nearly SEK 200 million as well. A number of items affecting the EBIT in both ways.
Looking at our strategic agenda in Sandvik that we've drawn up, I've shown this slide before at previous quarterly presentations, I'd like to highlight some of the steps that we've taken forward in our direction to build a Sandvik which is exposed to high growth segments, increasing its margins gradually, and reducing our earnings volatility. The main steps we've taken during this quarter is the initiation of the closure of four production units within mining. This will help us to shift our footprint closer towards our customers and, of course, reduce our cost base. In the quarter, we signed a letter of intent with the Chinese producer of metal cutting tools, Suzhou. This gives us a strong opportunity within the mid-market segment within Machining Solutions. These negotiations are still ongoing.
The letter of intent was the first step. This will be a method for us to accelerate our inroads into the mid-market area within metal cutting tools, which is important, and it is a fast growing sector in the market. Finally, within Sandvik Venture, on our journey to gradually shift our portfolio to fast growing sectors in the market, we closed the acquisition of Varel International, and this lays a great platform for us, I think, moving into the future to see high growth rates and also good profitability developments in that area. A number of things have been progressing during the quarter along our strategic agenda. Looking at Varel specifically.
Varel has a strong position in the oil and gas sector, and is very active in drilling technologies, but also down the hole tools, and completion tools regarding after the well has been drilled. This is also an area that's growing very rapidly. The interesting thing with the drill bit from Sandvik's perspective, to highlight that, is that the drill bit itself is a fairly low part of the total cost for the operator drilling the hole. It does have a significant impact on the productivity of drilling that hole and the security of drilling that hole.
That means that the drill bit itself has a similar dynamic to what we see in our metal cutting tools, where the actual metal cutting tool is a small part of the cost, but it can have a big impact on productivity and hence save a lot of money for the customers if you perform better than your competitor's drill bits. Sandvik has a lot of technology we can put in and support Varel with. We know industrial diamonds, we know cemented carbide, and we know a lot about cutting in hard materials. We go into an area which is technically close to what Sandvik really knows, but opens up new market opportunities for us for future growth.
Looking at the financial performance of Varel, the first 12 months, if Varel would've been part of the Sandvik Group, they would've delivered an EBIT of SEK 144 million, and a margin of just over 12%. This has been a bit under pressure, amongst other, due to the developments that we have seen in, for example, the Russian oil sector during the first half of this year. The EBIT margin trend has been improving during the year. If you look at the period that is included into Sandvik's result from the 21st of May, we have seen a higher EBIT margin during that period. The synergies that we will work on are related to, of course, supply chain cost synergies. We can supply diamond cutters, cemented carbide, and other materials into Varel that we are not doing today, creating cost synergies.
Maybe most importantly, leverage on our technical knowhow within the Sandvik Group to support and build better drill bits, giving us a competitive edge in this market. A further advantage for Varel being a smaller company is Sandvik's global reach. We cover really more or less the whole world with current daughter companies and sales presence, and we can help Varel to support them in growing at a more rapid pace than they have in the past, based on the strength that we have in Sandvik, and the presence that we have with the Sandvik Group. If I move in more specifically to the quarter here then, and our various regional developments. Most regions actually had a negative development.
You can see the development on the Southern Hemisphere that was clearly affected by what we've seen in the mining sector with the continued deterioration of sales, as sales are catching up with the lower order intake that we've seen over a longer period of time now. North America was stable to positive when it comes to the metal cutting business within Sandvik, but was affected negatively by the effects of the mining industry. Europe had a similar pattern also when it comes to our sectors, and also here we saw better development in the western parts of Europe, but had a negative impact of the developments around Russia due to the political situation there with Ukraine and the economic effects that that is having around the Russian economy. Asia saw all in all growth for the Sandvik Group. Looking at our sectors, and our sector exposure.
This again highlights a picture of, I would say, stabilized demands at where we're at right now. mining saw continued deterioration in the year-on-year on invoicing, the orange part of this pie chart. The sector where we saw continued growth was the aerospace sector. More or less all the other segments in the Sandvik Group saw a flat development compared to the same period last year. Sequentially, all areas, with an exception of aerospace, showed a flat development. While aerospace, we did see a continued positive development. I think it's important to note that mining appears to have stabilized at the level we are right now, and hopefully in quarters to come, we have prospects of seeing that trend changing to the positive direction.
