Good morning, ladies and gentlemen. Thank you for standing by, and welcome to the Q2 Report 2019 Conference Call. At this time, all participants are in listen-only mode. There will be a presentation followed by a question and answer session. At which time, if you wish to ask a question, you will need to press star one on your telephone. I must advise you the conference is being recorded today, Wednesday, the 17th of July 2019. I would now like to hand the call over to your first speaker today, Patrik Stenberg. Please go ahead.
Thank you. Good morning, everyone. Welcome to the conference call on the second quarter results for SKF. Today's speakers are President and CEO, Alrik Danielson, and our Senior Vice President and CFO, Niclas Rosenlew. Kevin Affenberg, Theo Kjellberg, and myself, Patrik Stenberg, are also present here in the room representing group controlling, media relations, and IR. As usual, we will start by presenting the results. It will probably take about 20- 30 minutes, and we will follow that up by a Q&A session. So with that, welcome once again, and I leave the word to Alrik, please.
Thank you. Welcome to what I see as yet another strong quarter from SKF. We have seen in the second quarter a strong operating performance on lower volumes. Our efforts to keep costs under control are showing good results in a market with lower demand. Operating profit for the second quarter was SEK 2.5 billion, including costs for restructuring and impairments of SEK 317 million. The underlying operating margin was 12.7%, the sixth straight quarter above 12% in a row. Our operating performance was positively impacted by cost reductions and price. Restructuring and impairment costs, on the other hand, had a negative impact. Net sales were SEK 22.5 billion, a drop in organic sales of 1.6% compared to last year. Sales were relatively unchanged in Europe, slightly lower in Asia and North America, and significantly higher in Latin America.
Cash flow from operations, which is always one of our fortes, was in line with last year. If we turn to the next page, a few comments about the industrial business. The industrial business had yet another strong quarter with operating margins of almost 14%. It was 14.6% last year, and organic growth of half a percent. The underlying operating margins was higher than last year, with restructuring costs and impairment impacting reported results negatively. Sales in Europe and Asia and North America were relatively unchanged but increased in Latin America. If we take and turn to the next page, we talk a little bit about the automotive.
The automotive business contributed with an operating margin of 5%, the organic growth was negative with 6.8% compared to a 5.2% growth last year, with significantly lower volumes in North America and Asia, lower sales volumes in Europe, and significantly higher sales in Latin America. We turn to the next page, we talk a little bit about our goals, and we can see that last year was a very strong year for SKF. We had record sales, record operating profit, and record cash flows. In 2019, we are seeing moderation in growth rates, we are delivering a solid performance in both Q1 and Q2 with good operating margins and return on capital employed.
The net debt ratio has increased somewhat due to the implementation of IFRS 16 on leasing, it's still well below the target of 80%, we will see it going down in the future. We continue to work on reduction our net working capital. At the end of the first quarter, we were at 30%, which is an improvement compared to last year, still above the target of 25%. There's still a lot of work to do, as we continue with our restructuring of our manufacturing and upgrading of our plants and our integrated planning and other activities, we will gradually be improving these figures, I'm absolutely convinced. We turn to the next page and talk a little bit about the regions, we saw revenues coming in line with guidance. We saw relatively stable revenues in the quarter.
In Europe, organic sales were 2% lower than last year. We saw a relatively unchanged in Europe industrial demand, with increased demand in aerospace, energy, and railway industries, relatively unchanged demand in distribution and heavy industries. Automotive volumes were lower in Q2 compared to last year for both trucks and light vehicles, as well as for the vehicle aftermarket. Organic sales in Asia was 2% lower than last year. With industrial sales, we saw a relatively unchanged demand. Looking at our different industries, sales to energy, railway, and the agricultural sectors, food and beverage industries was significantly higher, sales to electrical and industrial distribution were relatively unchanged. While sales declined to heavy industries, marine, industrial drives, aerospace, and off-highway compared to last year. In the automotive, volumes were lower than last year with significantly lower volumes for cars.
Relatively unchanged volume for truck, higher volumes for the vehicle aftermarket. In North America, sales were 3% lower than last year. We saw relatively unchanged industrial demand. Sales to the energy industry, to the industrial distribution, sales to heavy industries increased, while sales to aerospace and industrial drives were relatively unchanged. Sales to the electrical segment, railway, off-highway, and marine declined compared to last year. Automotive volumes were significantly lower in North America. In Latin America, sales grew organically by 9% compared to last year. We saw higher volumes with industrial significantly higher volumes to the automotive, as we are ramping up with more and more items made in Latin America for the automotive industry.