Sandvik's order intake year-on-year was neutral, 0% in price volume terms, while our invoicing dropped, mainly driven by the developments we saw in the mining sector. The invoicing increased compared to the preceding quarter and the higher order intake that we had there. Again, noting that Sandvik Mining showed a stable order backlog. Our EBIT came in just below SEK 2.6 billion. As I mentioned, we have a negative currency effect by about SEK 200 million. The biggest area seeing the negative currency effects was Sandvik Mining, where we have a lot of production in EUR and in other areas, and our sales in mining related currencies. Sandvik Materials Technology, on the other hand, which has the largest part of its production base in Sweden, saw actually positive year-on-year currency effects in this quarter.
Nickel prices driven by the developments in Indonesia, where they have restricted the exports of nickel pig iron, also the effects of what's happening in Russia, have been going up quite significantly. This has had a very material impact on the results for Sandvik Materials Technology, which gave them a positive impact of SEK 177 million in the quarter. Cash flow improved somewhat compared to the preceding quarter. We have seen some normal seasonal buildup of inventories in Sandvik Machining Solutions and Sandvik Materials Technology, but somewhat more limited than what we normally have seen in the past from Sandvik. As we've talked about before, it's our ambition to gradually even out the seasonal effects that we've had through the third quarter.
Investments came in in the quarter at SEK 1.1 billion, we have slightly revised down our CapEx estimates for the full year from between SEK 5 billion-SEK 5.5 billion to about SEK 5 billion for the Sandvik Group. Finally, looking then at our financial targets. Well, all in all, we did see a decline in our sales in the quarter. This was driven by what has been happening in the mining areas I've talked about before. We are focusing on creating that platform for our future growth in the company by our R&D efforts, by the shift of our portfolio into high-growing segments, through the acquisition of Varel, and gradually adjusting our geographic footprint to the areas in the world where we see the highest growth.
Looking then at our return on capital employed, it was for the last 12 months, 12.3%, but actually annualizing the current quarter, we came in at 15.5%. The main drivers to improve this is, of course, stabilizing and bringing up the results again for Sandvik Construction and Sandvik Mining, but also reducing our capital base by driving down our net working capital and being restrictive on our capital allocations in the company. Our net gearing for the group increased, as we talked about earlier, was expected due to the closure of the Varel acquisition and the dividend payment that we had in the second quarter.
At the end of the second quarter, we were at a net gearing level of 0.96, but we expect this to drop down fairly rapidly in the coming quarters, back below our financial target of 0.8 due to the underlying strong cash flows that the Sandvik Group generates. Finally, our dividend was paid to all of you shareholders during the second quarter, it was representing a share of 88% of our reported EPS. Again, Sandvik has an uninterrupted dividend payment since 1870, we have a strong cash flow out to our shareholders through the dividend payments. That summarizes my part of this presentation. Now I would like to hand over to Mats to make some further, maybe more detailed comments about some parts of the report.
Thank you, Olof. I will elaborate on some of our key priorities now going forward. I am starting with the supply chain optimization program, where we are aiming for reducing our number of production units from today's 150, down to 125 over the next three to four years. The first step of this program includes the closure of about 10 production units with annual savings of SEK 800 million with full run rate end 2015. During the second quarter, we announced the closure of a further four units, all of them related to Sandvik Mining. With that, we have announced and initiated the closure of 11 units, which actually completes the announcement for the first step of this program. We also closed one unit during the quarter, and that's a production unit related to Sandvik Construction in Chauny, France, affecting about 30 employees.
Looking on the phasing of the remaining 10 units and the closures, we will close another four units in the second half of 2014. Then the remaining six in 2015. All in all, this program is running according to plan, and we have actually started the process to detail the plans and activities for the second step of the supply chain optimization program. Moving over to net working capital. The relative net working capital increased slightly compared to the first quarter, from 29% to 29.5% in the second quarter. In terms of value, it increased with some SEK 2.7 billion. Out of the SEK 2.7 billion, SEK 900 million is related to structure coming from bringing Varel into the Sandvik Group. SEK 900 million approximately is due to currency effects. The remaining SEK 900 million is related to volume changes in our current BS.