If we then turn to the next page and talk a little bit about circular economy, which is one of my absolute favorite topics, how I see now how we, SKF, around the rotating shaft, are gearing up for not only substantially reduce our customers' costs and improve their efficiency, but also be able to significantly improve the environmental impacts of industrial operations. Around here, you see the different ingredients. You have the assets, you have the remote monitoring, you have the data analytics, you have the application knowledge, where we can go in and help our customers to re-engineer their machines and their applications. We have the remanufacturing opportunity that we have talked about, where we can really become circular, not talk about scrapping bearings, but actually reusing bearings for the benefit of both SKF and the customer.
Of course, the new logistics setups that we're working on with integrating planning and Supply Chain 4.0. Lubrication management. This time, I would like to highlight this lubrication management, how important it is. You can imagine how central lubrication is and how important it is to always have clean lubricants in a machine to extend the life and reduce downtime. What have we done during the quarter? If we change to the next page, we have acquired a company called RecondOil. RecondOil is a small startup at this moment, but with a ready technology to clean lubricants to an extent that you can prolong the life of the machine and you can reduce the usage of oil significantly.
You see here on the picture a industrial oil on the left side, and after being treated by our Double Separation Technology, where we're both using a chemical separation method and a normal filtering, constantly can provide into the machine a clean oil and a clean environment. Also extend the life of these oils considerably. I am actually absolutely convinced that this is a perfect addition to our ability to improve the working conditions of bearings and machines at our customers. You will see and hear much more about this going forward as we roll this technology out during the third quarter of this year and onwards. If we, by that, go to the next page, I want to just talk a little bit about our latest announced investment.
Last quarter, I talked about our new factory for tapered roller bearings in Changshan, in China, bringing our three brands, SKF, PEER, and GBC, together in a state-of-the-art manufacturing facility. During the second quarter, we continued this path, and we announced the regionalization and automating of our manufacturing footprint. We have announced a SEK 450 million investment within deep groove ball bearings. It is an investment in our existing factory in Bari, in Italy, where we will upgrade our facility there to be competitive and have absolutely the right cost performance ratio for the European markets, and create a factory in Xinchang. I apologize for my Chinese pronunciation. In China, where we will have a state-of-the-art and competitive and customer service-oriented factory already next year. This supports our ambition to adopt full value chain approach, as we have talked about Asia for Asia, Europe to Europe, Americas for Americas.
This strive that we have in SKF, now we're taking this to deep groove ball bearings. As you can understand, the main market for deep groove ball bearings in the world is China. Very soon you will be able to visit, for the ones who want, the world's best deep groove ball factory in China, and you are heartily welcome. If we then take to the next page, I, by that, introduce Niclas, our new CFO, that joined us also just during Q2. We're very happy that you are with us, Niclas. Welcome.
Thank you, Alrik. Good morning, everyone. I'm Niclas, and before moving on with the presentation, let me take the opportunity to introduce myself briefly. Extremely pleased to have joined SKF on the day, exactly a month ago. I have a background in technology, software, and banking. During my working life, I worked in Europe, North America, and spent a fair amount of time in the fast-moving Asian market. I'm truly impressed. I'm truly impressed about SKF's global reach in multiple industries. You'll get to know me as a team player for whom business understanding and results matter.
Besides many other things, I do look forward to working on IT, on digitalization, as well as the new business models related to the circular economy that Alrik just talked about, including ERP, where there's actually many similarities to what we see in the software industry. With that, let's move on with the presentation, starting with sales. In second quarter, net sales decreased by 0.7%. Organic sales were 1.6% lower than last year. Industrial grew organically by 0.6%, while then automotive declined by 6.8%. Currency effects on sales was positive in the quarter by 3.5%, with the largest effect coming from the dollar, the euro, and the renminbi. The structure component was a negative 2.6%, and this was related to the divestment of L&AT last year, the L&AT business. You could say, in sum, we had a stable sales development in the quarter. Moving on to operating profit.
Operating profit in the quarter have shown a positive trend, or during the period covered by this slide, 2016 onwards, we've seen a positive trend. The operating profit in the second quarter was SEK 2,539 million, which includes restructuring and impairment costs of SEK 370 million. The underlying operating profit was SEK 2,856 million in the quarter, and this represents an underlying margin of 12.7%, the sixth straight quarter, about 12%, as Alrik already mentioned. A few more comments on the operating profit and taking you through the operating profit bridge for the quarter. Firstly, we had a negative effect from divested companies amounting to SEK 68 million, and this related to the disposal of the L&AT business. The currency impact in the quarter was a positive SEK 112 million compared to last year. Let's spend a bit more time on the operational performance.
The operational performance decreased by SEK 430 million year-over-year. Contributions from organic sales and manufacturing volumes was SEK 60 million lower. This included positive effects from price mix as well as negative effects from lower sales volumes. It was also negatively affected by lower production volumes versus last year. In terms of finished goods, the year-over-year effect from changes in finished goods inventories was a -SEK 20 million in the quarter. In terms of cost development, costs were SEK 370 million higher than last year. Note that this includes the higher cost for restructuring and impairments of SEK 296 million. In absolute terms, we had SEK 370 million this year versus SEK 21 million last year, which is clearly higher than what was discussed at the last conference call. Excluding this, cost improvements were significant compared to last year, which we are very pleased with.
The restructuring costs relate primarily to our restructuring activities in Bari, Italy, in connection with the announced investments in deep groove ball bearings. The impairments, on the other hand, relate primarily to us upgrading to the latest SAP platform, S/4HANA. The negative material cost impact was slightly lower than guided for, and we do see good cost flexibility in production and more cost reduction effects than what we had actually forecasted. Let me take the opportunity here to comment a bit on the third quarter guidance to the bridge. I'll do this step by step in the same way as we see it in the bridge. In terms of M&A, we expect lost results from divested companies. Essentially, L&AT of about SEK 70 million.
In terms of price mix, we expect to see a continued positive effect from price mix in Q3. In terms of inventories, we expect to see a continued reduction in finished goods inventories in Q3 versus Q2. However, slightly less than the reduction we saw during the third quarter last year, which would translate to a positive year-over-year effect on operating profit of about SEK 30 million in Q3 2019. In terms of cost development in Q3, we expect to see an underlying cost inflation of about SEK 225 million, and this would be partially offset by cost savings of about SEK 100 million. In terms of material costs, we expect it to impact negatively by around SEK 100 million compared to Q3 2018, and we expect to have similar restructuring costs as last year. Last year it was about SEK 86 million.
In Q3 last year, we also had a positive effect from land sale, amounting to about SEK 185 million that we will not have this year. Moving on. Performance by customer group in the quarter. Industrial, quite happy with the development in industrial. Organic net sales within industrial increased by 0.6%. Sales in Europe, Asia and North America were relatively unchanged, and we saw increased sales in Latin America. The reported operating margin was 13.9% compared to 14.7% last year. The underlying operating margin was higher than last year as the kind of restructuring costs and impairments impacted the reported results negatively. Price mix contributed positively to the result in industrial, while then higher material costs and lower production volumes had a negative effect in the quarter.
In terms of automotive, our organic sales declined by 6.8% in the second quarter, as car sales continued to be weak across Asia, Europe and also North America. The operating margin was 4.8% compared to 8.7% last year. The negative effect from lower volume and increased material cost was actually partially offset by pricing, so higher pricing. What comes to the income statement for the group in the quarter, we reported a solid Q2 result with an operating margin of 11.3%. Note that this includes the restructuring and impairment costs of SEK 370 million. As mentioned, the comparable number was SEK 21 million last year. The moving 12-month margin trend was at 12.4%. Gross margin was unchanged versus last year at 25.1%.
Selling and administrative expenses as a percentage of sales actually increased compared to last year, primarily driven by higher IT costs, restructuring costs and impairments, as well as currency effects. The financial net in the second quarter was -SEK 278 million. The financial net was negatively impacted by exchange rate fluctuation, as well as the kind of IFRS 16 impact. IFRS 16 related to leases with a negative impact of SEK 40 million. Taxes in the quarter were SEK 682 million, and this resulted in an effective tax rate of 30.1%. Our earnings per share was SEK 3.32. The 12-month trend for EPS was SEK 15.07 versus a year ago, when we were at SEK 14.43.
Moving on to cash flow. As Alrik already commented, quite strong cash flow in the quarter. Cash flow excluding acquisitions and divestments was SEK 1,849 million, compared to SEK 2,182 million in the quarter.
The decrease here is mainly due to the lower operating profit, which again is mainly due to the items affecting comparability. The restructuring and footprint investments and projects that we initiated during Q2. The cash flow, excluding acquisitions and divestments for the last 12 months, has actually increased from SEK 5.1 billion last year to SEK 6.2 billion. Net working capital was 30.1% of sales at the end of the second quarter, which is one percentage point lower than in the second quarter last year. The decrease is mainly explained by exchange rates, divestments and then lower inventory levels. What comes to the net debt equity ratio, it was at 68% at the end of the quarter. The main reason behind the increase is, again, IFRS 16 on leasing. SEK 2,976 million impact.