Looking on the different business areas and the development in the second quarter, we can start with Sandvik Machining Solutions, where we have a good control of the net working capital. We are on the level of 25% in relative net working capital, which is actually according to the long term target for the business area. Construction has actually improved their relative net working capital during the quarter, and that's mostly due to a good control over inventory, and especially looking on the stock replenishment during the quarter as a positive development. Sandvik Materials Technology was somewhat a disappointment looking on the development in the quarter. With an increase in volume of SEK 700 million, where about SEK 350 million is related to increases in inventory volumes. Whereof SEK 180 million is due to the changes in nickel prices during the quarter, affecting the inventory value as well.
Accounts payable also had a negative effect on the net working capital for Sandvik Materials Technology. That's mainly due to lower raw material purchases going forward. It's actually having an initial negative impact on the net working capital, but that is in line with our plans to reduce the inventories going forward. Sandvik Mining had a negative relative development of net working capital, but we actually decreased the volume in mining in the quarter. In terms of destocking, we had a destocking of more than SEK 200 million. The negative effect on the relative net working capital is coming from a lower top line in combination with lower advanced payments from customers in the product business. All in all, looking on net working capital, what can you expect from the third quarter? We are looking on destocking in all business areas.
We have a lot of focus and a lot of activities on net working capital going forward, and we are targeting a sustainable level of 25% for the group by end 2015 when we are through the first step of the supply chain optimization program. I think that is important to remember. Moving over to another area where we have been quite active in the second quarter, and that is the funding. Like Olof said, we have had a cash outflow in the second quarter due to the dividend and due to the closure of the Varel transaction. We are now taking the opportunity to further improve the maturity profile for us and also to very attractive rates. We made a bond issue in Sweden, totally 4 billion SEK, with maturities in 2020 and 2021, with an average yield of slightly below 3%.
We made a bond issue in a euro bond as well of 350 million EUR maturing in 2026 with a coupon rate of approximately 3%, or at 3%. With that, I'm leaving for you, Olof, to summarize.
Thank you, Mats. Before we open up for questions from the audience and all of you calling into this conference call, I'd just like to summarize what I feel are the main points in this report for the second quarter. We are delivering on our strategic agenda, and we have taken several steps, very sizable steps forward on that agenda during the second quarter. This will help us to build a more profitable, a less volatile, and a faster-growing Sandvik in the future. The main items where we made progress during the quarter is the supply chain optimization. We have now announced 11 closures, and that marks the completion of the first phase that we communicated in December last year.
Now we are going to close these according to the plan that Mats showed here earlier, and you can expect in the first half of 2015 that we will then embark on the second step of this plan to improve our production structure in the company. We see further potential to improve our net working capital efficiency. The main driver in terms of volume development and net working capital in the company was reduced payables and reduced prepayments from the Mining Systems part of the business. But the reduced payables is a sign of our efforts to, in coming quarters, reduce our inventory levels in the company. That's a step in the right direction when it comes to net working capital.
Overall in the market, we've seen a fairly stable demand pattern, some growth in Machining Solutions, while Mining, most importantly, we seem to see firm grounds in the market where we are standing right now. Thank you. With that, I suggest we open up for questions and answers.
Yes, that is a good suggestion, Olof. Thank you for that. Thank you, Mats, as well. Now follows the question and answer session, as I suppose most of you know, it follows the usual pattern. Please be crisp and short with your questions. I know a lot of you are having questions, and time is of an essence. Please keep it short and crisp, also limit your question to one at a time. We have questions here on the floor in Stockholm. We have questions from the web as well, I suggest that we start with questions coming from the phone. Operator, would you please assist us with the first question?
Our first question comes from Mr. Andreas Koski from Credit Suisse. Please go ahead.
Good morning. Thanks. Thank you for my question. I actually want to start with Varel, what you said on benefiting from Sandvik's global reach. Can you just help us to understand how that will work within the Sandvik organization given it is within Venture? Will it be using Venture's global reach or other divisions, who would be the people selling those products, do you plan to invest in that? Then if I could have just a quick follow-up. Mats, thanks so much for taking us through the working capital dynamics. Could you just sum up what was the real underlying inventory increase that is non-currency, non-nickel-related in the quarter? Because you said it was smaller than usual seasonal ramp-up, but on the Balance Sheet number, it actually looks quite big, so it would be good to have the underlying number. Thank you.