The net debt equity ratio, excluding leasing, was actually unchanged on the total, while we saw an increase in provisions for post-employment benefits, so pensions. Net debt, excluding pensions and leasing, was 17% of equity by the end of the quarter. Finally, some additional guidance. For the third quarter, we expect finance net to be about SEK 245 million negative, including IFRS 16 effects. In terms of exchange rates, based on the 30th of June exchange rates, the currency impact on the operating profit is expected to be positive by about SEK 130 million compared to the third quarter last year. Based on exchange rates at July 15, the currency effect in the third quarter would be about SEK 190 million positive.
For the full year, we expect the tax rate of about 28%. Very much in line with our strategy, we are increasing our investments in property, plant, and equipment. For 2019, we expect to see additions to plant and property of about SEK 2.8 billion. With that, I will hand the floor back to Alrik.
Thank you, Niclas. Thank you. Just to summarize, if we go to the next slide. The second quarter was a strong quarter with solid margins, despite lower volumes. Demand developed in line with our expectations. Organic sales were relatively unchanged compared to last year. We continue to see positive pricing in our efforts to reduce our cost base are showing results. Entering the third quarter, we expect to see slightly lower volumes compared to last year, including relatively unchanged demand for the industrial and lower demand for the automotive. Demand is expected to be relatively unchanged in Asia, slightly lower in Europe and North America, and slightly higher in Latin America. With those words, I thank you for listening in to us. I give the floor back to Patrik.
Thank you, Alrik. Thank you for listening to the presentation. We are now ready to take your questions. With that, I leave the word back to operator, please.
Thank you. Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Your first question comes from the line of Erik Golrang. Please ask your question.
Thank you. I have a couple of questions. Starting on the development in Asia and your guidance there for the third quarter. As I understand it, you saw a stronger end to the second quarter than the initial month, which is a bit surprising. Could you give some flavor on the different segments there, perhaps particularly on the automotive side? My second question relates to the SAP impairments. What is the risk that there's more of that coming, given that you have capitalized quite a bit over a number of years? I'll start with those two. Thank you.
Well, let me start by saying that if you take the industrial business, I think it was clear that there are some very strong segments like wind and railway, and there are other segments that are a little bit weaker, and I think there's no mystery in that. The big question, of course, is that we've seen for a long time now in China, a lower automotive market. What we've seen is, it's interesting how uncertainty actually drives, of course, a more reluctance from consumers, for instance, to buy cars. What has happened in China is that there's been new emission laws coming, and originally the idea was that these laws were going to be implemented a year from now. To get rid of all the uncertainty, they have actually implemented these laws now, so they are actually in place.
Right now, the consumer knows exactly what are the emission regulations and what it means for their purchase. What we've seen then is that actually in the end of the quarter, we saw an improved demand. In June, as a matter of fact, we were flat. When we talked, myself, I tell you just in China a little bit more than one week ago, and speaking to many of our big Chinese car customers, this is how they see it, too. In other regions, the weakness in the automotive business is coming now recently, as you may recall, in China, it's been going on for quite a while.
What we're saying is that we see for the first time now a flattening out of the Chinese automotive market, and then maybe cautious understanding that maybe we have reached a trough, and we will be able to see some improvements compared to what we've seen in the last year. As far as the other question, I give it back to you, Niclas.
Yeah, thanks. In terms of the SAP kind of related impairments, essentially what we did was that we signed an agreement to move to S/4HANA, that made some of the old licenses redundant, therefore, we wrote down the old licenses. I don't think it's worth speculating on future write-downs or not. The whole point is that we are moving to a new platform.
Thank you.
Thank you.
The next question comes from the line of Klas Bergelind. Please ask your question.
Yes. Hi, Alrik and Niclas. It's Klas on Citi. Can I come back there, Alrik, to Asia and China? Could you talk a little bit on the industrial side, distribution versus heavy, and how we moved through the quarter? You talked about automotive. Would be interested to hear what happened through the quarter also on the industrial side. I will start there.
No. I can tell you what we see here in the quarter is what we've said. We see some of the segments for smaller drives and electrical, smaller electrical motors weakening, and that we saw through the quarter. Businesses like wind, we must understand right now there's a legislation that says that, if you get your wind mill ready by the end of next year, you will get a certain tariff, sort of, sorry, a feeding tariff, if you understand, a price for your electricity. Beyond that point, it's unknown. You can imagine now how everybody currently are pushing for getting their wind mills ready for that date, that year and a half as a timeframe. It may continue, or it may not. There you have sort of an induced improvement. Of course, that we see continuing, and that has been accelerating during the quarter.
The same as transport in rail and so forth is strong, as we see that continuing. Otherwise, we've been quite good at seeing one quarter ahead, and I think if you recall, if you look at how we've been sort of guiding, we've been quite successful so far. I hope that streak will continue. I cannot promise because, of course, we're always talking about the future, but this is how we see it, what we guide.
Understood.
This is the flavor I can give you, so to speak.
Yeah. No, I'm aware of wind. That was just the pure industrial bit, but it seems like smaller drives, et cetera, are weakening a bit. My second one is on price increases on spot. I think you were planning to push through there on distribution in Europe last quarter. I was wondering how effective these increases were, and if you're planning to increase yet again now in the second half. Obviously, very solid cost control yet again, but could mean that increasing prices is a bit more difficult. Price hikes often works better if there's a lot of cost inflation. Obviously, it's the other way around now. I was wondering how the distribution pricing happened.
Yeah. I think that as far as what we've done in distribution, it's been doing well and working well, and we're very disciplined in this, and we're pushing this through, and it's holding. As far as pricing in general, of course, we're always taking the opportunity. There's more always work to do, and I think there's a good initiative still on selective pricing going forward. You are right in the sense that it's easier when the demand is really hot, but it's still possible to work with pricing when you have a good product and a differentiated offering. On your last comment there that we now see the other way around. Well, I don't really see that yet, and I don't think our customers see that yet, so to speak.
That there is tendency, of course, that we will see that maybe steel prices, et cetera, will be different going forward. Right now, I think in many markets, what we've seen so far, there's quite a resilience in this. There's no increase. No, there's no increase, but we haven't really seen the inflection on this yet, and that is also true for us, and for our competitors, and for our customers. We're still not in that kind of territory, I would argue.
My final one is for you, Niclas, on the bridge. Just to confirm, you guided for SEK 225 million in cost inflation into the quarter, and this was, I think, a little bit more than SEK 70 million here in the second quarter, if that's correct. Reason for asking is that the last couple of quarters on SKF have been better on cost. It was more on IT, logistics, R&D, where cost came down. But the +SEK 200 million underlying cost inflation, I think we all thought was more difficult to cut back on. First, is the delta correct? I think it is SEK 74 versus SEK 225 guided, and now it seems like a guiding for SEK 100 million cost inflation of the savings into the third. Again, a low level. Just to understand how you can cut back here and what to expect ahead.
Patrik, not to make sure that I don't say anything stupid, which we have to regret and misguide you. On the exact details, Patrik, feel free to comment here.
Commenting on the performance in the current quarter, I would say we performed really strong on cost. As we discussed in the bridge, we were able to almost offset raw material cost inflation, which was about SEK 90 million negative in the quarter. The underlying cost inflation, which is about SEK 225 million per quarter by reducing our underlying cost. We've had very good cost flexibility in our manufacturing operations. We have also released quite a few people during this quarter compared to previously. I would say we've been successful in doing that.
Going forward, guidance for Q3, yes, underlying cost inflation still there, about SEK 225. Raw material cost inflation on a similar level, compared to what we saw now in Q2, about SEK 100 million in Q3. We expect to offset some of that with continuing cost reductions of about SEK 100 million in Q3.
That's on the pure cost side.
Yes.
Patrik, the SEK 225 million, you're talking about SEK 100 million savings, and typically you don't split out the SEK 100 million savings. If the SEK 225, less SEK 100, that is your cost inflation that should be compared with the SEK 74 you did this quarter?
Correct, yes.
Yeah. All right. Thank you.
Your next question comes from the line of Andrew Wilson. Please ask your question.
Hi. Good morning, everyone. I sort of had a broader question on the extension, I guess, of what was asked on Asia. Just in terms of Europe and North America, can you talk a little bit about how you saw the industrial markets develop kind of through the quarter? I think there's been some concerns that we saw a further down in June, but it sounds like it's been a pretty consistent message. Just, interested, I guess, on some color on that, please.
Well, I think, broadly you can say that when we started the turnaround, when it started to come in 2016, it was a broad-based, real strong geographically broad-based. It came in almost all segments going up. Now we're in this situation where we see some segments actually being positive and growing strongly, as we have commented on, and some segments weakening, as we have also commented on. That's where we are at. At the same time, when we look forward into our next quarter, we see that development continue. There are some strong segments also in industrial that is developing favorably, and there are some other segments that are a little bit weaker. That gives us this guidance that we have on this general industrial stability.