Good. Thank you for your questions. I would like to try to explain what we mean with Varel, because we have presence today from the Sandvik Group in 130 countries around the world, which is a much higher number than what Varel has. We have daughter companies, we have basic resources in terms of an organization to support a faster development of the sales presence in these countries. That's really what we mean, that we have this Sandvik global platform in terms of daughter companies and sales reach. By letting also Varel use that network and, well, if necessary, employ people in those regions, we believe that we can accelerate growth rates faster than what they maybe could have sustained as an independent company. The second question, I'll hand over to you, Mats.
Yeah, in terms of the volume development of net working capital, it's slightly below SEK 800 million looking on the actual volume, taking out the nickel effect. Out of those SEK 800, I would say something like two-thirds is related to the payables development.
The rest is inventory, I guess.
Yeah, it's inventory built up, and it's two business out of five are building inventories, and that's Sandvik Materials Technology and Sandvik Machining Solutions. I show that Sandvik Machining Solutions, it's a lower stock built up than the normal kind of seasonality. We are following the same pattern as we had last year with the lower stock built up in the second quarter, meaning a little bit lower de-stocking in the third quarter now.
Great. Thank you.
Okay.
Thank you very much for that. Operator, please, may we have the next question?
Our next question comes from Mr. Marcus Albert from Morgan Stanley. Please go ahead.
Hi, Marcus Albert here from Morgan Stanley. I would like to ask you about the margin and I'll start with the mining margin, which came under significant pressure, I guess, on the back of the sharp drop in sales. Now we're at the book to bill of about one, and the comparison getting easier. I guess the operational gearing impact should decrease going forward. What should we expect on the margin in the second half of the year? Should we bounce back to Q1 levels, or is the current level a sustainable one? When is the savings from the closure starting to come in?
If you look at the Mining margin, leverage was a bit more negative than what we normally see. That was driven, I might add, that we had some reserves that we had to do for stock obsolescence within the Mining business area. Those risks, we still have a bit at these low activity levels also going forward. Everything else unchanged, same market conditions, there's room for stable to slightly improving margins, I would say, going into the third quarter. Where I would say in normal seasonality, we would find some slight pressure in the negative direction of margins due to lower activities in the Northern Hemisphere during the holiday period. Going forward with the site closures and so, they've just initiated now, and the effects from them will come gradually during 2015.
With the ongoing programs we have, even if the market stays exactly as it is today, there's room to believe that we will see a gradual improvement in the Mining margins going forward due to ongoing activities. I don't know if you want to add anything, Mats, to that?
No.
Maybe you can talk a little bit about the SMS margin as well.
Yes. Leverage was a bit lower than what we normally see at 30% for SMS. That is due to the fact that we've communicated earlier also that we are making a larger investment right now, especially into our selling costs within Machining Solutions, enabled to strengthen our market positions and help us to improve growth rates going forward. That cost increase in our sales force is what has resulted in the lower leverage that we saw for Machining Solutions here. That's really due to an investment in the future.
Same thing there, with the current market environment, we should expect similar kind of margin levels because I assume that investments will go on throughout the year as well.
Yes. This increased cost base will stay. Our plan is, of course, to find future growth as a result of this investment. Looking to the third quarter, we do normally have certain margin pressure due to the seasonality in the business, but we expect that to be maybe half of normal levels due to lower swings in inventories and so than what we've seen in the past. Slightly lower seasonality effect in Q3.
Looking on a normal seasonality for Machining Solutions between the second and the third quarter is somewhere between one to 1.5% percentage unit on the margin then. Due to the kind of control over net working capital and the stock control, we have less volatility between the second and the third quarter now than we used to have in the past.
Okay. Thank you.
Thank you very much. Thank you for that. Please remember to limit your questions to one at a time. May we have the next question from the floor in Stockholm, please?
Hi. Thank you for taking my question. Guillermo Lanzas from UBS. Related, actually, to your investments in selling and R&D in Machining Solutions, are you at the level you want to be, or are you planning to continue to increasingly or incrementally add people, feet on the street, and actually R&D expenses as we move forward?
Do you want to comment on that, Mats?
What you need to put the actual amount is in relation to sales. What we're expecting is a growth coming from the effort we are doing within the R&D and on the sales side. In terms of the relative number, we don't expect any kind of big changes.
Sorry. Follow-up. Now you're doing the effort-
Yeah.
You're expecting the growth contribution.
Yes.
You can continue to do so. At the same time, what we have not appreciated in your organic development is that 43% of your organic growth in revenues is gone while you add it, selling and R&D expenses, hence the drop through is being lowered. I was wondering whether you will continue to add
Regardless of the organic developments we've seen as we speak, because we expect to capture future growth.
Yeah. We need to be prepared to adjust that, if we don't see the growth coming. For sure, yes.
Absolutely. We need to, of course, continuously take into consideration the market developments. So far, in the second quarter, we've seen a stable and strong demand. Looking into the first trading days of the third quarter, we've seen a good, solid, stable demand at the levels we've seen going after the second quarter. We have no reason to date really have a more negative view on the market. The only deviation of maybe what we could have expected is what we've seen in Russia, and that's negative development there, I would say.
Thank you.
Very good. Do we have another question from the floor in Stockholm? Yes, please.
Thank you. Andreas Brock from Nordea. A question on the Chinese mid-market there in the LOI on the JV. Could you contrast the growth rates happening in the premium markets versus the mid-markets, and thus give us some kind of rationale why the mid-market is that interesting? Also on that JV, will it go for the export markets or will it only be domestically focused on the Chinese market?
Well, the challenge we've seen in the past with our exposure, Sandvik has the three main brands, which are all positioned in the premium sector. If you look a number of our competitors, they have a brand portfolio positioned in different value parts of the market. It's been important for us through the Carboloy efforts, and now in trying to achieve this joint venture, to build a position in the more price-driven part of the segment. We've been very much in the value-selling part of the metal cutting tools. That has been growing clearly higher, and a lot of the growth that's happened in emerging markets, especially with local companies, I would say, has been driven by more price-based selection of product than actually productivity-based selection. That's why that is important.
We also see longer term, it is a strategic risk for us not being there, because if we let other companies fill that space, in the longer run, they're also going to develop and want to compete with us in the premium segment. It's both in terms of growth development, but also strategic positioning of the company to cover a broader part of the market that we feel this effort is important.
Will the JV only be China?
Sorry. No, we're going to have both a JV regarding the Chinese market, but also for exports into other parts of the world.
Very interesting. Thank you.
Thank you.
Thank you very much for that. Operator, please, may we have the next question?
Our next question comes from Mr. Alex Jones from J.P. Morgan. Please go ahead.
Good morning, everybody. It's Alex at J.P. Morgan. My first question is on the mining division. How far through the inventory adjustment process are you there? Should we be expecting to see a similar level of destocking for another couple of quarters? Just a little bit of guidance there, if you could.
Yes.
You will see a similar kind of destocking going forward the coming quarters.
Is that two quarters, four quarters, six quarters? How should we think about that?
At least two quarters.
Okay. At least two quarters. My second question was around construction. The restructuring doesn't really seem to have taken hold yet. What's the future course of action there?
Well, we're driving an active program, both in terms of aiming at building top-line sales in the business area. The biggest cost-saving effort we have ongoing is the closure of the Swadlincote site in the U.K., which has been initiated but won't be completed until the early parts of 2015. That will have a material impact also on reducing the cost base in Sandvik Construction. We have general cost-saving efforts going on throughout the business area.
The final question was Machining Solutions' demand in Europe. The organic growth numbers come down from 5% in Q1 to 2% in Q2. We heard SKF talking about weaker demand within its industrial distribution business late in the quarter. I was just wondering what you saw in Europe as we went through the quarter.
We have not seen any negative or deteriorating trend during the quarter. We've seen a stable demand throughout the quarter, and I have no reason to indicate any deterioration in market activity. What has been weaker in Q2 are sequential effects in Russia, which is a fairly important market for Machining Solutions, whilst in many parts of Western Europe, actually saw better development.
Okay. How big is Russia?
It's also important to remember when you look on the price volume figures for Q1 and Q2, that we have a working day effect in the second quarter due to Easter holidays between the first and second quarter. That's approximately 1% as well.
Okay. That's helpful. How big is Russia for Machining Solutions?
I would say maybe around seventh or eighth in terms of the size of the markets. That we need to double-check that number.
Seven or 8%?
No.
No.
In terms of the size-
Ranking of global markets, it's-
Okay
seventh or so in terms of size globally. Of global sales, a few %.