Yes, we are as aware of the reality of the automotive industry around the world as you are, and the only thing maybe where I feel that some people may think that are a little bit surprised when we say that we actually see this flattening out of demand in the automotive in China and where we actually can see maybe some light in the tunnel there. I would only say, if you look at China and you understand that the downturn has been going on for quite a while, well, maybe then it's not so strange, actually.
Thanks. If I can just ask a follow-up just on some of the cost savings, which you've mentioned, you kind of flagged in the Q3. Apologies if this was discussed before, but in terms of what actually these cost savings are, I mean, is this a sort of direct reflection of what you're seeing in auto markets, or is this just the more general, sort of structural improvement of the business?
I mean, it's definitely more the latter. It's a general initiatives across the whole business, rather than specific to automotive. It's also automotive, but it's across the business.
Can we expect to see sort of similar benefits in future quarters then? It sounds like there's still quite a lot that you guys are targeting in terms of opportunity.
Well, again, I mean, we don't want to speculate on kind of falling to the future. Exactly as you say, I mean, we've had initiatives ongoing. I mean, the footprint related to factories is only one area, but that's pretty clear, and we'll of course continue with these initiatives. There's no kind of end date to them.
I think that what pleases me is to see we've been preparing for this. You know that. We've been sort of saying that we have to prepare, and we've been doing that for a while, and we're ready with activities, and we're doing them.
That's perfect. Thank you.
Your next question comes from Andre Kukhnin. Please ask your question.
Good morning. Thanks so much for taking my questions. I'm sorry, I have to come back to the bridge. Can I just build on what was said before and run through what I see as the kind of cost development guidance for Q3? If we look at just that particular item, excluding the organic sales, and manufacturing volumes impact. I've got -SEK 100 f or raw materials. I've got -SEK 225 normal inflation, -SEK 70 for delta restructuring, -SEK 175 one-off reversal, and +SEK 100 cost improvement. Do I get these right? And am I missing anything in that line in terms of the guidance you've given?
Hi, Andre. It's Patrik.
Hi.
I think you misunderstood a little bit on the restructuring. There is no delta on that. We expect to be on a similar level in Q3 this year as we were last year. In the bridge, there is no restructuring delta.
Right. Zero on the bridge, it is a level 70 is the same. Okay. We sum up to -SEK 400. Great. Thank you very much for this. Can I just also ask on price mix? You clearly indicated that you have been successful in raising prices, and there was positive in Q2. The guidance for Q3 for that to be positive, can you calibrate it at all compared to Q2? Do you expect it to be as positive, more positive, less positive in Q3?
Yeah. As we have said, it has been mostly price and very little mix in this quarter. We see probably that is the way it is going to continue. Similar.
Thank you. Lastly, just much broader question on circular economy and selling bearings per rotation. Just wanted to come back to that. Could you give us more detail on where are we in terms of level of sales from this new business model? How significant is this for SKF now? How does that actually impact the economics for you? I mean, is this a higher margin business? What is it growing at?
There are two effects of this. One is, I can tell you right now, as we have said, apart from Latin America, actually, this is not yet a very big portion of our sales. What I mean by saying that, where we have fee-based arrangements, where everything is included, the bearings, the services, and everything, and we take a fee-based arrangement with our customers. That is still a relatively small part of our business today. It is going to grow. I mean, as I am completely convinced that this is going to be the general way we interact with our customers globally in a few years' time.
Just that it is a much larger portion, as you can understand, in Latin America, where we've been doing this for a while, it gives us a possibility to both increase market share and profitability, both for us and also for our customers. The key here is, of course, you understand, there's so much waste still to be eliminated, and when you have a fee-based contract, the interest of the supplier and the customers are completely aligned. There's no conflict of interest. This is why I'm so absolutely convinced that all of our customers, if there's any customer listening in, they would love to have a fee-based arrangement with us because it makes it possible for us to together eliminate all the waste.
The other thing that actually happens when we start approaching the customer with these fantastic value propositions that even if in the beginning, we don't actually manage to have a fee-based arrangement from day one, the customer sees us as a completely different kind of supplier. We become sort of straight into their strategic development, how they're going to run their factories in the future, how they're going to improve their efficiency, and how they're going to lower their environmental impact. I suggest there's a video on YouTube about Big River Steel and SKF. If you want to see sort of the perception of a customer that we've just signed up on this kind of agreement, it's not a bad thing to have a look on that YouTube, Big River Steel and SKF.