Global sales of 2%.
A few, yeah. I won't be more specific than that, but we can get back to you with that more specific number.
Okay. Thanks very much.
Thank you very much. Operator, may we have the next question, please?
Our next question comes from Mr. Peder Frölén from Handelsbanken Capital Markets. Please go ahead.
Yes, good morning. Thank you. Could you please give some clarity on the price component, on growth, obviously, but also by division? That's my first question.
Well, overall, we saw a neutral to positive price development across the business areas. For the group, we talk about roughly 1%. Mining, I would say, saw fairly flat pricing development, while we did see some price progression in Sandvik Machining Solutions.
Okay. Given the metal price effects in the SMT business, I guess that contributed to the group figure as well. Is that excluded in your price thinking on roughly 1% on group?
That's related to the base price effect, that's not including the general raw material price that we transfer through the company.
Okay. That's very important. A follow-up from this. On SMS, are we closer to 2% than 1%? Sorry about the nitty-gritty, but it is quite important given the R&D and your efforts there.
Well, we haven't been that specific, really, in our communication, but of course, that has to be at or above the group average to achieve the 1% level there.
Okay. A follow-up, if I may. A small one on Varel. 13.2% adjusted margin. How adjusted is that compared to the future? Will we see an increased pressure on the accounting efforts on PPA on others, or could we assume that this is a very clean margin if we look ahead?
This is a margin before the PPA, so that's why I put the word adjusted in there.
Okay.
As I said, we have been on a positive trend in terms of improving underlying EBIT margins for the business. We see opportunities for reasons to believe that trend will continue into the second half of 2014. The specification of the PPA effect we put into the presentation as the first backup slide. There you get the details, and as normally, we have more significant inventory PPA adjustments coming in the first quarters after an acquisition like this. They're all specified for you in some detail in that first slide, yeah.
That's very clear. I get back in line. Thank you.
Thank you.
Thank you very much. Operator, may we have another question, please? Our next question comes from Mr. Sebastian Kuenne from Société Générale. Please go ahead.
Hi, good morning. One question first on the FX, SEK 200 million hit in the quarter. You were guiding for SEK 150 million, while exchange rates improved through the quarter. I think there is a negative item in the corporate line. Could you give us some color about what happened, and why your guidance was too conservative? That's the first question.
Looking on the group activities, we have a negative currency effect of SEK 60 million in the quarter. That's related to the strategic hedges we have on the transactional exposure. We are hedging about 25% of the total transactional exposure. We have a negative effect from the valuation of hedges by the closing of the quarter.
Okay, that's a one-off.
Yes.
Yeah. Okay. Thank you. Just a follow-up question, looking at the big picture, you had a positive FX impact quarter-on-quarter, I think, at the group level. You have slightly higher production rates as well, but the underlying earnings ex inventory gains at SMT and ex other one-offs are stable quarter-on-quarter. When do you think, Olof, we could see volumes and cost savings more than offsetting investment in the business? Could it be H2 or is it more 2016, 2017?
More than offsetting what? Could you just specify?
The investments you make in the business to improve the growth profile.
In Sandvik Machining Solutions or in the Sandvik Group?
Overall for the Sandvik Group.
Yeah. Well, the effects from the program we have ongoing with these 11 sites that are initiated so far will follow roughly the profile that Mats showed when these sites actually will be closed. It's, of course, after the completion of that closure that we start to see the cost savings coming through in the gross profit. During the second half, we're going to have a number of closures, but the bulk of them are actually going to be during 2015, or more than half of them will be there. That's when that improvement will come from these savings.
Excluding any improvement in volume in H2, you don't expect earnings to improve.
Well, we have the seasonal effects in Q3 that we talked about. I think we're generally focusing on improving our costs and all the small efforts that you continuously do in a company. We have certain effects from these closures coming through. I think there are things that are moving things in a positive direction also in the second half. From this site closure program, the big effects will start to come during 2015.
Okay. Thank you, Victor.
Thank you very much. I am looking around on the floor to see if Yes, we have another question from the floor in Stockholm.
Hi, Guillermo Peinero from UBS again. Maybe a follow-up on mining. Most of the companies we hear nowadays are talking about a stabilization towards a slightly positive development in terms of demand, which is coinciding with the fact that the mining companies are growing its production very heavily, in fact. What happens if that growth, which is actually outpacing demand growth for minerals, slows down and flattens? Do you think that you could actually see further, let's say, deterioration in overall the intake or demand from the miners?