I'll definitely look it up. Thank you. Can I just follow up on this? In LATAM, can you give any idea on how big it is in LATAM? Is that a contributor to the faster growth that you've seen there?
Yeah. Well, the short-term growth that we see in Latin America is, of course, basically based on how we're working with our customers, where this is already sort of a main way of working our customer on the industrial side, also because we're coming in with a lot of new, interesting localizations of production for the automotive space. As you see, in Latin America, we're actually growing from an automotive perspective, there's a lot of really interesting initiatives that have enabled us to grow also our automotive business in Latin America.
Got it. Thank you very much for your time .
Your next question comes from the line of Alexander Virgo. Please ask your question.
Thanks very much. Morning, everyone. I just had a sort of a slight pedantic question, I suppose. If I compare the wording for the demand outlook for Q3 from the report to the presentation and what you said, Alrik. You described North America in the report, and then what you said is slightly lower, and in the presentation it says lower. I'm just wondering, A, can you just clarify which one it is? Whether that reflects a judgment call on exactly how weak the region is.
It should be slightly lower.
Slightly lower. Okay. It's not a reflection that we're kind of on the border, and it's a bit difficult to call and visibility is low.
I haven't seen this. I apologize for this if this is true. I didn't see this. You hear what we're saying. This is how we see it. I apologize for that.
Okay.
I apologize.
That's great. Thank you.
I know. I hope no harm done.
I just wanted to clarify that's all.
Yeah. Thank you for that. Thank you.
Just on, as a follow-up, I'm slightly surprised at how weak VSM is in auto. Are you not surprised to see a little bit more resilience in that part of the market, maybe? Can you talk a little bit about the regional development in terms of guidance as well? That would be helpful.
Yeah. I mean, there are two things that you have to see in this respect, one of the key areas where we're actually doing a good development is in China, for instance, where we see this developing better. If you look at the amount of cars that VSM really kicks in after about seven years. When you look at where you think the VSM is going to go as a market trend, you have to sort of extrapolate what were the cars that were sold into the market, let's say from 7- 15 years ago. That's how you're going to see the market develop. If you see all around, 7- 12 years ago, it was not a great sort of amount of cars entering the market. That's, of course, having a dampening effect.
On the other hand, I think we're doing a lot of good things to improve our channels to market and so forth, we have a lot of activities to mitigate this. My midterm prediction is that we will improve in VSM.
Got you. Okay. It's more of a phasing thing or a temporary thing. It's not something that we need to be.
Well, no. There's also dynamics in the marketplace. More OES channels. The car manufacturers taking over some spare part dealing. There's more e-channels coming up. There's a change in the VSM dynamics coming with new technologies as well, and new channels to market. I argue that we're going to be part of that as well. This is what I'm talking about.
Okay. Thank you. Then just a quick follow-up on industrial. We've heard a number of companies commenting about a sort of extension in terms of customer decision-making processes, customer behavior around conversion from inquiry to orders. I appreciate that's probably more of an industrial thing than an auto thing, maybe talk a little bit about what your customers are actually saying and how they're behaving, would be really helpful.
Well, from our point of view, if you're talking about OEM customers, we have an understanding and a business where we have very good service levels. It's more of actually seeing sales development. As we have guided you on both what happened during the quarter, and what we believe is going to happen in next quarter, that's actually how we see behavior as well.
Okay. That's helpful. Thanks, Alrik.
The next question comes from the line of Ben Uglow. Please ask your question.
Good morning, thank you for taking the question. I had a couple. First one, Alrik, you sounded cautiously optimistic about the China auto outlook, just from a kind of 10,000 foot view, don't some of the same rules apply in Europe and North America in the sense that you're going to begin to face easy comparables? Do you see any signs, or are you as optimistic about Europe and North America in auto as you are in China? That was my first question.
Well, the logic I'm trying to sort of portray on China is the fact that the downturn, if you recall, came much earlier in China. It's been going on for quite a while. When something has been going on for quite a while, and you understand that both governments and other forces are trying to mitigate these activities, and you see this confidence with the fact that everybody now knows what emission rules are going to prevail in the foreseeable future, there's a logic to actually believing that that could be actually truly a change.
I think that is more what I'm alluding to. In other markets, like in Europe, for instance, where the downturn has not been going on for as long, there's still not the same clarity in what's going to be the rules going forward. That's what you see in our guidance as well, the way we look at it.