That is a very speculative question here. Looking at the general dynamic in the mining industry, there's been a massive CapEx cut at the miners. Actually, global mine production has continued to tick upwards during this period. I think there's reason to believe that that dynamic is not sustainable. Given that the continued demand for metals is there and that this production development continues, this is going to have to trigger more investments in OpEx to start with, and then in the slightly longer term, also more CapEx investments in the mining companies. At Sandvik, we remain very positive about the long-term prospects of the mining industry for our company, and we see it as an important part and an area where we have great opportunities to improve. Looking at relating to an earlier question, what can drive margins going forward?
What we need to do, and focus hard on and drive, is working with the aftermarket business in these market conditions, the consumables, the spare parts, and these parts, and that's very much on Scot Smith's agenda, who joined the company earlier this year. He also has, I think, a strong track record from his specialty time at Weir, where they built up the aftermarket very successfully. These kind of efforts are also on our agendas. Even in a flat market, we should have, through these efforts, a gradually improving margin in our mining business.
Thank you.
Thank you very much. Operator, let us move back to the other audience.
Our next question comes from Mr. Colin Gibson from HSBC. Please go ahead.
Hi there. Hi, everybody. Two questions, please. I'll take them one at a time as requested. First of all, on Varel. You mentioned synergies in the presentation, there's no sizing of those new synergies, nor a timetable over which we might expect you to achieve those synergies. Could I tempt you to say anything more on either of those two fronts, please?
We don't have details that we've chosen to share regarding that, we do have improvements in cost and profitability for Sandvik coming through that we internalize supply of metal powders within cemented carbide diamond cutters in these kind of areas. The most important thing to leverage on Varel for the future for Sandvik is a high growth rate and a strong underlying EBIT margin that we feel we can develop even further through volume increases, also in part through the cost synergies. I would say the growth and the volume development are the key areas that we see as an opportunity in this business and not necessarily the cost-saving parts.
Okay, thank you. A follow-up question. I've asked about this before, in September it will be three years since you said you were going to review the group's involvement in Materials Technology and Construction, subject to their future performance. Obviously, since then, we've seen a turnaround at Materials Technology, not really at Construction. When would you anticipate getting back to the market with more information on your September 2011 comment?
Today, we don't have any more information to share about that, but this will of course be one topic we will discuss at our Capital Markets Day, this autumn, where we will try to clarify our future direction more on how we look at these assets.
Thanks very much.
Yeah.
Thank you very much for that. Operator, may we have the next question?
Our next question comes from Mr. Martin Wilkie from Deutsche Bank. Please go ahead.
Yeah, good morning. It's Martin Wilkie at Deutsche Bank. Coming back to mining, I think you mentioned in your opening remarks that there was some writedowns or some impact from obsolescence of equipment in mining. Just wonder if you could clarify that? Were these inventory writedowns, or just if you could clarify what you meant by that obsolescence. Thank you.
These were stock obsolescence. When we have aged inventory, we do certain writedowns in our books, and that's due to the low volumes we have in the business right now.
This is not that one end market is doing worse than the other. It's just simply a sort of timing effect, if you like.
I think that's fair. Would you?
Yes. Just to clarify, this is more accounting. It's not a physical obsolescence.
Exactly.
Right. Okay.
Yeah. That's right. Yeah.
Is that something that we should expect in future quarters, or is this a sort of an annual thing, or how should we think about that impact?
There are further risks of stock obsolescence with these low activity levels. I cannot say that we won't have those kind of effects going forward. The important thing for us to work with is getting the inventory levels down in the business area, because then, of course, we remove the risk of stock obsolescence in our books.
Very good. Thank you very much.
Thank you for that. We do have another few questions left. Operators, please carry on.
Our next question comes from Mr. Alexander Virgo from Berenberg. Please go ahead.
Thanks. Morning. Just on that last question, can you actually quantify it for us? The amount of the obsolescence write-down.
Well, we have chosen not to quantify that, but I think the 40% negative leverage we had in Sandvik Mining was driven a lot by these factors. Without that, we would've been at a more normal negative operating leverage in the quarter.
Okay, thanks. Just the second question, on the investments in SMS. If I look sequentially, obviously the margins are pretty similar. If I look at your gross margin at the Sandvik Group level, it's pretty similar, Q2 versus Q1. Your head count in SMS is, I think, down sequentially and about the same as it was year-on-year. I'm just wondering what the investment's going in on. Can you be a bit more specific on that, please?
It's on R&D efforts. It is on sales people.
It's being offset by people coming out elsewhere then, is it?
Well, I guess that's correct, yes.
Okay.
Due to the net effect we have, the biggest personnel movements in the quarter we had in mining, where we had a quite sizable reduction of the number of employees.
Yeah. That presumably isn't going to feed through until, I suppose Q3, but Q4, Q1, really.
Once again, the mining reductions.
Yeah.
Well, this is part of adapting our cost base to the current market conditions that we had that reduction. Of course, depending on the market development, we will continue to adapt our number of employees accordingly, yeah.
Okay. Thank you.
Thank you. Adding to the Machining Solutions sales increase as well, that is related not only to people, but also other efforts that go into these investments that we make. You might not necessarily see them in the headcount number. It is not a one to one on that one. Operator, the next question, please.
Our next question comes from Mr. Anders Roslund from Swedbank. Please go ahead.
Yes. Hello. I had one question regarding FX. When will you start to see more positive effects of the weaker Swedish krona, and a little bit in which divisions?
Well, actually, I think you saw some effects of that already in the second quarter with Sandvik Materials Technology actually having positive year-on-year FX developments. The net effect we expect going into the third quarter compared to where we're at the second quarter is about neutral here from currencies.
Yes, when should they start to get positive?
That will, of course, depend on the development of the currencies around the world. We give a guidance looking into Q3 based on the currency rates that we had at the end of the second quarter. Looking at that and the basket exposure we have of currencies in Sandvik, that means that we will have a neutral effect going into the third quarter, at the point we were at the end of the second quarter.
Okay.
I suppose an easy answer is also to say, as the year progresses. If we had issued a guidance for the fourth quarter, that would've been a positive effect. Naturally, yeah.
Okay. Thank you.
That is a year-on-year comparison, so that's something else-
Technically, yeah
to take into consideration there, yeah.
Sequentially, we had a positive effect on a number of areas of the Sandvik Group, as you can see in the report there. The sequential effect was positive for many business areas.
Okay.
Thank you very much for that. Was there a follow-up to it?
No.
No. Thank you very much. Operator, may we have the next question, please?
Our next question comes from Mr. Ben Maslen from Bank of America. Please go ahead.
Yeah. Thank you. Morning, Olof. Morning, Mats. Coming back to the factory closures, we're getting to the point where obviously the pace of those closures will pick up. Do you expect any disruption in terms of building buffer stocks, dual production, obsolescence, as these closures happen? A bit more volatility in the business, or is that kind of fully taken into account by the charges that you've taken? Thank you.
Well, we've taken charges for the closure costs, write-downs and so on in the fourth quarter last year. We don't expect any effect from that. There can be certain effects where we actually need to maintain production in two different locations during a transfer. That is something we cannot take provisions for. We don't expect any very large effects from this program. In terms of inventory buildup, we actually saw some of that happening in the earlier part of this year, for example, in construction. That is now being reversed, that effect, in this quarter, where we saw a drop in the constructions net working capital share as we transfer over to Northern Ireland, the manufacturing, and you see it there.
I don't foresee any big inventory buildups, any material effects from that, and more marginal in terms of cost effects when we do these transfers. The bulk of the costs from these closures have been taken in terms of provisions.
Got it. Thank you.
Thank you very much. There are no more questions at this time, which means Actually, we just got one question. Operator, may we have that one?
The last question comes from Mr. Daniel Schmidt from SEB. Please go ahead.
Yes. Hello, good morning. Last time around you actually gave us the number in terms of net working capital, the sales for the different divisions, and I think you mentioned that SMS was at 25% currently. What is the actual number for Mining? I think it was 33% in Q1.
Actually, I think you can see that from the presentation on the chart presented by me. We can take the exact number through Magnus.
Okay. Thank you.
You see on the graphical development, you can see all the five business areas actually there.
Right. Thank you.
Thank you very much. That was actually the last question, which concludes this hour. I thank you for your attention. Have a good day. Thank you and goodbye.