Understood. Thank you. Second question, I hope I'm not reading too much into it, in the press release, in Asia Pacific, I think Klas tried to pull this point out earlier, you do seem to make a distinction between what's happening in China in electrical and industrial distribution and what's happening elsewhere. Do you see any signs, or do you believe that any of the trends you saw in the quarter in China is due to a pre-buy effect or an inventory effect in the distribution channel? Is that something that you've seen, or am I reading too much into it?
No. That's not what we see, no. There's no industrial dynamics in this thinking from our side. You have to understand, if you look at the markets as such, there are some South Asian markets that are very heavy into mining and heavy industry and these kind of segments, while the big electrical motor producers and small gearbox producers and compressor producers, et cetera, they are in China.
Mm-hmm. Understood. Thank you. Final question for Niclas is, we're now guiding to about SEK 2.8 billion of investment in CapEx, which is around 3% of sales. My question is this a one-off in 2019, or should we expect CapEx to continue to be at this type of level? Do we think that 2019 is an unusual year, or is this going to be the sort of cost of doing business going forward?
It's not an unusual year. Whether the exact amount is 2.8 or plus, minus something, it's just a different thing. We have a major initiative, modernizing, upgrading, we call it world-class manufacturing here, which is a multi-year kind of program. In that sense, do expect some of that to continue going forward.
I resent your comment of saying cost of doing business. I can tell you, all of these investments have high returns. As a shareholder, I would be happy to see SKF investing in the operations with high returns. It's not about cost of doing business. It's actually something that will improve our competitiveness over time.
Yeah. That's the whole point. It affects our cost competitiveness, it affects the kind of product competitiveness and so on.
Is it fair for me to say that the restructuring cost over 1% of sales as well, that is again, that's just a one-off, that's not, and I don't want anybody to resent anything, but that's not a cost of doing business?
Well, what happens is when you take individual action, so there are two kinds of investment, you understand? One is when you're taking existing factory and you're upgrading it, et cetera, then it is a straightforward investment. Then, like we are doing in the case of Bari, where we took part of the production that was entirely in Italy, and we upgrade the part that we keep for Europe, and we take out a part of it and restructure that part and moves it. Also with good returns, please understand, with very good returns, and put them in China. Well, when we do these kind of things, you will get a small or one-offs when those activities happen. They are also with a good return. They're also with a fantastic return.
Okay, that's really helpful. Thank you very much.
The last question comes from the line of Lars Brorson. Please ask your question.
This is the last question, Lars. Thank you.
Understood. I'll keep it short and sweet, Patrik. Thanks. Hi, Alrik, Niclas, Patrik.
Hi.
Hi.
Hey. A quick one on automotive in North America, Alrik. I'm struggling a little bit with the performance, particularly for the car and light vehicle segment, down significantly now for the second consecutive quarter. Call it down high single or low double in a market where car production levels are down, call it low single. Could you explain to me why that is?
Well, I think that if you look at the kind of models that are really holding up in the U.S., as I think I've been saying before, maybe those are not really the ones where SKF has been, in the past, homologated on. This is the kind of mix maybe that is little bit in our disfavor at this point.
Finally, sorry.
As I said before, we're working good. We have good business coming in. We have really good contracts coming in and really good developments coming in for the future. Just as you remember a few years ago where we had a situation where we had not been homologated on a few platforms. We were back on those platforms. We saw the good development. What we see a little bit now is maybe our strongest platforms are not where the American market is performing the best at this moment.
Clear. Can I clarify just the raw material guidance for Q3, the -SEK 100, is that net of the savings in the quarter? I'm struggling a little bit with the -SEK 100 million. We've seen obviously a rebound in scrap in July, but still down materially year-over-year. Could you help me understand what you're baking in from a raw material standpoint and what's being baked in from a tariff headwind standpoint to the extent there is any?
Hi, Lars. Patrik. On the negative guidance on raw materials, it's not primarily price. It's primarily driven by our consumption. We have some of the industries and some of the products that we expect to perform best, consume a relatively higher proportion of raw material than others. It's mainly a manufacturing mix issue than actual price.
Instead of upsetting-
Tariffs also, of course, to some extent, but yes.
Thanks.
With that, we are done with the Q&A session. We have overstayed our hour by a couple of minutes, and I leave the word back to Alrik.
Well, thank you very much for listening in. I hope to have you all back in one quarter. Again, thank you for your very enlightened questions on this, as I see it, yet another strong quarter from SKF. Thank you very much.
Thank you.
Thank you. That concludes the conference for today. Thank you for participating. You may all disconnect.